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EXHIBIT 13
1998 ANNUAL REPORT
CONTENTS
Corporate Description 3
1998 in Brief 3
Letter to Shareholders 4
Financial Highlights 9
Banking Center Locations 10
Financial Report 11
Officers and Directors 47
Shareholders' Information 48
1999 1st Source Corporation
All rights reserved
The body of this
annual report is
printed on
recycled paper.
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ERNESTINE M. RACLIN,
CHAIRMAN EMERITUS
1ST SOURCE CORPORATION
With 21 years of distinguished service, Ernestine Raclin retired as Chairman of
the Board of 1st Source Corporation and was elected Chairman Emeritus. Our
deepest thanks go to "Ernie" for her life's work. With her strength, she made a
commitment to the independence of 1st Source, building something of value and
meaning, while giving people an opportunity to grow. Her grace and style have
set a tone for us all; her caring attitude has become the beacon for our
decision making; and her pride in the bank and in the community has become our
badge of honor. May her sage advice and enduring memory still lead us to
success.
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THE ERNESTINE M. RACLIN
COMMUNITY LEADERSHIP AWARD
Exceptional leadership to the community through volunteer service. It is only
fitting that our tribute to Ernestine Raclin, Chairman Emeritus of 1st Source,
exemplifies her distinct and powerful accomplishments. The Ernestine M. Raclin
Community Leadership Award has been established by 1st Source Bank to honor and
encourage those who give of themselves to benefit others. The award will be
given annually to as many as five 1st Source employees and five employees of
locally owned companies in our regional communities. Inaugurated in the spring
of 1999, those honored will receive a Globe of Leadership, a monetary award, and
a donation to the charity of their choice.
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CORPORATE DESCRIPTION
1st Source Corporation is the largest locally-owned financial institution
headquartered in the Northern Indiana-Southwestern Michigan area. While
delivering a comprehensive range of consumer and commercial banking services,
1st Source has distinguished itself with innovative products and highly
personalized services. 1st Source also competes for business nationally by
offering specialized financing services for used private aircraft, automobiles
for leasing and rental agencies, heavy duty trucks, and construction equipment.
The corporation's principal subsidiary, 1st Source Bank, has 47 banking
centers in 12 counties in Indiana and Michigan and 14 locations nationwide
supporting its Specialty Finance Group. 1st Source's wholly-owned mortgage
banking subsidiary, Trustcorp Mortgage Company, has five offices in Indiana and
Ohio. With a history dating back to 1863, 1st Source is proud of its tradition
of providing superior service to customers while playing a leadership role in
the continued development of the communities in which it serves.
1998 IN BRIEF
1998 net income of $31.0 million was the highest in 1st Source history and
17.1% higher than the $26.5 million earned in 1997. Adjusting for a 10% stock
dividend declared January 14, 1999, diluted net income per common share for 1998
was $1.60, up 17.6% from the $1.36 for 1997.
Return on average total assets was 1.22% compared to 1.21% a year ago. Return
on average common equity was 15.12% for 1998 compared to 14.51% for 1997. The
average common equity-to-assets ratio for 1998 was 8.05% compared to 8.30% last
year.
At year-end 1998, total assets were $2.73 billion, up 13.0% from a year
earlier. Loans were up 4.7%, deposits were up 15.1% and shareholders' equity
increased from $195.0 million at the end of 1997 to $215.9 million at the end of
1998.
The reserve for loan losses at year-end 1998 was 2.18% of total loans, while
nonperforming assets amounted to 0.56% of total loans.
NET INCOME (In Millions)
[GRAPH]
94 95 96 97 98
(18.5) (21.0) (23.2) (26.5) (31.0)
DILUTED NET INCOME PER COMMON SHARE
[GRAPH]
94 95 96 97 98
(.96) (1.08) (1.20) (1.36) (1.60)
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RETURN ON AVERAGE COMMON EQUITY (As a Percent)
[GRAPH]
94 95 96 97 98
(14.49) (14.75) (14.38) (14.51) (15.12)
RETURN ON AVERAGE TOTAL ASSETS (As a Percent)
[GRAPH]
94 95 96 97 98
(1.19) (1.25) (1.22) (1.21) (1.22)
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TO OUR SHAREHOLDERS:
1998 was a year of both continued good performance and change. By pursuing
our original Vision 2000 goals defined in 1995, we realized growth and record
earnings. For the year, our net income was up 17.1 percent over last year to
$31,020,000, with diluted net income per common share up 17.6 percent to $1.60.
The banking centers opened over the last few years performed well, leading us to
expect the same from the two branches we established in new markets in 1998. New
investment products and services were introduced by our Personal Wealth
Management Division. We also reorganized our reporting structures to ensure
continued management development through more direct authority and
accountability. We experienced record-setting growth in mortgage production at
both 1st Source Bank and at our mortgage company subsidiary, Trustcorp Mortgage.
Growth of our specialty finance businesses continued with the addition of sales
representatives in new markets and an increase in securitized loans in the
aircraft and auto finance industries. Substantial progress too was made in
ensuring that all our mission-critical operating and business systems are Year
2000 compliant; we expect few, if any, problems at the turn of the century.
Before outlining in greater detail the results of the past year and the
issues to be addressed in the coming one, I want to recognize and thank an
extraordinary woman, Ernestine Raclin, who retired as Chairman of the Board at
our Annual Meeting in April. For the last 20 years we have been signing this
shareholders' letter together. As Chairman of 1st Source she set a standard and
an example that ennobles us and challenges all of us to do our very best for all
of the constituencies we serve. She committed us to independence when others
were selling out, and to high performance for the benefit of our shareholders
and the community. She has imbued 1st Source with positive values, a family
atmosphere, and a commitment to service. As a result, and in tribute, we have
dedicated this Annual Report to her and have recently established the Ernestine
M. Raclin Community Leadership Awards to continue her legacy of a working
commitment to the communities we serve. Her unshakable values, distinctive
personality, incredible energy, and nonstop leadership have set an example for
all of us.
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GROWTH
1998 was again a year of growth. In 1995, we committed the company to a plan
to realize such growth. The prior five years had been spent trying to bring our
costs more into line. This was successful, yet it was apparent we had to find
ways to increase the number of customers we served and to increase the size of
our relationship with each customer. Since we had (and are) committed to staying
an independent company, we had to have profitable growth to meet the long term
needs of our shareholders; we naturally focused on ways to do just that. We had
a belief that there was more value in serving present customers well and in
attracting new customers on a one on one basis than in trying to grow by
acquisition.
During the late 1980's and the early 1990's, we had made a number of bids to
purchase other banks, savings and loans, or bank branch offices. In nearly every
case, we came in second place and sometimes by a large financial amount. Perhaps
the people we were bidding against were smarter or simply better managers. In
any event, we could never figure out how to make the purchase target profitable
enough at the levels being paid. There was an internal rate of return we were
determined to achieve; we couldn't justify the prices many buyers were willing
to pay. If we couldn't see a way to return 15 percent based on our investment,
we refused to bid up. The result of this sound fiscal discipline was that we
acquired very little. We resolved instead to "grow the old-fashioned way: one
customer at a time."
By opening 15 new banking centers from the end of 1995 through 1998, we
entered new markets and developed new customers. We also opened two new offices
at Trustcorp Mortgage and added four sales officers and markets in our specialty
finance businesses. As a result, our assets have grown from $1.80 billion at the
beginning of the period to over $2.73 billion today. This has been fueled by
annual loan growth averaging 18.7% over these three years. In 1998, our total
loans (including those securitized) grew 15.5 percent and ended the year at
$1.88 billion on the balance sheet and $321 million off the balance sheet. Our
annual mortgage production both in the bank and at Trustcorp Mortgage was $1.42
billion, an 87.9 percent increase
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over the prior year and up a full 362 percent over the $306 million dollars
produced in 1995. Today, Trustcorp services a portfolio of some $1.87 billion of
conventional, FHA and VA mortgages. This is up 57.2 percent from the $1.19
billion dollars serviced at the close of 1995. Our business loans also grew
substantially during this period, benefiting from expansion into new markets in
the Michiana area, the purchase of the last of our local business lending
competitors by out of town banks, and the continued growth of our specialty
finance lending. This growth since the end of 1995 was 71.5 percent from $805
million to $1.38 billion. Our consumer loans and leases excluding first
mortgages grew 87.0 percent over the same period and now total $119.3 million.
Deposit growth has followed the same pattern. After a slow start with some of
our new branches, many began to grow nicely this year. It takes time to enter a
market and develop the trust necessary for people to switch their "business." By
the close of the year our Quantum Leap branches, those we've added as part of
our Vision 2000 growth strategy, accounted for $129.7 million of our deposits.
At year's end, our total deposits stood at $2.18 billion, up 15.1 percent from
the prior year end and up 51 percent since the end of 1995.
We continue to be focused on expanding our physical presence with new banking
centers offering service and convenience to our customers. As I write this
letter, we are preparing to open a new full service
[PHOTO]
Al Qualey, Chris Murphy and Duke Jones
discuss opportunities
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branch in Warsaw, Indiana and will open at least one more before the end of
1999. We hope to open one Trustcorp Mortgage office in the Midwest region and
plan to add one or two more sales officers in our specialty lending businesses.
If the economy remains solid and we can continue to find good people, we will
pursue a similar set of objectives in 2000.
YEAR 2000 COMPUTER COMPLIANCE
A topic receiving enormous attention in the press these days is the Year 2000
computer glitch and its predicted impact on banking and other critical
industries. At 1st Source, we have been working diligently to identify, test,
and install date-correcting software to ensure that all our systems are
compliant. We have made significant progress and should have all our mission
critical systems compliant by the end of the second quarter of 1999. We are
confident that we will be ready for the change of the calendar with minimal
disruptions. We have also been developing contingency plans should systems on
which we rely outside of 1st Source become a problem. We know that the end of
the year will present some challenges, but it always does. Computer calculation
problems have occurred before, and we and the industry have been able to handle
them. I am more worried about the expectations and concerns of people leading to
irrational actions in anticipation of problems than I am of the problems
themselves. Unfortunately, there is a whole industry of people who have sprung
up to take advantage of the concerns surrounding Year 2000. Profiteers are
calling for everything from a computer meltdown to the end of the world. . . and
selling their wares to the unprepared. If nothing is going to work next year,
how are all these people expecting to get paid or enjoy their newfound wealth,
generated by preying on the fear of others? I suspect most of them know that
things will be okay and are planning to enjoy their riches! Clearly, there is no
need to panic. We are not talking about insoluble problems. Again, while there
may indeed be concerns with the "millennium" date change, they will most likely
be manageable.
ORGANIZATION
With Ernie's retirement and my taking on the title of Chairman of the holding
company, it seems only appropriate to recognize two of the people who drive our
businesses. "Duke" Jones (officially Wellington D. Jones III) and Allen Qualey
were promoted to President of their respective businesses, and they will
continue to report to me. Duke is President of 1st Source Bank and is
responsible for the deposit and lending business carried on in our regional
market. The branches, marketing, mortgage, consumer lending, commercial banking,
insurance, wealth management, trust and human resources report to him. He is
responsible for the "sales and service" side of the traditional bank. Duke began
his business career with IBM, joining 1st Source as head of our systems area in
1975. He took over the consumer banking business in 1979 and became Executive
Vice President of both the bank and the holding company in 1989. He and I have
worked in close cooperation for the last 20 years and he is well prepared for
his new duties and has certainly earned his new title. He has an excellent team
of executive managers and senior officers working with him throughout the bank.
Allen Qualey is responsible for our specialty finance businesses which
include auto and truck financing, turbine and piston aircraft financing and
construction machinery financing. Allen came to 1st Source in 1985 and started
our aircraft finance business. In 1993, he took over the Specialty Finance Group
and has done an excellent job integrating it into the bank. He has added product
lines, new markets and people and has built an efficient and effective
infrastructure to support our national businesses. This title change recognizes
the role he already plays. For the last seven years we have worked closely in
building our customer base and this Group's support operations. Allen will do an
excellent job leading these businesses into the next century.
Larry Lentych, our Chief Financial Officer, continues to report to me and has
taken on new responsibilities. Administrative Services including buildings and
grounds management, purchasing, communications, and security have joined
finance, accounting and audit as his area of responsibility. This has allowed
Larry Gardner, Senior Vice President and head of Operations and Information
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Services, to focus on the Year 2000 issue and the continued upgrade of our
mainframe and PC systems. These are such strategically important areas to our
continued success that it is appropriate that a tighter focus be developed.
Strong management from elsewhere in the bank and some from outside have been
added to ensure the talent necessary to keep 1st Source technologically and
operationally competitive. Jim Kunzler, President of Trustcorp Mortgage, Jim
Jackson, Senior Vice President of our Funds Management Division and Vince
Tamburo, General
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[PHOTO]
Christopher J. Murphy III
Chairman, President and Chief Executive Officer
Counsel, continue with their previous responsibilities and complete the officer
group reporting directly to me.
Inherent in the structure outlined above is a belief in a decentralized
operating environment with strong senior managers running their businesses.
Having said that, none of us is so good that we don't need our colleagues. One
of the strengths of 1st Source is the collegial nature of its management team.
We have all made mistakes and we all know we are fallible. We seek each others'
advice and we use it. We have a respect for the people here, throughout the
organization. We try to move decision making as close to the customer as
possible. This allows us to grow by developing people so they can manage more
diverse businesses and markets.
PEOPLE
Our future success depends on the ability to attract, train, motivate, and
retain good people. That is getting more difficult. We have always been blessed
with a great group of colleagues who truly like being in service to others. This
is what we do: serve others. We have been blessed, as well, with people who have
a strong set of values. They are attracted to a company that commits itself to
being in the leadership of the communities it serves by using both its financial
and human resources to improve them. Traditionally, our products have been
rather simple and our competition benign. Those days are gone for good.
Competition is rigorous and it comes from a number of areas: at the consumer
level, it is primarily the credit unions who have the advantage of no federal
income tax cost. It is also now the stock brokerages, mutual funds, insurance
companies, credit card companies and a variety of other consumer financial
service providers. For the commercial business it is banks all over the country,
insurance companies, investment banking firms and commercial finance companies.
They have all upgraded their product offerings and sales processes. To compete,
we must as well.
Our focus has to be on fully developing relationship management with our
customers and doing so with people who are intelligent enough to represent and
discuss a broad array of products and services. We must deliver on our
commitment to keep our customers' best
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interest in mind; therefore, we need people who are not driven to make every
sale because it results in more income to the individual or the company or both!
Rather, we have to have people who work with their clients on a day to day basis
making sure they are using the right array of products and services to properly
meet their clients' needs. Our colleague's interest must be in building a
relationship of trust where we are proactively working for the client. Our
colleagues need to be much more sales oriented than in the past, they must be
proactive for the benefit of the client! We can no
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longer wait until the client hears about a product or service elsewhere and then
asks if we have it, we need to understand needs and fill them. On the other
hand, we must be very careful of not falling into the trap of trying to have
every bell and whistle out there. Often a need is perceived by the client which
is not real and in these cases it is our responsibility to educate the client as
to the value proposition and then fill their real need.
Over the next year, we will continue to refine our training programs so we
are better able to prepare our colleagues for the competitive markets of the
next century. We must instill the basics and then upgrade our follow-up systems.
We will also have to look for more highly qualified students to fill our entry
level positions. Raw intelligence is important in a knowledge business. However,
it is worthless without the right value system. Our ethical culture at 1st
Source is very strong and we will work hard to see that it is maintained and
enhanced by the next generation of customer service people and sales officers
entering the business.
COMMUNITY INVOLVEMENT
We can't end this letter without talking about community involvement. It has
always been a core value at 1st Source. As a business we believe we have a
responsibility to make our communities better places to live. We do it by
encouraging our colleagues to become involved in a leadership way. We do it by
continuing a tradition of United Way leadership. We do it by direct financial
support to programs and projects throughout our region that make this a better
place to live. Two examples of this in the past year were the Indiana
University-South Bend Piano Festival which brought international masters and
young talent from all over the country here to collaborate as they prepare
themselves to move to the highest levels of international performance. A week of
incredible study and performance was concluded with a stirring performance by
the Kirov Orchestra from St. Petersburg, Russia. Their tour of the U.S. included
Boston, New York, South Bend, Chicago and San Francisco. 1st Source's leadership
support in money and administration put us among a select few. 1st Source Bank
has also offered long term support to Urban Youth Services. For almost twenty
years, we have provided board member involvement and underwriting of the 1st
Source Bank Academic Awards honoring African-American and Hispanic high-school
students in the program.
To recognize our own colleagues who give their time in leadership in the
communities we serve and to encourage other businesses to do the same, we have
established the Ernestine M. Raclin Community Leadership Awards which will be
presented for the first time in 1999. Up to five 1st Source employees and five
employees of 1st Source business customers will be recognized. In each case they
will receive the leadership award itself, a $1000 award, and a $1000
contribution to the charity of their choice. A panel of recognized regional
community leaders will make the first selections in February with the awards
presented at a luncheon at the end of March. We believe this is an excellent way
to recognize people's efforts; to bring attention to the importance of
businesses encouraging volunteer commitment; and to honor a woman who taught us
all how to serve.
Thank you for your commitment and support this past year.
/s/ Christopher J. Murphy
Chairman, President and Chief Executive Officer
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FINANCIAL HIGHLIGHTS
EARNINGS AND DIVIDENDS
(Dollars in thousands, except per share amounts)
1998 1997 1996 1995 1994
Operating income$ 247,669 $208,972 $174,299 $154,607 $127,816
Operating expense 196,883 166,353 138,700 122,564 101,483
Net income 31,020 26,489 23,203 21,042 18,465
Cash dividends 5,296 4,723 4,123 3,594 3,204
Per Common Share (1):
Diluted net income $1.60 $1.36 $1.20 $1.08 $0.96
Cash dividends .278 .250 .218 .189 .168
Book value 11.43 10.24 9.11 8.10 6.80
Return on average common equity 15.12% 14.51% 14.38% 14.75% 14.49%
Return on average total assets 1.22% 1.21% 1.22% 1.25% 1.19%
STATEMENT OF CONDITION
Average Balances:
Assets $2,550,218 $2,198,300 $1,895,214 $1,686,560 $1,546,965
Earning assets 2,344,555 2,046,637 1,767,055 1,569,703 1,435,892
Loans 1,853,537 1,610,889 1,348,089 1,172,438 1,066,752
Reserve for loan losses 38,861 31,966 28,482 26,081 23,685
Investment securities 445,310 424,086 400,209 373,976 360,276
Deposits 1,999,514 1,698,973 1,524,149 1,354,453 1,256,430
Shareholders' equity 205,180 182,543 161,324 142,667 127,451
(1) The computation of per common share data gives retroactive recognition to a
10% stock dividend declared January 14, 1999; a 10% stock dividend declared
January 20, 1998; a five-for-four stock split declared January 21, 1997; a 5%
stock dividend declared January 22, 1996; a three-for-two stock split declared
July 18, 1995; and a 5% stock dividend declared January 23, 1995.
[1ST SOURCE CORPORATION LOGO]
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BANKING CENTER LOCATIONS
[1ST SOURCE BANK LOGO]
[MAP OF BANKING CENTER LOCATIONS]
1st Source Bank is also located online at www.1stsource.com
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Management's Discussion and Analysis of
Financial Condition and Results of Operations
ABOUT OUR BUSINESS
1st Source Corporation (1st Source) is an Indiana-based, bank holding company
with $2.73 billion in total assets, $2.18 billion in total deposits, $1.88
billion in total loans, and $215.9 million in total shareholders' equity. 1st
Source's principal subsidiary is 1st Source Bank with its main office in South
Bend, Indiana. The assets of the bank account for 96% of the total consolidated
assets of 1st Source.
The bank offers a broad range of commercial banking, personal banking and
trust services. As part of its commercial banking services, 1st Source also
provides highly specialized financing services for automobile fleets in the
rental and leasing industries; privately owned aircraft used by businesses and
individuals; and heavy duty trucks and construction equipment.
This section of the Annual Report provides a narrative discussion and
analysis of 1st Source's financial condition and results of operations for the
last three years. All tables, graphs, financial statements and notes to the
consolidated financial statements should be considered an integral part of this
analysis.
Except for historical information contained herein, the matters discussed in
this document, and other information contained in 1st Source's SEC filings, may
express "forward-looking statements." Those statements may involve risk and
uncertainties, including statements concerning future events, performance and
assumptions and other statements that are other than statements of historical
facts. 1st Source cautions 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; 1st Source's
competitive position within its markets served; increasing consolidation within
the banking industry; customers and vendors of critical systems or services
failing to comply with Year 2000 programming issues; unforeseen changes in
interest rates; unforeseen downturns in the local, regional or national
economies - could cause 1st Source's actual results or circumstances for future
periods to differ materially from those anticipated or projected.
AVERAGE ASSETS (In Millions)
[GRAPH]
94 95 96 97 98
(1,547) (1,687) (1,895) (2,198) (2,550)
AVERAGE LOANS (In Millions)
[GRAPH]
94 95 96 97 98
(1,067) (1,172) (1,348) (1,611) (1,854)
AVERAGE DEPOSITS (In Millions)
[GRAPH]
94 95 96 97 98
(1,256) (1,354) (1,524) (1,699) (2,000)
10
AVERAGE SHAREHOLDERS' EQUITY (In Millions)
[GRAPH]
94 95 96 97 98
(127) (143) (161) (183) (205)
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Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Continued
SELECTED CONSOLIDATED FINANCIAL DATA
(Dollars in thousands, except per share amounts)
1998 1997 1996 1995 1994
Interest income $196,148 $173,316 $148,820 $135,115 $112,942
Interest expense 102,227 87,324 73,429 64,946 47,709
Net interest income 93,921 85,992 75,391 70,169 65,233
Provision for loan losses 9,156 6,052 4,649 2,757 4,197
Net interest income after
provision for loan losses 84,765 79,940 70,742 67,412 61,036
Noninterest income 51,521 35,656 25,479 19,492 14,874
Noninterest expense 85,500 72,977 60,622 54,861 49,577
Income before income taxes 50,786 42,619 35,599 32,043 26,333
Income taxes 17,545 14,392 12,396 11,001 7,868
Distribution on preferred
securities of subsidiary trusts,
net of income tax benefit 2,221 1,738 -- -- --
NET INCOME $31,020 $26,489 $23,203 $21,042 $18,465
Assets $2,732,021 $2,418,154 $2,079,767 $1,799,257 $1,583,027
Long-term debt 13,189 16,656 18,596 21,819 28,084
Shareholders' equity 215,859 194,953 171,833 152,601 129,082
Basic net income per
common share (1) 1.63 1.40 1.23 1.11 0.97
Diluted net income
per common share (1) 1.60 1.36 1.20 1.08 0.96
Cash dividends per
common share (1) .278 .250 .218 .189 .168
Return on average common
equity 15.12% 14.51% 14.38% 14.75% 14.49%
Return on average
total assets 1.22% 1.21% 1.22% 1.25% 1.19%
(1) The computation of per share data gives retroactive recognition to a 10%
stock dividend declared January 14, 1999; a 10% stock dividend declared January
20, 1998; a five-for-four stock split declared January 21, 1997; a 5% stock
dividend declared January 22, 1996; a three-for-two stock split declared July
18, 1995; and a 5% stock dividend declared January 23, 1995.
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1st Source Corporation and Subsidiaries
RESULTS OF OPERATIONS
Net income in 1998 was $31.0 million, up from $26.5 million in 1997 and $23.2
million in 1996. Diluted net income per common share was $1.60 in 1998, $1.36 in
1997 and $1.20 in 1996 after giving retroactive recognition to stock splits and
stock dividends.
Return on average total assets was 1.22% in 1998, compared to 1.21% in 1997
and 1.22% in 1996. Return on average common equity was 15.12% in 1998 versus
14.51% in 1997 and 14.38% in 1996.
Net income in 1998 was favorably affected by strong noninterest income
growth. By leveraging internal resources, 1st Source has been successful in
generating additional noninterest income as a way to mitigate the competitive
pressures on the interest margin. Offsetting the increase in noninterest income
were expense increases in salaries, leased equipment depreciation and other
expense.
Dividends declared on common stock in 1998 amounted to $.278 per share,
compared to $.250 in 1997 and $.218 in 1996. The level of earnings reinvested
and dividend payouts are based on management's assessment of future growth
opportunities and the level of capital necessary to support them.
The quarterly results of operations for the years ended December 31, 1998 and
1997 are summarized below.
QUARTERLY RESULTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
Three Months Ended
March 31 June 30 Sept. 30 Dec. 31
1998
Interest income $47,892 $49,318 $ 49,355 $49,583
Net interest income 23,244 23,611 23,512 23,554
Provision for loan losses 2,401 2,689 2,042 2,024
Investment securities and other
investment gains (losses) (122) (584) -- 94
Income before income taxes and
subsidiary trust distributions 11,651 12,211 13,133 13,791
Net incom 7,160 7,342 7,861 8,657
Diluted net income per common share (1) .36 .38 .41 .45
1997
Interest income $39,146 $42,758 $44,842 $46,570
Net interest income 19,671 21,675 22,092 22,554
Provision for loan losses 1,229 479 2,130 2,214
Investment securities and other
investment gains (losses) 181 (484) 24 (183)
Income before income taxes and
subsidiary trust distributions 9,360 10,224 11,033 12,002
Net income 6,066 6,441 6,638 7,344
Diluted net income per common share (1) .31 .33 .34 .38
(1) The computation of per share data gives retroactive recognition to a 10%
stock dividend declared January 14, 1999.
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BALANCE SHEET COMPOSITION AND MANAGEMENT
Changes in interest income and interest expense are affected by the
allocation of funds throughout the Statement of Financial Condition. The
following sections discuss the sources from which 1st Source obtains funds and
the manner in which management has chosen to invest these funds.
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SOURCE OF FUNDS
CORE DEPOSITS -- 1st Source's major source of investable funds is provided by
stable core deposits consisting of all interest bearing and non-interest bearing
deposits, excluding brokered certificates of deposit and certain certificates of
deposit of $100,000 and over. In 1998, average core deposits equaled 62.51% of
average total assets, compared to 63.36% in 1997 and 68.32% in 1996. The
effective cost rate of core deposits in 1998 was 3.94%, compared to 3.97% in
1997 and 3.98% in 1996.
Average demand deposits (non-interest bearing core deposits) increased 19.02%
in 1998, compared to an increase of 12.78% in 1997. They represented 15.73% of
total core deposits in 1998 compared to 15.13% in 1997 and 14.43% in 1996.
PURCHASED FUNDS -- 1st Source's purchased funds are used to supplement core
deposits and include certain certificates of deposit of $100,000 and over,
brokered certificates of deposit, federal funds, securities sold under
agreements to repurchase, commercial paper and other short-term borrowings.
Purchased funds are raised from customers seeking short-term investments and are
used to balance the bank's interest rate sensitivity. During 1998, 1st Source's
reliance on purchased funds increased to 25.44% of average total assets from
24.29% in 1997.
LOAN SECURITIZATIONS -- 1st Source sells many of the aircraft and auto loans
it originates through the issuance of securities backed by those loans in
securitization transactions. In a securitization, 1st Source sells and transfers
pools of loans to a wholly-owned, special purpose subsidiary of 1st Source Bank.
The special purpose subsidiary simultaneously sells and transfers its total
interest in the loans to a trust, which issues beneficial interests in the loans
in the form of securities which are sold through private placement transactions.
The special purpose subsidiary generally retains the right to receive any excess
cash flows of the trust. 1st Source sold $346 million of loans in 1998 and $63
million of loans in 1997 in conjunction with aircraft and auto loan
securitization transactions, and revolving agreements related to all current and
previous years' securitizations.
SHAREHOLDERS' EQUITY -- Management continues to emphasize profitable asset
growth and retention of equity in the business. Average shareholders' equity
equated to 8.05% of average total assets in 1998 compared to 8.30% in 1997.
Shareholders' equity was 7.90% of total assets at year-end 1998, compared to
8.06% at year-end 1997.
INVESTMENT OF FUNDS
INVESTMENT SECURITIES -- Investment securities at year-end 1998 increased
30.08% from 1997, following a 1.94% decrease from year-end 1996 to year-end
1997. The increase in 1998 is attributed to deposit growth. The decrease in 1997
was attributed to the sale of various securities used to fund a $20 million
bank-owned life insurance program.
LOANS -- Average loans, net of unearned discount, increased 15.06% in 1998,
following a 19.49% increase in 1997. Loans, net of unearned discount, at
December 31, 1998, were $1.88 billion and were 68.88% of total assets, compared
to $1.80 billion or 74.30% of total assets at December 31, 1997.
Commercial and agricultural lending outstandings, excluding those secured by
real estate, increased 9.50% during 1998. 1st Source has experienced success in
its market as customers seek professional personal service with local
decision-making authority.
Commercial loans secured by transportation and construction equipment at
year-end 1998 decreased 2.68% from year-end 1997. The decrease is reflective of
the $346 million of aircraft and auto loans sold through securitizations in
1998. Despite this, there were strong originations in construction equipment,
auto rental franchises, aircraft and truck, and automobile leasing company
financings.
Real estate loans recorded growth of 11.05% during 1998. This increase was
led by residential mortgage loans held for sale with an increase of 44.83%,
- --Page 15--
MATURITIES OF INVESTMENT SECURITIES AT DECEMBER 31, 1998
(Dollars in thousands)
U.S. Treasury States and Political Other
and Agencies Subdivisions Securities Total
13
Amount Yield Amount Yield Amount Yield Amount Yield
0 - 1 Year $ 99,487 5.68% $ 16,628 6.43% $ 31,464 5.58% $ 147,579 5.74%
1 - 5 Years 145,608 5.40 84,249 6.87 22,538 5.77 252,395 5.92
5 - 10 Years 3,582 5.95 44,411 8.13 254 7.01 48,247 7.96
Over 10 Years 35,650 6.01 9,185 6.58 46,643 6.32 91,478 6.23
Total $284,327 5.58% $154,473 7.17% $100,899 5.96% $ 539,699 6.11%
Weighted average yields on tax-exempt obligations have been computed by
adjusting tax-exempt income to a fully taxable equivalent basis, excluding the
effect of the tax preference interest expense adjustment.
followed by an increase of 9.89% in commercial real estate lending. Portfolio
residential mortgage loans decreased 13.34% from 1997.
Consumer loans grew a modest 6.90% in 1998.
LIQUIDITY RISK MANAGEMENT -- The Asset/Liability management process
incorporates overall bank liquidity and interest rate sensitivity. The purpose
of liquidity management is to match the sources and use of funds to anticipated
customer deposits, withdrawals and borrowing requirements, as well as to provide
for the cash flow needs of 1st Source. The primary source of liquidity is the
investment portfolio. At December 31, 1998, securities maturing in one year
amounted to $147.6 million which represented 27.34% of the investment portfolio
as compared to 23.59% at year-end 1997. Other alternative sources of funds are
loan repayments and loan securitizations. The liquidity of 1st Source is further
enhanced by a significant concentration of core deposits and $100,000-and-over
certificates of deposit. Both provide a relatively stable funding base.
INTEREST RATE RISK MANAGEMENT -- The Asset/Liability Management Committee of
1st Source monitors and manages the relationship of earning assets to interest
bearing liabilities and the responsiveness of asset yields, interest expense and
interest margins to changes in market interest rates. In the normal course of
business, 1st Source faces ongoing interest rate risks and uncertainties. 1st
Source occasionally utilizes interest rate swaps to partially manage the primary
market exposures associated with the interest rate risk related to underlying
assets, liabilities, and anticipated transactions. Under the current interest
rate swaps, 1st Source entered into agreements with another party to exchange,
at specific intervals, the difference between fixed-rate and floating-rate
interest amounts as calculated by reference to a notional amount as a means to
convert floating rate loans to a fixed rate. The notional amounts total $26.9
million at December 31, 1998. The current positions are not leveraged and are
not held for trading.
A hypothetical change in earnings was modeled by calculating an immediate 100
basis point (1.00%) change in interest rates across all maturities. This
analysis presents the hypothetical change in earnings of those rate sensitive
financial instruments and interest rate swaps held by 1st Source (excluding
Trustcorp Mortgage) at December 31, 1998. The aggregate hypothetical loss in
pre-tax earnings is estimated to be $2,440,690 on an annualized basis on all
rate sensitive financial instruments and the interest rate swaps based on a
hypothetical increase of a 100 basis point change in interest rates. The
aggregate hypothetical increase in pre-tax earnings is estimated to be
$2,386,140 on an annualized basis on all rate sensitive financial instruments
and the interest rate swaps based on a hypothetical decrease of a 100 basis
point change in interest rates. Actual results may differ materially from those
projected. The use of this methodology to quantify the market risk of the
balance sheet should not be construed as an endorsement of its accuracy or the
accuracy of the related assumptions.
- --Page 16--
INVESTMENT OF FUNDS -- CONCLUDED
Due to the nature of the mortgage banking business, 1st Source manages the
earning assets and interest-bearing liabilities of Trustcorp Mortgage Company on
a separate basis. The predominant assets on Trustcorp's balance sheet are
mortgage loans held for sale, which are funded by short-term borrowings
(normally less than 30 days) from non-affiliated banks. These borrowings are
managed on a daily basis. Trustcorp's other borrowings for working capital and
purchases of servicing assets are funded by 1st Source Corporation and
non-affiliated
14
banks.
Trustcorp manages the interest rate risk related to loan commitments by entering
into contracts for future delivery of loans. (See Note M of Notes to
Consolidated Financial Statements.)
COMPOSITION OF AVERAGE ASSETS (In millions)
[GRAPH]
94 95 96 97 98
Loans (net of unearned
discount and loss reserve) 1,043.1 1,146.3 1,323.6 1,578.9 1,814.7
Investments 368.2 396.2 411.9 434.1 489.3
Other earning assets 1.0 1.4 12.3 25.0 47.4
Other assets 134.7 142.7 147.4 160.3 198.8
Total 1,547.0 1,686.6 1,895.2 2,198.3 2,550.2
COMPOSITION OF AVERAGE LIABILITIES
AND SHAREHOLDERS' EQUITY (In millions)
[GRAPH]
94 95 96 97 98
Noninterest bearing deposits 162.2 173.2 186.8 210.7 250.8
Interest bearing core deposits 967.1 1,034.3 1,108.0 1,182.2 1,343.3
Purchased funds & long-term debt 264.2 305.7 405.2 585.3 706.6
Other liabilities 26.0 30.7 33.9 37.6 44.3
Shareholders' equity 127.5 142.7 161.3 182.5 205.2
Total 1,547.0 1,686.6 1,895.2 2,198.3 2,550.2
EARNING RESULTS
Net interest income, the difference between income from earning assets and
the interest cost of funding those assets, is 1st Source's primary source of
earnings. Net interest income, on a fully taxable equivalent basis, increased
8.74% in 1998, following a 13.31% increase in 1997.
Net interest margin, the ratio of net interest income to average earning
assets, is affected by movements in interest rates and changes in the mix of
earning assets and the liabilities that fund those assets. Net interest margin
on a fully taxable equivalent basis was 4.16% in 1998 compared to 4.38% in 1997
and 4.48% in 1996. The interest margin has decreased the last two years due to
competitive pricing pressures. In addition, 1st Source has relied more on
purchased funds to meet loan demand.
The yield on earning assets in 1998 was 8.52%, compared to 8.65% in 1997 and
8.64% in 1996. Average earning assets in 1998 increased 14.56%, following a
15.82% increase in 1997. The effective rate on interest bearing liabilities was
5.10% in 1998, compared to 5.04% for 1997 and 4.85% for 1996.
NONINTEREST INCOME -- Supplementing the growth in net interest income was an
increase in noninterest income of 44.49% over 1997. The factors influencing the
growth were increased aircraft
- --Page 17--
and auto loan securitization and servicing income, revenues generated from
operating leases, and the origination and sale of mortgage loans and servicing.
Noninterest income in 1997 increased 39.94% over 1996
15
primarily for the same reasons as in the current year.
Trust fees in 1998 were $8.26 million, compared to $7.31 million in 1997 and
$6.73 million in 1996. Trust fees increased 12.92% in 1998, following an 8.62%
increase in 1997.
Service charges on deposit accounts increased by 8.64% resulting in $5.84
million of income for 1998. The $5.38 million recorded in 1997 was an increase
of 11.41% from the $4.83 million of service charges on deposit accounts
generated in 1996.
Loan servicing and sale income generated from 1st Source's aircraft and auto
loan securitization and mortgage banking activities increased 56.88% to $15.12
million in 1998. The $9.64 million recorded in 1997 represented a 78.28%
increase over 1996.
1st Source recognized loan securitization gains of $1.95 million during 1998,
compared to $800,000 during 1997. Aircraft and auto loan servicing income in
1998 was $6.62 million, compared to $3.76 million in 1997. Servicing income has
increased as the result of additional loan sales. The outstanding servicing
portfolio grew to $321 million at year-end 1998, compared to $111 million at the
end of 1997.
Gains of $4.86 million were recognized on the origination and sale of
mortgage loans and servicing in 1998, compared to gains of $3.38 million in
1997. In addition, net servicing fees on mortgages remained steady at $1.69
million for both 1998 and 1997. As of year-end 1998, Trustcorp Mortgage
Company's mortgage servicing portfolio aggregates $1.87 billion, as compared to
$1.30 billion one year ago.
Equipment rental income generated from operating leases increased to $12.56
million in 1998, nearly an 81% increase over 1997. The $6.95 million recorded in
1997 was nearly a 154% increase over 1996. Revenues from operating leases for
construction equipment, automobiles and other equipment, and the related
depreciation on the equipment, have increased significantly in the past three
years as 1st Source has focused on increasing this line of business.
Other income increased 51.42% during 1998, following an increase of 23.44% in
1997. This growth in 1998 was generated primarily by an increase in mortgage
loan fees as homeowners took advantage of lower interest rates to refinance
their mortgages. In addition, increases were realized in insurance commissions,
standby letter of credit fees and appreciation in cash surrender value of
bank-owned life insurance (BOLI). The growth in 1997 was fueled by increases in
cash surrender value of BOLI, mortgage underwriting fees and standby letter of
credit fees.
The 1998 and 1997 net losses recorded for investment securities and other
represent, primarily, the write-offs of venture capital investments.
NONINTEREST EXPENSE -- During 1998, 1st Source experienced an increase in
noninterest expense of 17.16% primarily attributed to costs to attract and
retain quality people. In addition, the depreciation on our growing operating
lease portfolio and professional consulting expenses contributed to the overall
increase in operating expenses. Cost control across all business units and
better utilization of resources continues to be a major focus at 1st Source. The
increase in noninterest expense during 1997 of 20.38% was primarily due to the
branch expansion, salaries, operating lease depreciation and additional
provisions needed for our stock incentive reserves.
Salaries and employee benefits comprised approximately 55% of total
noninterest expense in 1998 compared to 57% in 1997. Salaries and employee
benefits increased 13.20% in 1998, following a 15.80% increase in 1997. Salaries
and wages increased 15.61% in 1998 and 12.73% in 1997. The number of full-time
equivalent employees stood at 1,036 at the end of 1998, compared to 966 and 895
at the end of 1997 and 1996, respectively. Employee benefits increased 5.34% in
1998, following a 27.07% increase in 1997. The smaller increase in employee
benefits was primarily the result of additional provisions made during 1997 to
fund the stock incentive reserves due to the significant 63% increase in the
market price of 1st Source common stock during that period. Group insurance
expense increased 20.01% in 1998, following a 9.86% decrease in 1997.
Occupancy expense in 1998 increased 9.26% from 1997, following a 3.22%
decrease in 1997. The increase in occupancy expense in 1998 is primarily due to
the full year impact of the previous year's branch expansion. The reduction in
occupancy expense in 1997 is attributed to greater tenant occupancy of our
head-quarters building. Furniture and equipment expense increased in 1998
16
- --Page 18--
SELECTED STATISTICAL INFORMATION
Distribution of Assets, Liabilities and Shareholders' Equity
Interest Rates and Interest Differential
(Dollars in thousands)
Year ended December 31, 1998
Interest
Average Income/ Yield/
ASSETS Balance Expense Rate
Investment securities:
Taxable $ 294,632 $17,419 5.91%
Tax exempt (1) 150,678 11,327 7.52
Net loans (2 & 3) 1,853,537 168,664 9.10
Other investments 45,708 2,348 5.14
Total earning assets 2,344,555 199,758 8.52
Cash and due from banks 86,452
Reserve for loan losses (38,861)
Other assets 158,072
Total $2,550,218
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing deposits $1,748,759 86,264 4.93
Short-term borrowings 243,431 15,034 6.18
Long-term debt 13,036 929 7.13
Total interest bearing liabilities 2,005,226 102,227 5.10
Noninterest bearing deposits 250,755
Other liabilities 89,057
Shareholders' equity 205,180
Total $2,550,218
Net interest income $ 97,531
Net yield on earning assets
on a taxable equivalent basis 4.16%
(1) Interest income includes the effects of taxable equivalent adjustments,
using a 40.525% rate. Tax equivalent adjustments were $3,408 in 1998, $3,536 in
1997 and $3,635 in 1996.
(2) Loan income includes fees on loans of $4,889 in 1998, $4,097 in 1997 and
$3,136 in 1996. Loan income also includes the effects of taxable equivalent
adjustments, using a 40.525% rate. Tax equivalent adjustments were $202 in 1998,
$162 in 1997 and $131 in 1996.
(3) For purposes of this computation, nonaccruing loans are included in the
daily average loan balance outstanding.
- --Page 19--
1997 1996
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
$ 272,400 $ 16,638 6.11% $ 254,033 $ 15,337 6.04%
151,686 11,723 7.73 146,176 11,787 8.06
1,610,889 148,061 9.19 1,348,089 124,467 9.23
17
11,662 592 5.09 18,757 995 5.30
2,046,637 177,014 8.65 1,767,055 152,586 8.64
73,246 75,378
(31,966) (28,482)
110,383 81,263
$2,198,300 $1,895,214
$1,488,287 73,150 4.92 $1,337,345 64,214 4.80
227,757 13,014 5.71 156,003 7,843 5.03
16,527 1,160 7.02 19,876 1,372 6.90
1,732,571 87,324 5.04 1,513,224 73,429 4.85
210,686 186,804
72,500 33,862
182,543 161,324
$2,198,300 $1,895,214
$ 89,690 $ 79,157
4.38% 4.48%
- --Page 20--
EARNING RESULTS -- CONTINUED
by 7.15%, following a 15.07% increase in 1997. The increase in 1997 is
attributed to depreciation on new furniture and equipment.
Depreciation on operating leases increased 80% in 1998, following a 176%
increase in 1997 due to the increased volume of operating leases.
Business development and marketing expense increased 2.98% in 1998, following
an increase of 33.78% in 1997. Contributions to the 1st Source Foundation
declined in 1998 compared to 1997.
An increase of 17.72% occurred in other expenses during 1998, compared to a
19.56% increase in 1997. During 1998, the majority of the increase in other
expenses was in professional consulting. The increase in professional consulting
expenses was attributed to loan securitization activity and costs in upgrading
various computer systems for Year 2000 (Y2K) compliance. During 1997, 1st Source
experienced increases in employee acquisition and training, communications,
professional consulting and collection and repossession expenses.
YEAR 2000 -- The Y2K 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 comprehensive project plan to address the Y2K issue as it relates
to 1st Source's operations was developed, approved by the Board of Directors and
implemented. The scope of the plan has five phases comprising Awareness,
Assessment, Renovation, Validation and Implementation as defined by federal
banking regulatory agencies. Two project teams were assigned. The first
consisted of key members of the technology staff, representatives of functional
business units and senior management. The second primarily consisted 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 determined what risk, if any, our key customers pose to the bank
with regards to their Y2K readiness. Additionally, the duties of the Senior Vice
President of Operations were realigned to allow him to serve as the Year 2000
Project Manager.
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, 1st
18
Source has identified and prioritized those systems deemed to be mission
critical or those that have a significant impact on normal operations.
1st Source 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 and other external counterparties were
initiated in 1997 to assess the Y2K 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, responses indicate that all of the significant providers
currently have compliant versions available or are well into the renovation and
testing phases. However, 1st Source can give no guarantee that the systems of
these service providers and vendors on which 1st Source's systems rely will be
timely renovated.
Additionally, 1st Source has implemented a plan to manage the potential risk
posed by the impact of the Y2K issue on its major borrowing customers. Formal
communications have been initiated, and the assessment was substantially
complete on December 31, 1998. Loan losses attributed to the Y2K issue are not
anticipated to be material to 1st Source. However, there can be no guarantee
that any loss incurred will be immaterial.
1st Source's total cost for the Y2K project is estimated to be between
$900,000 and $1,700,000. The total amount expended on the project through
December 31, 1998, was $630,000 of which approximately $610,000 related to the
cost to repair or replace software. Approximately $9,000 was related to the cost
of replacing equipment and approximately $11,000 was related to miscellaneous
items such as training for employees and communications with customers.
- --Page 21--
Funds have been provided from our normal operating budget and costs are
expensed as they are incurred.
The total cost to 1st Source 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.
The project teams feels that 1st Source's Y2K 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.
TARGET DATES FOR MISSION CRITICAL SYSTEMS
Project Phase %Completed Projected Completion
Date
Awareness 100% --
Assessment 100% --
Renovation 97% March 31, 1999
Validation 79% March 31, 1999
Implementation 70% June 30, 1999
No specific other 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 1st Source 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 plans and other factors. 1st
Source 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 has determined that the Y2K issue will not
pose significant operational problems for its computer systems. This
determination is based on the ability of those vendors and service providers to
renovate, in a timely manner, the products and services on which 1st Source's
systems rely. However, 1st Source can give no guarantee that the systems of
these suppliers will be renovated in a timely manner.
Realizing that some disruption may occur despite its best efforts, 1st Source
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, 1st Source expects to have the plans substantially documented by June
30, 1999.
INCOME TAXES -- Federal income taxes were $13.26 million and $10.79 million,
prior to the tax benefit of $1,196,000 and $936,000 relating to the distribution
on preferred securities of subsidiary trusts for 1998 and
19
1997, respectively. After this benefit, 1998 federal income taxes were $12.06
million, or 28.01% of income after state taxes, compared to $9.86 million or
27.12% in 1997 and $9.13 million or 28.24% in 1996. The higher percentage of
federal income taxes in 1998 is the result of less tax-exempt income. A
settlement with the Internal Revenue Service was reached during 1997 over a
dispute arising from the 1983 purchase of the First National Bank of Mishawaka
relating to deduction of core deposit intangibles. Interest of $955,000 related
to the settlement was paid to the IRS in 1998. State income taxes were $4.28
million and $3.60 million in 1998 and 1997, respectively, prior to the tax
benefit of $318,000 and $248,000 relating to the distribution on preferred
securities of subsidiary trusts for 1998 and 1997, respectively. After this
benefit, 1998 state income taxes were $3.96 million, compared to $3.35 million
in 1997 and $3.27 million in 1996.
CREDIT EXPERIENCE
PROVISION FOR LOAN LOSSES -- The ability of a bank to identify and assess the
risk factors affecting its loan portfolio is crucial for profitability.
Management follows a credit policy that balances the risk and return on loans
and monitors potential credit problems to ensure that they are adequately
managed and reserved.
The provision made to the reserve for loan losses is determined by management
based on the risk factors and general economic conditions affecting the loan
portfolio, including changes to the portfolio mix and past loan loss experience.
The provision for loan losses for 1998 was $9.16 million, compared to $6.05
million in 1997 and $4.65 million in 1996. Net charge-offs of $3.65 million,
$144,000, and $1.78 million were recorded in 1998,
- --Page 22--
1997 and 1996, respectively.
The reserve for loan losses at December 31, 1998 totaled $40.93 million and
was 2.18% of loans, compared to $35.42 million or 1.97% of loans at December 31,
1997, and $29.52 million or 2.03% of loans at December 31, 1996. It is
management's opinion that the reserve for loan losses is adequate to absorb
anticipated losses in the loan portfolio as of December 31, 1998.
NONPERFORMING ASSETS -- 1st Source's policy is to discontinue the accrual of
interest on loans on which principal or interest is past due and remains unpaid
for 90 days or more, unless the loan is well collateralized and in the process
of collection. Nonperforming assets amounted to $10.57 million at December 31,
1998, compared to $11.44 million at December 31, 1997 and $7.77 million at
December 31, 1996. Impaired loans totaled $13.30 million, $9.39 million and
$8.13 million at December 31, 1998, 1997 and 1996, respectively.
NONPERFORMING ASSETS AT DECEMBER 31
(Dollars in thousands) 1998 1997 1996 1995 1994
Loans past due over 90 days $ 275 $ 730 $ 557 $ 274 $ 477
Nonaccrual loans 9,266 10,030 6,678 4,893 3,314
Restructured loans - - - - 133
TOTAL NONPERFORMING LOANS 9,541 10,760 7,235 5,167 3,924
Other real estate 424 335 445 1,359 763
Other assets 606 341 93 58 13
TOTAL NONPERFORMING ASSETS $10,571 $11,436 $7,773 $6,584 $4,700
Nonperforming assets to loans,
net of unearned discount .56% .64% .54% .52% .43%
CAPITAL RESOURCES
1st Source manages its capital resources to serve its customers, protect its
depositors, support growth and provide a fair return to shareholders. As of
December 31, 1998, there were 1,137 holders of record of 1st Source common
stock.
1st Source's leverage capital ratio decreased from 9.98% at December 31,
1997, to 9.50% at December 31, 1998.
1st Source's common stock is traded on the Nasdaq Stock Market under the
National Market symbol
20
"SRCE." High and low stock prices and cash dividends paid for the last two
years by quarter were:
1998 Sales Price 1997 Sales Price
Cash Cash
Dividends Dividends
Common Stock Prices High Low Paid High Low Paid
Quarter Ended:
March 31 $33-3/4 $25-1/4 $.066 $20-1/4 $15-3/4 $.060
June 30 36-3/4 30-3/4 .066 22-3/4 17-3/4 .062
September 30 36 27-1/2 .073 23-1/2 21-1/4 .062
December 31 32 25-3/4 .073 27-1/2 22-1/4 .066
The above information gives retroactive recognition to a 10% stock dividend
declared January 14, 1999; and a 10% stock dividend declared January 20, 1998.
At December 31, 1998, the total market capitalization of 1st Source was
approximately $575 million.
- --Page 23--
CAPITAL RESOURCES -- CONCLUDED
Leverage Capital Ratio (As a Percent)
[GRAPH]
94 95 96 97 98
(8.33) (8.44) (8.48) (9.98) (9.5)
Common Stock Price Range (In Dollars)
[GRAPH]
1997 1998
1st 2nd 3rd 4th 1st 2nd 3rd 4th
------------------------------------------- -------------------------------------------
High 20 1/4 22 3/4 23 1/2 27 1/2 33 3/4 36 3/4 36 32
Low 15 3/4 17 3/4 21 1/4 22 1/4 25 1/4 30 3/4 27 1/2 25 3/4
Quarter
Ending 19 22 23 26 1/4 33 32 1/2 29 1/4 30 1/2
Book Value Per Common Share<F*>
[GRAPH]
94 95 96 97 98
(6.80) (8.10) (9.11) (10.24) (11.43)
<FN>
<F*>Book value is not necessarily indicative of the value of 1st Source common
stock.
21
Cash Dividends Per Common Share
[GRAPH]
94 95 96 97 98
(.168) (.189) (.218) (.250) (.278)
EFFECTS OF INFLATION -- The results of operations can also be affected by
inflation, although it is difficult to measure the precise impact on the various
types of income and expense. Interest rates, in particular, are significantly
affected by inflation, but neither the timing nor the magnitude of the changes
coincide with changes in the consumer price index nor other measures of
inflation. Additionally, increases in interest rates, such as those on consumer
deposits, lag behind increases in overall rates. This, in turn, affects the
composition of sources of funds by reducing core deposit growth and increasing
the need for purchased funds. Another significant effect of inflation is on
noninterest expenses, which tend to rise during periods of general inflation.
- --Page 24--
December 31
1998 1997
(Dollars in thousands)
ASSETS
Cash and due from banks $132,514 $90,864
Federal funds sold and
interest bearing deposits with other banks 41,951 11,677
Investment securities, available-for-sale
(amortized cost of $440,147 and
$298,439 at December 31, 1998 and
1997, respectively) 443,691 299,933
Investment securities, held-to-maturity
(fair value of $99,734 and $119,369
at December 31, 1998 and 1997,
respectively) 96,008 114,975
Loans, net of unearned discount:
Commercial and agricultural loans 399,013 364,391
Commercial loans secured by transportation
and construction equipment 732,488 752,677
Loans secured by real estate 630,915 568,136
Consumer loans 119,280 111,577
Total Loans 1,881,696 1,796,781
Less, Reserve for loan losses 40,929 35,424
Net Loans 1,840,767 1,761,357
Operating leases, net of accumulated depreciation
of $12,997 and $7,260 at December 31, 1998 and
1997, respectively. 54,170 32,046
Premises and equipment:
Land 4,130 4,123
Buildings and improvements 28,948 25,868
Furniture and equipment 21,996 23,750
Construction in progress 1,322 555
Total Premises and Equipment 56,396 54,296
Less, Accumulated depreciation 25,169 23,514
Net Premises and Equipment 31,227 30,782
22
Other assets 91,693 76,520
Total Assets $2,732,021 $2,418,154
The accompanying notes are a part of the consolidated financial statements.
- --Page 25--
December 31
1998 1997
(Dollars in thousands)
LIABILITIES
Deposits:
Noninterest bearing $ 294,810 $ 274,906
Interest bearing 1,882,297 1,616,885
Total Deposits 2,177,107 1,891,791
Short-term borrowings:
Federal funds purchased and securities
sold under agreements to repurchase 159,478 117,987
Other 82,681 117,019
Total Short-Term Borrowings 242,159 235,006
Other liabilities 38,957 34,998
Long-term debt 13,189 16,656
Total Liabilities 2,471,412 2,178,451
Commitments and contingencies (Notes L, M and P)
Guaranteed preferred beneficial interests
in the Company's subordinated debentures 44,750 44,750
SHAREHOLDERS' EQUITY Common stock; no par value:
Authorized 40,000,000 shares; issued 17,756,636 shares in
1998 and 16,147,791 shares in 1997, less unearned shares 6,270 5,700
Capital surplus 121,456 69,947
Retained earnings 97,863 124,394
Cost of common stock in treasury (1998 -- 465,405
shares and 1997 -- 289,627 shares) (12,723) (6,978)
Net unrealized appreciation
of securities available-for-sale 2,993 1,890
Total Shareholders' Equity 215,859 194,953
Total Liabilities and Shareholders' Equity $2,732,021 $2,418,154
23
- --Page 26--
CONSOLIDATED STATEMENTS OF INCOME
1st Source Corporation and Subsidiaries
Year Ended December 31
1998 1997 1996
(Dollars in thousands, except per share data)
Interest income:
Loans $168,462 $147,899 $124,553
Investment securities, taxable 17,419 16,638 15,121
Investment securities, tax-exempt 7,919 8,187 8,152
Total Investment Securities 25,338 24,825 23,273
Other 2,348 592 994
Total Interest Income 196,148 173,316 148,820
Interest expense:
Deposits 86,264 73,150 64,214
Short-term borrowings 15,034 13,014 7,843
Long-term debt 929 1,160 1,372
Total Interest Expense 102,227 87,324 73,429
Net Interest Income 93,921 85,992 75,391
Provision for loan losses 9,156 6,052 4,649
Net Interest Income After Provision for Loan Losses 84,765 79,940 70,742
Noninterest income:
Trust fees 8,257 7,312 6,732
Service charges on deposit accounts 5,845 5,380 4,829
Loan servicing and sale income 15,117 9,636 5,405
Equipment rental income 12,557 6,950 2,741
Other income 10,357 6,840 5,541
Investment securities and other investment
gains (losses) (612) (462) 231
Total Noninterest Income 51,521 35,656 25,479
Noninterest expense:
Salaries and employee benefits 47,265 41,755 36,058
Net occupancy expense 4,966 4,545 4,696
Furniture and equipment expense 7,241 6,758 5,873
Depreciation - leased equipment 8,941 4,971 1,800
Business development and marketing expense 3,564 3,461 2,587
Other expense 13,523 11,487 9,608
Total Noninterest Expense 85,500 72,977 60,622
Income Before Income Taxes and Subsidiary
Trust Distributions 50,786 42,619 35,599
Income taxes 17,545 14,392 12,396
Distribution on preferred securities of subsidiary trusts,
net of income tax benefit of $1,514 in 1998 and
$1,184 in 1997 2,221 1,738 -
Net Income $ 31,020 $ 26,489 $ 23,203
Basic Net Income Per Common Share $ 1.63 $ 1.40 $ 1.23
Diluted Net Income Per Common Share $ 1.60 $ 1.36 $ 1.20
The accompanying notes are a part of the consolidated financial statements.
24
- --Page 27--
Consolidated Statements of Shareholders' Equity
1st Source Corporation and Subsidiaries
Net
Unrealized
Cost of Appreciation
Common of Securities
Common Capital Retained Stock Available-
Total Stock Surplus Earnings in Treasury For-Sale
(Dollars in thousands, except per share data)
Balance at January 1, 1996 $152,601 $5,429 $56,337 $96,952 $(6,497) $380
Comprehensive income,
net of tax:
Net income 23,203 - - 23,203 - -
Change in unrealized
appreciation of
available-for-sale securities
(net of $52 income tax) 77 - - - - 77
Total comprehensive income 23,280
Cost of 67,267 shares of com-
mon stock acquired for treasury (1,488) - - - (1,488) -
Cash dividends ($.218
per share) (4,123) - - (4,123) - -
5% common stock dividend
($11 cash paid in lieu of
fractional shares) (11) 271 13,610 (13,892) - -
Other 1,574 - - 259 1,315 -
Balance at
December 31, 1996 171,833 5,700 69,947 102,399 (6,670) 457
Comprehensive income, net of tax:
Net income 26,489 - - 26,489 - -
Change in unrealized
appreciation of
available-for-sale securities
(net of $977
income tax) 1,433 - - - - 1,433
Total comprehensive income 27,922
Cost of 179,025 shares of com-
mon stock acquired for
treasury (5,023) - - - (5,023) -
Cash dividends
($.250 per share) (4,723) - - (4,723) - -
Five-for-four common stock split
($8 cash paid in lieu of
fractional shares) (8) - - (8) - -
Other 4,952 - - 237 4,715 -
Balance at
December 31, 1997 194,953 5,700 69,947 124,394 (6,978) 1,890
Comprehensive income, net of tax:
Net income 31,020 - - 31,020 - -
25
Change in unrealized
appreciation of
available-for-sale
securities (net of
$751 income tax) 1,103 - - - - 1,103
Total comprehensive income 32,123
Cost of 231,440 shares of com-
mon stock acquired
for treasury (7,116) - - - (7,116) -
Cash dividends
($.278 per share) (5,296) - - (5,296) - -
10% common stock dividend
($13 cash paid in lieu
of fractional shares) (13) 570 51,509 (52,092) - -
Other 1,208 - - (163) 1,371 -
Balance at
December 31, 1998 $215,859 $ 6,270 $121,456 $97,863 $(12,723) $2,993
The accompanying notes are a part of the consolidated financial statements.
- --Page 28--
Consolidated Statements of Cash Flows
1st Source Corporation and Subsidiaries
Year Ended December 31
1998 1997 1996
(Dollars in thousands)
Operating Activities:
Net income $31,020 $26,489 $23,203
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 9,156 6,052 4,649
Depreciation of premises and equipment 12,638 8,372 4,363
Amortization of investment security pre-
miums and accretion of discounts, net 1,039 817 739
Deferred income taxes 8,133 4,839 (1,147)
Realized investment securities (gains) losses 612 462 (231)
Realized (gains) on securitized loans (1,948) (800) -
Increase in interest receivable (787) (1,836) (573)
Increase in interest payable 2,023 3,660 120
Other (627) (3,303) (5,818)
Net Cash Provided by Operating Activities 61,259 44,752 25,305
Investing Activities:
Proceeds from sales and maturities of investment
securities 249,012 159,564 116,813
Purchase of investment securities (373,404) (144,491) (144,286)
Net (increase) decrease in short-term investments (30,274) (11,077) 2,34
Loans sold or participated to others 377,608 154,609 156,727
Net increase in loans made to customers
and principal collections on loans (466,370) (495,632) (355,104)
Net increase in leased assets (23,069) (16,585) (4,984)
26
Funding of bank-owned life insurance policies - (20,000) -
Purchase of premises and equipment (3,795) (4,455) (6,646)
Increase in servicing assets (16,632) (1,408) (251)
Other (9,288) (13,014) (2,115)
Net Cash Used in Investing Activities (296,212) (392,489) (237,500)
Financing Activities:
Net increase in demand deposits,
NOW accounts and savings accounts 311,160 46,384 57,688
Net increase (decrease) in certificates of deposit (25,844) 211,429 134,540
Net increase in short-term borrowings 7,153 10,143 71,884
Proceeds from issuance of long-term debt 747 1,559 123
Payments on long-term debt (4,214) (3,499) (3,346)
Proceeds from issuance of cumulative trust
preferred securities - 44,750 -
Acquisition of treasury stock (7,116) (5,023) (1,488)
Cash dividends (5,296) (4,723) (4,123)
Other 13 (7) (12)
Net Cash Provided by Financing Activities 276,603 301,013 255,266
Increase (Decrease) in Cash and Cash Equivalents 41,650 (46,724) 43,071
Cash and cash equivalents, beginning of year 90,864 137,588 94,517
Cash and Cash Equivalents, End of Year $132,514 $90,864 $137,588
The accompanying notes are a part of the consolidated financial statements.
- --Page 29--
Notes to Consolidated Financial Statements
1st Source Corporation and Subsidiaries
NOTE A -- ACCOUNTING POLICIES
The principal line of business of 1st Source Corporation ("1st Source") and
subsidiaries is banking and closely related activities. The following is a
summary of significant accounting policies followed in the preparation of the
consolidated financial statements.
PRINCIPLES OF CONSOLIDATION -- The financial statements consolidate 1st
Source and its subsidiaries (principally 1st Source Bank and Trustcorp Mortgage
Company). All significant intercompany balances and transactions have been
eliminated. For purposes of the parent company only financial information
presented in Note Q, investments in subsidiaries are carried at 1st Source's
equity in the underlying net assets.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS -- The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
INVESTMENT SECURITIES -- Securities that may be sold as part of 1st Source's
asset/liability or liquidity management or in response to or in anticipation of
changes in interest rates and resulting prepayment risk, or for other similar
factors, are classified as available-for-sale and carried at fair market value.
Unrealized holding gains and losses on securities available-for-sale are
reported net of related deferred income taxes as a separate component of
shareholders' equity and the change in such items is a component of
comprehensive income. Securities that 1st Source has the ability and positive
intent to hold to maturity are classified as held-to-maturity and carried at
amortized cost. Trading securities are carried at fair market value with
unrealized holding gains and losses included in earnings. There were no trading
securities at December 31, 1998 or 1997. Realized gains and losses on the sales
of all securities are reported in earnings and computed using the specific
identification cost basis.
LOANS -- Loans are reported at the principal amount outstanding, net of
unearned income. Loans identified as held-for-sale are carried at the lower of
cost or market determined on an aggregate basis. Included in real estate loans
are loans held for sale totaling $188.2 million and $130.0 million at December
31, 1998 and 1997, respectively.
27
SECURITIZED ASSETS -- The guidelines set forth in Statement of Financial
Accounting Standards (SFAS) No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities," are followed when
accounting for securitizations. When 1st Source sells loans in securitizations,
it retains servicing rights and interest-only strips, which are retained
interests in the securitized assets. Gain or loss on sale of the loans depends
in part on the previous carrying amount of all retained interests, allocated in
proportion to their fair value. 1st Source generally estimates fair value based
on the present value of future cash flows expected under management's best
estimates of the key assumptions - credit losses, prepayment speeds, forward
yield curves and discount rates commensurate with the risks involved and
regularly reviews all assets for impairment. In conjunction with its
securitization activities, 1st Source sold $346 million of aircraft and auto
loans in 1998 resulting in a recognized gain of $1.95 million.
Approximately $83,000 of cash and $9.1 million of other assets shown on the
December 31, 1998 consolidated statement of financial condition are assets of
1st Source Funding Corporation ("Funding"), a special-purpose subsidiary of 1st
Source Bank, and represent Funding's beneficial (i.e. residual) interest in
certain assets of the 1st Source Master Trust in accordance with 1st Source's
loan securitization transactions. Funding was established in 1998 as a
qualifying special-purpose entity for purposes of SFAS No. 125 and has been
structured to be bankruptcy-remote from 1st Source and its other affiliates.
MORTGAGE SERVICING RIGHTS -- The costs of purchasing the rights to service
mortgage loans originated by others are deferred and amortized as reductions of
mortgage servicing fee income over the estimated servicing period in proportion
to the estimated servicing income to be received. Gains and losses on the sale
of mortgage servicing rights are recognized as non-interest income in the period
in which such rights are sold on a servicing released basis.
SFAS No. 125 also requires companies that intend to sell originated or
purchased loans and retain the related servicing rights, to allocate a portion
of the total costs of the loans to servicing rights, based on estimated fair
value. Fair value is estimated based on market prices, when available, or the
present value of future net servicing income, adjusted for such factors as
discount and prepayment rates. As of December 31, 1998, and 1997, $20.3 million
and $11.0 million, respectively, of mortgage servicing rights have been
capitalized. As of these dates, the servicing rights had a fair value of $35.7
million and $21.0 million respectively.
Mortgage servicing rights are being amortized using a method which
approximates the effective yield method and for the years ended December 31,
1998, 1997 and 1996,
- --Page 30--
NOTE A -- ACCOUNTING POLICIES -- CONTINUED
$4.09 million, $2.72 million and $2.68 million of amortization expense has
been recognized.
SFAS No. 125 also requires 1st Source to assess its capitalized servicing
rights for impairment based on their current fair value. 1st Source
disaggregates its servicing portfolio based on loan type and interest rate, the
predominant risk characteristics of the underlying loans. There were no
valuation allowances associated with capitalized mortgage servicing rights at
December 31, 1998 and 1997.
REVENUE RECOGNITION -- Interest on loans is included in interest income on
the accrual method over the terms of the loans based upon principal balances
outstanding. The accrual of interest on loans is discontinued when a loan
becomes contractually delinquent for 90 days, except for installment loans where
payments are being received regularly and mortgage loans, which are placed on
nonaccrual at the time the loan is placed in foreclosure. When interest accruals
are discontinued, interest credited to income in the current year is reversed,
and interest accrued in the prior year is charged to the reserve for loan
losses. Management may elect to continue the accrual of interest when the net
realizable value of collateral is sufficient to cover the principal and accrued
interest. Certain loan origination and commitment fees and certain direct loan
origination costs are deferred and the net amount amortized to interest income
generally over the contractual life of the related loan or commitment.
RESERVE FOR LOAN LOSSES -- A loan is considered impaired, based on current
information and events, if it is probable that 1st Source will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. The measurement of impaired loans
is generally based on the present value of expected future cash flows discounted
at the historical effective interest rate, except that all collateral-dependent
loans are measured for impairment based on the fair value of the collateral. The
provision for loan losses charged to expense is based upon the actual net loan
losses incurred as determined by credit loss experience, the evaluation of
potential losses in the portfolio and the evaluation of impaired loans. Loans
are charged against the reserve for loan losses when deemed uncollectible.
157
28
PREMISES AND EQUIPMENT -- Premises and equipment are stated at cost, less
accumulated depreciation. The provision for depreciation is computed generally
by the straight-line method, primarily with useful lives of 5, 7, 15 and 31H
years.
LEASED ASSETS -- 1st Source finances various types of equipment and
automobiles under leases principally classified as operating leases. These
assets are being depreciated on a straight-line method over the life of the
lease.
TRUST FEES -- Trust fees are recognized on the accrual basis.
INCOME TAXES -- Deferred income taxes are determined under the liability
method. The net deferred tax assets are comprised of the tax effect of net
temporary differences related principally to differing methods of accounting for
loan losses offset by differing methods of accounting for depreciation on
premises and leased equipment and amortization of purchased mortgage servicing
rights.
NET INCOME PER COMMON SHARE -- Net income per common share is computed in
accordance with SFAS No. 128, "Earnings per Share." Basic earnings per share is
computed by dividing net income by the weighted average number of shares of
common stock outstanding which were as follows (in thousands): 1998, 18,995;
1997, 18,935; and 1996, 18,893. Diluted earnings per share is computed by
dividing net income by the weighted average number of shares of common stock
outstanding plus the dilutive effect of outstanding stock options. The weighted
average number of common shares, increased for the dilutive effect of stock
options, used in the computation of diluted earnings per share were as follows
(in thousands): 1998, 19,371; 1997, 19,543; and 1996, 19,357.
The computations of the weighted average number of common shares used for the
determination of both basic and diluted earnings per share give retroactive
recognition to a 10% stock dividend declared January 14, 1999, payable February
12, 1999, to shareholders of record on February 4, 1999.
FUNDS HELD IN TRUST FOR INVESTORS AND MORTGAGORS -- As of December 31, 1998
and 1997, serviced loans which were owned by investors aggregated $1.87 billion
and $1.30 billion, respectively. Funds held in trust at 1st Source for the
payment of principal, interest, taxes and insurance premiums applicable to
mortgage loans being serviced for others, aggregated approximately $50.8 million
and $23.0 million at December 31, 1998 and December 31, 1997, respectively.
CASH FLOW INFORMATION -- For purposes of the consolidated and parent company
only statements of cash flows, 1st Source considers cash and due from banks as
cash and cash equivalents. Cash paid during the years ended December 31, 1998,
1997 and 1996, for interest and for income taxes was $100.2 million and $7.8
million, $83.7
- --Page 31--
NOTE A -- ACCOUNTING POLICIES -- CONCLUDED
million and $10.7 million, and $73.3 million and $14.9 million, respectively.
OFF-BALANCE SHEET FINANCIAL INVESTMENTS -- 1st Source enters into interest
rate swap agreements as part of its interest rate risk management strategies.
These instruments are accounted for under the accrual basis of accounting,
whereby the income or expense is recorded as a component of interest income. If
a swap is terminated, the resulting gain or loss is deferred and amortized over
the remaining life of the off-balance sheet investment product.
RECENT ACCOUNTING PRONOUNCEMENTS -- 1st Source has adopted SFAS No. 130,
"Reporting Comprehensive Income," as of January 1, 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. The
only component of comprehensive income not included in 1st Source's net income
is unrealized gains or losses on available-for-sale investment securities, net
of related income taxes. Prior year financial statements have been restated in
order to conform to the requirements of SFAS No. 130.
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 segment
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.
1st Source's principal business is banking, and management has not separately
organized the business beyond commercial banking and mortgage banking. Its
wholly owned mortgage subsidiary, Trustcorp Mortgage Company, constitutes a
segment by definition of SFAS No. 131, however, it does not meet the
quantitative thresholds for separate disclosure as set forth by this Statement.
Trustcorp Mortgage Company's revenue is less than 10 percent of consolidated
revenue, the absolute amount of its reported income is less than 10 percent of
the absolute amount of the consolidated net income of 1st Source, and, finally,
its assets are less than 10 percent of consolidated assets.
158
29
In June 1998, the 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 the intended use of the derivative and its resulting
designation. 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
1st Source's results of operations or its financial position.
RECLASSIFICATIONS -- Certain amounts in the 1996 and 1997 consolidated
financial statements have been reclassified to conform with the 1998
presentation. These reclassifications had no effect on total assets,
shareholders' equity or net income as previously reported.
NOTE B -- FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of 1st Source's financial instruments as of December 31, 1998
and 1997, are summarized in the following table.
The following methods and assumptions were used by 1st Source in estimating
the fair value of its financial instruments:
CASH AND CASH EQUIVALENTS -- The carrying values reported in the consolidated
statements of financial condition for cash and due from banks, federal funds
sold and interest bearing deposits with other banks approximate their fair
values.
INVESTMENT SECURITIES -- Fair values for investment securities are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are estimated based on quoted market prices of comparable
investments.
LOANS -- For variable rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying values. The
fair values for certain real estate loans (e.g., one-to-four single family
residential mortgage loans) are based on quoted market prices of similar loans
sold in conjunction with securitization transactions, adjusted for differences
in loan characteristics. The fair values of all other loans are estimated using
discounted cash flow analyses, using interest rates currently being offered for
loans with similar terms to borrowers of similar credit quality.
- --Page 32--
NOTE B -- FAIR VALUES OF FINANCIAL INSTRUMENTS -- CONCLUDED
DEPOSITS -- The fair values for all deposits other than time deposits are
equal to the amounts payable on demand (the carrying value). Fair values of
variable rate time deposits are equal to their carrying values. Fair values for
fixed rate time deposits are estimated using discounted cash flow analyses using
interest rates currently being offered for deposits with similar remaining
maturities.
SHORT-TERM BORROWINGS -- The carrying values of federal funds purchased,
securities sold under repurchase agreements and other short-term borrowings
approximate their fair values.
LONG-TERM DEBT -- The fair values of 1st Source's long-term debt are
estimated using discounted cash flow analyses, based on 1st Source's current
estimated incremental borrowing rates for similar types of borrowing
arrangements.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S SUBORDINATED
DEBENTURES (CUMULATIVE TRUST PREFERRED SECURITIES) -- Fair values are based on
quoted market prices.
GUARANTEES AND LOAN COMMITMENTS -- Contract and fair values for certain of
1st Source's off-balance-sheet financial instruments (guarantees and loan
commitments) are estimated based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties' credit standing.
INTEREST RATE SWAPS -- Fair values for interest rate swaps are based on the
net amount necessary to currently settle the transaction.
LIMITATIONS -- Fair value estimates are made at a discrete point in time
based on relevant market information and information about the financial
instruments. Because no market exists for a significant portion of 1st Source's
financial instruments, fair value estimates are based on judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments and other such factors.
These estimates are subjective in nature and involve uncertainties and
matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the estimates. In
addition, the fair value estimates are based on existing on and
off-balance-sheet financial instruments without attempting to estimate the value
of anticipated future business and the value of assets and liabilities that are
not considered financial instruments. For example, 1st Source has a substantial
annual trust net fee income. The trust business is not considered a financial
instrument and its value has not been incorporated into the fair value
estimates.
Other significant assets and liabilities that are not considered financial
instruments include the mortgage banking operation,
159
30
premises and equipment and other assets. In addition, for investment and
mortgage-backed securities, the income tax ramifications related to the
realization of unrealized gains and losses can have a significant effect on fair
value estimates and have not been considered in many of the estimates. Also, the
fair value estimates for deposits do not include the benefit that results from
the low-cost funding provided by the deposit liabilities compared to the cost of
borrowing funds in the market.
Carrying Carrying
or Contract Fair or Contract Fair
Value Value Value Value
1998 1997
ASSETS: (Dollars in thousands)
Cash and due from banks $ 132,514 $ 132,514 $ 90,864 $ 90,864
Federal funds sold and
interest bearing deposits with other banks 41,951 41,951 11,677 11,677
Investment securities, available-for-sale 443,691 443,691 299,933 299,933
Investment securities, held-to-maturity 96,008 99,734 114,975 119,369
Loans, net of reserve for loan losses 1,840,767 1,905,335 1,761,357 1,788,005
LIABILITIES:
Deposits 2,177,107 2,189,910 1,891,791 1,896,130
Short-term borrowings 242,159 242,159 235,006 235,006
Long-term debt 13,189 13,755 16,656 16,807
Guaranteed preferred beneficial
interests in the Company's
subordinated debentures 44,750 47,036 44,750 46,726
OFF-BALANCE-SHEET INSTRUMENTS* - (351) - (392)
* Represents estimated cash outflows required to currently settle the obligations at current market rates.
- --Page 33--
NOTE C -- RESTRICTIONS ON CASH DUE FROM BANKS
1st Source Bank is required to maintain reserve balances with the Federal
Reserve Bank. The average amount of those reserve balances for the year ended
December 31, 1998 was approximately $13.0 million.
Under available line of credit agreements, 1st Source may borrow up to $3
million. At December 31, 1998, there were no outstanding borrowings under these
lines, which were assigned to support commercial paper borrowings.
NOTE D -- INVESTMENT SECURITIES
The amortized cost and estimated aggregate fair value of securities
classified as available-for-sale and held-to-maturity at December 31, 1998, are
as follows:
Available-For-Sale
Gross Gross Estimated
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
Cost Gains Losses Value
EQUITY SECURITIES: (Dollars in thousands)
Marketable securities $ 14,315 $1,304 $ (91) $ 15,528
Other equity securities 3,465 17 - 3,482
Total equity securities 17,780 1,321 (91) 19,010
DEBT SECURITIES:
United States Treasury and agency securities 243,003 1,019 (85) 243,937
Obligations of states and political subdivisions 69,115 1,007 (24) 70,098
Debt securities issued by foreign governments 2,205 1,492 - 3,697
Corporate securities 20,276 394 (31) 20,639
Mortgage-backed securities 40,681 172 (211) 40,642
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Other debt securities 20,549 105 (36) 20,618
Commercial paper 28,128 - - 28,128
Total debt securities 423,957 4,189 (387) 427,759
TOTAL INVESTMENT SECURITIES $441,737 $5,510 $(478) $446,769
Held-To-
Maturity
Gross Estimated
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
Cost Gains Losses Value
EQUITY SECURITIES: (Dollars in thousands)
Other equity securities $11,633 $ - $- $11,633
DEBT SECURITIES:
Obligations of states and political subdivisions 84,375 3,726 - 88,101
TOTAL INVESTMENT SECURITIES $96,008 $3,726 $- $99,734
- --Page 34--
The amortized cost and estimated aggregate fair value of securities classified
as available-for-sale and held-to-maturity at December 31, 1997, were as
follows:
NOTE D -- INVESTMENT SECURITIES -- CONTINUED
The amortized cost and estimated aggregate fair value of debt securities
classified as available-for-sale and held-to-maturity at December 31, 1998, by
contractual maturity (except for mortgage-backed securities), are shown below.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
Available-For-Sale Held-To-Maturity
Estimated Estimated
Aggregate Aggregate
Amortized Fair Amortized Fair
Cost Value Cost Value
(Dollars in thousands)
Due in one year or less $138,823 $139,273 $ 8,200 $ 8,309
Due after one year through five years 214,826 216,067 35,243 36,622
Due after five years through ten years 8,203 8,405 36,296 38,429
Due after ten years 21,424 23,372 4,636 4,741
Mortgage-backed securities 40,681 40,642 - -
TOTAL $423,957 $427,759 $84,375 $88,101
The amortized cost and estimated aggregate fair value of securities classified
as available-for-sale and held-to-maturity at December 31, 1997, were as
follows:
Available-For-Sale
Gross Gross Estimated
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
Cost Gains Losses Value
EQUITY SECURITIES: (Dollars in thousands)
Marketable securities $ 14,315 $1,304 $(91) $ 15,528
Other equity securities 3,465 17 - 3,482
Total equity securities 17,780 1,321 (91) 19,010
DEBT SECURITIES:
United States Treasury and agency securities 243,003 1,019 (85) 243,937
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Obligations of states and political subdivisions 69,115 1,007 (24) 70,098
Debt securities issued by foreign governments 2,205 1,492 - 3,697
Corporate securities 20,276 394 (31) 20,639
Mortgage-backed securities 40,681 172 (211) 40,642
Other debt securities 20,549 105 (36) 20,618
Commercial paper 28,128 - - 28,128
Total debt securities 423,957 4,189 (387) 427,759
TOTAL INVESTMENT SECURITIES $441,737 $5,510 $(478) $446,769
- --Page 35--
Held-To-Maturity
Gross Gross Estimated
Unrealized Unrealized Aggregate
Amortized Holding Holding Fair
Cost Gains Losses Value
EQUITY SECURITIES: (Dollars in thousands)
Other equity securities $ 11,648 $ - $ - $ 11,648
DEBT SECURITIES:
Obligations of states and political subdivisions 103,327 4,395 (1) 107,721
TOTAL INVESTMENT SECURITIES $114,975 $4,395 $(1) $119,369
Other equity securities classified as held-to-maturity at December 31, 1998
and 1997 include securities such as Federal Reserve Bank and Federal Home Loan
Bank stock, which are not traded on established exchanges and have only
redemption capabilities. Fair values for such equity securities are considered
to approximate cost. Debt securities issued by foreign governments (classified
as available-for-sale) with an amortized cost of $1.59 million and estimated
aggregate fair values of $3.08 million and $3.27 million at December 31, 1998
and 1997, respectively, are included in the above debt securities, but are
classified as loans in the accompanying 1998 and 1997 consolidated statements of
financial condition. 1st Source had no trading securities as of December 31,
1998 and 1997. The following represents the segregation of cash flows between
securities available-for-sale and held-to-maturity:
1998 1997 1996
Available-Held-To- Available- Held-To- Available- Held-To-
For-Sale Maturity Total For-Sale Maturity Total For-Sale Maturity Total
(Dollars in thousands)
Purchase of
securities $372,883 $ 521 $373,404 $139,534 $4,957 $144,491 $143,146 $1,140 $144,286
Proceeds from
sales of securities 13,437 - 13,437 16,684 - 16,684 207 - 207
Proceeds from
maturities and
prepayments of
securities 216,752 18,823 235,575 133,051 9,829 142,880 110,233 6,373 116,606
Gross losses of $199,135 were realized during 1998 on the sale of securities
available-for-sale. There were no gains or losses for 1997 or 1996 on the sale
of securities available-for-sale. During 1998 and 1997, gross losses of $300,000
and $324,037, respectively, were realized on the sales of securities
held-to-maturity. These gross losses were due to the write-off of venture
capital investments. There were no gains or losses on the sale of securities
held-to-maturity in 1996.
At December 31, 1998 and 1997, investment securities with carrying values of
$237.9 million and $210.1 million, respectively, were pledged as collateral to
secure government, public and trust deposits and for other purposes.
The mortgage-backed securities held by 1st Source consist primarily of FNMA,
GNMA and FHLMC pass-through certificates which are guaranteed by those
respective agencies of the United States government.
NOTE E -- LOANS TO RELATED PARTIES
1st Source and its subsidiaries have extended loans to officers and directors
of 1st Source and its subsidiaries and to their associates. The aggregate dollar
amount of these loans was $15.74 million and $12.92 million at December 31, 1998
and 1997,
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33
respectively. During 1998, $12.26 million of new loans were made and repayments
and other reductions totaled $9.44 million.
- --Page 36--
NOTE F -- RESERVE FOR LOAN LOSSES
Changes in the reserve for loan losses for each of the three years ended
December 31 were as follows:
1998 1997 1996
(Dollars in thousands)
Balance, beginning of year $35,424 $29,516 $27,470
Provision for loan losses 9,156 6,052 4,649
Charge-offs, net of recoveries of $1,148 in 1998, $1,266
in 1997 and $1,507 in 1996 (3,651) (144) (1,779)
Recaptured reserve due to loan securitization - - (824)
Balance, end of year $40,929 $35,424 $29,516
At December 31, 1998 and 1997, loans amounting to $9.27 million and $10.03
million, respectively, substantially all of which are collateralized, are
considered to be nonaccrual or restructured loans. Interest income for the years
ended December 31, 1998, 1997 and 1996 would have increased by approximately
$719,000, $786,000, and $533,000, respectively, if these loans earned interest
at their full contract rate.
As of December 31, 1998 and 1997, impaired loans totaled $13.30 million and
$9.39 million, respectively, of which $3.73 million and $1.14 million had
corresponding specific reserves for loan losses totaling $1.18 million and $0.61
million, respectively. The remaining balances of impaired loans had no specific
reserves for loan losses associated with them. The vast majority of the impaired
loans are nonaccrual loans; interest is not recognized on nonaccrual loans
subsequent to the date the loan is placed in nonaccrual status. While a loan is
classified as nonaccrual and the future collectibility of the recorded loan
balance is doubtful, collections on interest and principal are generally applied
as a reduction to principal outstanding. Interest on the remainder of the
impaired loans is recognized on the accrual basis. For 1998 and 1997, the
average recorded investment in impaired loans was $13.28 million and $9.46
million, respectively, and interest income recognized on impaired loans totaled
$1.23 million and $508,000, respectively.
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NOTE G -- LONG-TERM DEBT
Details of long-term debt are as follows:
December 31
1998 1997
(Dollars in thousands)
Term loan (7.4%) $10,000 $10,000
Subordinated capital
notes (4.47%) 1,145 5,075
Federal Home Loan Bank
borrowings (5.54% - 6.98%) 1,037 956
Other 1,007 625
TOTAL LONG-TERM DEBT $13,189 $16,656
Annual maturities of long-term debt at December 31, 1998 are as follows (in
thousands): 1999, $886; 2000, $237; 2001, $136; 2002, $10,659; and, 2003, $353.
The $10.0 million term loan has a fixed interest rate of 7.4% payable
quarterly with principal due at maturity, October 1, 2002. The Term Loan
Agreement contains, among other provisions, a make-whole provision for early
extinguishment of debt, and certain covenants relating to existence and mergers,
capital structure and financial requirements.
The subordinated capital notes include $572,000 due June 18, 1999 and
$573,000 due June 18, 2002. The interest rate on these notes is adjusted monthly
and was 4.47% at December 31, 1998. The notes are callable in whole or in part
by 1st Source at par value. The notes are unsecured and are subordinated to the
claims of depositors and other creditors of 1st Source Bank.
At December 31, 1998, the Federal Home Loan Bank borrowings represent a
source of funding for certain residential mortgage activities and consist of
five fixed rate notes with maturities ranging from 2003 to 2018. These notes are
collateralized by $1.66 million of certain real estate loans.
- --Page 37--
NOTE H -- COMMON STOCK
Effective January 1, 1996, 1st Source adopted SFAS No. 123, "Accounting for
Stock-Based Com-pensation," on a disclosure basis only. The disclosure
requirements include reporting the pro forma effect on net income and net income
per share of compensation expense that is attributable to the fair value of
stock options and other stock-based compensation that have been issued to
employees under the Stock Option Plans and the Employee Stock Purchase Plan. 1st
Source will continue to apply APB No. 25 in accounting for these plans. The
Executive Incentive Plan, the Special Long-Term Incentive Award Plan and the
Restricted Stock Award Plan are already being accounted for as compensatory
plans in accordance with the provisions of SFAS No. 123. Compensation cost that
has been charged against income for these plans was $3.05 million, $1.83
million, and $1.52 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
STOCK OPTION PLANS
1st Source's incentive stock option plans include the 1992 Stock Option Plan
(the "1992 Plan") and a certain other stock option agreement which became
effective January 1, 1992. As of December 31, 1998, an aggregate of 2,090,619
shares of common stock are reserved for issuance under the above plans. Under
the 1992 Plan, the exercise price of each option equals the market price of 1st
Source stock on the date of grant and an option's term is 10 years. Options
under the 1992 Plan generally vest in one to five years from date of grant.
Options are granted on a discretionary basis by the Executive Compensation
Committee (the "Committee") of the 1st Source Board of Directors.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1998: dividend yield of .74%; expected volatility
of 19.60%; risk-free interest rate of 5.50%; and expected life of 6.47 years.
The following is a summary of the activity with respect to 1st Source's stock
option plans for the years ended December 31, 1996, 1997 and 1998:
Weighted-
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35
Average
Number of Exercise
Shares Price
Options outstanding,
January 1, 1996 840,442 $ 6.95
Options granted 177,435 13.72
Options exercised (8,751) 9.05
Options outstanding,
December 31, 1996 1,009,126 8.13
Options granted 12,100 17.98
Options exercised (259,649) 4.82
Options forfeited (8,701) 9.86
Options outstanding,
December 31, 1997 752,876 9.36
Options granted 332,750 34.25
Options exercised (44,287) 9.88
Options forfeited (378) 13.72
Options outstanding,
December 31, 1998 1,040,961 17.29
Options exercisable,
December 31, 1998 622,965 $ 8.66
The following table summarizes information about stock options outstanding at
December 31, 1998:
OPTIONS OUTSTANDING
Weighted-
Average Weighted-
Range of Number Remaining Average
Exercise Outstanding Contractual Exercise
Prices at 12/31/98 Life (Years) Price
$ 6.00 to $12.99 530,742 5.11 $ 7.76
13.00 to 29.99 177,469 7.63 14.01
30.00 to 35.99 332,750 9.55 34.25
OPTIONS EXERCISABLE
Weighted-
Range of Number Average
Exercise Exercisable Exercise
Prices at 12/31/98 Price
$ 6.00 to $12.99 530,742 $ 7.76
13.00 to 29.99 92,223 13.83
30.00 to 35.99 _ _
- --Page 38--
NOTE H -- COMMON STOCK -- CONCLUDED
EMPLOYEE STOCK PURCHASE PLAN
1st Source also has an employee stock purchase plan for substantially all
employees with at least two years of service on the effective date of an
offering under the plan. Eligible employees may elect to purchase any dollar
amount of stock so long as such
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36
amount does not exceed 25% of their base rate of pay and the aggregate stock
accrual rate for all offerings does not exceed $25,000 in any calendar year.
Payment for the stock is made through payroll deductions over the offering
period, and employees may discontinue the deductions at any time and exercise
the option or take the funds out of the program. The most recent offering began
June 1, 1998, and runs through May 31, 2000, with $386,216 in stock value to be
purchased at $32.05 per share. The fair value of the employees' purchase rights
for the 1998 offering was estimated using the Black-Scholes model with the
following assumptions: dividend yield of .74%; expected volatility of 17.53%;
risk-free interest rate of 5.52%; and expected life of two years.
Pro forma net income and diluted net income per common share, reported as if
compensation expense had been recognized under the fair value provisions of SFAS
No. 123 for the stock option and employee stock purchase plans, are as follows:
1998 1997 1996
Net income (000s):
As reported $31,020 $26,489 $23,203
Pro forma 29,908 26,146 23,049
Diluted net income per common share:
As reported $1.60 $1.36 $1.20
Pro forma 1.55 1.35 1.20
EXECUTIVE INCENTIVE PLAN
1st Source has an Executive Incentive Plan which is administered by the
Committee. Awards under the plan include "Book Value" shares of common stock.
These shares are awarded annually based on weighted performance criteria and
vest over a period of five years. The plan shares may only be sold to 1st
Source, and such sale is mandatory in the event of death, retirement, disability
or termination of employment. Grants under the plan for 1998, 1997 and 1996 are
summarized below:
1998 1997 1996
Number of shares 47,996 39,491 48,246
Weighted-average
grant-date fair value $ 10.14 $ 9.07 $ 8.08
SPECIAL LONG-TERM INCENTIVE AWARD
During February 1996 and March 1991, 1st Source granted special long-term
incentive awards, including 1st Source common stock, to participants in the
Executive Incentive Plan. Shares granted under the plan vest over a period of
ten years. The first 10% was vested at the time of the grants. Subsequent
vesting requires (i) the participant to remain an employee of 1st Source and
(ii) that 1st Source be profitable on an annual basis based on the determination
of the Committee. Grants under the plan for 1996 are summarized below:
1996
Number of shares 28,079
Weighted-average
grant-date fair value $ 14.79
RESTRICTED STOCK AWARD PLAN
1st Source also has a restricted stock award plan for key employees. Awards
under the plan are made to employees recommended by the Chief Executive Officer
and approved by the Committee. Shares granted under the plan vest over a five to
ten-year period, and vesting is based upon meeting certain criteria, including
continued employment by 1st Source. Grants under the plan for 1998, 1997 and
1996 are summarized below:
1998 1997 1996
Number of shares 4,805 1,915 2,212
Weighted-average
grant-date fair value $32.04 $19.01 $14.79
- --Page 39--
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NOTE I -- PREFERRED STOCK AND CUMULATIVE PREFERRED SECURITIES
As of December 31, 1998, 1st Source has 10 million shares of authorized but
unissued preferred stock. The Board of Directors of 1st Source is authorized to
determine the terms, preferences, limitations, voting rights and number of
shares of each series it elects to issue.
In 1997, 1st Source raised $44.75 million through the issuance of Cumulative
Trust Preferred Securities. 1st Source Capital Trust I issued $27.5 million of
9.00% Cumulative Trust Preferred Securities. 1st Source Capital Trust II issued
$17.25 million of floating rate Cumulative Trust Preferred Securities. 1st
Source Capital Trust I and 1st Source Capital Trust II are wholly owned,
consolidated subsidiaries of 1st Source.
The holders of the fixed rate Cumulative Trust Preferred Securities are
entitled to receive preferential cumulative cash distributions from 1st Source
Capital Trust I, at the annual rate of 9.00% of the liquidation amount of $25
per Preferred Security, accruing from the date of original issuance and payable
quarterly in arrears on the last day of March, June, September and December of
each year. Holders of the floating rate Cumulative Trust Preferred Securities
are entitled to receive preferential cumulative cash distributions from 1st
Source Capital Trust II, at an annual rate equal to the sum of the three-month
Treasury adjusted to a constant maturity, plus 2.25%, applied to the liquidation
amount of $25 per Floating Rate Preferred Security accruing from the date of
original issuance and payable quarterly in arrears on the last day of March,
June, September and December of each year.
NOTE J -- EMPLOYEE BENEFIT PLANS
1st Source maintains a defined contribution money purchase pension plan
covering the majority of its employees. Contributions to the plan are based on
2% of participants' eligible compensation. For the years ended December 31,
1998, 1997 and 1996, total pension expense for this plan amounted to $422,000,
$433,000 and $422,000, respectively.
1st Source also maintains a defined contribution profit sharing and savings
plan covering the majority of its employees. The plan allows eligible employees
to make contributions by salary reduction pursuant to Section 401(k) of the
Internal Revenue Code. 1st Source is required under the plan to match 100% of
participant contributions up to 4% of compensation and one-half of any
additional participant contributions up to 6% of compensation provided that 1st
Source is profitable for the respective plan year. 1st Source may also make
discretionary contributions to the plan, depending on its profitability.
Contribution expense for this plan for the years ended December 31, 1998, 1997
and 1996, amounted to $1.34 million, $1.29 million, and $1.21 million,
respectively.
Trustcorp Mortgage Company contributes to a defined contribution plan for all
of its employees who meet the general eligibility requirements of the plan. The
contributions, which in part are based on amounts of compensation deferred by
the participants in the plan, were $78,000 in 1998, $54,000 in 1997 and $40,000
in 1996. In addition, Trustcorp Mortgage Company made discretionary
contributions of $145,000 in 1998, $103,000 in 1997, and $100,000 in 1996.
In addition to the pension and profit sharing plans, 1st Source provides
certain health care and life insurance benefits for substantially all of their
retired employees. All of 1st Source's full-time employees become eligible for
these retiree benefits upon reaching age 55 with 20 years of credited service.
Generally, the medical plan pays a stated percentage of eligible medical
expenses reduced for any deductibles and payments made by government programs
and other group coverage. The lifetime maximum benefit payable under the medical
plan is $15,000 and $3,000 for life insurance.
1st Source's accrued postretirement benefit cost and net periodic
postretirement benefit cost recognized in the consolidated financial statements
for the years ended December 31, 1998, 1997 and 1996 were not material.
- --Page 40--
NOTE K -- INCOME TAXES
Income tax expense is comprised of the following:
1998 1997 1996
Current: (Dollars in thousands)
Federal $6,935 $6,969 $10,036
State 2,477 2,584 3,507
Total Current 9,412 9,553 13,543
Deferred:
Federal 6,328 3,824 (906)
State 1,805 1,015 (241)
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38
Total Deferred 8,133 4,839 (1,147)
Total Provision $17,545 $14,392 $12,396
Deferred tax assets and liabilities as of December 31, 1998 and 1997 consisted
of the following:
1998 1997
Deferred tax assets: (Dollars in thousands)
Reserve for loan losses $17,303 $14,991
Accruals for employee benefits 3,323 2,554
Asset securitization 1,627 2,309
Mortgage loans - Section 475 416 441
Deferred income 376 427
Excess servicing 249 119
Other 792 511
Total $24,086 $21,352
1998 1997
Deferred tax liabilities:
Differing depreciable bases in premises and
leased equipment $10,597 $5,373
Purchased servicing 5,259 1,728
Originated mortgage servicing rights 2,456 1,017
Net unrealized appreciation
of securities available-for-sale 2,039 1,288
Differing bases in assets related to acquisitions 1,000 1,235
Discounts accreted on investment securities 157 210
Other 636 426
Total $22,144 $11,277
There was no valuation allowance at December 31, 1998 and 1997.
The reasons for the difference between income tax expense and the amount
computed by applying the statutory federal income tax rate (35 percent) to
income before income taxes are as follows:
Year Ended December 31
1998 1997 1996
Percent of Percent of Percent of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
(Dollars in thousands)
Statutory federal income tax $17,775 35.0% $14,917 35.0% $12,460 35.0%
Increase (decrease) in income
taxes resulting from:
Tax-exempt interest income (2,894) (5.7) (2,968) (7.0) (2,922) (8.2)
State taxes, net of federal
income tax benefit 2,783 5.4 2,339 5.5 2,123 5.9
Interest expense incurred to
carry tax-exempt securities 403 0.8 417 1.0 376 1.1
Contribution of appreciated
stock (150) (0.3) (358) (0.8) - -
Other (372) (0.7) 45 0.1 359 1.0
Total $17,545 34.5% $14,392 33.8% $12,396 34.8%
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- --Page 41--
NOTE L -- LEASES
1st Source and its subsidiaries are obligated under operating leases for
certain office premises and equipment. The headquarters building is leased for a
remaining term of 13 years with options to renew for up to 15 additional years.
Approximately 30% of the facility is subleased to other tenants.
At December 31, 1998, future minimum rental commitments for all
noncancellable operating leases, reduced by future minimum rentals from
subleases of $1.91 million, aggregate $17.41 million. Annual rental commitments
and sublease rentals for noncancellable operating leases (excluding operating
costs) for the five years succeeding December 31, 1998, are as follows:
Rental Sublease
Commitments Rentals
(Dollars in thousands)
1999 $ 2,105 $389
2000 1,845 388
2001 1,648 386
2002 1,395 382
2003 1,327 76
Thereafter $10,999 $291
Rental expense of office premises and equipment and related sublease income
were as follows:
Years Ended December 31
1998 1997 1996
(Dollars in thousands)
Gross rental expense $2,243 $2,190 $2,203
Sublease rental income (672) (677) (677)
Net Rental Expense $1,571 $1,513 $1,526
NOTE M -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
1st Source and its subsidiaries are parties to financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These off-balance-sheet financial instruments include
commitments to originate, purchase and sell loans, standby letters of credit and
interest rate swaps. The instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated statements of financial condition.
1st Source's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments and standby letters
of credit is represented by the dollar amount of those instruments. 1st Source
uses the same credit policies and collateral requirements in making commitments
and conditional obligations as it does for on-balance-sheet instruments.
Loan commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.
Trustcorp Mortgage Company grants mortgage loan commitments to borrowers,
subject to normal loan underwriting standards. The interest rate risk associated
with these loan commitments is managed by entering into contracts for future
deliveries of loans.
Letters of credit are conditional commitments issued by 1st Source to
guarantee the performance of a customer to a third party. The credit risk
involved and collateral obtained in issuing letters of credit is essentially the
same as that involved in extending loan commitments to customers.
As of December 1998 and 1997, 1st Source and its subsidiaries had commitments
outstanding to originate and purchase loans aggregating $362 million and $410
million, respectively. Outstanding commitments to sell loans aggregated $198
million at December 31, 1998 and $120 million at December 31, 1997. Commercial
and standby letters of credit totaled $82 million and $57 million at December
31, 1998 and 1997, respectively.
1st Source Bank participates in interest rate swap agreements as part of its
program to manage the impact of fluctuating interest
40
rates, namely with respect to floating rate loans.
Interest rate swaps generally involve the exchange of fixed and floating rate
interest payments without the exchange of the underlying notional amount.
Notional amounts represent agreed upon amounts on which calculations of
- --Page 42--
NOTE M -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK -- CONCLUDED
interest payments to be exchanged are based. Notional amounts do not represent
direct credit exposures. The actual market or credit exposure of this type of
financial instrument is significantly less than the notional amount. 1st
Source's direct credit exposure is limited to the net difference between the
calculated "to be paid" and "to be received" amounts on each transaction, which
is generally netted and paid or received monthly, and the inability of the
counterparty to meet the terms of the contract. This risk is normally a small
percentage of the notional amount and fluctuates as interest rates move up and
down. Market risk to 1st Source is more directly measured by the fair values of
the interest rate swap agreements.
At December 31, 1998, 1st Source had two outstanding amortizing interest rate
swap agreements with an aggregate notional value of $26.9 million. The
agreements have maturities of January 25, 2002 and March 25, 2001. The notional
amounts and lives of amortizing swaps change based on certain interest rate
indices. Generally, as rates fall, the notional amounts of amortizing swaps
decline more rapidly and as rates increase notional amounts decline more slowly.
Unrealized gains/(losses) based on fair value approximated $70,000 at December
31, 1998 and ($137,000) at December 31, 1997.
NOTE N -- CONCENTRATIONS OF CREDIT RISK
Most of 1st Source's commercial and agricultural, real estate and consumer
loan activity is with customers located in north-central Indiana and southwest
lower Michigan. 1st Source's commercial loans secured by transportation and
construction equipment are with customers located throughout the United States.
Included in loans as of December 31, 1998 and 1997, are business loans to
companies in the following industries:
Percentage of Total
Amount Business Loans
1998 1997 1998 1997
(Dollars in thousands)
Truck and automobile leasing $200,005 $267,596 13.9% 18.9%
Air transportation and aircraft dealers 199,459 179,653 13.9 12.7
Construction equipment and contractors 149,288 124,148 10.4 8.8
Real estate operators, managers and developers 64,381 74,542 4.5 5.3
Van conversion, manufactured housing
and recreational vehicle industries 61,405 52,870 4.3 3.7
Generally, these loans are collateralized by assets of the borrower. The
loans are expected to be repaid from cash flow or proceeds from the sale of
selected assets of the borrower. 1st Source requires collateral on substantially
all borrowings in these categories, which is typically the item being financed.
NOTE O -- CAPITAL ADEQUACY
1st Source is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on 1st
Source's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, 1st Source must meet specific
capital guidelines that involve quantitative measures of 1st Source's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. 1st Source's capital amounts and classification are
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require 1st Source to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital to risk-weighted assets, and of Tier I
capi-tal to average assets. Management believes, as of De-cember 31, 1998, that
1st Source meets all capital adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the federal bank
regulators categorized 1st Source Bank, the largest of 1st Source's
subsidiaries, as "well capitalized" under the regulatory framework for prompt
corrective action. To be
41
categorized as "well capitalized" 1st Source must maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in
- --Page 43--
NOTE O -- CAPITAL ADEQUACY -- CONCLUDED
the table. There are no conditions or events since that notification that
management believes changed the institution's category. 1st Source and its
largest subsidiary, 1st Source Bank's actual capital amounts and ratios are
presented in the table below:
To Be Well
Capitalized Under
Minimum Capital Prompt Corrective
Actual Adequacy Action Provisions
$ Amount Ratio $ Amount Ratio $ Amount Ratio
As of December 31, 1998: (Dollars in thousands)
Total Capital (to Risk-
Weighted Assets):
Consolidated $281,604 13.37% $168,444 8.00% $210,555 10.00%
1st Source Bank 253,379 12.42 163,203 8.00 204,003 10.00
Tier I Capital (to Risk-
Weighted Assets):
Consolidated 254,760 12.10 84,222 4.00 126,333 6.00
1st Source Bank 227,344 11.14 81,601 4.00 122,402 6.00
Tier I Capital (to Average Assets):
Consolidated 254,760 9.50 107,219 4.00 134,024 5.00
1st Source Bank 227,344 8.84 102,870 4.00 128,587 5.00
NOTE P -- COMMITMENTS AND CONTINGENT LIABILITIES
1st Source and its subsidiaries are defendants in various legal proceedings
arising in the normal course of business. In the opinion of management, based on
the advice of legal counsel, the ultimate resolution of these proceedings will
not have a material effect on 1st Source's consolidated financial position or
results of operations.
The consolidated financial statements do not reflect various commitments and
contingent liabilities, such as guarantees and liability for assets held in
trust, which arise in the normal course of business.
NOTE Q -- 1ST SOURCE CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION
STATEMENTS OF FINANCIAL CONDITION
December 31
1998 1997
ASSETS (Dollars in thousands)
Cash $1 $30
Short-term investments with bank subsidiary 3,402 2,244
Investment securities, available-for-sale
(amortized cost of $20,341 and $17,889
at December 31, 1998 and 1997, respectively) 20,999 18,873
Investments in:
Bank subsidiaries 229,713 182,919
Non-bank subsidiaries 11,687 11,098
Loan receivables:
Bank subsidiary _ 30,000
Non-bank subsidiary 7,755 4,000
Premises and equipment, net 3,150 3,398
Other assets 4,568 4,174
Total Assets $281,275 $256,736
42
December 31
1998 1997
LIABILITIES AND (Dollars in thousands)
SHAREHOLDERS' EQUITY
Commercial paper borrowings $6,171 $4,198
Other liabilities 2,689 1,356
Long-term debt 56,556 56,229
Total Liabilities 65,416 61,783
Shareholders' Equity 215,859 194,953
Total Liabilities and Shareholders' Equity $281,275 $256,736
- --Page 44--
NOTE Q -- 1ST SOURCE CORPORATION (PARENT COMPANY ONLY)
FINANCIAL INFORMATION -- CONTINUED
STATEMENTS OF INCOME
Year Ended December 31
1998 1997 1996
(Dollars in thousands)
Income:
Dividends from bank subsidiaries $6,596 $5,725 $5,029
Rental income from subsidiaries 2,363 2,273 2,071
Other 2,883 3,447 679
Total Income 11,842 11,445 7,779
Expenses:
Interest on long-term debt 4,612 3,810 1,015
Interest on commercial paper and
other short-term borrowings 264 309 274
Rent expense 1,076 1,076 1,074
Other 2,501 2,681 1,775
Total Expenses 8,453 7,876 4,138
Income Before Income Tax Credits and
Equity in Undistributed Income of Subsidiaries 3,389 3,569 3,641
Income tax credits 1,556 925 639
Income Before Equity in Undistributed
Income of Subsidiaries 4,945 4,494 4,280
Equity in undistributed income of subsidiaries:
Bank subsidiaries 23,194 19,736 18,257
Non-bank subsidiaries 2,881 2,259 666
Net Income $31,020 $26,489 $23,203
- --Page 45--
NOTE Q -- 1ST SOURCE CORPORATION (PARENT COMPANY ONLY)
FINANCIAL INFORMATION -- CONCLUDED
STATEMENTS OF CASH FLOWS
Year Ended December 31
1998 1997 1996
(Dollars in thousands)
Operating Activities:
Net income $31,020 $ 26,489 $23,203
Adjustments to reconcile net income to
net cash provided by operating activities:
43
Equity in undistributed income of subsidiaries (26,075) (21,995) (18,923)
Depreciation of premises and equipment 225 201 175
Realized and unrealized investment
securities gains (losses) 99 176 (52)
Other 2,284 3,054 2,854
Net Cash Provided by Operating Activities 7,553 7,925 7,257
Investing Activities:
Proceeds from sales and maturities
of investment securities 3,603 8,759 3,804
Purchase of investment securities (6,195) (15,788) (2,955)
Sale (purchase) of premises and equipment, net 23 (422) (471)
Contributed capital for new non-bank subsidiary - (1,384) -
Decrease (increase) in short-term investments
with bank subsidiary (1,158) 3,593 (582)
Decrease (increase) in loans made to
subsidiaries, net 6,245 (34,000) 300
Net Cash Provided by (Used in) Investing Activities 2,518 (39,242) 96
Financing Activities:
Net increase (decrease) in commercial
paper and other short-term borrowings 1,973 (2,269) 1,616
Proceeds from issuance of cumulative trust
preferred securities - 44,750 -
Proceeds from issuance of long-term debt 434 1,45 -
Payments on long-term debt (107) (2,834) (3,346)
Acquisition of treasury stock (7,116) (5,023) (1,488)
Cash dividends (5,296) (4,723) (4,123)
Other 12 (7) (12)
Net Cash Provided by (Used in) Financing Activities (10,100) 31,346 (7,353)
Increase (Decrease) in Cash and Cash Equivalents (29) 29 -
Cash and cash equivalents, beginning of year 30 1 1
Cash and Cash Equivalents, End of Year $1 $30 $ 1
- --Page 46--
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
1st Source Corporation:
In our opinion, the accompanying consolidated statements of financial
condition and the related consolidated statements of income, shareholders'
equity and of cash flows present fairly, in all material respects, the financial
position of 1st Source Corporation and its subsidiaries at December 31, 1998 and
1997, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Corporation's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
South Bend, Indiana
January 14, 1999
44
- --Page 47--
OFFICERS AND DIRECTORS
OFFICERS
[1ST SOURCE CORPORATION LOGO]
Christopher J. Murphy III Chairman of the Board, President and Chief Executive Officer
Wellington D. Jones III Executive Vice President
Larry E. Lentych Treasurer and Chief Financial Officer
Vincent A. Tamburo Secretary and General Counsel
DIRECTORS
Rev. E. William Beauchamp Executive Vice President, University of Notre Dame
Paul R. Bowles Former Vice President, Corporate Development,
Clark Equipment Company
Philip J. Faccenda General Counsel Emeritus, University of Notre Dame
Daniel B. Fitzpatrick Chairman, President and Chief Executive Officer,
Quality Dining, Inc.
Lawrence E. Hiler Chairman, Hiler Industries
William P. Johnson Chairman and Chief Executive Officer,
Goshen Rubber Company, Inc.
Wellington D. Jones III Executive Vice President
Rex Martin Chairman, President and Chief Executive Officer
NIBCO INC.
Dane A. Miller President and Chief Executive Officer, Biomet, Inc.
Christopher J. Murphy III Chairman, President and Chief Executive Officer
Richard J. Pfeil Chairman and President, Koontz-Wagner Electric Company, Inc.
[1ST SOURCE BANK LOGO]
OFFICERS
Christopher J. Murphy III Chairman of the Board and Chief Executive Officer
Wellington D. Jones III President and Chief Operating Officer
Allen R. Qualey President and Chief Operating Officer,
Specialty Finance Group
Richard Q. Stifel Executive Vice President, Business Banking Group
Larry E. Lentych Senior Vice President, Treasurer and Chief Financial Officer,
Finance and Administrative Services Group
James S. Jackson Senior Vice President, Funds Management Division
Larry A. Gardner Senior Vice President, Operations Group
Steven J. Wessell Vice President, Trust Operations Group
Vincent A. Tamburo Senior Vice President and Secretary, General Counsel
Maggie M. Kernan Senior Vice President, Marketing Division
45
Dan L. Craft Senior Vice President, Human
Resources Division
DIRECTORS
Rev. E. William Beauchamp Executive Vice President, University of Notre Dame
Paul R. Bowles Former Vice President, Corporate Development,
Clark Equipment Company
Philip J. Faccenda General Counsel Emeritus, University of Notre Dame
Daniel B. Fitzpatrick Chairman, President and Chief Executive Officer,
Quality Dining, Inc.
Terry L. Gerber President and Chief Executive Officer,
Gerber Manufacturing Company, Inc.
Lawrence E. Hiler Chairman, Hiler Industries
Anne M. Hillman Civic Leader
Hollis E. Hughes, Jr. Executive Director, United Way of St. Joseph County
H. Thomas Jackson Chairman, Bornemann Coated Fabrics, Bornemann Products
William P. Johnson Chairman and Chief Executive Officer,
Goshen Rubber Company, Inc.
Wellington D. Jones III President
Craig A. Kapson President, Jordan Ford, Toyota, Volvo, Lincoln Mercury
David L. Lerman President, Steel Warehouse Co. Inc.
Christopher J. Murphy III Chairman and Chief Executive Officer
Richard J. Pfeil Chairman and President, Koontz-Wagner Electric Company, Inc.
John T. Phair President, Holladay Partners-Midwest, Inc.
Mark D. Schwabero President and Chief Executive Officer, Hendrickson International
Elmer H. Tepe President, E.H. Tepe Co.
- --Page 48--
SHAREHOLDERS' INFORMATION
1998 STOCK PERFORMANCE AND DIVIDENDS
1st Source Corporation common stock is traded on the Over-The-Counter market
and is listed on the Nasdaq Stock Market under the symbol "SRCE." 1st Source is
also listed on the National Market System tables in many daily papers under the
symbol "1stSrc."
High and low common stock prices, cash dividends paid for 1998 and book value
were:
Cash
Dividends
Quarter Ended High* Low* Paid*
March 31 $ 33 3/4 $25 1/4 $.066
June 30 36 3/4 30 3/4 .066
September 30 36 27 1/2 .073
December 31 32 25 3/4 .073
Book value per common share at December 31, 1998: $11.43.*
46
*Adjusted for a 10% stock dividend declared January 14, 1999.
ANNUAL MEETING
OF SHAREHOLDERS
The Annual Meeting of Shareholders has been called for 10:00 am, EST, Thursday,
April 15, 1999, at 1st Source Center, 100 N. Michigan Street, South Bend,
Indiana.
All shareholders are invited to attend the meeting.
COMMON STOCK LISTING
The Nasdaq Stock Market National
Market Symbol: "SRCE"
CUSIP #336901 10 3
TRANSFER AGENT, REGISTRAR AND DIVIDEND DISBURSING AGENT
1st Source Bank
Post Office Box 1602
South Bend, IN 46634
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP
P.O. Box 6877
South Bend, IN 46660-6877
SHAREHOLDER INQUIRIES
1st Source Corporation
Larry E. Lentych
Chief Financial Officer
Post Office Box 1602
South Bend, IN 46634
(219) 235-2702
FORM 10-K INQUIRIES
A copy of 1st Source Corporation's Annual Report on Form 10-K for the year ended
December 31, 1998, as required to be filed with the Securities and Exchange
Commission, is available upon request.
MARKET MAKERS
(AS OF JANUARY 14, 1999)
The following firms make a market in the common shares of 1st Source
Corporation:
ABN-AMRO Securities (USA)
City Securities Corporation
Herzog, Heine, Geduld, Inc.
Howe, Barnes Investments, Inc.
Keefe, Bruyette & Woods, Inc.
NatCity Investments, Inc.
Roney Capital Markets
Stifel, Nicolaus & Company, Incorporated
Troster Singer Corporation
- --Outside Back Cover--
100 North Michigan Street
Post Office Box 1602
South Bend, Indiana 46634