2001 Annual Report
1st Source Corporation
Corporate Description 1
2001 in Brief 1
Financial Highlights 2
Letter to Shareholders 3
Banking Center Locations 8
Shareholders' Information 9
Officers and Directors Back Cover
Financial Report Enclosure
This Annual Report consists of two sections: the color shareholders' letter sec-
tion and a black and white section entitled "2001 Management's Discussion and
Analysis of Financial Condition and Consolidated Financial Statements and
Notes."
1st Source Corporation
(C) 2002 1st Source Corporation
All rights reserved
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 and cargo aircraft,
automobiles for leasing and rental agencies, heavy duty trucks, construction and
environmental equipment.
The corporation's principal subsidiary, 1st Source Bank, has 64 banking
centers in 17 counties in Indiana and Michigan, and 28 locations nationwide
supporting its Specialty Finance Group. 1st Source's wholly owned mortgage
banking subsidiary, Trustcorp Mortgage Company, has 8 offices in Indiana, Ohio,
Michigan and North Carolina. 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 it serves.
2001 in Brief
2001 net income of $38.5 million was the highest in 1st Source history and
2.5% higher than the $37.6 million earned in 2000. Adjusted for a 5% stock
dividend declared April 24, 2001, diluted net income per common share for 2001
was $1.82, up 1.7% from the $1.79 for 2000.
Return on average total assets was 1.14% compared to 1.24% a year ago.
Return on average common equity was 13.14% for 2001, compared to 14.88% for
2000. The average common equity-to-assets ratio for 2001 was 8.69%, compared to
8.31% last year.
At year-end 2001, total assets were $3.56 billion, up 12.0% from a year
earlier. Loans were up 9.8%, deposits were up 17.1%, and shareholders' equity
increased 13.2% from $270.6 million at the end of 2000 to $306.2 million at the
end of 2001.
The reserve for loan losses at year-end 2001 was 2.27% of total loans,
while nonperforming assets amounted to 1.69% of total loans.
1
Financial Highlights
Earnings and Dividends
(Dollars in thousands, except per share amounts) 2001 2000 1999 1998 1997
Operating income $ 335,019 $ 309,306 $ 263,689 $ 248,404 $ 208,972
Operating expense 273,252 249,305 207,191 196,883 166,353
Net income 38,498 37,573 35,768 31,457 26,489
Cash dividends 7,297 6,956 5,922 5,296 4,723
Per common share *
Diluted net income $ 1.82 $ 1.79 $ 1.69 $ 1.47 $ 1.23
Cash dividends .351 .334 .284 .252 .226
Book value 14.73 13.07 11.46 10.41 9.29
Return on average common equity 13.14% 14.88% 15.74% 15.30% 14.51%
Return on average total assets 1.14% 1.24% 1.31% 1.23% 1.21%
Statement of Condition
Average Balances:
Assets $3,369,943 $ 3,040,091 $ 2,740,044 $ 2,550,925 $ 2,198,300
Earning assets 3,065,891 2,767,721 2,478,182 2,344,555 2,046,637
Loans 2,464,798 2,207,382 1,949,172 1,853,537 1,610,889
Reserve for loan losses 50,895 41,441 39,105 38,050 31,966
Investment securities 568,631 537,083 510,656 445,310 424,086
Deposits 2,636,361 2,352,207 2,127,171 1,999,514 1,698,973
Shareholders' equity 292,986 252,574 227,194 205,601 182,543
* The computation of per common share data gives retroactive recognition to a 5%
stock dividend declared April 24, 2001; a 5% stock dividend declared July 18,
2000; a 10% stock dividend declared January 14, 1999; and a 10% stock dividend
declared January 20, 1998.
2
To Our Shareholders: 2001
2001 ended as it began: a weakened and difficult economy trying hard to find
bottom. Throughout the year, the Federal Reserve Board moved aggressively to cut
interest rates in the hope of avoiding a recession. Those of us in the Midwest
serving the durable goods manufacturing industries knew well before the
economists declared it, that a recession had occurred in the second and third
quarters of 2001. Then, the tragic events of September 11 added a crushing blow
to the fourth quarter. The technology sector and basic manufacturing,
represented by autos, trucks and steel, sagged severely. We were negatively
impacted in almost all of our businesses. With this as a background, I am
pleased that 1st Source was able to achieve an earnings increase of 2.5 percent
and an earnings per share increase of 1.7 percent for the year. We were also
able to expand our primary banking market by acquiring two branches in Michigan,
two in Northwestern Indiana and thirteen in the Fort Wayne, Indiana market area.
The last brought $222 million in new deposits, thousands of customers and over a
hundred new colleagues.
The Numbers
Net income for 2001 was $38.50 million, a slight increase of 2.5 percent
over the $37.57 million reported in 2000. Earnings per share for 2001 were
$1.82, up 1.7 percent from the $1.79 attained in 2000. Year-end shareholders'
equity totaled $306.2 million, up 13.2 percent from the $270.6 million at the
close of 2000. Total assets grew substantially and were $3.56 billion at the end
of 2001, up 12.0 percent over last year. Total deposits were $2.88 billion, up
17.1 percent over the end of 2000. Loan growth was also robust for the year with
total loan and lease balances of $2.54 billion, an increase of 9.8 percent over
the $2.31 billion in 2000. Our return on assets was 1.14 percent and our return
on equity -- a respectable 13.14 percent.
Numerous factors negatively impacted our earnings in 2001. These included
substantial provisions to our loan loss reserves of $28.6 million -- an almost
100 percent increase over last year. This addition was made to cover the growth
in non-performing assets and substantial net charge-offs of $4.6 million in our
commercial portfolio and $6.0 million in our aircraft and auto rental
portfolios.
In the fourth quarter, we took a write-down of $692,000 in our venture
investment portfolio reflecting revaluation of portfolio investments both in and
out of the technology sector. Even with the write-down, a small profit was
achieved in our venture investments for the year. We also experienced a dramatic
333 percent increase in check fraud over last year amounting to losses of close
to $1.0 million. We responded quickly to this situation by installing
significantly more sophisticated systems to reduce future fraud exposure.
Our non-performing assets grew substantially this past year, rising from
$24.46 million at the end of 2000 to $42.92 million at the end of 2001. Even
with the increased charge-offs of .54 percent of average loans in 2001, we ended
the year with a strong loan loss reserve of $57.62 million, giving us a ratio of
2.27 percent to loans. This compares to a reserve of 1.93 percent of loans at
the end of 2000. Since we still anticipate problems with the economy through all
of 2002 and the possible deterioration in some portfolios, we believe it best to
go into 2002 with a strong reserve.
Growth
1st Source Corporation also showed strong positives during 2001. At the
very early part of the year, we believed that the market valued mortgage
servicing assets much higher than we valued them. As a result, we sold $1.0
billion in servicing rights and recognized a $6.87 million gain on the sale, net
of tax. We expected to replace the servicing from our retail and wholesale
mortgage production activities over the next several years. With the aggressive
reduction of interest rates by the Federal Reserve Board, an unprecedented
refinance wave hit during 2001. By the close of the year, we had replaced 68
percent of the servicing sold in the first quarter. The mortgage finance volume
in our mortgage subsidiary, Trustcorp Mortgage, was $1.81 billion in 2001, a 200
percent increase over the $606.0 million in 2000.
3
1st Source expanded its retail market presence through the purchase of 17 branch
locations this past year,adding over $321 million to our deposits. These
purchases helped grow our branch presence to 64 by the close of the year, up
from 49 at the beginning. It also gave us a whole new market by extending our
reach into the Fort Wayne area. We now have branches in 14 counties in Indiana
and 3 counties in Michigan. Our service area has grown from a population of 1.2
million in 2000 to 1.6 million at the close of 2001, offering us both challenges
and opportunities in the years ahead.
1st Source Insurance, which serves both the commercial and personal areas, also
grew nicely during the year and increased its contribution to our net income by
67.5 percent. While presently not a big portion of our business, we believe it's
an important service to our clients and a necessary part of a balanced financial
plan.
We continued to add experienced professionals in our Specialty Finance
businesses and now have people in 28 locations across the country versus 23
locations at the end of 2000. We expanded our truck financing business and added
a specialty capability in the financing of step vans. The creation of a new
subsidiary, 1st Source Corporation Investment Advisors, Inc. reflects the
continued success of our investment management. Our capabilities were recognized
throughout the year, as a number of our mutual funds were identified as among
the best managed in the country. The Wall Street Journal, Barron's, Investment
News Magazine, and Lipper listed or mentioned the 1st Source Monogram Income
Equity Fund or the 1st Source Monogram Special Equity Fund as among the top
performing funds in their catagories. Also, Morningstar, the leading mutual fund
rating organization, bestowed its 5-star (highest) and 4-star ratings,
respectively, on these 1st Source Monogram funds during the year.
4
New assets under management in our Personal Asset Management area grew
strongly in 2001, as customers, recognizing the soundness of our long-term
approach to money management, added dollars to accounts managed by both our
Investment Advisory subsidiary and our Asset Management Group.
People
With the opening of an entirely new market in Fort Wayne (on the heels of
branch acquisitions in St.Joseph, Michigan and LaPorte and Michigan City,
Indiana), the strength and depth of the 1st Source team was once again
demonstrated. The acquisitions were a clear departure from our "de novo"
strategy and at a scale that was dramatically larger than we had undertaken in
quite some time. We were converting a group of Savings & Loan branches into
banking offices. While not flawless, I could not have been more pleased with the
energy, enthusiasm, professionalism, and success of my colleagues. People from
accounting, legal, operations, security, systems, facilities, communication, and
marketing all worked around the clock to make this transition as smooth as
possible for our new customers. Volunteers from a number of our banking centers
in Michiana even stayed in Fort Wayne for a week, serving as ambassadors to help
our new Fort Wayne colleagues deal with both the customer and internal issues
that developed during their first week as part of the 1st Source family. The
teamwork among our Michiana colleagues and the 100+ new "1st Sourcers" in Fort
Wayne was inspiring. I could not have been more proud.
We asked our colleague, Glenn Borden, who has done a wonderful job building
our Community Banking Division over the last 16 years, to move from Plymouth,
Indiana, to Fort Wayne. This was no small sacrifice as he and his wife,
Janellen, had become very much a part of the fabric of the community they
served. Uprooting and starting over was asking a lot of them, considering how
active they are in church, school and United Way, not to mention having to leave
friends and family. To their credit, they agreed, and now we have good
leadership for 1st Source in Fort Wayne and will have a wonderful couple leading
our effort to become an integral part of the Fort Wayne community.
John Del Vecchio, manager of our Bremen facility, also moved to Fort Wayne
to give Glenn some much-needed operations and lending assistance. John has a
solid understanding of how we do things and will do a good job inculcating 1st
Source values among our new colleagues. Glenn's move gave us an opportunity to
promote Bob Ax to President of the Community Banking Division. Bob has
distinguished himself as our leading agricultural banker and he and his wife,
Sandy, are also closely involved in the Marshall and Starke County communities.
Bob has always brought a very serious and determined approach to the business
and, as expected, he is performing very well in his new leadership position.
Connie Lemler, an affable and aggressive agriculture banker was promoted to
Manager of the Ag Banking Division. She has had a wonderful career at 1st
Source, and we're pleased she has taken on these additional management
challenges.
Many people at 1st Source distinguish themselves daily by giving
exceptional service to our customers or to each other. As in all businesses that
rely on teamwork to succeed, there are hundreds of unsung heroes at 1st Source
and every one of them makes a significant contribution to our success. We have a
strong collegial environment and recognize we are interdependent on each other.
No one of us can perform well without the active assistance of many others. So,
when you read the few names I have cited, think of them as representatives of
many others doing the same things, making the same sacrifices, providing the
same commitment, and bringing the same professionalism to the job every day.
I mentioned the excellent results achieved by our investment management
area. This year, Ralph Shive and Brian Bythrow were each recognized time and
again for the success of the funds they manage. Steve Wessell, head of our
Personal Asset Management Group, has a great team of customer service people and
investment managers. 1st Source Corporation Investment Advisors, Inc. was
established in 2001 as a new subsidiary, allowing us to focus our skills on both
funds management and individual client asset management. Working together, the
Personal Asset Management Group has built a successful presence for 1st Source
in South Bend/Mishawaka, Elkhart, Warsaw, Plymouth and Goshen, and is now poised
to do the same in St. Joseph, Michigan. Of course, we will assess our
opportunities in Fort Wayne during the next year and develop a long-term
approach for that market.
5
Systems and Facilities
To make a business work, you must have good people with adequate facilities
in the right places and appropriate infrastructure supporting them. We have
continued to build out our old First Bank building by moving a number of
operations into its vacant space. We refurbished two floors in our corporate
headquarters, allowing us to increase our density and accommodate the growth of
our businesses without taking on new space commitments. We consolidated our
storage areas to increase the efficiency and effectiveness of file utilization.
Similarly, we continued to decentralize where appropriate, added space in
Indianapolis to accommodate the growth of our Environmental Equipment Financing
Division, and leased new space in Wilmington, Ohio, to house our newest
business, step van financing.
A new banking center was built in St. Joseph, Michigan to consolidate two
existing locations; we acquired two additional locations in St. Joseph from Old
Kent; and we opened a new banking center in Three Rivers, Michigan. In LaPorte
County, Indiana, we purchased two branches from Citizens Financial; a downtown
LaPorte location and an office in Michigan City which we consolidated into our
existing branch there. Finally, 1st Source acquired thirteen locations from
Standard Federal in Fort Wayne, New Haven, Bluffton, Auburn, Columbia City and
Huntington, Indiana. This was a year of excellent growth in customer facilities.
During the year we undertook a number of initiatives to improve our
operations' performance and productivity. As in the past, we had a large number
of quality projects underway. Over 92 people received training in the use of
quality improvement tools in preparation for their participation in one of our
teams this year.
Over 108 teams, averaging five members per team, started projects during
the year, and over 88 teams completed their projects. Cost reduction from these
teams were in the hundreds of thousands of dollars, while revenue increases
reached the millions. Projects included the selection and installation of a new
check fraud system, reductions in overtime and over base hours, reduced cycle
times for balance forward allocations and a four-fold increase in "First
Contact" answers to customer questions. Quality improvement and quality planning
projects touched all areas of the Company, ranging from the large to the very
small. Our goal is to ensure that we are disciplined about everything we do,
that we collect data, properly analyze it, and then find lasting solutions to
problems. A continued dedication to the process can help us achieve just that.
Credit Quality
I cannot finish this letter without discussing credit. As I have often told
my colleagues, "credit is the Achilles Heel of banking. "We want to have
pristine credit quality. We know that there are business cycles, and we want to
serve our customers' needs mindful of these cycles. There is no question that
we, like any bank, are a reflection of the customers, the markets, and the
economies we serve.
Over the past 16 years we have had great success in Michiana and in our
national niche businesses. We have grown well and developed an enviable record
in "de novo" growth and credit quality. Over the last couple of years, however,
the economy has weakened in the technology and basic manufacturing areas. We
experienced more problems and greater charge-offs than we would have liked. Our
home market is a concentration of basic manufacturing in steel, autos, trucks,
appliances, mobile homes, recreational vehicles, farm equipment, construction
equipment, office furniture -- and suppliers to all of these. Our specialty
niche businesses are the financing of used aircraft for businesses and
individuals and cargo aircraft for the movement of small freight; automobiles
and trucks for the rental and leasing industries; construction machinery, and
environmental equipment.
6
As the economy slowed in technology and the financial markets reacted,
sales fell off in the basic businesses we serve in our home market. The same
thing happened around the country, prompting consumers to back off large
purchases. There was a slowdown in the RV and auto markets, a dramatic slowing
of the truck financing business, a serious curtailment in our cargo markets and
a drop off in air charter and plane purchases. Used product was increasingly
offered, inventories built and valuations decreased. High interest rates in 2000
and high energy prices in early 2001 also took their toll. The slowdown I wrote
about last year and mentioned in our quarterly press releases accelerated during
2001 into the third quarter. Just as we began to see an improvement, however,
September 11 happened and further jolted many of the industries we serve --
especially those related to travel and tourism. The rental car and air cargo
industries hit a crisis with a number of prominent companies declaring
bankruptcy.
In the face of this, we have aggressively built our reserves and written
down asset values and charged off loans. We have also looked upon this as a time
of opportunity to work through the tough times with our clients; it is one of
our basic values. We strive to have a strong balance sheet, take an aggressive
stand on charge-offs, and to distinguish ourselves in the market-place with
personal service. Our earnings growth may not have been as robust as we would
have liked this past year, but we are still a profitable company. We still make
money. We believe by being careful and cautious now and aggressively facing
concerns, we are building solid opportunities for the future. We believe this is
the best way to do business.
1st Source has distinguished itself as a personal service institution
serving customers from generation to generation. We have been doing this since
1863 and look forward to doing so for generations to come.
Kudos
In closing, I am pleased to report that in 2001 we were once again named to
Keefe, Bruyette & Woods, Inc.'s Honor Roll of banks which "acknowledges those
banking companies that have continually reported increases in earnings per share
regardless of the banking environment over the last decade." They report that of
the 138 banking companies in their active research universe, only 13 have
achieved this distinction.
Thank You
I want to thank all of my colleagues at 1st Source for making this a great
place to be. Their commitment and dedication to our customers and each other is
inspiring and humbling. I welcome to the 1st Source family our new colleagues in
St. Joseph and Three Rivers; in Michigan City and LaPorte; in Fort Wayne,
Auburn, Bluffton, Columbia City, Huntington, and New Haven, Indiana, and in
Wilmington, Ohio. Thank you to our Board of Directors and our advisory boards
for their support and guidance and especially to Sonny Tepe, who retires from
the 1st Source Bank Board after 30 years of service. His experience as a
multi-store retailer in the region, as a real estate owner and developer, and as
a trust customer have proven invaluable. We will miss his commitment and his
counsel.
Lastly, I want to thank you, our shareholders, for your support. We
rededicate ourselves to continue building a company you can be proud of as
owners.
Sincerely yours,
Christopher J. Murphy III
Chairman, President and Chief Executive Officer
7
SHAREHOLDERS' INFORMATION
2001 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 2001 and book value were:
Cash Dividends
Quarter Ended High Low Paid
March 31 $20.00 $16.31 $.086
June 30 28.07 17.26 .085
September 30 25.03 18.40 .090
December 31 22.71 19.65 .090
Book value per common share at December 31,2001: $14.73
Annual Meeting of Shareholders
The Annual Meeting of Shareholders has been called for 10:00 a.m., EST,
Thursday, April 25, 2002, 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
1stsource.com
For the latest shareholder information, log on to 1stsource.com. Click on the
"1st Source Corporation" link and follow the prompts.
If you would like to help us reduce printing costs by downloading our
quarterlies and our annual report directly from our website, please e-mail us at
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Transfer Agent, Registrar and Dividend
Disbursing Agent
1st Source Bank
Post Office Box 1602
South Bend, IN 46634
Independent Auditors
Ernst & Young LLP
1100 Huntington Center
41 S. High Street
Columbus, OH 43215
Shareholder Inquiries
1st Source Corporation
Larry E. Lentych
Chief Financial Officer
Post Office Box 1602
South Bend, IN 46634
(574) 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, 2001, as required to be filed with the Securities and
Exchange Commission, is available upon request.
Market Makers (as of January 28,2002)
The following firms make a market in the common shares of 1st Source
Corporation:
AnPac Securities Group, Inc.
Dain Rauscher, Inc.
First Tennessee Securities Corporation
Herzog, Heine, Geduld, Inc.
Keefe, Bruyette & Woods, Inc.
NatCity Investments, Inc.
Sandler, O'Neill and Partners
Schwab Capital Markets
Sherwood Securities Corporation
Spear, Leeds and Kellogg
Stifel, Nicolaus & Company
William Blair and Company
8
1st Source Corporation
OFFICERS
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
John B. Griffith.................Secretary and General Counsel
DIRECTORS
Rev. E. William Beauchamp........Executive Vice President 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................President, Flying J, LLC
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
Timothy K. Ozark.................Chairman and Chief Executive Officer, Aim
Financial Corporation
Richard J. Pfeil.................Chairman and President, Koontz-Wagner Electric
Company, Inc.
Claire C. Skinner................Chairman, President and Chief Executive
Officer, Coachmen Industries,Inc.
1st Source Bank
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...............Senior Vice President, Personal Asset Management
Group
John B. Griffith................Senior Vice President and Secretary, General
Counsel
Maggie M. Kernan................Senior Vice President, Marketing Division
Dan L. Craft....................Senior Vice President, Human Resources Division
DIRECTORS
Rev. E. William Beauchamp.......Executive Vice President Emeritus, University of
Notre Dame
Marilou Eldred, Ph. D...........President, Saint Mary's College
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
Hollis E. Hughes,Jr.............Executive Director, United Way of St.
Joseph County
H. Thomas Jackson...............Chairman, Bornemann Coated Fabrics, Bornemann
Products
William P. Johnson..............President Flying J, LLC
Wellington D. Jones III.........President
Craig A. Kapson.................President, Jordan Automotive Group
David L. Lerman.................Chief Executive Officer, Steel Warehouse Co.
Inc.
Christopher J. Murphy III.......Chairman and Chief Executive Officer
Timothy K. Ozark................Chairman and Chief Executive Officer, Aim
Financial Corporation
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.
1st Source Corporation
100 North Michigan Street
PO Box 1602
South Bend, Indiana 46634
9
2001 MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND CONSOLIDATED
FINANCIAL STATEMENTS AND NOTES
1st Source Corporation
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 $3.56 billion in total assets, $2.54 billion in total loans, $2.88
billion in total deposits, and $306.2 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 approximately 98% 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 activities, 1st Source also
provides highly specialized financing services for automobile fleets in the
rental and leasing industries; privately owned aircraft for businesses and
individuals; heavy duty trucks; step vans; construction and environmental
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, 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, per formance and
assumptions, and other statements that are other than statements of historical
fact. 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 accounting principles generally accepted in the United States;
1st Source's competitive position within its markets served; increasing
consolidation within the banking industry; 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.
1st Source Corporation and Subsidiaries
Selected Consolidated Financial Data
(Dollars in thousands, except per share amounts) 2001 2000 1999 1998 1997
Interest income $ 242,183 $ 235,392 $ 200,429 $ 196,148 $ 173,316
Interest expense 123,397 130,425 100,726 102,227 87,324
Net interest income 118,786 104,967 99,703 93,921 85,992
Provision for loan losses 28,623 14,877 7,442 9,156 6,052
Net interest income after
provision for loan losses 90,163 90,090 92,261 84,765 79,940
Noninterest income 92,836 73,914 63,260 52,256 35,656
Noninterest expense 121,232 104,003 99,023 85,500 72,977
Income before income taxes 61,767 60,001 56,498 51,521 42,619
Income taxes 21,059 20,030 18,471 17,843 14,392
Distribution on preferred securities of
subsidiary trusts, net of income tax benefit 2,210 2,398 2,259 2,221 1,738
Net income $ 38,498 $ 37,573 $ 35,768 $ 31,457 $ 26,489
Assets $3,562,691 $ 3,182,181 $ 2,872,945 $ 2,733,592 $2,418,154
Long-term debt 11,939 12,060 12,174 13,189 16,656
Shareholders' equity 306,190 270,572 238,820 216,793 194,953
Basic net income per common share * 1.85 1.81 1.71 1.50 1.27
Diluted net income per common share * 1.82 1.79 1.69 1.47 1.23
Cash dividends per common share * .351 .334 .284 .252 .226
Return on average common equity 13.14% 14.88% 15.74% 15.30% 14.51%
Return on average total assets 1.14% 1.24% 1.31% 1.23% 1.21%
* The computation of per common share data gives retroactive recognition to a 5%
stock dividend declared April 24, 2001; a 5% stock dividend declared July 18,
2000; a 10% stock dividend declared January 14, 1999; and a 10% stock dividend
declared January 20, 1998.
Results of Operations
Net income in 2001 was $38.5 million, up from $37.6 million in 2000 and
$35.8 million in 1999. Diluted net income per common share was $1.82 in 2001,
$1.79 in 2000, and $1.69 in 1999 after giving retroactive recognition to stock
dividends.
Return on average total assets was 1.14% in 2001, compared to 1.24% in 2000
and 1.31% in 1999. Return on average common equity was 13.14% in 2001 versus
14.88% in 2000 and 15.74% in 1999.
Net income in 2001 was favorably affected by strong noninterest income
growth. 1st Source has been successful in generating additional noninterest
income as a way to mitigate the impact of increased loan charge-offs and
additional provisions to the loan loss reserve. The management of both
noninterest income and expense resulted in a greater increase in noninterest
income than expense. These actions enabled 1st Source to reduce the expense to
net revenue ratio below 53%for 2001.
Dividends declared on common stock in 2001 amounted to $.351 per share,
compared to $.334 in 2000 and $.284 in 1999. 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, 2001
and 2000 are summarized below.
Quarterly Results of Operations
Three Months Ended
(Dollars in thousands, except per share amounts) March 31 June 30 September 30 December 31
2001
Interest income $61,597 $62,557 $60,357 $57,672
Interest expense 34,427 32,899 30,401 25,670
Net interest income 27,170 29,658 29,956 32,002
Provision for loan losses 7,295 4,464 9,807 7,057
Investment securities and other
investment gains (losses) 1,032 52 - (645)
Income before income taxes and
subsidiary trust distributions 22,062 15,202 9,846 14,657
Net income 13,643 9,447 6,174 9,234
Diluted net income per common share * .65 .44 .29 .44
2000
Interest income $ 53,049 $ 58,065 $ 61,130 $ 63,148
Interest expense 27,850 31,577 34,830 36,168
Net interest income 25,199 26,488 26,300 26,980
Provision for loan losses 3,918 4,678 1,292 4,989
Investment securities and other
investment gains 497 - - 1,831
Income before income taxes and
subsidiary trust distributions 14,109 13,725 14,793 17,374
Net income 8,685 8,906 9,226 10,756
Diluted net income per common share * .41 .42 .44 .52
* The computation of per share data gives retroactive recognition to a 5% stock
dividend declared April 24, 2001 and a 5% stock dividend declared July 18, 2000.
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.
Sources of Funds
Core Deposits -- 1st Source's major source of investable funds is provided
by stable core deposits consisting of all interest bearing and noninterest
bearing deposits, excluding brokered certificates of deposit and certain
certificates of deposit of $100,000 and over. In 2001, average core deposits
equaled 61.18% of average total assets, compared to 62.41% in 2000 and 65.47% in
1999. The effective cost rate of core deposits in 2001 was 3.76%, compared to
4.25% in 2000 and 3.74% in 1999. During 2001, 1st Source Bank acquired a total
of 17 branch offices with core and other deposits of $322 million.
Average demand deposits (noninterest bearing core deposits) increased 7.01%
in 2001, compared to an increase of 0.66% in 2000. They represented 14.81% of
total core deposits in 2001, compared to 15.04% in 2000 and 15.80% in 1999.
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 manage the bank's interest rate sensitivity. During 2001, 1st Source's
reliance on purchased funds increased to 26.71% of average total assets from
25.75% in 2000.
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 special-purpose entity. The special-purpose entity
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 entity
generally retains the right to receive any excess cash flows of the trust. 1st
Source sold $230 million of loans in 2001 and $248 million of loans in 2000 in
conjunction with aircraft and auto loan securitization transactions.
Shareholders' Equity -- Management continues to emphasize profitable asset
growth and retention of equity in the business. Average shareholders' equity
equated to 8.69% of average total assets in 2001 compared to 8.31% in 2000.
Shareholders' equity was 8.59% of total assets at year-end 2001, compared to
8.50% at year-end 2000.
Investment of Funds
Investment Securities -- Investment securities at year-end 2001 increased
13.74% from 2000, following a 2.90% increase from year-end 1999 to year-end
2000. Investment securities at December 31, 2001 were $640 million or 17.98% of
total assets, compared to $563 million or 17.70% of total assets at December 31,
2000.
Loans -- Average loans, net of unearned discount, increased 11.66% in 2001,
following a 13.25% increase in 2000. Loans, net of unearned discount, at
December 31, 2001 were $2.54 billion and were 71.16% of total assets, compared
to $2.31 billion or 72.56% of total assets at December 31, 2000.
Commercial and agricultural lending outstandings, excluding those secured
by real estate, decreased 6.80% during 2001. Many of the industries 1st Source
serves experienced a marked decline in business activity in 2001, resulting in
reduced loan needs.
Maturities of Investment Securities at December 31, 2001
U.S. Treasury States and Political
and Agencies Subdivisions Other Securities Total
(Dollars in thousands)
Amount Yield Amount Yield Amount Yield Amount Yield
0 1 Year $129,516 4.42% $ 36,012 6.28% $ 4,783 4.68% $170,311 4.82%
1 5 Years 252,068 4.08 96,933 6.51 2,943 4.39 351,944 4.75
5 10 Years 10,262 4.99 6,855 6.90 5,070 3.08 22,187 5.14
Over 10 Years 43,021 4.12 4,200 6.41 48,815 6.02 96,036 5.19
Total $434,867 4.21% $144,000 6.46% $ 61,611 5.59% $640,478 4.85%
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.
Commercial loans secured by transportation and construction equipment at
year-end 2001 increased 13.60% from year-end 2000. Substantial growth occurred
in environmental and construction equipment with modest increases in aircraft
and heavy, medium and light trucks, whereas auto fleet rental and leasing
franchises declined, primarily due to decreased business and personal travel.
Also contributing to the increase, fewer loans were sold in 2001 through loan
securitizations than in 2000.
Real estate loans increased 17.84% during 2001. This increase was due to a
235.27% increase in residential mortgage loans held for sale. Residential
mortgage loans increased as customers refinanced to take advantage of lower
mortgage rates.
Consumer loans held steady as greater marketing efforts were offset by
customers utilizing mortgage refinances to make home improvements and to payoff
consumer debt.
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 uses 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, 2001, securities maturing in one year
amounted to $170.3 million, which represented 26.59% of the investment portfolio
as compared to 34.34% at year-end 2000. 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.
Interest Rate Risk Management -- 1st Source's Asset/Liability Management
Committee 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.
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 held by 1st Source (excluding Trustcorp Mortgage) at
December 31, 2001. The aggregate hypothetical decrease in pre-tax earnings is
estimated to be $620,000 on an annualized basis on all rate-sensitive financial
instruments 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 $3.02 million on an annualized basis on all rate-sensitive
financial instruments 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.
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 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.)
Operating 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
12.43% in 2001, following a 5.10% increase in 2000.
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 3.98% in 2001 compared to 3.92% in 2000
and 4.17% in 1999. The net interest margin was positively impacted in 2001
primarily due to the balance sheet composition being liability rate sensitive in
a falling rate environment.
Selected Statistical Information
Distribution of Assets, Liabilities, and Shareholders' Equity
Interest Rates and Interest Differential
Year ended December 31, 2001
Average Interest Income/ Yield/
(Dollars in thousands) Balance Expense Rate
ASSETS
Investment securities
Taxable $ 416,638 $ 22,695 5.45%
Tax exempt(1) 151,993 9,925 6.53
Net loans(2,3) 2,464,798 212,067 8.60
Other investments 32,462 820 2.53
Total earning assets 3,065,891 245,507 8.01
Cash and due from banks 99,453
Reserve for loan losses (50,895)
Other assets 255,494
Total $ 3,369,943
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing deposits $ 2,330,988 108,069 4.64
Short-term borrowings 325,456 14,455 4.44
Long-term debt 12,078 873 7.23
Total interest bearing
liabilities 2,668,522 123,397 4.62
Noninterest bearing deposits 305,373
Other liabilities 103,062
Shareholders' equity 292,986
Total $ 3,369,943
Net interest income $ 122,110
Net yield on earning assets
on a taxable equivalent basis 3.98%
2000 1999
Average Interest Income/ Yield/ Average Interest Income/ Yield/
Balance Expense Expense Rate Balance Expense Rate
$ 369,401 $ 22,264 6.03% $ 348,944 $ 20,049 5.75%
167,682 11,413 6.81 161,712 11,336 7.01
2,207,382 203,905 9.24 1,949,172 171,770 8.81
23,256 1,455 6.26 18,354 911 4.96
2,767,721 239,037 8.64 2,478,182 204,066 8.23
97,096 113,099
(41,441) (39,105)
216,715 187,868
$ 3,040,091 $ 2,740,044
$ 2,066,846 109,866 5.32 $ 1,843,692 84,839 4.60
327,941 19,664 6.00 283,035 14,995 5.30
12,193 895 7.34 12,492 892 7.14
2,406,980 130,425 5.42 2,139,219 100,726 4.71
285,361 283,479
95,176 90,152
252,574 227,194
$ 3,040,091 $ 2,740,044
$ 108,612 $ 103,340
3.92% 4.17%
(1) Interest income includes the effects of taxable equivalent adjustments,
using a 35% rate. Tax equivalent adjustments were $3,058 in 2001, $3,457
in 2000, and $3,441 in 1999.
(2) Loan income includes fees on loans of $6,394 in 2001, $6,043 in 2002,
and $5,745 in 1999. Loan income also includes the effects of taxable
equivalent adjustments, using a 35% tax rate. Tax equivalent adjustments
were $266 in 2001, $188 in 2000, and $196 in 1999.
(3) For purposes of this comparison, nonaccruing loans are included in the
daily average loan balance outstanding.
The yield on earning assets in 2001 was 8.01%, compared to 8.64% in 2000 and
8.23% in 1999. Average earning assets in 2001 increased 10.77%, following an
11.68% increase in 2000.The effective rate on interest bearing liabilities was
4.62% in 2001, compared to 5.42% for 2000 and 4.71% for 1999.
Noninterest Income --Supplementing the growth in net interest income was an
increase in noninterest income of 25.60% over 2000.The factors influencing the
growth were increases in deposit service charges, mortgage servicing sales,and
revenues generated from operating leases. In addition to the factors
above,investment gains contributed to an increase in noninterest income of
16.84% in 2000 over 1999.
Trust fees in 2001 were $9.67 mill ion,compared to $9.61 million in 2000 and
$8.95 mill ion in 1999. Trust fees increased 0.62% in 2001, following a 7.35%
increase in 2000.The downturn in stock prices negatively impacted recorded trust
fees in 2001.
Service charges on deposit accounts increased by 45.09% resulting in $11.71
million of income for 2001. The $8.07 mill ion recorded in 2000 was an increase
of 17.05% from the $6.90 million of service charges on deposit accounts
generated in 1999.Generally, overdraft fees and debit card fees accounted for
the increase in service charges on deposit accounts for both 2001 and 2000.
Loan servicing and sale income generated from 1st Source's aircraft and auto
loan securitization and mortgage banking activities increased 45.17% to $31.94
million in 2001. The $22.00 mill ion recorded in 2000 represented a
12.89%increase over 1999.Loan securitization income was $11.97 million during
2001, compared to $12.40 million during 2000.The outstanding servicing portfolio
of aircraft and auto loans remains at $350 million for year-end 2001 and 2000.
Gains of $19.34 mill ion were recognized on the sale of mortgage loans and
servicing in 2001,compared to gains of $7.03 million in 2000. In addition, net
servicing fees on mortgages declined to $625,000 for 2001,from $2.57 million for
2000.The significant increase in gains on the sale of mortgage loan servicing
and the decrease in mortgage loan servicing fees in 2001 are reflective of
Trustcorp Mortgage Company's $1.0 billion sale of mortgage servicing rights
during the first quarter of 2001.
Equipment rental income generated from operating leases increased to $26.25
million in 2001, a 23.68% increase over 2000.The $21.22 million recorded in 2000
was a 21.93% increase over 1999. Revenues from operating leases for construction
equipment, automobiles and other equipment,and the related depreciation on the
equipment have increased significantly in the past few years as 1st Source has
focused on increasing this line of business.
Other income experienced significant growth of 20.11%during 2001,compared to
only a 3.05% increase in 2000.The increase in 2001 was fueled by greater
consumer mortgage refinancings.The modest increase during 2000 was the result of
increases in insurance commissions and standby letter of credit fees.
The reduction in investment gains in 2001 is attributed to a realized gain of
$1.96 million on the sale of foreign bonds in 2000.The balance of the net
investment securities and other investment gains in 2001 and 2000 were primarily
the result of disposals and adjustments on venture capital investments.
Noninterest Expense --1st Source experienced an increase in noninterest expense
of 16.57%in 2001 compared to 5.03%for 2000. The leading factors contributing to
the increase of noninterest expense were in the form of costs to attract and
retain quality people, professional consulting fees,supply and communication
upgrades and improvements, and our continued branch expansion.Cost control
across allbusiness units and better utilization of resources continue to be a
major focus at 1st Source.
Salaries and employee benefits increased 14.74% in 2001,following an 4.00%
increase in 2000. Salaries and wages increased 17.78% in 2001 and 3.86% in 2000.
The increase in 2001 from the prior year was due,in part, to higher commissions
paid to mortgage originators. The number of full-time equivalent employees stood
at 1,260 at the end of 2001,compared to 1,070 and 1,083 at the end of 2000 and
1999,respectively.A major contributor to the increase in the number of full-time
equivalent employees was the acquisition of 17 branches in 2001,13 of which were
acquired in the fourth quarter. Employee benefits increased 4.04% in 2001,
following a 4.51% increase in 2000. The lower percentage of increase in employee
benefits for 2001 was primarily the result of an 18.87% decrease in executive
incentives in 2001, following a 12.90% increase in 2000. This decrease was
offset by an increase in group insurance expense of 18.99% in 2001,following a
6.12% decrease in 2000.
Occupancy expense in 2001 increased 9.70% from 2000, following a 6.56% increase
in 2000. The 2001 and 2000 increases were primarily due to normal annual lease
and operating cost adjustments and the newly acquired branches.
Furniture and equipment expense, including depreciation,increased in 2001 by
6.24%, following an 8.88% increase in 2000. The increase in 2001 is attributed
primarily to upgrades in hardware and computer systems and increased computer
processing charges.
Depreciation on operating leases increased 25.27% in 2001,following a
29.38% increase in 2000 due to the continued expansion of our operating lease
portfolio.
Supplies and communications expense increased 18.61% in 2001, following a
4.37% decrease in 2000. The increase in 2001 was primarily due to providing the
materials and up-to-date communication resources necessary to achieve optimal
service for our customers.
Business development and marketing expense increased 18.06% in 2001, following a
decrease of 15.06% in 2000. The increase in 2001 was in part due to advertising
and marketing campaigns related to the branch acquisitions.
An increase of 23.88% occurred in other expenses during 2001, compared to a
10.70% decrease in 2000. The increase in 2001 was attributable to increased
check forgery losses and professional consulting expenses.
Income Taxes -- Federal income taxes were $18.03 million and $17.43 million,
prior to the tax benefit of $1.19 million and $1.29 million relating to the
distribution on preferred securities of subsidiary trusts for 2001 and 2000,
respectively.After this benefit, 2001 federal income taxes were $16.84 million
or 30.43% of income after state taxes, compared to $16.14 million or 30.05% in
2000 and $14.04 million or 28.19% in 1999.
State income taxes were $3.03 million and $2.60 million in
2001 and 2000, respectively,prior to the tax benefit of $160,000 and $174,000
relating to the distribution on preferred securities of subsidiary trusts for
2001 and 2000, respectively. After this benefit, 2001 state income taxes were
$2.87 million, compared to $2.43 million in 2000 and $3.01 million in 1999.
Credit Experience
Provision for Loan Losses -- The ability of a bank to identify and assess
the risk factors af fecting 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 current economic
conditions affecting the loan portfolio, including changes to the portfolio mix
and past loan loss experience. The provision for loan losses for 2001 was $28.62
million, compared to $14.88 million in 2000 and $7.44 million in 1999. The
increase in the provision for loan losses in 2001 compared to 2000 reflects the
continued weakening economy as problem loans grew and charge-offs increased. The
higher net charge-offs occurred primarily in commercial and aircraft lending.
Net charge-offs of $13.36 million, $7.40 million, and $2.39 million were
recorded in 2001, 2000, and 1999, respectively.
The reserve for loan losses at December 31, 2001 totaled $57.62 million and
was 2.27% of loans, compared to $44.64 million or 1.93% of loans at December 31,
2000, and $40.21 million or 1.95% of loans at December 31, 1999. It is
management's opinion that the reserve for loan losses is adequate to absorb
losses inherent in the loan portfolio as of December 31, 2001.
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, except for mortgage loans, which are placed on
nonaccrual at the time the loan is placed in foreclosure. Nonperforming assets
amounted to $42.92 million at December 31, 2001, compared to $24.46 million at
December 31, 2000, and $14.51 million at December 31, 1999. Impaired loans
totaled $45.40 million, $37.01 million and $31.57 million at December 31, 2001,
2000, and 1999, respectively.
The overall increase in nonperforming assets for 2001 is primarily the
result of growing nonaccrual loans. The increase in nonaccrual loans is
primarily attributed to commercial loans secured by transportation and
construction equipment. In addition, there has been a moderate increase in other
real estate owned.
Nonperforming Assets at December 31
(Dollars in thousands) 2001 2000 1999 1998 1997
Loans past due over 90 days $ 453 $ 385 $ 254 $ 275 $ 730
Nonaccrual loans 35,825 19,168 11,967 9,266 10,030
Total nonperforming loans 36,278 19,553 12,221 9,541 10,760
Other real estate 3,137 1,697 1,167 424 335
Other assets 3,509 3,211 1,123 422 187
Total nonperforming assets $42,924 $ 24,461 $14,511 $10,387 $11,282
Nonperforming assets to loans,
net of unearned discount 1.69% 1.06% .70% .55% .63%
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, 2001, there were 1,119 holders of record of 1st Source common
stock.
1st Source's common stock is traded on the Nasdaq Stock Market under the
National Market symbol "SRCE." High and low stock prices and cash dividends paid
for the last two years by quarter were:
Cash Cash
2001 Sales Price Dividends 2000 Sales Price Dividends
Common Stock Prices High Low Paid High Low Paid
Quarter ended:
March 31 $20.00 $16.31 $.086 $23.13 $16.10 $.081
June 30 28.07 17.26 .085 20.86 14.17 .082
September 30 25.03 18.40 .090 20.60 14.17 .086
December 31 22.71 19.65 .090 20.42 13.93 .085
The above information gives retroactive recognition to a 5% stock dividend
declared April 24, 2001 and a 5% stock dividend declared July 18, 2000. At
December 31, 2001, the total market capitalization of 1st Source was
approximately $430.3 million.
Consolidated Statements of Financial Condition
December 31
(Dollars in thousands) 2001 2000
Assets
Cash and due from banks $ 129,431 $ 118,123
Federal funds sold and interest
bearing deposits with other banks 17,038 901
Investment securities, available-for-sale
(amortized cost of $632,712 and $503,238 at
December 31, 2001 and 2000, respectively) 640,478 503,910
Investment securities, held-to-maturity
(fair value of $0 and $60,332 at
December 31, 2001 and 2000, respectively) 0 59,212
Loans, net of unearned discount:
Commercial and agricultural loans 448,349 481,068
Commercial loans secured by
transportation and construction equipment 1,198,615 1,055,145
Loans secured by real estate 760,095 645,041
Consumer loans 128,305 127,808
Total loans 2,535,364 2,309,062
Reserve for loan losses (57,624) (44,644)
Net loans 2,477,740 2,264,418
Equipment owned under operating leases
(net of accumulated depreciation of
$40,826 and $29,616 at December 31, 2001
and 2000, respectively) 115,754 84,892
Premises and equipment
Land 6,789 4,509
Buildings and improvements 39,435 33,910
Furniture and equipment 29,317 25,024
Total premises and equipment 75,541 63,443
Accumulated depreciation (33,618) (29,860)
Net premises and equipment 41,923 33,583
Other assets 140,327 117,142
Total assets $3,562,691 $ 3,182,181
The accompanying notes are a part of the consolidated financial statements.
Consolidated Statements of Financial Condition
December 31
(Dollars in thousands) 2001 2000
Liabilities
Deposits:
Noninterest bearing $ 365,193 $ 293,564
Interest bearing 2,517,613 2,169,160
Total deposits 2,882,806 2,462,724
Short-term borrowings
Federal funds purchased and securities
sold under agreements to repurchase 214,709 192,307
Other 49,764 141,083
Total short-term borrowings 264,473 333,390
Long-term debt 11,939 12,060
Other liabilities 52,533 58,685
Total liabilities 3,211,751 2,866,859
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
21,587,919 shares in 2001 and 21,535,912
shares in 2000, less unearned shares
(206,915 -- 2001 and 154,892 -- 2000) 7,579 7,227
Capital surplus 214,001 195,197
Retained earnings 91,591 80,881
Cost of common stock in treasury
(593,044 shares -- 2001 and 680,341
shares -- 2000) (12,591) (14,954)
Accumulated other comprehensive income 5,610 2,221
Total shareholders' equity 306,190 270,572
Total liabilities and shareholders' equity $3,562,691 $ 3,182,181
Consolidated Statements of Income
1st Source Corporation and Subsidiaries
Year Ended December 31
(Dollars in thousands, except per share data) 2001 2000 1999
Interest and fee income:
Loans $ 211,801 $ 203,717 $ 171,575
Investment securities, taxable 22,695 22,264 20,049
Investment securities, tax-exempt 6,867 7,955 7,895
Total investment securities 29,562 30,219 27,944
Other 820 1,456 910
Total interest income 242,183 235,392 200,429
Interest expense:
Deposits 108,069 109,866 84,839
Short-term borrowings 14,455 19,664 14,995
Long-term debt 873 895 892
Total interest expense 123,397 130,425 100,726
Net interest income 118,786 104,967 99,703
Provision for loan losses 28,623 14,877 7,442
Net interest income after provision
for loan losses 90,163 90,090 92,261
Noninterest income:
Trust fees 9,672 9,612 8,954
Service charges on deposit accounts 11,714 8,073 6,897
Loan servicing and sale income 31,940 22,002 19,490
Equipment rental income 26,249 21,224 17,407
Other income 12,822 10,675 10,359
Investment securities and other
investment gains 439 2,328 153
Total noninterest income 92,836 73,914 63,260
Noninterest expense:
Salaries and employee benefits 62,614 54,572 52,472
Net occupancy expense 6,199 5,651 5,303
Furniture and equipment expense 9,428 8,874 8,150
Depreciation -- leased equipment 21,034 16,790 12,978
Supplies and communications 6,047 5,098 5,331
Business development and marketing expense 4,359 3,692 4,346
Other expense 11,551 9,326 10,443
Total noninterest expense 121,232 104,003 99,023
Income before income taxes and
subsidiary trust distributions 61,767 60,001 56,498
Income taxes 21,059 20,030 18,471
Distribution on preferred securities of
subsidiary trusts, net of income
tax benefit of $1,350 in 2001 and
$1,465 in 2000 2,210 2,398 2,259
Net income $ 38,498 $ 37,573 $ 35,768
Basic net income per common share $ 1.85 $ 1.81 $ 1.71
Diluted net income per common share $ 1.82 $ 1.79 $ 1.69
The accompanying notes are a part of the consolidated financial statements.
Consolidated Statements of Shareholders' Equity
1st Source Corporation and Subsidiaries
Cost of Accumulated
Common Other
Common Capital Retained Stock Comprehensive
(Dollars in thousands, except per share data) Total Stock Surplus Earnings in Treasury Income (Loss), Net
Balance at January 1, 1999 $ 216,793 $ 6,270 $ 121,456 $ 98,300 $ (12,723) $ 3,490
Comprehensive income, net of tax:
Net income 35,768 - - 35,768 - -
Change in unrealized appreciation
of available-for-sale securities (5,385) - - - - (5,385)
Total comprehensive income 30,383 - - - - -
Cost of 210,966 shares of common
stock acquired for treasury (6,646) - - - (6,646) -
Cash dividends ($.284 per share) (5,922) - - (5,922) - -
10% common stock dividend
($17 cash paid in lieu of fractional shares) (17) 613 58,449 (59,079) - -
Other 4,229 - - (758) 4,987 -
Balance at December 31, 1999 238,820 6,883 179,905 68,309 (14,382) (1,895)
Comprehensive income, net of tax:
Net income 37,573 - - 37,573 - -
Change in unrealized appreciation
of available-for-sale securities 4,116 - - - - 4,116
Total comprehensive income 41,689 - - - - -
Cost of 282,903 shares of common
stock acquired for treasury (4,990) - - - (4,990) -
Cash dividends ($.334 per share) (6,956) - - (6,956) - -
5% common stock dividend
($9 cash paid in lieu of fractional shares) (9) 344 15,292 (15,645) - -
Other 2,018 - - (2,400) 4,418 -
Balance at December 31, 2000 $ 270,572 $ 7,227 $ 195,197 $ 80,881 $ (14,954) $ 2,221
Comprehensive income, net of tax:
Net income 38,498 - - 38,498 - -
Cumulative effect of change
in accounting principle 688 - - - - 688
Change in unrealized appreciation
of available-for-sale securities 2,701 - - - - 2,701
Total comprehensive income 41,887 - - - - -
Cost of 71,514 shares of common
stock acquired for treasury (1,308) - - - (1,308) -
Cash dividends ($.351 per share) (7,297) - - (7,297) - -
5% common stock dividend
($10 cash paid in lieu of fractional shares) (10) 352 18,804 (19,166) - -
Other 2,346 - - (1,325) 3,671 -
Balance at December 31, 2001 $306,190 $ 7,579 $214,001 $ 91,591 $ (12,591) $ 5,610
The accompanying notes are a part of the consolidated financial statements.
Consolidated Statements of Cash Flows
1st Source Corporation and Subsidiaries
Year Ended December 31
(Dollars in thousands) 2001 2000 1999
Operating activities:
Net income $ 38,498 $ 37,573 $ 35,768
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 28,623 14,877 7,442
Depreciation of premises and equipment 25,779 21,159 17,099
Amortization of investment security
premiums and accretion of discounts, net 1,811 757 1,432
Amortization of mortgage servicing rights 4,382 5,485 5,787
Deferred income taxes (2,259) 3,013 (926)
Realized investment securities gains (439) (2,328) (153)
Realized gains on securitized loans (8,532) (8,880) (6,702)
Decrease (increase) in interest receivable 3,607 (5,011) (1,705)
(Decrease) increase in interest payable (9,184) 17,148 (2,209)
Other 1,798 (1,713) 13,580
Net cash provided by operating activities 84,084 82,080 69,413
Investing activities:
Proceeds from sales and maturities of
investment securities 336,827 213,942 253,736
Purchases of investment securities (408,611) (222,091) (271,441)
Net (increase) decrease in
short-term investments (15,987) 348 40,552
Loans sold or participated to others 236,741 259,126 335,205
Increase in loans net of
principal collections (449,283) (522,526) (522,499)
Purchase of loans (29,641) - -
Net increase in equipment owned
under operating leases (48,385) (37,491) (24,389)
Purchases of premises and equipment (11,673) (3,905) (5,899)
Decrease (increase) in other assets 4,040 412 (8,584)
Net cash paid in purchase acquisition (27,821) - -
Other (1,412) (535) (1,025)
Net cash used in investing activities (415,205) (312,720) (204,344)
Financing activities:
Net increase (decrease) in demand deposits,
NOW accounts and savings accounts 82,696 130,948 (66,741)
Purchase of demand deposits and
savings accounts 129,451 - -
Net increase in certificates of deposit 15,845 204,325 17,086
Purchase of certificates of deposits 192,090 - -
Net (decrease) increase in
short-term borrowings (68,917) (76,352) 167,583
Proceeds from issuance of long-term debt 217 255 2,211
Payments on long-term debt (338) (369) (3,226)
Acquisition of treasury stock (1,308) (4,990) (6,646)
Cash dividends (7,297) (6,956) (5,922)
Other (10) (9) (17)
Net cash provided by financing activities 342,429 246,852 104,328
Increase (decrease) in cash and
cash equivalents 11,308 16,212 (30,603)
Cash and cash equivalents, beginning of year 118,123 101,911 132,514
Cash and cash equivalents, end of year $ 129,431 $ 118,123 $ 101,911
The accompanying notes are a part of the consolidated financial statements.
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 R, 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 accounting principles
generally accepted in the United States 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.
Securities held-to-maturity, when present, are carried at amortized cost.
There were no securities held-to-maturity at December 31, 2001. 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, 2001 or 2000. Realized gains and losses on the sales of all securities are
reported in earnings and computed using the specific identification cost
basis.
On adoption of SFAS No.133, 1st Source was permitted to transfer
held-to-maturity debt securities to available-for-sale or trading securities
without calling into question the intent of management to hold other debt
securities to maturity in the future. In conjunction with the adoption of SFAS
No. 133, 1st Source transferred the held-to-maturity portfolio with an amortized
cost of $59.2 million and a gross unrealized gain of $1.1 million into the
available-for-sale portfolio at January 1, 2001.
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 $173.5 million and $51.8 million at December
31, 2001 and 2000, respectively.
Securitized Assets -- The guidelines set forth in Statement of Financial
Accounting Standards (SFAS) No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, "are followed when
accounting for securitizations. When 1st Source sells loans in securitizations,
it retains servicing rights and interest-only strips. The interest-only strips
are capitalized as 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 certain key assumptions. Key
assumptions used by 1st Source in its securitization model are as follows:
discount rate (15%); loan loss assumption for cash flow purposes (0.50%);
interest earned on the trust cash tied to the 30 day LIBOR; and future
liquidations of securitized loans based on an 18 month rolling historical
average. In conjunction with its securitization activities, 1st Source sold $230
million of aircraft and auto loans in 2001 and $248 million in 2000.
Securitization activities generated income of $11.97 million in 2001 and $12.40
million in 2000.
Included in the consolidated statements of financial condition, as other
assets, are the retained interests in the securitized assets. The retained
interests are assets of 1st Source Funding, LLC ("Funding"), a special-purpose
subsidiary of 1st Source Bank, and represent Funding's beneficial interests in
certain assets of the 1st Source Master Trust in accordance with 1st Source's
loan securitization transactions. The recorded fair value of the retained
interests decreased to $21.2 million in 2001 from $22.5 million at year
end 2000. Changes in fair value are recorded as a component of other
comprehensive income. Declines in fair value that are other than temporary are
reported in net income.
The following analysis shows the impact on the fair value of the retained
interests for unfavorable, hypothetical changes in the key assumptions used to
value the retained interests:
1. An increase in the loss assumption from 0.50% to 0.75% and 1.00% reduces
the fair value by $1.12 million and $2.27 million, respectively.
2. An increase in the discount rate from 15% to 18% and 20% reduces the fair
value by $940,000 and $1.53 million, respectively.
3. A decrease of 0.50% and 1.00% in the trust cash earnings rate reduces the
fair value by $293,000 and $586,000, respectively.
4. An increase in future liquidations from the current assumption by 50% and
100% reduces the fair value by $627,000 and $1.10 million, respectively.
These results of the above analysis are hypothetical and should be used
with caution. As some of the figures indicate, changes in fair value based on
unfavorable variations in key assumptions generally cannot be projected, because
the relationship of the change in the assumption to the change in fair value
vary. Also, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated above without changing any other
assumption. In reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit losses), which might alter the results.
As of December 31,2001,$350 million of securitized auto and aircraft loans
are outstanding, all of which qualified for sale accounting. In addition,$20.89
million or 6.0% of securitized loans are 60 days or more delinquent. Credit
losses, net of recoveries,for 2001 and 2000,were 1.38% and 0.05%, respectively.
Mortgage Servicing Rights -- The costs of purchasing the rights to service
mortgage loans originated by others are defer red 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 noninterest income in the period
in which such rights are sold on a servicing released basis.
SFAS No.140 allows companies to allocate a portion of the total costs of the
originated mortgage loans to servicing rights, based on their relative 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 31,2001 and 2000, $20.1 million
and $18.7 million, respectively,of mortgage servicing rights have been
capitalized. As of these dates, the servicing rights had a fair value of $29.9
million and $33.4 million respectively.
Mortgage servicing rights are being amortized using a method which
approximates the income forecast method. For the years ended December
31, 2001, 2000,and 1999,$4.38 million, $5.49 million and $5.79 million of
amortization expense has been recognized.
SFAS No.140 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, and the predominant risk characteristics of the underlying loans. There
were no valuation allowances associated with capitalized mortgage servicing
rights at December 31, 2001 and 2000.
Revenue Recognition -- Interest on loans is included in interest income,using
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 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.
Loan origination and commitment fees and direct loan origination costs, when
material, are defer red and the net amount amortized to interest income
generally over the contractual life of the related loan or commitment.
Reserve for Loan Losses -- The reserve for loan losses is maintained
at a level believed to be adequate by management to absorb probable losses
inherent in the loan portfolio. Management evaluates the adequacy of the
reserve, reviewing all loans over a fixed-dollar amount where the internal
credit rating is at or below a predeter mined classification, actual and
anticipated loss experience, current economic events in specific industries
and other pertinent factors including general economic conditions. Determination
of the reserve is inherently subjective as it requires significant
estimates, including the amounts and timing of expected future cash flows or
fair value of collateral on collateral dependent impaired loans, estimated
losses on pools of homogeneous loans based on historical loss experience and
consideration of economic trends, all of which may be susceptible to significant
change. Loan losses are charged off against the reserve, while recoveries of
amounts previously charged off are credited to the reserve. A provision
for loan losses is charged to operations based on management's periodic
evaluation of the factors previously mentioned as well as other pertinent
factors.
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 31 1/2
years.
Leased Assets -- 1st Source finances various types of construction
equipment, heavy duty trucks and automobiles under leases principally classified
as operating leases. Revenue consists of the contractual lease payments and
is recognized on a straight-line basis over the lease term, generally three to
seven years. Leased assets are being depreciated on a straight-line method over
the lease term to the estimate of the equipment's fair market value at lease
termination, also commonly referred to as "residual" value. These estimates are
reviewed periodically to ensure realization.
Trust Fees -- Trust fees are recognized on the accrual basis.
Income Taxes -- Deferred income taxes are determined under the liability method.
The significant components of the deferred tax assets and liabilities are the
tax effect of net temporary differences related principally to differing methods
of accounting for loan losses, accounting for depreciation on premises and
leased equipment and amortization of 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):2001, 20,767;
2000, 20,769; and 1999, 20,876. 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): 2001, 21,170; 2000, 20,982; and 1999, 21,211. The
computation of weighted-average number of shares gives retroactive effect to a
5% stock dividend declared April 24, 2001 and a 5% stock dividend declared July
18, 2000.
Funds Held in Trust for Investors and Mortgagors -- As of December 31,2001
and 2000, serviced mortgage loans which were owned by investors aggregated $1.30
billion and $1.77 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 $45.2 million
and $24.9 million at December 31, 2001 and December 31, 2000, 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, 2001,
2000, and 1999 for interest and for income taxes was $132.6 million and $19.7
million, $113.3 million and $18.8 million, and $102.9 million and $11.0 million,
respectively.
Segment Information -- 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, "Disclosure about
Segments of an Enterprise and Related Information. "Due to the nonrecurring net
gain of approximately $7 million on the sale of approximately $1 billion of
mortgage servicing rights during the first quarter of 2001, Trustcorp Mortgage
Company meets the quantitative thresholds for separate disclosure as set forth
by this Statement. However, excluding the above mentioned gain, Trustcorp
Mortgage Company's revenues fall below the 10 percent disclosure threshold in
all years presented. In addition, total assets of Trustcorp Mortgage Company are
less than 10 percent of the consolidated assets of 1st Source. Accordingly, no
disclosure is made.
Derivative Financial Instruments -- 1st Source occasionally enters into
derivative financial instruments as part of its interest rate risk management
strategies. These derivative financial instruments consist primarily of
interest rate swaps and forward sales. On January 1, 2001, 1st Source adopted
Statement of Financial Accounting Standards No.133 ("SFAS No. 133"), "Accounting
for Derivative Instruments and Hedging Activities," as amended. SFAS No.133
establishes accounting and reporting standards for derivative instruments
and forhedging activities and 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. The transition adjustment, in 2001, upon adoption of SFAS No.133,
was immaterial. Prior to 2001, these instruments were accounted for under the
accrual basis of accounting, whereby the income or expense was recorded as a
component of interest income. If a swap was terminated, the resulting gain or
loss was deferred and amortized over the remaining life of the derivative.
Recent Accounting Pronouncements -- In June 2001, FASB issued SFAS No.141,
"Business Combinations," which replaces APB Option 16. SFAS No.141 requires all
business combinations to be accounted for by the purchase method and eliminates
the pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. While SFAS No. 141 will affect how future
business combinations, if undertaken, are accounted for and disclosed in the
financial statements, the issuance of the new guidance had no effect on 1st
Source's results of operations, financial position, or liquidity during 2001.
In conjunction with the issuance of the new guidance for business
combinations, the FASB also issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which addresses the accounting and reporting for acquired goodwill and
other intangible assets and supersedes APB Opinion 17. Under the provisions of
SFAS No.142, goodwill and certain other intangible assets, which do not possess
finite useful lives, will no longer be amortized into net income over an
estimated life but rather will be tested at least annually for impairment based
on specific guidance provided in the new standard. Intangible assets determined
to have finite lives will continue to be amortized over their estimated useful
lives and also continue to be subject to impair ment testing. The provisions of
SFAS No. 142 were adopted by 1st Source as required, effective January 1, 2002.
Application of the nonamortization provisions of the statement is expected to
result in an increase in net income of approximately $220,000, or $.01 per
common share, in 2002 as compared to 2001. 1st Source believes the goodwill
acquired in the branch acquisitions, discussed in Note Q, will not be amortized
under SFAS No.142. During 2002, the FASB plans to address goodwill amortization
in bank branch acquisitions specifically considering SFAS No.72, which requires
goodwill amortization in certain instances.
Reclassifications -- Certain amounts in the prior period consolidated
financial statements have been reclassified to conform with the current year
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, 2001 and 2000 are summarized in the table below.
Carrying or Carrying or
Contract Value Fair Value Contract Value Fair Value
(Dollars in thousands) 2001 2000
Assets:
Cash and due from banks $ 129,431 $ 129,431 $ 118,123 $ 118,123
Federal funds sold and interest
bearing deposits with other banks 17,038 17,038 901 901
Investment securities, available-for-sale 640,478 640,478 503,910 503,910
Investment securities, held-to-maturity - - 59,212 60,332
Loans, net of reserve for loan losses 2,477,740 2,564,094 2,264,418 2,309,459
Liabilities:
Deposits 2,882,806 2,907,716 2,462,724 2,474,091
Short-term borrowings 264,473 264,473 333,390 333,390
Long-term debt 11,939 12,415 12,060 12,425
Guaranteed preferred beneficial interests
in the Company's subordinated debentures 44,750 41,490 44,750 41,714
Off-balance-sheet instruments * - (691) - (829)
* Represents estimated cash outflows required to currently settle the obligations at current market rates.
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 which use interest rates currently being offered
for loans with similar terms to borrowers of similar credit quality.
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
counter parties' credit standing.
Off-Balance-Sheet Instruments -- Fair values for off-balance-sheet instruments
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 of the assets and liabilities which 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, 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.
Note C -- Restrictions on Cash and 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, 2001 and 2000 was approximately $2.5 million and $5.1 million,
respectively.
Under available line of credit agreements, 1st Source may borrow up to $3
million. At December 31, 2001 and 2000, 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 at December 31, 2001, are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Aggregate
(Dollars in thousands) Cost Holding Gains Holding Losses Fair Value
Equity securities:
Marketable securities $ 38,944 $ 887 $ (1,095) $ 38,736
Other equity securities 5,791 286 - 6,077
Total equity securities 44,735 1,173 (1,095) 44,813
Debt securities:
United States Treasury and agency securities 376,806 5,019 (265) 381,560
Obligations of states and political subdivisions 141,346 2,724 (70) 144,000
Debt securities issued by foreign governments 725 - - 725
Corporate securities 3,917 85 - 4,002
Mortgage-backed securities 54,888 279 (132) 55,035
Other debt securities 10,295 61 (13) 10,343
Total debt securities 587,977 8,168 (480) 595,665
Total investment securities $ 632,712 $ 9,341 $ (1,575) $ 640,478
The amortized cost and estimated aggregate fair value of debt securities
classified as available-for-sale at December 31, 2001, by contractual maturity
(except for mortgage-backed securities), are shown to the right.
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
Estimated
Amortized Aggregate
(Dollars in thousands) Cost Fair Value
Due in one year or less $ 168,403 $ 170,307
Due after one year through five years 344,803 350,195
Due after five years through ten years 11,882 12,000
Due after ten years 14,176 14,285
Mortgage-backed securities 48,713 48,878
Total $ 587,977 $ 595,665
The amortized cost and estimated aggregate fair value of securities classified
as available-for-sale and held-to-maturity at December 31, 2000, are as follows:
Available-For-Sale
Gross Gross Estimated
Amortized Unrealized Unrealized Aggregate
(Dollars in thousands) Cost Holding Gains Holding Losses Fair Value
Equity securities:
Marketable securities $ 24,254 $ 780 $ (1,100) $ 23,934
Other equity securities 5,128 128 - 5,256
Total equity securities 29,382 908 (1,100) 29,190
Debt securities:
United States Treasury and agency securities 314,831 1,058 (307) 315,582
Obligations of states and political subdivisions 104,298 402 (185) 104,515
Debt securities issued by foreign governments 710 1 - 711
Corporate securities 12,323 56 (1) 12,378
Mortgage-backed securities 24,892 67 (175) 24,784
Other debt securities 11,805 5 (57) 11,753
Commercial paper 4,997 - - 4,997
Total debt securities 473,856 1,589 (725) 474,720
Total investment securities $503,238 $ 2,497 $ (1,825) $503,910
Held-To-Maturity
Gross Gross Estimated
Amortized Unrealized Unrealized Aggregate
Cost Holding Gains Holding Losses Fair Value
Equity securities:
Other equity securities $ 12,226 $ - $ - $ 12,226
Debt securities:
Obligations of states and political subdivisions 46,986 1,120 - 48,106
Total investment securities $ 59,212 $ 1,120 $ - $ 60,332
Other equity securities classified as available-for-sale at December 31,
2001 and as held-to-maturity at December 31, 2000 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. At December 31, 1999,
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
$3.14 million were included in debt securities, but were classified as loans in
the accompanying 2000 consolidated statements of financial condition. In 2000,
these debt securities were sold. 1st Source had no trading securities as of
December 31, 2001 and 2000. The following represents the segregation of cash
flows between securities available-for-sale and held-to-maturity.
2001 2000 1999
Available- Held-To- Available- Held-To- Available- Held-To-
(Dollars in thousands) For-Sale Maturity Total For-Sale Maturity Total For-Sale Maturity Total
Purchase of securities $408,611 $ - $408,611 $222,091 $ - $222,091 $270,835 $ 606 $271,441
Proceeds from sales of securities 2,160 - 2,160 4,460 - 4,460 3,315 - 3,315
Proceeds from maturities and
prepayments of securities 334,667 - 334,667 195,108 17,974 213,082 231,121 19,300 250,421
Gross gains of $47,000 and $1,964,000 were realized during 2001 and 2000,
respectively, on the sale of securities available-for-sale. The gross gain in
2000 was due to the sale of the $1.59 million of debt securities issued by
foreign governments mentioned above.
At December 31, 2001 and 2000, investment securities with carrying values of
$375.6 million and $272.5 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 $18.38 million and $25.89 million at
December 31, 2001 and 2000, respectively. During 2001, $10.55 million of new
loans were made and repayments and other reductions totaled $18.06 million.
Note F -- Reserve for Loan Losses
At December 31, 2001 and 2000, loans amounting to $35.83 million and $19.17
million, respectively, substantially all of which are collateralized, are
considered to be nonaccrual. Currently, 1st Source has no restructured loans.
Interest income for the years ended December 31, 2001, 2000, and 1999 would have
increased by approximately $2,816,000, $1,862,000, and $866,000, respectively,
if these loans earned interest at their full contract rate.
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. As of December 31, 2001 and 2000, impaired loans totaled $45.40
million and $37.01 million, respectively, of which $27.70 million and $15.19
million had corresponding specific reserves for loan losses totaling $6.94
million and $4.24 million, respectively. The remaining balances of impaired
loans had no specific reserves for loan losses associated with them. As of
December 31, 2001, a total of $33.78 million 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 2001, 2000, and 1999 the average
recorded investment in impaired loans was $45.69 million, $34.92 million, and
$19.32 million, respectively, and interest income recognized on impaired loans
totaled $3.40 million, $1.98 million, and $2.18 million, respectively.
Changes in the reserve for loan losses for each of the three years ended
December 31 are shown on page 26.
Note F -- Reserve for Loan Losses (concluded)
(Dollars in thousands) 2001 2000 1999
Balance, beginning of year $ 44,644 $ 40,210 $38,629
Provision for loan losses 28,623 14,877 7,442
Charge-offs, net of recoveries of $971 in 2001,
$1,673 in 2000, and $639 in 1999 (13,361) (7,402) (2,388)
Recaptured reserve due to loan securitizations (2,878) (3,041) (3,473)
Reserves related to loans acquired 596 - -
Balance, end of year $ 57,624 $ 44,644 $40,210
Note G -- Long-Term Debt
Details of long-term debt are as follows:
December 31
(Dollars in thousands) 2001 2000
Term loan (7.40%) $10,000 $ 10,000
Federal Home Loan Bank
borrowings (5.54%--6.98%) 1,010 1,020
Other 929 1,040
Total long-term debt $11,939 $ 12,060
Annual maturities of long-term debt outstanding at December 31, 2001 for
the next five years beginning in 2002 are as follows (in thousands): $10,255,
$462, $47, $217, and $82.
The $10.0 million term loan has a fixed interest rate of 7.40% 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.
At December 31, 2001, 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 $1.62 million of certain real estate loans.
Note H -- Common Stock
Effective January 1, 1996, 1st Source adopted SFAS No.123, "Accounting for
Stock-Based Compensation," 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 attributable to the fair value of stock
options and other stock-based compensation which 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. In addition, the
Executive Incentive Plan, the Special Long-Term Incentive Award Plan and the
Restricted Stock Award Plan are also accounted for under the provisions of APB
No.25. Compensation cost charged against income for these plans was $2.95
million, $3.64 million, and $3.22 million for the years ended December 31, 2001,
2000, and 1999, respectively.
Stock Option Plans -- 1st Source's incentive stock option plans include the
1992 Stock Option Plan (the "1992 Plan"), the 2001 Stock Option Plan (the "2001
Plan") and a certain other stock option agreement which became effective January
1, 1992. As of December 31, 2001, an aggregate 2,933,621 shares of common stock
are reserved for issuance under the above plans. Under the 2001 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, except for reload options, which
are given the remaining term of the original grant. Options under the 2001 Plan
generally vest in one to six 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 on the date of grant is estimated using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants made in 2001: dividend yield of 1.77%; expected
volatility of 30.63%; risk-free interest rate of 4.91%; and expected life of
6.51 years. The following table on page 27, is a summary of the activity with
respect to 1st Source's stock option plans for the years ended December 31,
1999, 2000, and 2001:
Weighted-
Number of Average
Shares Exercise Price
Options outstanding,
January 1, 1999 1,147,674 $15.69
Options granted 11,025 23.13
Options exercised (146,596) 6.40
Options forfeited (1,213) 32.15
Options outstanding,
December 31, 1999 1,010,890 17.09
Options granted - -
Options exercised (37,783) 8.35
Options forfeited (5,927) 13.90
Options outstanding,
December 31, 2000 967,180 17.47
Options granted 53,608 21.85
Options exercised (40,928) 9.09
Options forfeited (2,212) 10.60
Options outstanding,
December 31, 2001 977,648 18.07
Options exercisable,
December 31, 2001 915,638 $17.78
The following table summarizes information about stock
options outstanding at December 31, 2001:
Options Outstanding
Weighted-
Average Weighted-
Range of Number Remaining Average
Exercise Outstanding Contractual Exercise
Prices at 12/31/01 Life (Years) Price
$5.00 to $11.99 371,303 1.29 $ 7.16
12.00 to 29.99 247,973 5.02 15.54
30.00 to 31.99 358,372 6.55 31.12
Options Exercisable
Weighted-
Range of Number Average
Exercise Exercisable Exercise
Prices at 12/31/01 Price
$5.00 to$11.99 371,303 $ 7.16
12.00 to 29.99 188,389 13.50
30.00 to 31.99 355,946 31.12
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 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 1,2001,and runs through
May 31, 2003, with $262,326 in stock value to be purchased at $19.38 per share.
The fair value of the employees' purchase rights for the 2001 offering was
estimated using the Black-Scholes model with the following assumptions: dividend
yield of 1.86%; expected volatility of 40.69%; risk-free interest rate of 4.22%;
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:
2001 2000 1999
Net income (000s):
As reported $38,498 $ 37,573 $35,768
Pro forma 38,206 37,234 34,376
Diluted net income
per common share:
As reported $ 1.82 $ 1.79 $ 1.69
Pro forma 1.81 1.78 1.63
Executive Incentive Plan -- 1st Source's Executive Incentive Plan is also
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 2001, 2000,
and 1999 are summarized below:
2001 2000 1999
Number of shares 51,168 62,492 60,312
Weighted-average
grant-date fair value $13.07 $11.46 $10.22
Special Long-Term Incentive Award -- During February 2001 and February 1996, 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. The number of shares granted under
the Plan for 2001 is 46,353 and the weighted-average grant-date fair value is
$17.38.
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 Of ficer 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 2001, 2000, and 1999 are summarized below:
2001 2000 1999
Number of shares 22,737 2,481 1,285
Weighted-average
grant-date fair value $22.13 $18.50 $26.98
Note I -- Preferred Stock and Cumulative Preferred Securities
As of December 31, 2001, 1st Source has ten 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, due March 31, 2027. 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. The annual rate is 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. The annual rate is 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,
2001, 2000, and 1999, total pension expense for this plan amounted to $599,000,
$506,000, and $445,000, 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 contr ibutions to the plan, depending on its profitability.
Contribution expense for this plan for the years ended December 31, 2001, 2000,
and 1999, amounted to $1.89 million, $1.68 million, and $1.58 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.
Contribution expense for this plan for the years ended December 31, 2001, 2000,
and 1999, amounted to $320,000, $160,000, and $209,000, respectively.
In addition to the pension and profit sharing plans, 1st Source provides
certain health care and life insurance benefits for substantially all of its
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, 2001, 2000, and 1999 were not material.
Note K -- Income Taxes
Income tax expense is comprised of the following:
(Dollars in thousands) 2001 2000 1999
Current:
Federal $15,904 $ 15,129 $ 15,897
State 2,897 1,888 3,500
Total current 18,801 17,017 19,397
Deferred:
Federal 2,128 2,302 (637)
State 131 711 (289)
Total deferred 2,259 3,013 (926)
Total provision $21,060 $ 20,030 $ 18,471
Deferred tax assets as of December 31, 2001 and 2000 consisted
of the following:
(Dollars in thousands) 2001 2000
Deferred tax assets:
Reserve for loan losses $25,252 $ 20,884
Accruals for employee benefits 3,466 3,005
Asset securitization - 397
Deferred income 125 127
Excess servicing 258 190
Mortgage loans --Section 475 110 174
Other 384 856
Total $29,595 $ 25,633
Deferred tax liabilities as of December 31, 2001 and 2000
consisted of the following:
(Dollars in thousands) 2001 2000
Deferred tax liabilities:
Differing depreciable bases in
premises and leased equipment $19,902 $ 16,336
Purchased servicing 3,960 4,548
Originated mortgage servicing rights 2,600 2,472
Net unrealized gains on securities
available-for-sale 3,517 1,513
Asset securitization 818 -
Differing bases in assets related to
acquisitions 504 88
Discounts accreted on investment
securities 252 570
Other 446 251
Total $31,999 $ 25,778
There was no valuation allowance at December 31, 2001 or 2000.
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
2001 2000 1999
Percent of Percent of Percent of
Pretax Pretax Pretax
(Dollars in thousands) Amount Income Amount Income Amount Income
Statutory federal income tax $21,618 35.0% $ 21,000 35.0% $ 19,774 35.0%
Increase (decrease) in income
taxes resulting from:
Tax-exempt interest income (2,195) (3.6) (2,403) (4.0) (2,486) (4.4)
State taxes, net of federal
income tax benefit 1,968 3.2 1,689 2.8 2,087 3.7
Other (331) (0.5) (256) (0.4) (904) (1.6)
Total $21,060 34.1% $ 20,030 33.4% $ 18,471 32.7%
The tax expense (benefit) applicable to securities gains and losses for the years 2001, 2000, and 1999 was
$166,000, $883,000, and $58,000, respectively.
The following is a summary of the income tax effect allocated to other comprehensive income:
Year Ended December 31
2001 2000 1999
Before-Tax Tax Net-of-Tax Before-Tax Tax Net-of-Tax Before-Tax Tax Net-of-Tax
(Dollars in thousands) Amount Expense Amount Amount Expense Amount Amount Expense Amount
Unrealized gains (losses) on
available-for-sale securities
(including effect of change
in accounting principle) $ 5,958 $ 2,299 $ 3,659 $ 9,248 $ 3,747 $ 5,501 $(8,812) $(3,518) $(5,294)
Less, reclassification
adjustment for gains
realized in net income 439 169 270 2,328 943 1,385 153 62 91
Other comprehensive income $ 5,519 $ 2,130 $ 3,389 $ 6,920 $ 2,804 $ 4,116 $(8,965) $(3,580) $(5,385)
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 10 years with options to renew for up to 15 additional years.
Approximately 30% of the facilit y is subleased to other tenants.
At December 31, 2001, future minimum rental commitments for all
noncancellable operating leases, reduced by future minimum rentals from
subleases of $4.33 million, aggregate $11.39 million. Annual rental commitments
and sublease rentals for noncancellable operating leases (excluding operating
costs) for the five years succeeding December 31, 2001, are as follows:
Rental Sublease
(Dollars in thousands) Commitments Rentals
2002 $2,565 $ 402
2003 2,181 395
2004 1,917 394
2005 1,280 394
2006 1,220 393
Thereafter 6,554 2,355
Rental expense of office premises and equipment and related
sublease income were as follows:
Year Ended December 31
(Dollars in thousands) 2001 2000 1999
Gross rental expense $2,866 $ 2,817 $ 2,596
Sublease rental income (720) (734) (700)
Net rental expense $2,146 $ 2,083 $ 1,896
Note M -- Financial Instruments with Off--Balance-Sheet Risk
To meet the financing needs of its customers, 1st Source and its
subsidiaries are parties to financial instruments with off-balance-sheet risk in
the normal course of business. 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 under writing standards. The interest rate risk
associated with these loan commitments is managed by entering into contracts for
future deliveries of loans.
Note M -- Financial Instruments with Off--Balance-Sheet Risk (concluded)
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 2001 and 2000, 1st Source and its subsidiaries had
commitments outstanding to originate and purchase loans aggregating $366 million
and $135 million, respectively. Outstanding commitments to sell loans aggregated
$228 million at December 31, 2001 and $75 million at December 31, 2000.
Commercial and standby letters of credit totaled $114 million and $78 million at
December 31, 2001 and 2000, respectively.
1st Source Bank participates in interest rate swap agreements as part of
its program to manage the impact of fluctuating interest 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 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, 2001, 1st Source had no interest rate swap agreements
outstanding. At December 31, 2000, 1st Source had one interest rate swap and the
unrealized loss based on fair value approximated $237,000.
Note N -- Concentration of Credit Risk
Most of 1st Source's commercial and agricultural, real estate and consumer
loan activity is with customers located in Northern 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, 2001 and 2000 are business loans to
companies in the industries listed below:
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.
Percentage of Total
Amount Business Loans
(Dollars in thousands) 2001 2000 2001 2000
Truck and auto rental and leasing agencies $303,157 $ 264,048 15.5% 13.6%
Air transportation and aircraft dealers 244,309 249,852 12.5 12.9
Construction equipment and contractors 207,322 167,317 10.6 8.6
Real estate operators, managers and developers 117,895 111,736 6.0 5.8
Agriculture 75,853 68,123 3.9 3.5
Van conversion, manufactured housing
and recreational vehicle industries 43,161 59,867 2.1 3.1
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 result in certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a 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 (table on page 32) of
total and Tier I capital to risk-weighted assets, and of Tier I capital to
average assets. Management believes, as of December 31, 2001, that 1st Source
meets all capital adequacy requirements to which it is subject.
As of December 31, 2001, 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 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 the table. There are no conditions or events since that
notification that management believes will have changed the institution's
category.
The actual capital amounts and ratios of 1st Source and its largest
subsidiary, 1st Source Bank, are presented in the table below:
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Adequacy Action Provisions
(Dollars in thousands) $ Amount Ratio $ Amount Ratio $ Amount Ratio
As of December 31, 2001:
Total Capital (to Risk-Weighted Assets):
Consolidated $ 352,118 12.26% $ 229,843 8.00% $ 287,303 10.00%
1st Source Bank 322,070 11.37 226,528 8.00 283,160 10.00
Tier I Capital (to Risk-Weighted Assets):
Consolidated 315,278 10.97 114,921 4.00 172,382 6.00
1st Source Bank 285,838 10.09 113,264 4.00 169,896 6.00
Tier I Capital (to Average Assets):
Consolidated 315,278 8.96 140,701 4.00 175,876 5.00
1st Source Bank 285,838 8.39 136,303 4.00 170,379 5.00
Dividends that may be paid by a subsidiary bank to the parent company are
subject to certain regulatory limitations. At December 31,2001,approximately
$85.5 million of the total shareholders equity of 1st Source Bank is available
for the payment of dividends to 1st Source without approval by the applicable
regulatory authorities.
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. 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 -- Branch Acquisitions
During 2001, 1st Source Bank acquired a total of 17 branch offices; two in
Michigan, two in Northwestern Indiana,and 13 in the Fort Wayne, Indiana market
area. In addition to the fixed assets,the purchases included $322 million of
deposits.The core deposit intangible associated with the acquisitions totals
$4.4 million and is being amortized on an accelerated basis over 10 years. The
goodwill of $24.0 million will be subject to annual impairment tests in
accordance with SFAS No.142.
Notes to Consolidated Financial Statements concluded--
1st Source Corporation and Subsidiaries
Note R-- 1st Source Corporation (Parent Company Only) Financial Information
Statements of Financial Condition December 31
(Dollars in thousands) 2001 2000
ASSETS
Cash $ 2 $ 7
Short-term investments with bank subsidiary 4,412 6,403
Investment securities, available for sale
(amortized cost of $19,341 and $19,504 at
December 31, 2001 and 2000, respectively) 19,494 19,586
Investments in:
Bank subsidiaries 319,009 291,319
Non-bank subsidiaries 11,092 11,968
Loan receivables:
Non-bank subsidiaries 9,096 9,082
Premises and equipment, net 4,627 4,687
Other assets 2,482 2,915
Total assets $370,214 $ 345,967
LIABILITIESAND HAREHOLDERS' E QUITY
Commercial paper borrowings $ 4,992 $ 14,756
Other liabilities 2,528 4,251
Long-term debt 56,504 56,388
Total liabilities 64,024 75,395
Shareholders' equity 306,190 270,572
Total liabilities and shareholders' equity $370,214 $ 345,967
Statements of Income Year Ended December 31
(Dollars in thousands) 2001 2000 1999
Income:
Dividends from bank and non-bank subsidiaries $17,593 $ 8,260 $ 7,439
Rental income from subsidiaries 2,697 2,664 2,422
Other 1,759 2,937 2,814
Total income 22,049 13,861 12,675
Expenses:
Interest on long-term debt 4,430 4,748 4,556
Interest on commercial paper
and other short-term borrowings 537 800 402
Rent expense 1,065 1,059 1,074
Other 1,998 2,272 2,099
Total expenses 8,030 8,879 8,131
Income before income tax benefit and
equity in undistributed income of subsidiaries 14,019 4,982 4,544
Income tax benefit 1,508 1,273 1,162
Income before equity in undistributed
income of subsidiaries 15,527 6,255 5,706
Equity in undistributed income of subsidiaries:
Bank subsidiaries 12,978 28,959 27,817
Non-bank subsidiaries 9,993 2,359 2,245
Net income $38,498 $ 37,573 $ 35,768
Note R 1st Source Corporation (Parent Company Only) Financial Information
(concluded)
Statements of Cash Flows
Year Ended December 31
(Dollars in thousands) 2001 2000 1999
Operating activities:
Net income $ 38,498 $ 37,573 $ 35,768
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed income of subsidiaries (22,971) (31,318) (30,062)
Depreciation of premises and equipment 341 336 264
Realized and unrealized investment securities losses (gains) 645 (367) (553)
Other 1,545 2,850 6,381
Net cash provided by operating activities 18,058 9,074 11,798
Investing activities:
Proceeds from sales and maturities of investment securities 2,829 1,050 2,254
Purchases of investment securities (3,325) (1,260) (321)
Purchases of premises and equipment, net (281) (266) (1,871)
Decrease (increase) in short-term investments with bank subsidiary 1,991 (2,415) (586)
Increase in loans made to subsidiaries, net (14) (82) (1,245)
Capital contribution to subsidiary (1,000) - -
Net cash provided by (used in) investing activities 200 (2,973) (1,769)
Financing activities:
Net (decrease) increase in commercial
paper and other short-term borrowings (9,763) 5,950 2,635
Proceeds from issuance of long-term debt 217 2 112
Payments on long-term debt (101) (92) (191)
Acquisition of treasury stock (1,308) (4,990) (6,646)
Cash dividends (7,298) (6,956) (5,922)
Other (10) (9) (17)
Net cash used in financing activities (18,263) (6,095) (10,029)
(Decrease) increase in cash and cash equivalents (5) 6 0
Cash and cash equivalents, beginning of year 7 1 1
Cash and cash equivalents, end of year $ 2 $ 7 $ 1
Report of Independent Auditors
Report of Ernst & Young LLP;
Independent Auditors
To the Board of Directors and Shareholders of
1st Source Corporation:
We have audited the accompanying consolidated statements of financial condition
of 1st Source Corporation and Subsidiaries as of December 31,2001 and 2000,and
the related consolidated statements of income, shareholders' equity,,and cash
flows for each of the two years in the period ended December 31,2001. These
financial statements are the responsibility of the Company's management.Our
responsibility is to express an opinion on these financial statements based on
our audits. The financial statements of 1st Source Corporation for the year then
ended December 31, 1999 were audited by other auditors whose report dated
February 15,2000 expressed an unqual ified opinion on those statements.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and
significant estimates made by management,as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion,the financial statements referred to above present fairly, in all
material respects,the consolidated financial position of 1st Source Corporation
and Subsidiaries at December 31, 2001 and 2000, and the consolidated results of
their operations and their cash flows for each of the two years in the period
ended December 31,2001, in conformity with accounting principles generally
accepted in the United States.
Columbus, Ohio
January 14,2002