1ST SOURCE CORP - Annual Report: 2008 (Form 10-K)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
x ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d)
OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal
year ended December 31, 2008
OR
r TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition from _________ to ____________
Commission file number
0-6233
1 ST
SOURCE CORPORATION
(Exact
name of registrant as specified in its charter)
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Indiana
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35-1068133
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(State
or other jurisdiction of incorporation or organization)
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(I.R.S.
Employer
Identification
No.)
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100 North Michigan Street
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South Bend, Indiana
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46601
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(Address
of principal executive offices)
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(Zip
Code)
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Registrant’s
telephone number, including area code: (574) 235-2000
Securities
registered pursuant to Section 12(b) of the Act:
Title of
Class Name of Each Exchange on Which
Registered
Common Stock-wihout par
value The
NASDAQ Stock Market LLC
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o No x
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No r
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large
accelerated filer
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o |
Accelerated
filer
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x |
Non-accelerated
filer
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o |
Smaller
reporting company
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o |
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes r No
x
The
aggregate market value of the voting common stock held by non-affiliates of the
registrant as of June 30, 2008 was $218,217,564
The
number of shares outstanding of each of the registrant’s classes of stock as of
February 16, 2009:
Common
Stock, without par value –– 24,176,342 shares
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the annual proxy statement for the 2009 annual meeting of shareholders to be
held April 23, 2009, are incorporated by reference into Part III.
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Part
I
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Item
1.
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3 | |
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Item
1A.
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7 | |
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Item
1B.
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10 | |
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Item
2.
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10 | |
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Item
3.
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10 | |
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Item
4.
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10 | |
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Part
II
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Item
5.
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Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 10 |
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Item
6.
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11 | |
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Item
7.
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11 | |
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Item
7A.
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26 | |
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Item
8
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26 | |
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| 28 | ||
| 29 | ||
| 30 | ||
| 31 | ||
| 32 | ||
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Item
9.
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51 | |
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Item
9A.
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51 | |
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Item
9B.
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51 | |
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Part
III
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Item
10.
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51 | |
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Item
11.
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51 | |
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Item
12.
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51 | |
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Item
13.
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52 | |
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Item
14.
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52 | |
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Part
IV
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Item
15.
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52 | |
| 54 | ||
| Exhibit 23 | ||
| Exhibit 32.1 | ||
| Exhibit 32.2 | ||
Part
I
Construction
equipment financing includes financing of equipment (i.e., asphalt and concrete
plants, bulldozers, excavators, cranes, and loaders, etc.) to the construction
industry. Construction equipment finance receivables generally range from
$100,000 to $15 million with fixed or variable interest rates and terms of three
to seven years.
We also
generate equipment rental income through the leasing of construction equipment,
various trucks, and other equipment to clients through operating
leases.
Specialty Finance Group
Subsidiaries
The
Specialty Finance Group also consists of separate wholly owned subsidiaries of
1st Source Bank which include: Michigan Transportation Finance Corporation, 1st
Source Specialty Finance, Inc., SFG Equipment Leasing, Inc., 1st Source
Intermediate Holding, LLC, 1st Source Commercial Aircraft Leasing, Inc., and SFG
Equipment Leasing Corporation I.
First National Bank,
Valparaiso
First
National Bank, Valparaiso (First National) was a wholly owned subsidiary of 1st
Source Corporation that was acquired on May 31, 2007. On June 9, 2008, First
National was merged with 1st Source Bank.
Trustcorp Mortgage
Company
Trustcorp
Mortgage Company (Trustcorp) is a mortgage banking company and is a wholly owned
subsidiary of 1st Source Corporation. During 2007, its mortgage activity was
merged with 1st Source Bank.
1st Source Insurance,
Inc.
1st
Source Insurance, Inc. is a wholly owned subsidiary of 1st Source Bank that
provides insurance products and services to individuals and businesses covering
corporate and personal property, casualty insurance, and individual and group
health and life insurance. 1st Source Insurance, Inc. has seven
offices.
1st Source Corporation
Investment Advisors, Inc.
1st
Source Corporation Investment Advisors, Inc. (Investment Advisors) is a wholly
owned subsidiary of 1st Source Bank that provides investment advisory services
to trust and investment clients of 1st Source Bank. Investment Advisors
is registered as an investment advisor with the Securities and Exchange
Commission under the Investment Advisors Act of 1940. Investment Advisors serves
strictly in an advisory capacity and, as such, does not hold any client
securities.
Other Consolidated
Subsidiaries
We have
other subsidiaries that are not significant to the consolidated
entity.
1st Source Capital Trust IV
and 1st Source Master Trust
Our
unconsolidated subsidiaries include 1st Source Capital Trust IV and 1st Source
Master Trust. These subsidiaries were created for the purposes of issuing $30.00
million and $57.00 million of trust preferred securities, respectively, and
lending the proceeds to 1st Source. We guarantee, on a limited basis, payments
of distributions on the trust preferred securities and payments on redemption of
the trust preferred securities. 1st Source Capital Trust II and 1st Source
Capital Trust III were dissolved during 2008.
Competition
The
activities in which we and the Bank engage in are highly competitive. Our
businesses and the geographic markets we serve match us against other banks,
some of which are affiliated with large bank holding companies headquartered
outside of our principal market. We generally compete on the basis of client
service and responsiveness to client needs, available loan and deposit products,
the rates of interest charged on loans and leases, the rates of interest paid
for funds, other credit and service charges, the quality of services rendered,
the convenience of banking facilities, and in the case of loans and leases to
large commercial borrowers, relative lending limits.
In
addition to competing with other banks within our primary service areas, the
Bank also competes with other financial service companies, such as credit
unions, industrial loan associations, securities firms, insurance companies,
small loan companies, finance companies, mortgage companies, real estate
investment trusts, certain governmental agencies, credit organizations, and
other enterprises.
Additional
competition for depositors’ funds comes from United States Government
securities, private issuers of debt obligations, and suppliers of other
investment alternatives for depositors. Many of our non-bank competitors are not
subject to the same extensive Federal regulations that govern bank holding
companies and banks. Such non-bank competitors may, as a result, have certain
advantages over us in providing some services.
We
compete against these financial institutions by being convenient to do business
with, and by taking the time to listen and understand our clients needs. We
deliver personalized, one on one banking through knowledgeable local members of
the community, offering a full array of products and highly personalized
services. We rely on our history and our reputation in northern Indiana dating
back to 1863.
Employees
At
December 31, 2008, we had approximately 1,280 employees on a full-time
equivalent basis. We provide a wide range of employee benefits and consider
employee relations to be good.
Regulation and
Supervision
General — 1st Source and the
Bank are extensively regulated under Federal and State law. To the extent that
the following information describes statutory or regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions. Any change in applicable laws or regulations may have a
material effect on our business and our prospective business. Our operations may
be affected by legislative changes and by the policies of various regulatory
authorities. We are unable to predict the nature or the extent of the effects on
our business and earnings that fiscal or monetary policies, economic controls,
or new Federal or State legislation may have in the future.
We are a
registered bank holding company under the Bank Holding Company Act of 1956
(BHCA) and, as such, we are subject to regulation, supervision, and examination
by the Board of Governors of the Federal Reserve System (Federal Reserve). We
are required to file annual reports with the Federal Reserve and to provide the
Federal Reserve such additional information as it may require.
1st
Source Bank, as an Indiana state bank and member of the Federal Reserve System,
is supervised by the Indiana Department of Financial Institutions (DFI) and the
Federal Reserve. As such, 1st Source Bank is regularly examined by and subject
to regulations promulgated by the DFI and the Federal Reserve. Because the
Federal Deposit Insurance Corporation (FDIC) provides deposit insurance to 1st
Source Bank, we are also subject to supervision and regulation by the FDIC (even
though the FDIC is not our primary Federal regulator).
Bank Holding Company Act —
Under the BHCA, as amended, our activities are limited to business so closely
related to banking, managing, or controlling banks as to be a proper incident
thereto. We are also subject to capital requirements applied on a consolidated
basis in a form substantially similar to those required of the Bank. The BHCA
also requires a bank holding company to obtain approval from the Federal Reserve
before (i) acquiring, or holding more than 5% voting interest in any bank or
bank holding company, (ii) acquiring all or substantially all of the assets of
another bank or bank holding company, or (iii) merging or consolidating with
another bank holding company.
The BHCA
also restricts non-bank activities to those which, by statute or by Federal
Reserve regulation or order, have been identified as activities closely related
to the business of banking or of managing or controlling banks. As discussed
below, the Gramm-Leach-Bliley Act, which was enacted in 1999, established a new
type of bank holding company known as a "financial holding company" that has
powers that are not otherwise available to bank holding companies.
Financial Institutions Reform,
Recovery and Enforcement Act of 1989 — The Financial Institutions Reform,
Recovery and Enforcement Act of 1989 (FIRREA) reorganized and reformed the
regulatory structure applicable to financial institutions
generally.
The Federal Deposit Insurance
Corporation Improvement Act of 1991 — The Federal Deposit Insurance
Corporation Improvement Act of 1991 (FDICIA) was adopted to supervise and
regulate a wide variety of banking issues. In general, FDICIA provides for the
recapitalization of the Bank Insurance Fund (BIF), deposit
insurance
reform, including the implementation of risk-based deposit insurance premiums,
the establishment of five capital levels for financial institutions ("well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized") that would impose more
scrutiny and restrictions on less capitalized institutions, along with a number
of other supervisory and regulatory issues. At December 31, 2008, the Bank was
categorized as "well capitalized," meaning that our total risk-based capital
ratio exceeded 10.00%, our Tier 1 risk-based capital ratio exceeded 6.00%, our
leverage ratio exceeded 5.00%, and we are not subject to a regulatory order,
agreement, or directive to meet and maintain a specific capital level for any
capital measure.
Federal Deposit Insurance Reform
Act — On February 1, 2006, Congress approved the Federal Deposit
Insurance Reform Act of 2005 (FDIRA). Among other things, the FDIRA provides for
the merger of the Bank Insurance Fund with the Savings Association Insurance
Fund and for an immediate increase in Federal deposit insurance for certain
retirement accounts up to $250,000. The statute further provides for the
indexing of the maximum deposit insurance coverage for all types of deposit
accounts in the future to account for inflation. The FDIRA also requires the
FDIC to provide certain banks and thrifts that were in existence prior to
December 31, 1996 with one-time credits against future premiums based on the
amount of their payments to the Bank Insurance Fund or Savings Association
Insurance Fund prior to that date.
FDIC Deposit Insurance
Assessments — On October 16, 2008, in response to the recent problems
facing the financial markets and the economy, the Federal Deposit Insurance
Corporation published a restoration plan designed to replenish the Deposit
Insurance Fund over a period of five years and to increase the deposit insurance
reserve ratio. On December 16, 2008, the FDIC adopted a final rule increasing
risk-based assessment rates uniformly by 7 basis points, on an annual basis, for
the first quarter 2009. The FDIC indicated that it will issue another final rule
early in 2009, to take effect on April 1, 2009, to change the way that the
FDIC's assessment system differentiates for risk, make corresponding changes to
assessment rates beginning with the second quarter of 2009, and make certain
technical and other changes to the assessment rules.
Temporary Liquidity Guarantee
Program — On November 21, 2008, the FDIC Board of Directors adopted a
final rule implementing the Temporary Liquidity Guarantee Program (TLG Program).
The TLG Program consists of two basic components: a guarantee of newly issued
senior unsecured debt of banks, thrifts, and certain holding companies (the debt
guarantee program) and full guarantee of non-interest bearing deposit
transaction accounts, such as business payroll accounts, regardless of dollar
amount (the transaction account guarantee program). The purpose of the guarantee
of transaction accounts and the debt guarantee is to reduce funding costs and
allow banks and thrifts to increase lending to consumers and businesses. All
insured depository institutions were automatically enrolled in both programs
unless they elected to opt out by a specified date. 1st Source did not elect to
opt out and thus participates in both programs.
Emergency Economic Stabilization Act
of 2008 —
On October 3, 2008, President George W. Bush signed the Emergency
Economic Stabilization Act of 2008 (EESA). This Act temporarily raises the basic
limit on federal deposit insurance coverage from $100,000 to $250,000 per
depositor effective immediately. This temporary increase in the deposit
insurance limit expires on December 31, 2009.
Under the
Troubled Asset Relief Program established by EESA, the U.S. Treasury Department
announced a Capital Purchase Program (CPP). CPP is designed to encourage U.S.
financial institutions to build capital to increase the flow of financing to
U.S. businesses and consumers and support the U.S. economy. Under the program,
Treasury will purchase up to $250 billion of senior preferred shares on
standardized terms as described in the program's term sheet. The program is
available to qualifying U.S. controlled banks, savings associations, and certain
bank and savings and loan holding companies engaged only in financial activities
that elect submitted applications to Treasury by November 14, 2008. EESA
provides for Treasury to determine an applicant’s eligibility to participate in
the CPP after consulting with the appropriate federal banking
agency.
1st
Source submitted an application to participate in the CPP and obtained Treasury
approval on December 11, 2008. On January 23, 2009, 1st Source issued preferred
stock valued at $111.00 million and a warrant to acquire 837,947 shares of its
common stock to Treasury pursuant to the CPP. The warrant is exercisable at any
time during the ten-year period following issuance at an exercise price of
$19.87.
Securities and Exchange Commission
(SEC) and The Nasdaq Stock Market (Nasdaq) — We are under the
jurisdiction of the SEC and certain state securities commissions for matters
relating to the offering and sale of our securities and our investment advisory
services. We are subject to the disclosure and regulatory requirements of the
Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, as administered by the SEC. We are listed on the Nasdaq Global Select
Market under the trading symbol "SRCE," and we are subject to the rules of
Nasdaq for listed companies.
Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 — Congress enacted the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 (Interstate Act) in
September 1994. Beginning in September 1995, bank holding companies have the
right to expand, by acquiring existing banks, into all states, even those which
had theretofore restricted entry. The legislation also provides that, subject to
future action by individual states, a holding company has the right to convert
the banks which it owns in different states to branches of a single bank. The
states of Indiana and Michigan have adopted the interstate branching provisions
of the Interstate Act.
Economic Growth and Regulatory
Paperwork Reduction Act of 1996 — The Economic Growth and Regulatory
Paperwork Reduction Act of 1996 (EGRPRA) was signed into law on September 30,
1996. Among other things, EGRPRA streamlined the non-banking activities
application process for well-capitalized and well-managed bank holding
companies.
Gramm-Leach-Bliley Act of 1999
— The Gramm-Leach-Bliley Act of 1999 (GLBA) is intended to modernize the banking
industry by removing barriers to affiliation among banks, insurance companies,
the securities industry, and other financial service providers. It provides
financial organizations with the flexibility of structuring such affiliations
through a holding company structure or through a financial subsidiary of a bank,
subject to certain limitations. The GLBA establishes a new type of bank holding
company, known as a financial holding company, which may engage in an expanded
list of activities that are "financial in nature," which include securities and
insurance brokerage, securities underwriting, insurance underwriting, and
merchant banking. The GLBA also sets forth a system of functional regulation
that makes the Federal Reserve the "umbrella supervisor" for holding companies,
while providing for the supervision of the holding company’s
subsidiaries by other Federal and state agencies. A bank holding company may not
become a financial holding company if any of its subsidiary financial
institutions are not well-capitalized or well-managed. Further, each bank
subsidiary of the holding company must have received at least a satisfactory
Community Reinvestment Act (CRA) rating. The GLBA also expands the types of
financial activities a national bank may conduct through a financial subsidiary,
addresses state regulation of insurance, generally prohibits unitary thrift
holding companies organized after May 4, 1999 from participating in new
activities that are not financial in nature, provides privacy protection for
nonpublic customer information of financial institutions, modernizes the Federal
Home Loan Bank system, and makes miscellaneous regulatory improvements. The
Federal Reserve and the Secretary of the Treasury must coordinate their
supervision regarding approval of new financial activities to be conducted
through a financial holding company or through a financial subsidiary of a bank.
While the provisions of the GLBA regarding activities that may be conducted
through a financial subsidiary directly apply only to national banks, those
provisions indirectly apply to state-
chartered
banks. In addition, the Bank is subject to other provisions of the GLBA,
including those relating to CRA and privacy, regardless of whether we elect to
become a financial holding company or to conduct activities through a financial
subsidiary. We do not, however, currently intend to file notice with the Board
to become a financial holding company or to engage in expanded financial
activities through a financial subsidiary.
Financial Privacy — In
accordance with the GLBA, Federal banking regulators adopted rules that limit
the ability of banks and other financial institutions to disclose non-public
information about customers to nonaffiliated third parties. These limitations
require disclosure of privacy policies to consumers and, in some circumstances,
allow consumers to prevent disclosure of certain personal information to a
nonaffiliated third party. The privacy provisions of the GLBA affect how
consumer information is transmitted through diversified financial companies and
conveyed to outside vendors.
USA Patriot Act of 2001 — The
USA Patriot Act of 2001 (USA Patriot Act) was signed into law following the
terrorist attacks of September 11, 2001. The USA Patriot Act is comprehensive
anti-terrorism legislation that, among other things, substantially broadened the
scope of anti-money laundering laws and regulations by imposing significant new
compliance and due diligence obligations on financial institutions.
The
regulations adopted by the United States Treasury Department under the USA
Patriot Act impose new obligations on financial institutions to maintain
appropriate policies, procedures and controls to detect, prevent and report
money laundering, and terrorist financing. Additionally, the regulations require
that we, upon request from the appropriate Federal regulatory agency, provide
records related to anti-money laundering, perform due diligence of private
banking and correspondent accounts, establish standards for verifying customer
identity, and perform other related duties.
Failure
of a financial institution to comply with the USA Patriot Act's requirements
could have serious legal and reputational consequences for the
institution.
Regulations Governing Capital
Adequacy — The Federal bank regulatory agencies use capital adequacy
guidelines in their examination and regulation of bank holding companies and
banks. If capital falls below the minimum levels established by these
guidelines, a bank holding company or bank will be required to submit an
acceptable plan for achieving compliance with the capital guidelines and will be
subject to denial of applications and appropriate supervisory enforcement
actions. The various regulatory capital requirements that we are subject to are
disclosed in Part II, Item 8, Financial Statements and Supplementary Data — Note
R of the Notes to Consolidated Financial Statements. Our management believes
that the risk-weighting of assets and the risk-based capital guidelines do not
have a material adverse impact on our operations or on the operations of the
Bank.
Community Reinvestment Act —
The Community Reinvestment Act of 1977 requires that, in connection with
examinations of financial institutions within their jurisdiction, the Federal
banking regulators must evaluate the record of the financial institutions in
meeting the credit needs of their local communities, including low and moderate
income neighborhoods, consistent with the safe and sound operation of those
banks. Federal banking regulators are required to consider a financial
institution's performance in these areas as they review applications filed by
the institution to engage in mergers or acquisitions or to open a branch or
facility.
Regulations Governing Extensions of
Credit — 1st Source Bank is subject to certain restrictions imposed by
the Federal Reserve Act on extensions of credit to 1st Source or our
subsidiaries, or investments in our securities and on the use of our securities
as collateral for loans to any borrowers. These regulations and restrictions may
limit our ability to obtain funds from the Bank for our cash needs, including
funds for acquisitions and for payment of dividends, interest and operating
expenses. Further, the BHCA, certain regulations of the Federal Reserve, state
laws and many other Federal laws govern the extensions of credit and generally
prohibit a bank from extending credit, engaging in a lease or sale of property,
or furnishing services to a customer on the condition that the customer obtain
additional services from the bank’s holding company or from one of its
subsidiaries.
1st
Source Bank is also subject to certain restrictions imposed by the Federal
Reserve Act on extensions of credit to executive officers, directors, principal
shareholders, or any related interest of such persons. Extensions of credit (i)
must be made on substantially the same terms, including interest rates and
collateral, and subject to credit underwriting procedures that are at least as
stringent as those prevailing at the time for comparable transactions with non
affiliates, and (ii) must not involve more than the normal risk of repayment or
present other unfavorable features. The Bank is also subject to certain lending
limits and restrictions on overdrafts to such persons.
Reserve Requirements — The
Federal Reserve requires all depository institutions to maintain reserves
against their transaction account deposits. The Bank must maintain reserves of
3.00% against net transaction accounts greater than $10.30 million and up to
$44.40 million (subject to adjustment by the Federal Reserve) and reserves of
10.00% must be maintained against that portion of net transaction accounts in
excess of $44.40 million.
Dividends — The ability of the
Bank to pay dividends is limited by state and Federal Regulations that require
1st Source Bank to obtain the prior approval of the DFI before paying a dividend
that, together with other dividends it has paid during a calendar year, would
exceed the sum of its retained net income for the year to date combined with its
retained net income for the previous two years. The amount of dividends the Bank
may pay may also be limited by certain covenant agreements and by the principles
of prudent bank management. See Part II, Item 5, Market for Registrant's Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
for further discussion of dividend limitations.
Monetary Policy and Economic
Control — The commercial banking business in which we engage is affected
not only by general economic conditions, but also by the monetary policies of
the Federal Reserve. Changes in the discount rate on member bank borrowing,
availability of borrowing at the "discount window," open market operations, the
imposition of changes in reserve requirements against member banks deposits and
assets of foreign branches, and the imposition of, and changes in, reserve
requirements against certain borrowings by banks and their affiliates are some
of the instruments of monetary policy available to the Federal Reserve. These
monetary policies are used in varying combinations to influence overall growth
and distributions of bank loans, investments, and deposits, and such use may
affect interest rates charged on loans and leases or paid on deposits. The
monetary policies of the Federal Reserve have had a significant effect on the
operating results of commercial banks and are expected to do so in the future.
The monetary policies of the Federal Reserve are influenced by various factors,
including inflation, unemployment, short-term and long-term changes in the
international trade balance, and in the fiscal policies of the U.S. Government.
Future monetary policies and the effect of such policies on our future business
and earnings, and the effect on the future business and earnings of the Bank
cannot be predicted.
Sarbanes-Oxley Act of 2002 —
On July 30, 2002, the Sarbanes-Oxley Act of 2002 (SOA) was signed into law. The
SOA's stated goals include enhancing corporate responsibility, increasing
penalties for accounting and auditing improprieties at publicly traded companies
and protecting investors by improving the accuracy
and reliability of corporate disclosures pursuant to the securities laws. The
SOA generally applies to all companies that file or are required to file
periodic reports with the SEC under the Securities Exchange Act of 1934
(Exchange Act.)
Among
other things, the SOA creates the Public Company Accounting Oversight Board as
an independent body subject to SEC supervision with responsibility for setting
auditing, quality control, and ethical standards for auditors of public
companies. The SOA also requires public companies to make faster and
more-extensive financial disclosures, requires the chief executive officer and
the chief financial officer of public companies to provide signed certifications
as to the accuracy and completeness of financial information filed with the SEC,
and provides enhanced criminal and civil penalties for violations of the Federal
securities laws.
The SOA
also addresses functions and responsibilities of audit committees of public
companies. The statute, by mandating certain stock exchange listing
rules, makes the audit committee directly responsible for the appointment,
compensation, and oversight of the work of the company's outside auditor, and
requires the auditor to report directly to the audit committee. The SOA
authorizes each audit committee to engage independent counsel and other
advisors, and requires a public company to provide the appropriate funding, as
determined by its audit committee, to pay the company's auditors and any
advisors that its audit committee retains. The SOA also requires public
companies to prepare an internal control report and assessment by management,
along with an attestation to this report prepared by the company's registered
public accounting firm, in their annual reports to stockholders.
Pending Legislation — Because
of concerns relating to competitiveness and the safety and soundness of the
banking industry, Congress often considers a number of wide-ranging proposals
for altering the structure, regulation, and competitive relationships of the
nation’s financial institutions. We cannot predict whether or in what form any
proposals will be adopted or the extent to which our business may be affected
thereby.
Fluctuations
in interest rates could reduce our profitability and affect the value of our
assets — Like other financial institutions, we are subject to interest
rate risk. Our primary source of income is net interest income, which is the
difference between interest earned on loans and leases and investments, and
interest paid on deposits and borrowings. We expect that we will periodically
experience imbalances in the interest rate sensitivities of our assets and
liabilities and the relationships of various interest rates to each other. Over
any defined period of time, our interest-earning assets may be more sensitive to
changes in market interest rates than our interest-bearing liabilities, or
vice-versa. In addition, the individual market interest rates underlying our
loan and lease and deposit products may not change to the same degree over a
given time period. In any event, if market interest rates should move contrary
to our position, earnings may be negatively affected. In addition,
loan and lease volume and quality and deposit volume and mix can be affected by
market interest rates as can the businesses of our clients. Changes in levels of
market interest rates could have a material adverse affect on our net interest
spread, asset quality, origination volume, and overall
profitability.
Market
interest rates are beyond our control, and they fluctuate in response to general
economic conditions and the policies of various governmental and regulatory
agencies, in particular, the Federal Reserve Board. Changes in monetary policy,
including changes in interest rates, may negatively affect our ability to
originate loans and leases, the value of our assets and our ability to realize
gains from the sale of our assets, all of which ultimately could affect our
earnings.
Future
expansion involves risks — In the future, we may acquire all or part of
other financial institutions and we may establish de novo branch offices. There
could be considerable costs involved in executing our growth strategy. For
instance, new branches generally require a period of time to generate sufficient
revenues to offset their costs, especially in areas in which we do not have an
established presence. Accordingly, any new branch expansion could be expected to
negatively impact earnings for some period of time until the branch reaches
certain economies of scale. Acquisitions and mergers involve a number of risks,
including the risk that:
|
·
|
We
may incur substantial costs identifying and evaluating potential
acquisitions and merger partners, or in evaluating new markets, hiring
experienced local managers, and opening new
offices;
|
|
·
|
Our
estimates and judgments used to evaluate credit, operations, management,
and market risks relating to target institutions may not be
accurate;
|
|
·
|
There
may be substantial lag-time between completing an acquisition or opening a
new office and generating sufficient assets and deposits to support costs
of the expansion;
|
|
·
|
We
may not be able to finance an acquisition, or the financing we obtain may
have an adverse effect on our operating results or dilution of our
existing shareholders;
|
|
·
|
The
attention of our management in negotiating a transaction and integrating
the operations and personnel of the combining businesses may be diverted
from our existing business;
|
|
·
|
Acquisitions
typically involve the payment of a premium over book and market values
and; therefore, some dilution of our tangible book value and net income
per common share may occur in connection with any future
transaction;
|
|
·
|
We
may enter new markets where we lack local
experience;
|
|
·
|
We
may incur goodwill in connection with an acquisition, or the goodwill we
incur may become impaired, which results in adverse short-term effects on
our operating results; or
|
|
·
|
We
may lose key employees and clients.
|
Competition
from other financial services providers could adversely impact our results of
operations — The banking
and financial services business is highly competitive. We face competition in
making loans and leases, attracting deposits and providing insurance,
investment, trust, and other financial services. Increased competition in the
banking and financial services businesses may reduce our market share, impair
our growth or cause the prices we charge for our services to decline. Our
results of operations may be adversely impacted in future periods depending upon
the level and nature of competition we encounter in our various market
areas.
We are
dependent upon the services of our management team — Our future success
and profitability is substantially dependent upon our management and the banking
abilities of our senior executives. We believe that our future results will also
depend in part upon our ability to attract and retain highly skilled and
qualified management. We are especially dependent on a limited number of key
management personnel, many of whom do not have employment agreements
with us.
The loss of the chief executive officer and other senior management and key
personnel could have a material adverse impact on our operations because other
officers may not have the experience and expertise to readily replace these
individuals. Many of these senior officers have primary contact with our clients
and are important in maintaining personalized relationships with our client
base. The unexpected loss of services of one or more of these key employees
could have a material adverse effect on our operations and possibly result in
reduced revenues if we were unable to find suitable replacements promptly.
Competition for senior personnel is intense, and we may not be successful in
attracting and retaining such personnel. Changes in key personnel and their
responsibilities may be disruptive to our businesses and could have a material
adverse effect on our businesses, financial condition, and results of
operations.
Technology security breaches and
constant technological change — Any compromise of our security also could
deter our clients from using our internet
banking
services that involve the transmission of confidential information. We rely on
standard internet security systems to provide the security and authentication
necessary to effect secure transmission of data. These precautions may not
protect our systems from compromises or breaches of our security measures that
could result in damage to our reputation and business.
The
financial services industry is constantly undergoing rapid technological change
with frequent introductions of new technology-driven products and services. The
effective use of technology increases efficiency and enables financial
institutions to better service clients and reduce costs. Our future success
depends, in part, upon our ability to address the needs of our clients by using
technology to provide products and services that will satisfy client demands, as
well as create additional efficiencies within our operations. Many of our
competitors have substantially greater resources to
invest in technological improvements. We may not be able to effectively
implement new technology-driven products and services or be successful in
marketing these products and services to our clients. Failure to successfully
keep pace with technological change affecting the financial services industry
could have a material adverse impact on our business and, in turn, our financial
condition and results of operations.
We are subject to credit risks
relating to our loan and lease portfolios — We have certain lending
policies and procedures in place that are designed to optimize loan and lease
income within an acceptable level of risk. Our management reviews and approves
these policies and procedures on a regular basis. A reporting system supplements
the review process by providing our management with frequent reports related to
loan and lease production, loan quality, concentrations of credit, loan and
lease delinquencies, and nonperforming and potential problem loans and leases.
Diversification in the loan and lease portfolios is a means of managing risk
associated with fluctuations and economic conditions.
We
maintain an independent loan review department that reviews and validates the
credit risk program on a periodic basis. Results of these reviews are presented
to our management. The loan and lease review process complements and reinforces
the risk identification and assessment decisions made by lenders and credit
personnel, as well as our policies and procedures.
In the
financial services industry, there is always a risk that certain borrowers may
not repay borrowings. Our reserve for loan and lease losses may not be
sufficient to cover the loan and lease losses that we may actually incur. If we
experience defaults by borrowers in any of our businesses, our earnings could be
negatively affected. Changes in local economic conditions could adversely affect
credit quality, particularly in our local business loan and lease portfolio.
Changes in national economic conditions could also adversely affect the quality
of our loan and lease portfolio and negate, to some extent, the benefits of
national diversification through our Specialty Finance Group’s
portfolio.
Commercial
and commercial real estate loans generally involve higher credit risks than
residential real estate and consumer loans. Because payments on loans secured by
commercial real estate or equipment are often dependent upon the successful
operation and management of the underlying assets, repayment of such loans may
be influenced to a great extent by conditions in the market or the economy. We
seek to minimize these risks through our underwriting standards. We obtain
financial information and perform credit risk analysis on our customers. Credit
criteria may include, but are not limited to, assessments of income, cash flows,
and net worth; asset ownership; bank and trade credit reference; credit bureau
report; and operational history.
Commercial
real estate or equipment loans are underwritten after evaluating and
understanding the borrower's ability to operate profitably and generate positive
cash flows. Our management examines current and projected cash flows of the
borrower to determine the ability of the borrower to repay their obligations as
agreed. Underwriting standards are designed to promote relationship banking
rather than transactional banking. Most commercial and industrial loans are
secured by the assets being financed or other business assets; however, some
loans may be made on an unsecured basis. Our credit policy sets different
maximum exposure limits both by business sector and our current and historical
relationship and previous experience with each customer.
We offer
both fixed-rate and adjustable-rate consumer mortgage loans secured by
properties, substantially all of which are located in our primary market area.
Adjustable-rate mortgage loans help reduce our exposure to changes in interest
rates; however, during periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans may increase as a result of repricing and the
increased payments required from the borrower. Additionally, most residential
mortgages are sold into the secondary market and serviced by our principal
banking subsidiary, 1st Source Bank.
Consumer
loans are primarily all other non-real estate loans to individuals in our
regional market area. Consumer loans can entail risk, particularly in the case
of loans that are unsecured or secured by rapidly depreciating assets. In these
cases, any repossessed collateral may not provide an adequate source of
repayment of the outstanding loan balance. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower’s continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness, or personal
bankruptcy.
The 1st
Source Specialty Finance Group loan and lease portfolio consists of commercial
loans and leases secured by construction and transportation equipment, including
aircraft, autos, trucks, and vans. Finance receivables for this Group generally
provide for monthly payments and may include prepayment penalty
provisions.
Our
construction and transportation related businesses could be adversely affected
by slow downs in the economy. Clients who rely on the use of assets financed
through the Specialty Finance Group to produce income could be negatively
affected, and we could experience substantial loan and lease losses. By the
nature of the businesses these clients operate in, we could be adversely
affected by continued rapid increases of fuel costs. Since some of the
relationships in these industries are large (up to $25 million), a slow down
could have a significant adverse impact on our performance.
Our
construction and transportation related businesses could be adversely impacted
by the negative effects caused by high fuel costs, terrorist and other potential
attacks, and other destabilizing events. These factors could contribute to the
deterioration of the quality of our loan and lease portfolio, as they could have
a negative impact on the travel sensitive businesses for which our specialty
finance businesses provide financing.
In
addition, our leasing and equipment financing activity is subject to the risk of
cyclical downturns, industry concentration and clumping, and other adverse
economic developments affecting these industries and markets. This area of
lending, with transportation in particular, is dependent upon general economic
conditions and the strength of the travel, construction, and transportation
industries.
The soundness of other financial
institutions could adversely affect us — Financial services institutions
are interrelated as a result of trading, clearing, counterparty, or other
relationships. We have exposure to many different industries and counterparties,
and we routinely execute transactions with counterparties in the financial
services industry, including commercial banks, brokers and dealers, investment
banks, and other institutional clients. Many of these transactions expose us to
credit risk in the event of a default by our counterparty or client. In
addition, our credit risk may be exacerbated when the collateral held by us
cannot be realized or is liquidated at prices not sufficient to recover the full
amount of the credit or derivative exposure due us. Any such losses could have a
material adverse affect on our financial condition and results of
operations.
Economic conditions and current
levels of market volatility are unprecedented — We are impacted by
general business and economic conditions in the United States and abroad. These
conditions include short-term and long-term interest rates, inflation, money
supply, political issues, legislative and regulatory changes, fluctuations in
both debt and equity capital markets, broad trends in industry and finance,
unemployment, and the strength of the U.S. economy and the local economies in
which we operate, all of which are beyond our control. A deterioration in
economic conditions could result in an increase in loan delinquencies and
non-performing assets, decreases in loan collateral values and a decrease in
demand for our products and services.
The
capital and credit markets have been experiencing extreme volatility and
disruption for more than 12 months. The volatility and disruption have reached
unprecedented levels. In some cases, the markets have exerted downward pressure
on stock prices, security prices and credit capacity for certain issuers without
regard to those issuers’ underlying financial strength. If the current levels of
market disruption and volatility continue or worsen, there can be no assurance
that we will not experience adverse effects, which may be material, on our
ability to access capital and on our results of operations.
We are subject to extensive
government regulation and supervision — Our operations are subject to
extensive federal and state regulation and supervision. Banking regulations are
primarily intended to protect depositors' funds, federal deposit insurance funds
and the banking system as a whole, not security holders. These regulations
affect our lending practices, capital structure, investment practices, dividend
policy and growth, among other things. Congress and federal regulatory agencies
continually review banking laws, regulations and policies for possible change.
Changes to statutes, regulations or regulatory policies, including changes in
interpretation or implementation of statutes, regulation or policies, could
affect us in substantial and unpredictable ways. Such changes could subject us
to additional costs and limit the types of financial services and products we
may offer. Failure to comply with laws, regulations or policies could result in
sanctions by regulatory agencies, civil money penalties and/or reputation
damage, which could have a material adverse effect on our business, financial
condition and results of operations. While we have policies and procedures
designed to prevent any such violations, there can be no assurance that such
violations will not occur.
Reliance on dividends from our
subsidiaries — Our parent company, 1st Source Corporation, receives
substantially all of its revenue from dividends from our subsidiaries. These
dividends are the principal source of funds to pay dividends on our common stock
and interest and principal on our debt. Various federal and/or state laws and
regulations limit the amount of dividends that our subsidiaries may pay to our
parent company. In the event our subsidiaries are unable to pay dividends to our
parent company, we may not be able to service debt, pay obligations or pay
dividends on our common stock. The inability to receive dividends from our
subsidiaries could have a material adverse affect on our business, financial
condition and results of operations.
Changes in accounting standards could
impact reported earnings — Current accounting and tax rules, standards,
policies and interpretations influence the methods by which financial
institutions conduct business, implement strategic initiatives and tax
compliance, and govern financial reporting and disclosures. These laws,
regulations, rules, standards, policies and interpretations are constantly
evolving and may change significantly over time. Events that may not have a
direct impact on us, such as bankruptcy of major U.S. companies, have resulted
in legislators, regulators, and authoritative bodies, such as the Financial
Accounting Standards Board, the Securities and Exchange Commission, the Public
Company Accounting Oversight Board and various taxing authorities, responding by
adopting and/or proposing substantive revision to laws, regulations, rules,
standards, policies and interpretations. New accounting pronouncements and
varying interpretations of accounting pronouncements have occurred and may occur
in the future. A change in accounting standards may adversely affect reported
financial condition and results of operations.
Impact of recently enacted
legislation and our participation in the programs — The Emergency
Economic Stabilization Act of 2008 (the "EESA") is intended to stabilize and
provide liquidity to the U.S. financial markets. There can be no assurance,
however, as to the actual impact that the EESA and its regulations and other
governmental programs will have on the financial markets. The failure of the
financial markets to stabilize and a continuation or worsening of current
financial market conditions could adversely affect our business, financial
condition and results of operations. The
programs established or to be established under the EESA and Troubled Asset
Relief Program may have adverse effects on us. We may face increased regulation
of our industry. Compliance with such regulation may increase our
costs and limit our ability to pursue business opportunities.
Our participation in the
Treasury’s Capital Purchase Program may adversely affect the value of our common
stock and the rights of our common shareholders — The terms of the
preferred stock we issued under the Treasury’s Capital Purchase Program
could reduce investment returns to our common shareholders by restricting
dividends, diluting existing shareholders’ ownership interests, and restricting
capital management practices. Without the prior consent of the Treasury, we will
be prohibited from increasing our common stock dividends for the first three years
while the Treasury holds the preferred stock.
Also, the
preferred stock requires quarterly dividends to be paid at the rate of 5% per
annum for the first five years and 9% per annum thereafter until the stock is
redeemed by us. The payments of these dividends will decrease the excess cash we
otherwise have available to pay dividends on our common stock and to use for
general corporate purposes, including working capital.
Finally,
we will be prohibited from continuing to pay dividends on our common stock
unless we have fully paid all required dividends on the preferred stock issued
to the Treasury. Although we fully expect to be able to pay all required
dividends on the preferred stock (and to continue to pay dividends on our
common stock at current levels), there is no guarantee that we will be able to
do so in the future.
Our deposit insurance premiums could
be substantially higher in the future which will have an adverse effect on our
future earnings — Under the Federal
Deposit Insurance Act, the FDIC, absent extraordinary circumstances, must
establish and implement a plan to restore the deposit insurance reserve ratio to
1.15% of insured deposits, over a five-year period, at any time that the reserve
ratio falls below 1.15%. The recent failures of a large financial institution
and several smaller ones have significantly increased the Deposit Insurance
Fund’s loss provisions, resulting in a decline in the reserve ratio to 1.01% as
of June 30, 2008, 18 basis points below the reserve ratio as of March 31, 2008.
The FDIC expects a higher rate of insured institution failures in the next few
years, which may result in a continued decline in the reserve
ratio.
On
October 7, 2008, the FDIC released a five-year recapitalization plan and a
proposal to raise premiums to recapitalize the fund. In order to implement the
restoration plan, the FDIC proposed to change both its risk-based assessment
system and its base assessment rates. Assessment rates would increase by seven
basis points across the range of risk weightings. In December 2008, the FDIC
adopted its rule, uniformly increasing the risk-based assessment rates by seven
basis points, annually, resulting in a range of risk-based assessment of 12
basis points to 50 basis points. Changes to the risk-based assessment system
would include increasing premiums for institutions that rely on excessive
amounts of brokered deposits, increasing premiums for excessive use of secured
liabilities, and lowering premiums for smaller institutions with very high
capital levels.
As a
member institution of the FDIC, we are required to pay quarterly deposit
insurance premium assessments to the FDIC. Due to the continued failures of
unaffiliated FDIC insured depository institutions, we anticipate that our FDIC
deposit insurance premiums will increase in the future, perhaps significantly,
which will adversely impact our future earnings.
None
Our
headquarters building is located in downtown South Bend. In 1982, the land was
leased from the City of South Bend on a 49-year lease, with a 50-year renewal
option. The building is part of a larger complex, including a 300-room hotel and
a 500-car parking garage. Also, in 1982, we sold the building and entered into a
leaseback agreement with the purchaser for a term of 30 years. The building is a
structure of approximately 160,000 square feet, with 1st Source and our
subsidiaries occupying approximately 65% of the available office space and
approximately 35% subleased to unrelated tenants.
At
December 31, 2008, we also owned property and/or buildings on which 55 of the
1st Source Bank's 79 banking centers were located, including the facilities in
Allen, Elkhart, Fulton, Huntington, Kosciusko, LaPorte, Marshall, Porter, St.
Joseph, Starke, and Wells Counties in the State of Indiana and Berrien and Cass
Counties in the State of Michigan, as well as an operations center, training
facility, warehouse, and our former headquarters building, which is utilized for
additional business operations. The Bank leases additional property and/or
buildings to and from third parties under lease agreements negotiated at
arms-length.
1st Source
and our subsidiaries are involved in various legal proceedings incidental to the
conduct of our businesses. Our management does not expect that the outcome of
any such proceedings will have a material adverse effect on our consolidated
financial position or results of operations.
None
Part
II
Our
common stock is traded on the Nasdaq Global Select Market under the symbol
"SRCE." The following table sets forth for each quarter the high and low sales
prices for our common stock, as reported by Nasdaq, and the cash dividends paid
per share for each quarter.
|
2008
Sales Price
|
Cash
Dividends
|
2007
Sales Price
|
Cash
Dividends
|
|||||||||
|
Common Stock
Prices (quarter
ended)
|
High
|
Low
|
Paid
|
High
|
Low
|
Paid
|
||||||
|
March
31
|
$
|
21.81
|
$
|
15.13
|
$
|
.14
|
$
|
32.62
|
$
|
24.27
|
$
|
.14
|
|
June
30
|
22.62
|
16.10
|
.14
|
27.92
|
23.32
|
.14
|
||||||
|
September
30
|
30.00
|
14.54
|
.14
|
27.00
|
18.41
|
.14
|
||||||
|
December
31
|
25.56
|
12.61
|
.16
|
24.47
|
16.28
|
.14
|
||||||
|
As
of December 31, 2008, there were 1,012 holders of record of 1st Source
common stock
|
||||||||||||
Comparison of Five Year Cumulative
Total Return*
Among 1st
Source, Morningstar Market Weighted NASDAQ Index** and Peer Group
Index***
*
Assumes $100 invested on December 31, 2003, in 1st Source Corporation common
stock, NASDAQ market index, and peer group index.
**
The Morningstar Weighted NASDAQ Index Return is calculated using all companies
which trade as NASD Capital Markets, NASD Global Markets or NASD Global
Select It includes both domestic and foreign companies. The index is
weighted by the then current shares outstanding and assumes dividends
reinvested. The return is calculated on a monthly basis.
*** The
peer group is a market-capitalization-weighted stock index of 59 banking
companies in Indiana, Michigan, Ohio, and Wisconsin.
NOTE:
Total return assumes reinvestment of dividends.
1st
Source maintains a stock repurchase plan that was authorized by the
Board of Directors on April 26, 2007. Under the terms of the plan, 1st Source
may repurchase up to 2,000,000 shares of its common stock when favorable
conditions exist on the open market or through private transactions at various
prices from time to time. Since the inception of the plan, 1st Source has
repurchased a total of 552,552 shares. No shares were repurchased during the
three months ended December 31, 2008.
Federal
laws and regulations contain restrictions on the ability of 1st Source and the
Bank to pay dividends. For information regarding restrictions on dividends, see
Part I, Item 1, Business - Regulation and Supervision - Dividends and Part II,
Item 8, Financial Statements and Supplementary Data - Note R of the Notes to
Consolidated Financial Statements. In
addition, as a result of our participation in the TARP Capital Purchase Program,
we may not increase the quarterly dividends we pay on our common stock above
$0.16 per share during the three-year period ending January 23, 2012, without
the consent of the Treasury Department, unless the Treasury Department no longer
holds shares of the Series A Preferred Stock we issued in the TARP Capital
Purchase Program.
The
following selected financial data should be read in conjunction with our
Consolidated Financial Statements and the accompanying notes presented elsewhere
herein.
|
(Dollars
in thousands, except per share amounts)
|
2008
|
2007
(2)
|
2006
|
2005
|
2004
|
|||||||||||||||
| $ | 235,308 | $ | 253,587 | $ | 208,994 | $ | 168,532 | $ | 151,437 | |||||||||||
|
Interest
expense
|
103,148 | 134,677 | 102,561 | 70,104 | 52,749 | |||||||||||||||
|
Net
interest income
|
132,160 | 118,910 | 106,433 | 98,428 | 98,688 | |||||||||||||||
|
Provision
for (recovery of) loan and lease losses
|
16,648 | 7,534 | (2,736 | ) | (5,855 | ) | 229 | |||||||||||||
|
Net
interest income after provision for (recovery of)
|
||||||||||||||||||||
|
loan
and lease losses
|
115,512 | 111,376 | 109,169 | 104,283 | 98,459 | |||||||||||||||
|
Noninterest
income
|
84,003 | 70,619 | 76,585 | 68,533 | 62,733 | |||||||||||||||
|
Noninterest
expense
|
153,114 | 140,312 | 126,211 | 123,439 | 127,091 | |||||||||||||||
|
Income
before income taxes
|
46,401 | 41,683 | 59,543 | 49,377 | 34,101 | |||||||||||||||
|
Income
taxes
|
13,015 | 11,144 | 20,246 | 15,626 | 9,136 | |||||||||||||||
|
Net
income
|
$ | 33,386 | $ | 30,539 | $ | 39,297 | $ | 33,751 | $ | 24,965 | ||||||||||
|
Assets
at year-end
|
$ | 4,464,174 | $ | 4,447,104 | $ | 3,807,315 | $ | 3,511,277 | $ | 3,563,715 | ||||||||||
|
Long-term
debt and mandatorily redeemable
|
||||||||||||||||||||
|
securities
at year-end
|
29,832 | 34,702 | 43,761 | 23,237 | 17,964 | |||||||||||||||
|
Shareholders’
equity at year-end
|
453,664 | 430,504 | 368,904 | 345,576 | 326,600 | |||||||||||||||
|
Basic
net income per common share (1)
|
1.38 | 1.30 | 1.74 | 1.48 | 1.10 | |||||||||||||||
|
Diluted
net income per common share (1)
|
1.37 | 1.28 | 1.72 | 1.46 | 1.08 | |||||||||||||||
|
Cash
dividends per common share (1)
|
.580 | .560 | .534 | .445 | .382 | |||||||||||||||
|
Dividend
payout ratio
|
42.34 | % | 43.75 | % | 31.05 | % | 30.48 | % | 35.37 | % | ||||||||||
|
Return
on average assets
|
0.76 | % | 0.74 | % | 1.11 | % | 1.00 | % | 0.75 | % | ||||||||||
|
Return
on average common equity
|
7.52 | % | 7.47 | % | 10.98 | % | 10.12 | % | 7.81 | % | ||||||||||
|
Average
common equity to average assets
|
10.09 | % | 9.85 | % | 10.07 | % | 9.89 | % | 9.55 | % | ||||||||||
|
(1)
The computation of per common share data gives retroactive recognition to
a 10% stock dividend declared July 27, 2006.
|
||||||||||||||||||||
|
(2)
Results for 2007 and later include the acquisition of FINA Bancorp,
Inc. Refer to Note C of the Notes to Consolidated Financial
Statements for further details.
|
||||||||||||||||||||
The
purpose of this analysis is to provide the reader with information relevant to
understanding and assessing our results of operations for each of the past three
years and financial condition for each of the past two years. In order to fully
appreciate this analysis the reader is encouraged to review the consolidated
financial statements and statistical data presented in this
document.
Forward-Looking
Statements
This
report, including Management’s Discussion and Analysis of Financial Condition
and Results of Operations, contains forward-looking statements. Forward-looking
statements include statements with respect to our beliefs, plans, objectives,
goals, expectations, anticipations, assumptions, estimates, intentions, and
future performance, and involve known and unknown risks, uncertainties and other
factors, which may be beyond our control, and which may cause actual results,
performance or achievements to be materially different from future results,
performance or achievements expressed or implied by such forward-looking
statements.
All
statements other than statements of historical fact are statements that could be
forward-looking statements. Words such as “believe”, “contemplate”, “seek”,
“estimate”, “plan”, “project”, “anticipate”, “possible”, “assume”, “expect”,
“intend”, “targeted”, “continue”, “remain”, “will”, “should”, “indicate”,
“would”, “may” and other similar expressions are intended to identify
forward-looking statements but are not the exclusive means of identifying such
statements. Forward-
looking
statements provide current expectations or forecasts of future events and are
not guarantees of future performance, nor should they be relied upon as
representing management’s views as of any subsequent date. The forward-looking
statements are based on our expectations and are subject to a number of risks
and uncertainties.
All
written or oral forward-looking statements that are made by or attributable to
us are expressly qualified in their entirety by this cautionary notice. We have
no obligation and do not undertake to update, revise, or correct any of the
forward-looking statements after the date of this report, or after the
respective dates on which such statements otherwise are made. We have expressed
our expectations, beliefs, and projections in good faith and we believe they
have a reasonable basis. However, we make no assurances that our expectations,
beliefs, or projections will be achieved or accomplished. These forward-looking
statements may not be realized due to a variety of factors, including, without
limitation, the following:
|
·
|
Local,
regional, national, and international economic conditions and the impact
they may have on us and our clients and our assessment of that
impact.
|
|
·
|
Changes
in the level of nonperforming assets and
charge-offs.
|
|
·
|
Changes
in estimates of future cash reserve requirements based upon the periodic
review thereof under relevant regulatory and accounting
requirements.
|
|
·
|
The
effects of and changes in trade and monetary and fiscal policies and laws,
including the interest rate policies of the Federal Reserve
Board.
|
|
·
|
Inflation,
interest rate, securities market, and monetary
fluctuations.
|
|
·
|
Political
instability.
|
|
·
|
Acts
of war or terrorism.
|
|
·
|
Substantial
increases in the cost of fuel.
|
|
·
|
The
timely development and acceptance of new products and services and
perceived overall value of these products and services by
others.
|
|
·
|
Changes
in consumer spending, borrowings, and savings
habits.
|
|
·
|
Changes
in the financial performance and/or condition of our
borrowers.
|
|
·
|
Technological
changes.
|
|
·
|
Acquisitions
and integration of acquired
businesses.
|
|
·
|
The
ability to increase market share and control
expenses.
|
|
·
|
Changes
in the competitive environment among bank holding
companies.
|
|
·
|
The
effect of changes in laws and regulations (including laws and regulations
concerning taxes, banking, securities, and insurance) with which we and
our subsidiaries must comply.
|
|
·
|
The
effect of changes in accounting policies and practices and auditing
requirements, as may be adopted by the regulatory agencies, as well as the
Public Company Accounting Oversight Board, the Financial Accounting
Standards Board, and other accounting standard
setters.
|
|
·
|
Changes
in our organization, compensation, and benefit
plans.
|
|
·
|
The
costs and effects of legal and regulatory developments including the
resolution of legal proceedings or regulatory or other governmental
inquires and the results of regulatory examinations or
reviews.
|
|
·
|
Greater
than expected costs or difficulties related to the integration of new
products and lines of business.
|
|
·
|
Our
success at managing the risks described in Item 1A. Risk
Factors.
|
Application of Critical
Accounting Policies and Estimates
Our
consolidated financial statements are prepared in accordance with U. S.
generally accepted accounting principles and follow general practices within the
industries in which we operate. Application of these principles requires our
management to make estimates or judgments that affect the amounts reported in
the financial statements and accompanying notes. These estimates or judgments
reflect our management’s view of the most appropriate manner in which to record
and report our overall financial performance. Because these estimates or
judgments are based on current circumstances, they may change over time or prove
to be inaccurate based on actual experience. As such, changes in these
estimates, judgments, and/or assumptions may have a significant impact on our
financial statements. All accounting policies are important, and all policies
described in Part II, Item 8, Financial Statements and Supplementary Data, Note
A (Note A), should be reviewed for a greater understanding of how our financial
performance is recorded and reported.
We have
identified three policies as being critical because they require our management
to make particularly difficult, subjective, and/or complex estimates or
judgments about matters that are inherently uncertain and because of the
likelihood that materially different amounts would be reported under different
conditions or using different assumptions. These policies relate to the
determination of the reserve for loan and lease losses, the valuation of
mortgage servicing rights, and the valuation of securities. Our management has
used the best information available to make the estimations or judgments
necessary to value the related assets and liabilities. Actual performance that
differs from estimates or judgments and future changes in the key variables
could change future valuations and impact net income. Our management has
reviewed the application of these policies with the Audit Committee of the Board
of Directors. Following is a discussion of the areas we view as our
most critical accounting policies.
Reserve for Loan and Lease
Losses — The
reserve for loan and lease losses represents our management’s estimate of
probable losses inherent in the loan and lease portfolio and the establishment
of a reserve that is sufficient to absorb those losses. In determining an
adequate reserve, our management makes numerous judgments, assumptions, and
estimates based on continuous review of the loan and lease portfolio, estimates
of client performance, collateral values, and disposition, as well as historical
loss rates and expected cash flows. In assessing these factors, our management
benefits from a lengthy organizational history and experience with credit
decisions and related outcomes. Nonetheless, if our management’s underlying
assumptions prove to be inaccurate, the reserve for loan and lease losses would
have to be adjusted. Our accounting policy related to the reserve is disclosed
in Note A under the heading "Reserve for Loan and Lease
Losses."
Fair Value Measurements: —
We use fair value
measurements to record certain financial instruments and to determine fair value
disclosures. Available-for-sale securities, mortgage loans held for sale, and
interest rate swap agreements are financial instruments recorded at fair value
on a recurring basis. Additionally,
from time to time, we may
be required to record at fair value other financial assets on a nonrecurring
basis. These nonrecurring fair value adjustments typically involve write-downs
of, or specific reserves against, individual assets. SFAS No. 157, Fair Value
Measurements establishes a three-level hierarchy
for disclosure of assets and liabilities recorded at fair value. The
classification of assets and liabilities within the hierarchy is based on
whether the inputs to the valuation methodology used in the measurement are
observable or unobservable. Observable inputs reflect market-driven or
market-based information obtained from independent sources, while unobservable
inputs reflect our estimates about market data.
The
degree of management judgment involved in determining the fair value of a
financial instrument is dependent upon the availability of quoted market prices
or observable market data. For financial instruments that trade actively and
have quoted market prices or observable market data, there is minimal
subjectivity involved in measuring fair value. When observable market prices and
data are not fully available, management judgment is necessary to estimate fair
value. In addition, changes in the market conditions may reduce the availability
of quoted prices or observable data. For example, reduced liquidity in the
capital markets or changes in secondary market activities could result in
observable market inputs becoming unavailable. Therefore, when market data is
not available, we use valuation techniques that require more management judgment
to estimate the appropriate fair value measurement. Fair value is discussed
further in Note A under the heading "Fair Value Measurements" and in Note S,
"Fair Values of Financial Instruments."
Mortgage Servicing Rights
Valuation — We recognize as assets the rights to service mortgage loans
for others, known as mortgage servicing rights, whether the servicing rights are
acquired through purchases or through originated loans. Mortgage servicing
rights do not trade in an active open market with readily observable market
prices. Although sales of mortgage servicing rights do occur, the precise terms
and conditions may not be readily available. As such, the value of mortgage
servicing assets are established and valued using discounted cash flow modeling
techniques which require management to make estimates regarding estimated future
net servicing cash flows, taking into consideration actual and expected mortgage
loan prepayment rates, discount rates, servicing costs, and other economic
factors. The expected rates of mortgage loan prepayments are the most
significant factors driving the value of mortgage servicing assets. Increases in
mortgage loan prepayments reduce estimated future net servicing cash flows
because the life of the underlying loan is reduced. In determining the fair
value of the mortgage servicing assets, mortgage interest rates (which are used
to determine prepayment rates), and discount rates are held constant over the
estimated life of the portfolio. Expected mortgage loan prepayment rates are
derived from a third-party model and adjusted to reflect our actual prepayment
experience. Mortgage servicing assets are carried at the lower of the initial
capitalized amount, net of accumulated amortization, or fair value. The values
of these assets are sensitive to changes in the assumptions used and readily
available market pricing does not exist. The valuation of mortgage servicing
assets is discussed further in Note A under the heading "Mortgage Banking
Activities."
Recent Market
Developments
The
global and U.S. economies are experiencing significantly reduced business
activity as a result of, among other factors, disruptions in the financial
system during the past year. Dramatic declines in the housing market during the
past year, with falling home prices and increasing foreclosures and
unemployment, have resulted in significant write-downs of asset values by
financial institutions, including government-sponsored entities and major
commercial and investment banks. These write-downs, initially of
residential-related loans and mortgage-backed securities, but spreading to
credit default swaps and other derivative securities, have caused many financial
institutions to seek additional capital, to merge with larger and stronger
institutions and, in some cases, to fail.
Reflecting
concern about the stability of the financial markets generally and the strength
of counterparties, many lenders and institutional investors have reduced, and in
some cases, ceased to provide funding to borrowers, including other financial
institutions. The availability of credit, confidence in the financial sector,
and level of volatility in the financial markets have been significantly
adversely affected as a result. In recent months, volatility and disruption in
the capital and credit markets have reached unprecedented levels. In some cases,
the markets have produced downward pressure on stock prices and credit capacity
for certain issuers without regard to those issuers’ underlying financial
strength.
In
response to the financial crises affecting the banking system and financial
markets and going concern threats to investment banks and other financial
institutions, the Emergency Economic Stabilization Act of 2008 ("EESA") was
signed into law on October 3, 2008. The EESA authorizes the Treasury
to, among other things, purchase up to $700 billion of mortgages,
mortgage-backed securities and certain other financial instruments from
financial institutions for the purpose of stabilizing and providing liquidity to
the U.S. financial markets. The EESA also provided a temporary increase
in deposit insurance coverage from $100,000 to $250,000 per insured account
until December 31, 2009.
On
October 14, 2008, Secretary Paulson, after consulting with the Federal Reserve
and the FDIC, announced that the Treasury will purchase equity stakes in certain
banks and thrifts. Under this program, known as the Troubled Asset Relief
Program Capital Purchase Program (the "TARP Capital Purchase Program"), the
Treasury will make $250 billion of capital available to U.S. financial
institutions in the form of preferred stock (from the $700 billion authorized by
the EESA). In conjunction with the purchase of preferred stock, the Treasury
will receive warrants to purchase common stock with an aggregate market price
equal to 15% of the preferred investment. Participating financial institutions
will be required to adopt the Treasury’s standards for executive compensation
and corporate governance for the period during which the Treasury holds equity
issued under the TARP Capital Purchase Program.
Also on
October 14, 2008, after receiving a recommendation from the boards of the FDIC
and the Federal Reserve, and consulting with the President, Secretary Paulson
signed the systemic risk exception to the FDIC Act, enabling the FDIC to
temporarily provide a 100% guarantee of the senior unsecured debt of all
FDIC-insured institutions and their holding companies, as well as deposits in
noninterest-bearing transaction deposit accounts under a Temporary Liquidity
Guarantee Program through December 31, 2009. All
insured depository institutions automatically participated in the Temporary
Liquidity Guarantee Program for 30 days following the announcement of the
program without charge (subsequently extended to December 5, 2008) and
thereafter, unless an institution opted out, at a cost of 75 basis points per
annum for senior unsecured debt and 10 basis points per annum for
noninterest-bearing transaction deposits.
1st
Source elected to participate in the TARP Capital Purchase Program, and on
January 23, 2009 received $111.00 million in additional capital through the
program. In exchange, the Treasury received a like amount of 1st Source
Corporation preferred stock that pays an annual dividend of 5.00 percent for the
first five years, and an annual dividend of 9.00 percent in any years
thereafter. We may redeem the preferred shares issued to Treasury in full during
the first three years following issuance only with the proceeds of a qualifying
equity offering. Thereafter, the preferred shares may be redeemed in full or in
part at any time. We also issued a warrant to the Treasury to purchase 837,947
shares of 1st Source common stock, which, upon issuance, would represent
approximately 3.3 percent of our outstanding common shares, based upon current
information. The warrant is exercisable at any time during the ten-year period
following issuance at an exercise price of $19.87.
Notwithstanding
the foregoing, The American Recovery and Reinvestment Act of 2009 (“ARRA”),
which was signed into law by President Obama on February 17, 2009, provides that
the Secretary of the Treasury shall permit a recipient of funds under the
Troubled Assets Relief Program, subject to consultation with the recipient’s
appropriate Federal banking agency, to repay such assistance without regard to
whether the recipient has replaced such funds from any other source or to any
waiting period. ARRA further provides that when the recipient repays such
assistance, the Secretary of the Treasury shall liquidate the warrants
associated with the assistance at the current market price. While Treasury has
not yet issued implementing regulations, it appears that ARRA will permit 1st
Source, if it so elects and following consultation with the FRB, to redeem the
Series A Preferred Stock at any time without restriction.
Additionally,
1st Source has decided to continue to participate in the Temporary Liquidity
Guarantee Program following the expiration of the initial opt-out period. Our
participation includes both the Transaction Account Guarantee Program related to
the guarantee of noninterest bearing deposit accounts and eligible, low earning
NOW accounts (interest rate equal to or less than 0.50%) and the Debt Guarantee
Program related to the guarantee of applicable senior unsecured
debt.
It is not
clear at this time what impact the EESA, the TARP Capital Purchase Program, the
Temporary Liquidity Guarantee Program, or other liquidity and funding
initiatives will have on the financial markets and the other difficulties
described above, including the high levels of volatility and limited credit
availability currently being experienced, or on the U.S. banking and financial
industries and the broader U.S. global economies. Further adverse effects could
have an adverse effect on our business.
Earnings
Summary
Net
income in 2008 was $33.39 million, up from $30.54 million in 2007 and down from
$39.30 million in 2006. Diluted net income per common share was in $1.37 in
2008, $1.28 in 2007, and $1.72 in 2006. Return on average total assets was 0.76%
in 2008 compared to 0.74% in 2007, and 1.11% in 2006. Return on average common
shareholders' equity was 7.52% in 2008 versus 7.47% in 2007, and
10.98% in 2006.
Net
income in 2008 was favorably impacted by an 11.14% increase in net interest
income over 2007, an $11.49 million gain on the sale of certain assets of
Investment Advisors and increased noninterest income. These increases were
offset by increased provision for loan and lease losses, investment securities
impairment and increased noninterest expenses. Net income in 2007 was favorably
affected by an 11.72% increase in net interest income over 2006. However, this
increase was more than offset by an increase in the provision for loan and lease
losses, decreased mortgage banking income, investment securities impairment and
increased noninterest expenses.
Dividends
paid on common stock in 2008 amounted to $0.58 per share, compared to $0.56 per
share in 2007, and $0.534 per share in 2006. 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.
Acquisition
of First National Bank, Valparaiso — On May 31, 2007,
we acquired FINA Bancorp (FINA), the parent company of First National Bank,
Valparaiso for $134.19 million. First National was a full service bank with
16 banking facilities, as of December 31, 2007, located in Porter and LaPorte
Counties of Indiana. Pursuant to the definitive agreement, FINA shareholders
were able to choose whether to receive 1st Source common stock and/or cash
pursuant to the election procedures described in the definitive agreement. Under
the terms of the transaction, FINA was acquired in exchange for 2,124,974 shares
of 1st Source common stock valued at $53.68 million and $80.51 million in cash.
The value of the common stock was $25.26 per share. We believe that the purchase
of FINA is a natural extension of our service area and is consistent with our
growth and market expansion initiatives. On June 6, 2008, First
National was merged with 1st Source Bank.
Upgrade of Core Systems —
During 2007, we upgraded a majority of our core and ancillary data processing
systems. Numerous internal teams were formed to manage the installation and
conversion of data and various systems. The core technology includes a loan
system, deposit system, general ledger system, and customer information file
system. Additionally, ATM networks, a voice response unit (VRU) system, and
document imaging systems were installed. Total 2007 expenses for this
upgrade were $2.71 million.
Net Interest Income — Our
primary source of earnings is net interest income, the difference between income
on earning assets and the cost of funds supporting those assets. Significant
categories of earning assets are loans and securities while deposits and
borrowings represent the major portion of interest-bearing liabilities. For
purposes of the following discussion, comparison of net interest income is done
on a tax equivalent basis, which provides a common basis for comparing yields on
earning assets exempt from federal income taxes to those which are fully
taxable.
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 3.34% in 2008 compared to 3.18% in 2007, and 3.29%
in 2006. The higher margin in 2008 reflects lower funding costs compared with
the decline in yields on earning assets. Net interest income was $132.16 million
for 2008, compared to $118.91 million for 2007. Tax-equivalent net interest
income totaled $135.75 million for 2008, an increase of $13.22 million from the
$122.53 million reported for 2007. The $13.22 million increase is mainly due to
changes in rates.
During
2008, average earning assets increased $215.89 million while average
interest-bearing liabilities increased $194.30 million over the comparable
period. The yield on average earning assets decreased 81 basis points to 5.87%
for 2008 from 6.68% for 2007. The rate earned on assets was negatively impacted
by decreases in market rates. Total cost of average interest-bearing liabilities
decreased 112 basis points during 2008 as liabilities were also impacted by
decreases in market rates. The result was an increase of 31 basis points to net
interest spread, or the difference between interest income on earning assets and
expense on interest-bearing liabilities.
The
largest contributor to the decrease in the yield on average earning assets in
2008 was the 97 basis point decrease in the loan and lease portfolio yield. The
decrease in the loan and lease portfolio yield was offset by an increase in net
loan and lease outstandings. Average net loans and leases increased $270.74
million or 9.05% in 2008 from 2007.
During
2008, the tax-equivalent yield on securities available for sale decreased 28
basis points to 4.60% while the average balance decreased $22.99
million.
Average
interest-bearing deposits increased $78.07 million during 2008 while the
effective rate paid on those deposits decreased 104 basis points. Average demand
deposits increased $26.39 million during 2008.
Average
short-term borrowings increased $115.47 million during 2008; however, the
effective rate paid decreased 206 basis points. Average subordinated notes which
represent our trust preferred borrowings increased $8.55 million during 2008,
while the effective rate increased four basis points. Average long-term debt
decreased $7.79 million during 2008 as the effective rate decreased 57 basis
points.
The
following table provides an analysis of net interest income and illustrates
interest income earned and interest expense charged for each major component of
interest earning assets and the interest bearing liabilities. Yields/rates are
computed on a tax-equivalent basis, using a 35% rate. Nonaccrual loans and
leases are included in the average loan and lease balance
outstanding.
|
2008
|
2007 | 2006 | ||||||||||||||||||||||||||||||||||
|
(Dollars
in thousands)
|
Average
Balance
|
Interest
Income/Expense
|
Yield/Rate
|
Average
Balance
|
Interest
Income/Expense
|
Yield/Rate
|
Average
Balance
|
Interest
Income/Expense
|
Yield/Rate
|
|||||||||||||||||||||||||||
|
ASSETS
|
||||||||||||||||||||||||||||||||||||
|
Investment
securities:
|
||||||||||||||||||||||||||||||||||||
|
Taxable
|
$ | 491,061 | $ | 22,170 | 4.51 | % | $ | 510,949 | $ | 25,136 | 4.92 | % | $ | 458,152 | $ | 19,177 | 4.19 | % | ||||||||||||||||||
|
Tax-exempt
|
222,751 | 10,692 | 4.80 | 225,849 | 10,800 | 4.78 | 173,652 | 7,416 | 4.27 | |||||||||||||||||||||||||||
|
Mortgages
held for sale
|
33,925 | 2,069 | 6.10 | 28,913 | 1,892 | 6.54 | 53,034 | 3,549 | 6.69 | |||||||||||||||||||||||||||
|
Net
loans and leases
|
3,263,276 | 202,539 | 6.21 | 2,992,540 | 214,725 | 7.18 | 2,566,217 | 178,125 | 6.94 | |||||||||||||||||||||||||||
|
Other
investments
|
57,601 | 1,425 | 2.47 | 94,478 | 4,657 | 4.93 | 64,049 | 3,271 | 5.11 | |||||||||||||||||||||||||||
|
Total
earning assets
|
4,068,614 | 238,895 | 5.87 | 3,852,729 | 257,210 | 6.68 | 3,315,104 | 211,538 | 6.38 | |||||||||||||||||||||||||||
|
Cash
and due from banks
|
83,270 | 81,714 | 78,365 | |||||||||||||||||||||||||||||||||
|
Reserve
for loan and lease losses
|
(71,358 | ) | (61,555 | ) | (59,082 | ) | ||||||||||||||||||||||||||||||
|
Other
assets
|
319,997 | 278,421 | 217,914 | |||||||||||||||||||||||||||||||||
|
Total
assets
|
$ | 4,400,523 | $ | 4,151,309 | $ | 3,552,301 | ||||||||||||||||||||||||||||||
|
LIABILITIES AND SHAREHOLDERS'
EQUITY
|
||||||||||||||||||||||||||||||||||||
|
Interest
bearing deposits
|
$ | 2,996,830 | $ | 86,903 | 2.90 | % | $ | 2,918,756 | $ | 115,113 | 3.94 | % | $ | 2,418,344 | $ | 85,067 | 3.52 | % | ||||||||||||||||||
|
Short-term
borrowings
|
386,850 | 7,626 | 1.97 | 271,377 | 10,935 | 4.03 | 265,824 | 11,011 | 4.14 | |||||||||||||||||||||||||||
|
Subordinated
notes
|
90,960 | 6,714 | 7.38 | 82,414 | 6,051 | 7.34 | 59,022 | 4,320 | 7.32 | |||||||||||||||||||||||||||
|
Long-term
debt and mandatorily redeemable securities
|
34,472 | 1,905 | 5.53 | 42,265 | 2,578 | 6.10 | 36,952 | 2,163 | 5.85 | |||||||||||||||||||||||||||
|
Total
interest bearing liabilities
|
3,509,112 | 103,148 | 2.94 | 3,314,812 | 134,677 | 4.06 | 2,780,142 | 102,561 | 3.69 | |||||||||||||||||||||||||||
|
Noninterest
bearing deposits
|
377,440 | 351,050 | 352,204 | |||||||||||||||||||||||||||||||||
|
Other
liabilities
|
69,823 | 76,472 | 62,196 | |||||||||||||||||||||||||||||||||
|
Shareholders'
equity
|
444,148 | 408,975 | 357,759 | |||||||||||||||||||||||||||||||||
|
Total
liabilities and shareholders' equity
|
$ | 4,400,523 | $ | 4,151,309 | $ | 3,552,301 | ||||||||||||||||||||||||||||||
|
Net
interest income
|
$ | 135,747 | $ | 122,533 | $ | 108,977 | ||||||||||||||||||||||||||||||
|
Net
interest margin on a tax equivalent basis
|
3.34 | % | 3.18 | % | 3.29 | % | ||||||||||||||||||||||||||||||
The
change in interest due to both rate and volume has been allocated to volume and
rate changes in proportion to the relationship of the absolute dollar amounts of
the change in each. The following table shows changes in tax equivalent interest
earned and interest paid, resulting from changes in volume and changes in
rates:
|
Increase
(Decrease) due to
|
||||||||||||
|
(Dollars
in thousands)
|
Volume
|
Rate
|
Net
|
|||||||||
|
2008
compared to 2007
|
||||||||||||
|
Interest
earned on:
|
||||||||||||
|
Investment
securities:
|
||||||||||||
|
Taxable
|
$ | (927 | ) | $ | (2,039 | ) | $ | (2,966 | ) | |||
|
Tax-exempt
|
(153 | ) | 45 | (108 | ) | |||||||
|
Mortgages
held for sale
|
290 | (113 | ) | 177 | ||||||||
|
Net
loans and leases
|
24,816 | (37,002 | ) | (12,186 | ) | |||||||
|
Other
investments
|
(1,417 | ) | (1,815 | ) | (3,232 | ) | ||||||
|
Total
earning assets
|
$ | 22,609 | $ | (40,924 | ) | $ | (18,315 | ) | ||||
|
Interest
paid on:
|
||||||||||||
|
Interest
bearing deposits
|
$ | 3,045 | $ | (31,255 | ) | $ | (28,210 | ) | ||||
|
Short-term
borrowings
|
16,581 | (19,890 | ) | (3,309 | ) | |||||||
|
Subordinated
notes
|
630 | 33 | 663 | |||||||||
|
Long-term
debt and mandatorily redeemable securities
|
(447 | ) | (226 | ) | (673 | ) | ||||||
|
Total
interest bearing liabilities
|
$ | 19,809 | $ | (51,338 | ) | $ | (31,529 | ) | ||||
|
Net
interest income
|
$ | 2,800 | $ | 10,414 | $ | 13,214 | ||||||
|
2007
compared to 2006
|
||||||||||||
|
Interest
earned on:
|
||||||||||||
|
Investment
securities:
|
||||||||||||
|
Taxable
|
$ | 2,383 | $ | 3,576 | $ | 5,959 | ||||||
|
Tax-exempt
|
2,422 | 962 | 3,384 | |||||||||
|
Mortgages
held for sale
|
(1,579 | ) | (78 | ) | (1,657 | ) | ||||||
|
Net
loans and leases
|
30,264 | 6,336 | 36,600 | |||||||||
|
Other
investments
|
1,497 | (111 | ) | 1,386 | ||||||||
|
Total
earning assets
|
$ | 34,987 | $ | 10,685 | $ | 45,672 | ||||||
|
Interest
paid on:
|
||||||||||||
|
Interest
bearing deposits
|
$ | 19,125 | $ | 10,921 | $ | 30,046 | ||||||
|
Short-term
borrowings
|
241 | (317 | ) | (76 | ) | |||||||
|
Subordinated
notes
|
1,719 | 12 | 1,731 | |||||||||
|
Long-term
debt and mandatorily redeemable securities
|
320 | 95 | 415 | |||||||||
|
Total
interest bearing liabilities
|
$ | 21,405 | $ | 10,711 | $ | 32,116 | ||||||
|
Net
interest income
|
$ | 13,582 | $ | (26 | ) | $ | 13,556 | |||||
Noninterest Income —
Noninterest income increased 18.95% in 2008 from 2007 following a
7.79%
decrease in 2007 over 2006. Noninterest income for the most recent three
years ended December 31 was as follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
2006
|
|||||||||
|
Noninterest
income:
|
||||||||||||
|
Trust
fees
|
$ | 18,599 | $ | 15,567 | $ | 13,806 | ||||||
|
Service
charges on deposit accounts
|
22,035 | 20,470 | 19,040 | |||||||||
|
Mortgage
banking income
|
2,994 | 2,868 | 11,637 | |||||||||
|
Insurance
commissions
|
5,363 | 4,666 | 4,574 | |||||||||
|
Equipment
rental income
|
24,224 | 21,312 | 18,972 | |||||||||
|
Other
income
|
9,293 | 8,864 | 6,554 | |||||||||
|
Gain
on sale of certain Investment Advisor assets
|
11,492 | - | - | |||||||||
|
Investment
securities and other investment (losses) gains
|
(9,997 | ) | (3,128 | ) | 2,002 | |||||||
|
Total
noninterest income
|
$ | 84,003 | $ | 70,619 | $ | 76,585 | ||||||
Trust
fees (which include investment management fees, estate administration fees,
mutual fund fees, annuity fees, and fiduciary fees) increased by 19.48% in 2008
from 2007 compared to an increase of 12.76% in 2007 over 2006. Trust fees are
largely based on the size of client relationships and the market value and mix
of assets under management. The market value of trust assets under management at
December 31, 2008 and 2007, was $2.65 billion and $3.05 billion, respectively.
At December 31, 2008, these trust assets were comprised of $1.59 billion of
personal and agency trusts, $0.64 billion of employee benefit plan assets,
$314.02 million of estate administration assets and individual retirement
accounts, and $98.05 million of custody assets. Growth in trust fees was mainly
attributed to an increase in revenue sharing fees earned on the Monogram mutual
funds sold outside the Bank and administered by the Investment Advisors
subsidiary.
Service
charges on deposit accounts increased 7.65% in 2008 from 2007 compared to an
increase of 7.51% in 2007 from 2006. The growth in service charges on deposit
accounts reflects growth in the number of deposit accounts due to the May 2007
acquisition of First National and a higher volume of fee generating
transactions, primarily overdrafts, debit card and nonsufficient funds
transactions.
Mortgage
banking income increased 4.39% in 2008 over 2007, compared to a decrease of
75.35% in 2007 over 2006. In 2008, increased gains on mortgage loan sales were
offset by $1.91 million in mortgage servicing rights impairment. The decrease in
2007 was primarily due to a decline in production volume, non-recurring 2006
gains on the sale of mortgage servicing rights and a decline in loan servicing
fee income. In 2006, we recognized $4.75 million in pre-tax gains on bulk sales
of mortgage servicing rights related to both governmental and conventional loans
that occurred during the second and third quarters. During 2008, 2007 and 2006,
we determined that no permanent write-down was necessary for previously recorded
impairment on mortgage servicing assets.
Insurance
commissions were up 14.94% in 2008 from 2007 compared to an increase of 2.01% in
2007 from 2006. The increase for 2008 and 2007 was mainly attributed to an
acquisition of an insurance agency in the Fort Wayne area. The increase for 2006
was mainly attributed to higher contingent commissions.
Equipment
rental income generated from operating leases grew by 13.66% during 2008 from
2007 compared to an increase of 12.33% during 2007 from 2006. Revenues from
operating leases for construction equipment, various trucks, and other equipment
increased as clients responded positively to our strong marketing efforts and
entered into new lease agreements.
On August
25, 2008, Investment Advisors entered into a Purchase and
Sale Agreement with WA Holdings, Inc. ("Buyer") whereby Investment Advisors
agreed to sell certain assets to Buyer and to enter into a long-term
strategic partnership with Buyer. Pursuant to the Purchase and Sale
Agreement, in December 2008, Buyer and its wholly-owned subsidiary, Wasatch
Advisors, Inc., investment advisor of the Wasatch Funds, Inc., acquired assets
of Investment Advisors related to the management of the 1st Source Monogram
Mutual Funds - the Income Equity Fund, the Long/Short Fund and the Income
Fund. The 1st Source Monogram Mutual Funds were reorganized into the Wasatch -
1st Source Income Equity Fund, the Wasatch - 1st Source Long/Short Fund,
and the Wasatch - 1st Source Income Fund. Investment Advisors recorded a
net gain of $11.49 million at closing, which was net of $1.51 million of legal
and compensation expense.
Investment
securities and other investment losses totaled $10.00 million for the year ended
2008 compared to losses of $3.13 million for the year ended 2007 and gains of
$2.00 million for the year ended 2006. In 2008 and 2007, we took $10.82 million
and $4.11 million, respectively, in impairment charges on investments
in the Federal National Mortgage Association (FNMA) and the Federal Home Loan
Mortgage Corporation (FHLMC) preferred stock and other preferred equities. In
2008, deterioration in the residential mortgage business and government
intervention at the FNMA and the FHLMC resulted in further impairment of
the FNMA and the FHLMC securities. Due to the uncertainty of future market
conditions and how they might impact the financial performance of the FNMA and
the FHLMC, we were unable to determine when or if this impairment will be
recovered. As of December 31, 2008, the carrying value of our investment in
the FHLMC preferred stock was $0.13 million and the carrying value of
our investment in the FNMA preferred stock was $0.03 million. Favorable
market valuation adjustments on our venture partnership investments during 2006
were the main factor contributing to the 2006 gains.
Other
income remained relatively stable in 2008 from 2007 after an increase of 35.25%
in 2007 compared to 2006. The increase in 2007 was primarily due to increases in
interest rate swap fee income, credit card merchant fees, and income on bank
owned life insurance policies.
Noninterest Expense —
Noninterest expense increased 9.12% in 2008 over 2007 following an 11.17%
increase in 2007
from 2006. Noninterest expense for the recent three years ended December
31 was as follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
2006
|
|||||||||
|
Noninterest
expense:
|
||||||||||||
|
Salaries
and employee benefits
|
$ | 76,965 | $ | 73,944 | $ | 66,605 | ||||||
|
Net
occupancy expense
|
9,698 | 9,030 | 7,492 | |||||||||
|
Furniture
and equipment expense
|
15,095 | 15,145 | 12,316 | |||||||||
|
Depreciation
— leased equipment
|
19,450 | 17,085 | 14,958 | |||||||||
|
Professional
fees
|
8,446 | 4,575 | 3,998 | |||||||||
|
Supplies
and communications
|
6,782 | 5,987 | 5,496 | |||||||||
|
Business
development and marketing expense
|
3,749 | 4,788 | 4,008 | |||||||||
|
Intangible
asset amortization
|
1,393 | 874 | 1,910 | |||||||||
|
Loan
and lease collection and repossession expense
|
1,162 | 1,123 | 704 | |||||||||
|
Other
expense
|
10,374 | 7,761 | 8,724 | |||||||||
|
Total
noninterest expense
|
$ | 153,114 | $ | 140,312 | $ | 126,211 | ||||||
Total
salaries and employee benefits increased 4.09% in 2008 from 2007, following an
11.02% increase in 2007 from 2006.
Employee
salaries increased 3.69% in 2008 from 2007 compared to an increase of 13.25% in
2007 from 2006. The increase in 2008 is due to a full year of First National
staff and a decline in salaries deferred relating to the origination of loans
(SFAS 91). The increase in 2007 is mainly attributable to a larger work force
following the acquisition of First National and lower 2006 salaries due to the
first quarter 2006 reversal of previously recognized stock-based compensation
expense under historical accounting methods related to the estimated forfeiture
of stock awards. This one-time expense reversal, combined with the adoption of
Statement of Financial Accounting Standards No. 123(R), Share-based Payment, (SFAS
No. 123(R)) estimated forfeiture accounting requirements, resulted in a
reduction in stock-based compensation of $2.07 million, pre-tax, for the 2006
year.
Employee
benefits increased 5.74% in 2008 from 2007 after remaining relatively stable in
2007 and 2006. The increase in 2008 was primarily due to increased group
insurance costs.
Occupancy
expense increased 7.40% in 2008 from 2007, compared to an increase of 20.53% in
2007 from 2006. The increase in 2008 and 2007 was primarily due to the increase
in number of locations following the acquisition of First National.
Furniture
and equipment expense, including depreciation, declined slightly in 2008 from
2007 compared to a 22.97% increase in 2007 from 2006. During 2008 increased
computer processing charges offset declines in repairs and depreciation. During
2007, higher software costs, which were mostly related to implementation of
upgrades to our core accounting and management systems, and higher debit card
transaction expense were the significant factors contributing to the
increase.
Depreciation
on equipment owned under operating leases increased 13.84% in 2008 from 2007,
following a 14.22% increase in 2007 from 2006. In 2008 and in 2007, depreciation
on equipment owned under operating leases increased in conjunction with the
increase in equipment rental income as some of our clients opted to enter into
new lease arrangements rather than purchase equipment.
Professional
fees increased 84.61% in 2008 from 2007, compared to a 14.43% increase in 2007
from 2006. The increase in 2008 was due to expenses recorded for a systems
security breach that occurred in May 2008 and other consulting expenses. The
majority of the increase in 2007 was due to higher consulting fees paid in
conjunction with our core system upgrade.
Supplies
and communications expense increased 13.28% in 2008 from 2007 after an 8.93%
increase in 2007 as compared to 2006. The increase in 2008 was due to increased
printing cost, freight expense and data line expense. The increase in 2007 was
due to increased telephone and data line expense and increased freight
expense.
Business
development and marketing expense decreased 21.70% in 2008 from 2007 compared to
a 19.46% increase in 2007 from 2006. The decrease in 2008 was due to reduced
retail marketing expenses. The increase in 2007 was mainly due to strong
marketing across our entire footprint area.
Intangible
asset amortization increased 59.38% in 2008 from 2007 compared to a 54.24%
decrease in 2007 from 2006. The increase in intangible asset amortization for
2008 was due to the amortization of intangibles related to the First National
acquisition. The decrease in intangible asset amortization for 2007 was
primarily due to the effects of the complete amortization of assets associated
with acquisitions which occurred during 2001.
Loan and
lease collection and repossession expenses remained stable in 2008 from 2007
compared to a 59.52% increase in 2007 from 2006. The increase in 2007 was mainly
due to increased collection and repossession legal activity.
Other
expenses increased 33.67% in 2008 as compared to 2007 following a decrease of
11.04% in 2007 from 2006. Increased FDIC insurance expense, correspondent bank
fees, and write-downs of former bank premises held for sale attributed to the
2008 increase.
Income Taxes — 1st Source
recognized income tax expense in 2008 of $13.02 million, compared to $11.14
million in 2007, and $20.25 million in 2006. The effective tax rate in 2008 was
28.05% compared to 26.74% in 2007, and 34.00% in 2006. The effective tax rate
increased in 2008 compared to 2007 due to a decrease in tax-exempt
interest in relation to income before taxes as well as an increase in
state tax expense. For detailed analysis of 1st Source’s income taxes see Part
II, Item 8, Financial Statements and Supplementary Data — Note O of the Notes to
Consolidated Financial Statements.
Financial
Condition
Loan and
Lease Portfolio — The following table shows 1st Source’s loan and lease
distribution at the end of each of the last five years as of December
31:
|
(Dollars
in thousands)
|
2008
|
2007
|
2006
|
2005
|
2004
|
|||||||||||||||
|
Commercial
and agricultural loans
|
$ | 643,440 | $ | 593,806 | $ | 478,310 | $ | 453,197 | $ | 425,018 | ||||||||||
|
Auto,
light truck and environmental equipment
|
353,838 | 305,238 | 317,604 | 310,786 | 263,637 | |||||||||||||||
|
Medium
and heavy duty truck
|
243,375 | 300,469 | 341,744 | 302,137 | 267,834 | |||||||||||||||
|
Aircraft
financing
|
632,121 | 587,022 | 498,914 | 459,645 | 444,481 | |||||||||||||||
|
Construction
equipment financing
|
375,983 | 377,785 | 305,976 | 224,230 | 196,516 | |||||||||||||||
|
Loans
secured by real estate
|
918,749 | 881,646 | 632,283 | 601,077 | 583,437 | |||||||||||||||
|
Consumer
loans
|
130,706 | 145,475 | 127,706 | 112,359 | 99,245 | |||||||||||||||
|
Total
loans and leases
|
$ | 3,298,212 | $ | 3,191,441 | $ | 2,702,537 | $ | 2,463,431 | $ | 2,280,168 | ||||||||||
|
At
December 31, 2008, 12.3% of total loans and leases were concentrated with
construction end users.
|
||||||||||||||||||||
Average
loans and leases, net of unearned discount, increased 9.05% and 16.61% in 2008
and 2007, respectively. Loans and leases, net of unearned discount, at December
31, 2008, were $3.30 billion and were 73.88% of total assets, compared to $3.19
billion and 71.76% of total assets at December 31, 2007.
Commercial
and agricultural lending, excluding those loans secured by real estate,
increased 8.36% in 2008 over 2007. Commercial and agricultural lending
outstandings were $643.44 million and $593.81 million at December 31, 2008 and
December 31, 2007, respectively. This increase was mainly due to growth in our
newer markets and strong business activity during the first half of 2008.
Agricultural loan outstandings benefited from a robust market coupled with
increased working capital needs attributed to higher commodity
prices.
Loans
secured by real estate increased 4.21% during 2008 over 2007. Loans secured by
real estate outstanding at December 31, 2008, were $918.75 million
and
$881.65 million at December 31, 2007. Loans on commercial real estate, the
majority of which is owner occupied, were $621.08 million at December 31, 2008
and $530.45 million at December 31, 2007. The increase was mostly due to growth
in our newer markets and strong business activity during the first half of 2008.
Residential mortgage lending was $344.36 million at December 31, 2008 and
$351.20 million at December 31, 2007.
Auto,
light truck, and environmental equipment financing increased 15.92% in 2008 over
2007. At December 31, 2008, auto, light truck, and environmental equipment
financing had outstandings of $353.84 million and $305.24 million at December
31, 2007. Environmental equipment financing remained flat in 2008. Auto and
light truck financing increased 24.00% at December 31, 2008 compared to December
31, 2007, mainly due to the elimination of our program with Vehicle Services of
America which caused letters of credit to be funded, and to our competition
leaving the market.
Medium
and heavy duty truck loans and leases decreased 19.00%, in 2008. Medium and
heavy duty truck financing at December 31, 2008 and 2007, had outstandings of
$243.38 million and $300.47 million, respectively. Most of the decrease at
December 31, 2008 from December 31, 2007 can be attributed to a reduced need for
funding as clients downsized.
Aircraft
financing at year-end 2008 increased 7.68% from year-end 2007. Aircraft
financing at December 31, 2008 and 2007, had outstandings of $632.12 million and
$587.02 million, respectively. The increase in 2008 was primarily due to focused
sales efforts and a reduction in competition.
Construction
equipment financing remained relatively stable in 2008 compared to 2007.
Construction equipment financing at December 31, 2008, had outstandings of
$375.98 million, compared to outstandings of $377.79 million at December 31,
2007.
Consumer
loans decreased 10.15% in 2008 over 2007. Consumer loans outstanding at December
31, 2008, were $130.71 million and $145.48 million at December 31, 2007. The
decrease during 2008 was due to the economic slow down caused an increase in the
unemployment rates in our primary markets, thereby decreasing the number of
credit worthy customers.
The
following table shows the maturities of loans and leases in the categories of
commercial and agriculture, auto, light truck and environmental equipment,
medium and heavy duty truck, aircraft and construction equipment outstanding as
of December 31, 2008. The amounts due after one year are also classified
according to the sensitivity to changes in interest rates.
|
(Dollars
in thousands)
|
0-1
Year
|
1-5
Years
|
Over
5 Years
|
Total
|
||||||||||||
|
Commercial
and agricultural loans
|
$ | 465,587 | $ | 177,655 | $ | 198 | $ | 643,440 | ||||||||
|
Auto,
light truck and environmental equipment
|
238,730 | 111,178 | 3,930 | 353,838 | ||||||||||||
|
Medium
and heavy duty truck
|
124,767 | 117,285 | 1,323 | 243,375 | ||||||||||||
|
Aircraft
financing
|
297,928 | 321,532 | 12,661 | 632,121 | ||||||||||||
|
Construction
equipment financing
|
176,238 | 199,180 | 565 | 375,983 | ||||||||||||
|
Total
|
$ | 1,303,250 | $ | 926,830 | $ | 18,677 | $ | 2,248,757 | ||||||||
|
Rate
Sensitivity (Dollars in thousands)
|
Fixed
Rate
|
Variable
Rate
|
Total
|
|||||||||
|
1 –
5 Years
|
$ | 639,869 | $ | 286,961 | $ | 926,830 | ||||||
|
Over
5 Years
|
5,723 | 12,954 | 18,677 | |||||||||
|
Total
|
$ | 645,592 | $ | 299,915 | $ | 945,507 | ||||||
Most of
the Bank's residential mortgages are sold into the secondary market. Mortgage
loans held for sale were $46.69 million at December 31, 2008 and were $25.92
million at December 31, 2007.
Credit
Experience
Reserve for Loan and Lease
Losses — Our reserve for loan and lease losses is provided for by direct
charges to operations. Losses on loans and leases are charged against the
reserve and likewise, recoveries during the period for prior losses are credited
to the reserve. Our management evaluates the adequacy of the reserve quarterly,
reviewing all loans and leases over a fixed-dollar amount ($100,000) where the
internal credit rating is at or below a predetermined 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 and leases, estimated losses
on pools of homogeneous loans and leases based on historical loss experience,
and consideration of economic trends, all of which may be susceptible to
significant and unforeseen changes. We review the status of the loan and lease
portfolio to identify borrowers that might develop financial problems in order
to aid borrowers in the handling of their accounts and to mitigate losses. See
Part II, Item 8, Financial Statements and Supplementary Data — Note A of the
Notes to Consolidated Financial Statements for additional information on
management’s evaluation of the adequacy of the reserve for loan and lease
losses.
The
reserve for loan and lease losses at December 31, 2008 totaled $79.78 million
and was 2.42% of loans and leases, compared to $66.60 million or 2.09% of loans
and leases at December 31, 2007 and $58.80 million or 2.18% of loans and leases
at December 31, 2006. It is our opinion that the reserve for loan and lease
losses was adequate to absorb losses inherent in the loan and lease portfolio as
of December 31, 2008.
The
provision for loan and lease losses was $16.65 million for 2008, compared to the
provision for loan and lease losses of $7.53 million for 2007 and the recovery
of provision for loan and lease losses of $2.74 million for 2006. The increased
provision for loan and lease losses in 2008 was due to the deterioration in the
loan portfolio mainly due to the deterioration in the economy. The recovery of
the provision for 2006 was due to increased loan recoveries and was consistent
with our improved credit quality of the loan and lease portfolio.
The
following table summarizes our loan and lease loss experience for each of the
last five years ended December 31:
|
(Dollars
in thousands)
|
2008
|
2007
|
2006
|
2005
|
2004
|
|||||||||||||||
|
Amounts of loans and leases
outstanding
|
||||||||||||||||||||
|
at
end of period
|
$ | 3,298,212 | $ | 3,191,441 | $ | 2,702,537 | $ | 2,463,431 | $ | 2,280,168 | ||||||||||
|
Average
amount of net loans and leases outstanding
|
||||||||||||||||||||
|
during
period
|
$ | 3,263,276 | $ | 2,992,540 | $ | 2,566,217 | $ | 2,348,690 | $ | 2,240,055 | ||||||||||
|
Balance
of reserve for loan and lease losses
|
||||||||||||||||||||
|
at
beginning of period
|
$ | 66,602 | $ | 58,802 | $ | 58,697 | $ | 63,672 | $ | 70,045 | ||||||||||
|
Charge-offs:
|
||||||||||||||||||||
|
Commercial
and agricultural loans
|
1,580 | 1,841 | 1,038 | 1,478 | 6,104 | |||||||||||||||
|
Auto,
light truck and environmental equipment
|
234 | 1,770 | 340 | 630 | 2,408 | |||||||||||||||
|
Medium
and heavy duty truck
|
924 | 569 | - | 15 | 352 | |||||||||||||||
|
Aircraft
financing
|
462 | 378 | 1,126 | 2,424 | 3,585 | |||||||||||||||
|
Construction
equipment financing
|
1,695 | 799 | 118 | - | 686 | |||||||||||||||
|
Loans
secured by real estate
|
879 | 356 | 129 | 167 | 456 | |||||||||||||||
|
Consumer
loans
|
2,619 | 1,654 | 1,203 | 858 | 1,090 | |||||||||||||||
|
Total
charge-offs
|
8,393 | 7,367 | 3,954 | 5,572 | 14,681 | |||||||||||||||
|
Recoveries:
|
||||||||||||||||||||
|
Commercial
and agricultural loans
|
1,177 | 2,356 | 1,594 | 1,308 | 1,312 | |||||||||||||||
|
Auto,
light truck and environmental equipment
|
330 | 446 | 430 | 1,140 | 1,277 | |||||||||||||||
|
Medium
and heavy duty truck
|
248 | 64 | 59 | 174 | 14 | |||||||||||||||
|
Aircraft
financing
|
2,230 | 1,779 | 3,612 | 2,255 | 4,460 | |||||||||||||||
|
Construction
equipment financing
|
139 | 19 | 753 | 1,065 | 547 | |||||||||||||||
|
Loans
secured by real estate
|
171 | 169 | 31 | 89 | 107 | |||||||||||||||
|
Consumer
loans
|
624 | 421 | 316 | 421 | 362 | |||||||||||||||
|
Total
recoveries
|
4,919 | 5,254 | 6,795 | 6,452 | 8,079 | |||||||||||||||
|
Net
charge-offs (recoveries)
|
3,474 | 2,113 | (2,841 | ) | (880 | ) | 6,602 | |||||||||||||
|
Provision
for (recovery of provision for) loan and lease losses
|
16,648 | 7,534 | (2,736 | ) | (5,855 | ) | 229 | |||||||||||||
|
Reserves
acquired in acquisitions
|
- | 2,379 | - | - | - | |||||||||||||||
|
Balance
at end of period
|
$ | 79,776 | $ | 66,602 | $ | 58,802 | $ | 58,697 | $ | 63,672 | ||||||||||
|
Ratio
of net charge-offs (recoveries) to average net
|
||||||||||||||||||||
|
loans
and leases outstanding
|
0.11 | % | 0.07 | % | (0.11 | ) % | (0.04 | ) % | 0.29 | % | ||||||||||
Net
(recoveries) charge-offs as a percentage of average loans and leases by
portfolio type follow:
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||
|
Commercial
and agricultural loans
|
0.06 | % | (0.09 | ) % | (0.12 | ) % | 0.04 | % | 1.14 | % | ||||||||||
|
Auto,
light truck and environmental equipment
|
(0.03 | ) | 0.40 | (0.03 | ) | (0.17 | ) | 0.43 | ||||||||||||
|
Medium
and heavy duty truck
|
0.25 | 0.16 | (0.02 | ) | (0.06 | ) | 0.14 | |||||||||||||
|
Aircraft
financing
|
(0.30 | ) | (0.26 | ) | (0.54 | ) | 0.04 | (0.19 | ) | |||||||||||
|
Construction
equipment financing
|
0.41 | 0.22 | (0.24 | ) | (0.51 | ) | 0.07 | |||||||||||||
|
Loans
secured by real estate
|
0.08 | 0.02 | 0.02 | 0.01 | 0.06 | |||||||||||||||
|
Consumer
loans
|
1.44 | 0.88 | 0.74 | 0.41 | 0.77 | |||||||||||||||
|
Total
net charge-offs (recoveries) to average portfolio loans and
leases
|
0.11 | % | 0.07 | % | (0.11 | ) % | (0.04 | ) % | 0.29 | % | ||||||||||
The
reserve for loan and lease losses has been allocated according to the amount
deemed necessary to provide for the estimated probable losses that have been
incurred within the categories of loans and leases set forth in the table below.
The amount of such components of the reserve at December 31 and the ratio of
such loan and lease categories to total outstanding loan and lease balances, are
as follows (for purposes of this analysis, auto, light truck and environmental
equipment and medium and heavy duty truck loans and leases have been
consolidated into the category truck and automobile financing):
|
|
2008
|
2007
|
2006
|
2005
|
2004
|
|||||||||||||||||||||||||||||||||||
|
Percent
of
|
Percent
of
|
Percent
of
|
Percent
of
|
Percent
of
|
||||||||||||||||||||||||||||||||||||
|
Loans
and
|
Loans
and
|
Loans
and
|
Loans
and
|
Loans
and
|
||||||||||||||||||||||||||||||||||||
|
Leases
|
Leases
|
Leases
|
Leases
|
Leases
|
||||||||||||||||||||||||||||||||||||
|
in
Each
|
in
Each
|
in
Each
|
in
Each
|
in
Each
|
||||||||||||||||||||||||||||||||||||
|
Category
|
Category
|
Category
|
Category
|
Category
|
||||||||||||||||||||||||||||||||||||
|
to
Total
|
to
Total
|
to
Total
|
to
Total
|
to
Total
|
||||||||||||||||||||||||||||||||||||
|
Reserve
|
Loans
and
|
Reserve
|
Loans
and
|
Reserve
|
Loans
and
|
Reserve
|
Loan
and
|
Reserve
|
Loans
and
|
|||||||||||||||||||||||||||||||
|
(Dollars
in thousands)
|
Amount
|
Leases
|
Amount
|
Leases
|
Amount
|
Leases
|
Amount
|
Leases
|
Amount
|
Leases
|
||||||||||||||||||||||||||||||
|
Commercial
and agricultural loans
|
$ | 23,025 | 19.51 | % | $ | 17,393 | 18.61 | % | $ | 14,547 | 17.70 | % | $ | 15,472 | 18.40 | % | $ | 13,612 | 18.64 | % | ||||||||||||||||||||
|
Auto,
light truck, and environmental equipment
|
9,852 | 10.73 | 7,242 | 9.57 | 7,022 | 11.75 | 6,877 | 12.62 | 7,933 | 11.56 | ||||||||||||||||||||||||||||||
|
Medium
and heavy duty truck
|
8,915 | 7.38 | 8,775 | 9.41 | 6,337 | 12.65 | 6,131 | 12.26 | 4,700 | 11.75 | ||||||||||||||||||||||||||||||
|
Aircraft
financing
|
19,163 | 19.17 | 17,761 | 18.39 | 18,621 | 18.46 | 19,583 | 18.66 | 26,475 | 19.49 | ||||||||||||||||||||||||||||||
|
Construction
equipment financing
|
10,672 | 11.40 | 6,171 | 11.84 | 5,030 | 11.32 | 4,235 | 9.10 | 4,502 | 8.62 | ||||||||||||||||||||||||||||||
|
Loans
secured by real estate
|
4,602 | 27.85 | 6,320 | 27.62 | 4,672 | 23.40 | 4,058 | 24.40 | 4,187 | 25.59 | ||||||||||||||||||||||||||||||
|
Consumer
loans
|
3,547 | 3.96 | 2,940 | 4.56 | 2,573 | 4.72 | 2,341 | 4.56 | 2,263 | 4.35 | ||||||||||||||||||||||||||||||
|
Total
|
$ | 79,776 | 100.00 | % | $ | 66,602 | 100.00 | % | $ | 58,802 | 100.00 | % | $ | 58,697 | 100.00 | % | $ | 63,672 | 100.00 | % | ||||||||||||||||||||
Nonperforming Assets — Our
policy is to discontinue the accrual of interest on loans and leases where
principal or interest is past due and remains unpaid for 90 days or more, or
when an individual analysis of a borrower's credit worthiness indicates a credit
should be placed on nonperforming status, except for residential mortgage loans,
which are placed on nonaccrual at the time the loan is placed in foreclosure and
consumer loans that are both well secured and in the process of collection.
Nonperforming assets amounted to $44.17 million at December 31, 2008, compared
to $18.48 million at December 31, 2007, and $17.67 million at December 31, 2006.
Impaired loans and leases totaled $30.94 million, $6.19 million, and $12.32
million at December 31, 2008, 2007, and 2006, respectively. During 2008,
interest income that would have been recorded on nonaccrual loans and leases
under their original terms was $1.54 million, compared to $0.98 million in
2007.
Nonperforming
assets at December 31, 2008 increased from December 31, 2007, mainly due to
increases in nonaccrual loans. Nonaccrual loans increased in all categories with
the largest increases coming in aircraft financing, medium and heavy duty truck
loans, loans secured by real estate and commercial and agricultural
loans.
|
Nonperforming
assets at December 31 (Dollars in
thousands)
|
2008
|
2007
|
2006
|
2005
|
2004
|
|||||||||||||||
|
Loans
past due over 90 days
|
$ | 1,022 | $ | 1,105 | $ | 116 | $ | 245 | $ | 481 | ||||||||||
|
Nonaccrual
loans and leases and restructured loans:
|
||||||||||||||||||||
|
Commercial
and agricultural loans
|
5,399 | 1,597 | 1,768 | 3,701 | 6,928 | |||||||||||||||
|
Auto,
light truck and environmental equipment
|
709 | 507 | 481 | 812 | 2,336 | |||||||||||||||
|
Medium
and heavy duty truck
|
7,801 | 277 | 1,755 | 17 | 179 | |||||||||||||||
|
Aircraft
financing
|
9,975 | 1,846 | 8,219 | 7,641 | 10,132 | |||||||||||||||
|
Construction
equipment financing
|
1,934 | 1,196 | 853 | 2,513 | 4,097 | |||||||||||||||
|
Loans
secured by real estate
|
9,147 | 3,581 | 2,214 | 1,475 | 1,141 | |||||||||||||||
|
Consumer
loans
|
1,590 | 1,132 | 285 | 393 | 440 | |||||||||||||||
|
Total
nonaccrual loans and leases and restructured loans
|
36,555 | 10,136 | 15,575 | 16,552 | 25,253 | |||||||||||||||
|
Total
nonperforming loans and leases
|
37,577 | 11,241 | 15,691 | 16,797 | 25,734 | |||||||||||||||
|
Other
real estate
|
1,381 | 783 | 800 | 960 | 1,307 | |||||||||||||||
|
Former
bank premises held for sale
|
3,356 | 4,038 | - | - | - | |||||||||||||||
|
Repossessions:
|
||||||||||||||||||||
|
Commercial
and agricultural loans
|
53 | 45 | 2 | - | - | |||||||||||||||
|
Auto,
light truck and environmental equipment
|
226 | 183 | 178 | 128 | 1,112 | |||||||||||||||
|
Medium
and heavy duty truck
|
1,248 | 54 | - | - | - | |||||||||||||||
|
Aircraft
financing
|
16 | 1,850 | 300 | 4,073 | 3,037 | |||||||||||||||
|
Construction
equipment financing
|
67 | 92 | 400 | - | 183 | |||||||||||||||
|
Consumer
loans
|
59 | 67 | 95 | 83 | 50 | |||||||||||||||
|
Total
repossessions
|
1,669 | 2,291 | 975 | 4,284 | 4,382 | |||||||||||||||
|
Operating
leases
|
185 | 126 | 201 | - | 1,785 | |||||||||||||||
|
Total
nonperforming assets
|
$ | 44,168 | $ | 18,479 | $ | 17,667 | $ | 22,041 | $ | 33,208 | ||||||||||
|
Nonperforming
loans and leases to loans and leases,
|
||||||||||||||||||||
|
net
of unearned discount
|
1.14 | % | 0.35 | % | 0.58 | % | 0.68 | % | 1.13 | % | ||||||||||
|
Nonperforming
assets to loans and leases and operating leases,
|
||||||||||||||||||||
|
net
of unearned discount
|
1.30 | % | 0.56 | % | 0.64 | % | 0.87 | % | 1.42 | % | ||||||||||
At
December 31, 2008, our management was not aware of any potential problem loans
or leases that would have a material effect on loan and lease delinquency or
loan and lease charge-offs. Loans and leases are subject to continual review and
are given management’s attention whenever a problem situation appears to be
developing. While we are hopeful the new President and his cabinet will be able
to stabilize capital and financial markets allowing some normality to return to
the economy leading to higher employment and positive impacts, we expect further
deterioration in the loan and lease portfolio.
Investment
Portfolio
The
amortized cost of securities at year-end 2008 decreased 7.80% from 2007,
following an 11.02% increase from year-end 2006 to year-end 2007. The amortized
cost of securities at December 31, 2008 was $715.38 million or 16.02% of total
assets, compared to $775.92 million or 17.45% of total assets at December 31,
2007. Subsequent
to year-end 2008, we sold $111.00 million in preferred shares under the TARP
Capital Purchase Program. To replenish the investment portfolio, we have
invested the proceeds of this transaction for the time being in investment
securities, which has increased our investment portfolio.
The
amortized cost of securities available-for-sale as of December 31 is summarized
as follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
2006
|
|||||||||
|
U.S.
Treasury and government agencies, including agency mortgage-backed
securities
|
$ | 501,415 | $ | 483,596 | $ | 466,326 | ||||||
|
States
and political subdivisions
|
198,640 | 258,260 | 182,356 | |||||||||
|
Other
securities
|
15,325 | 34,066 | 50,197 | |||||||||
|
Total
investment securities available-for-sale
|
$ | 715,380 | $ | 775,922 | $ | 698,879 | ||||||
Yields on
tax-exempt obligations are calculated on a fully tax equivalent basis assuming a
35% tax rate. The following table shows the maturities of securities
available-for-sale at December 31, 2008, at the amortized costs and weighted
average yields of such securities:
|
(Dollars
in thousands)
|
Amount
|
Yield
|
||||||
|
U.S.
Treasury and government agencies, including agency mortgage-backed
securities
|
||||||||
|
Under
1 year
|
$ | 172,205 | 1.87 | % | ||||
|
1 –
5 years
|
76,698 | 4.50 | ||||||
|
5 –
10 years
|
80,674 | 4.88 | ||||||
|
Over
10 years
|
171,838 | 4.30 | ||||||
|
Total
U.S. Treasury and government agencies, including agency mortgage-backed
securities
|
501,415 | 3.59 | ||||||
|
States
and political subdivisions
|
||||||||
|
Under
1 year
|
42,475 | 4.37 | ||||||
|
1 –
5 years
|
81,917 | 5.18 | ||||||
|
5 –
10 years
|
54,904 | 5.53 | ||||||
|
Over
10 years
|
19,344 | 3.71 | ||||||
|
Total
states and political subdivisions
|
198,640 | 4.96 | ||||||
|
Other
securities
|
||||||||
|
Under
1 year
|
160 | 4.21 | ||||||
|
1 –
5 years
|
10,769 | 2.33 | ||||||
|
5 –
10 years
|
- | - | ||||||
|
Over
10 years
|
- | - | ||||||
|
Marketable
equity securities
|
4,396 | 8.38 | ||||||
|
Total
other securities
|
15,325 | 4.09 | ||||||
|
Total
investment securities available-for-sale
|
$ | 715,380 | 3.98 | % | ||||
Deposits
The
average daily amounts of deposits and rates paid on such deposits are summarized
as follows:
|
2008
|
2008
|
2007
|
2007
|
2006
|
2006
|
|||||||||||||||||||
|
(Dollars
in thousands)
|
Amount
|
Rate
|
Amount
|
Rate
|
Amount
|
Rate
|
||||||||||||||||||
|
Noninterest
bearing demand deposits
|
$ | 377,440 | - | % | $ | 351,050 | - | % | $ | 352,204 | - | % | ||||||||||||
|
Interest
bearing demand deposits
|
1,137,491 | 1.82 | 988,308 | 3.10 | 715,242 | 2.51 | ||||||||||||||||||
|
Savings
deposits
|
285,538 | 0.63 | 250,927 | 1.21 | 190,347 | 0.44 | ||||||||||||||||||
|
Other
time deposits
|
1,573,801 | 4.09 | 1,679,521 | 4.85 | 1,512,755 | 4.38 | ||||||||||||||||||
|
Total
deposits
|
$ | 3,374,270 | - | $ | 3,269,806 | - | $ | 2,770,548 | - | |||||||||||||||
The
amount of certificates of deposit of $100,000 or more and other time deposits of
$100,000 or more outstanding at December 31, 2008, by time remaining until
maturity is as follows:
|
(Dollars
in thousands)
|
||||
|
Under
3 months
|
$ | 124,795 | ||
|
4 –
6 months
|
97,227 | |||
|
7 –
12 months
|
102,874 | |||
|
Over
12 months
|
289,889 | |||
|
Total
|
$ | 614,785 | ||
Scheduled
maturities of time deposits, including both private and public funds, at
December 31, 2008 were as follows:
|
(Dollars
in thousands)
|
||||
|
2009
|
$ | 877,734 | ||
|
2010
|
471,670 | |||
|
2011
|
187,918 | |||
|
2012
|
57,126 | |||
|
2013
|
22,339 | |||
|
Thereafter
|
48,367 | |||
|
Total
|
$ | 1,665,154 | ||
Short-Term
Borrowings
The
following table shows the distribution of our short-term borrowings and the
weighted average interest rates thereon at the end of each of the last three
years. Also provided are the maximum amount of borrowings and the average amount
of borrowings, as well as weighted average interest rates for the last three
years.
|
Federal
Funds
|
||||||||||||||||
|
Purchased
and
|
||||||||||||||||
|
Security
|
Other
|
|||||||||||||||
|
Repurchase
|
Commercial
|
Short-Term
|
Total
|
|||||||||||||
|
(Dollars
in thousands)
|
Agreements
|
Paper
|
Borrowings
|
Borrowings
|
||||||||||||
|
2008
|
||||||||||||||||
|
Balance
at December 31, 2008
|
$ | 272,529 | $ | 4,461 | $ | 19,185 | $ | 296,175 | ||||||||
|
Maximum
amount outstanding at any month-end
|
359,452 | 9,875 | 247,828 | 617,155 | ||||||||||||
|
Average
amount outstanding
|
270,503 | 7,694 | 108,653 | 386,850 | ||||||||||||
|
Weighted
average interest rate during the year
|
1.97 | % | 2.35 | % | 1.95 | % | 1.97 | % | ||||||||
|
Weighted
average interest rate for outstanding amounts at
|
||||||||||||||||
|
December
31, 2008
|
0.49 | % | 0.29 | % | 2.92 | % | 0.65 | % | ||||||||
|
2007
|
||||||||||||||||
|
Balance
at December 31, 2007
|
$ | 303,429 | $ | 10,783 | $ | 23,620 | $ | 337,832 | ||||||||
|
Maximum
amount outstanding at any month-end
|
327,623 | 15,478 | 42,784 | 385,885 | ||||||||||||
|
Average
amount outstanding
|
246,792 | 12,598 | 11,987 | 271,377 | ||||||||||||
|
Weighted
average interest rate during the year
|
3.92 | % | 4.84 | % | 5.49 | % | 4.03 | % | ||||||||
|
Weighted
average interest rate for outstanding amounts at
|
||||||||||||||||
|
December
31, 2007
|
2.98 | % | 4.04 | % | 2.60 | % | 2.99 | % | ||||||||
|
2006
|
||||||||||||||||
|
Balance
at December 31, 2006
|
$ | 195,262 | $ | 10,907 | $ | 16,549 | $ | 222,718 | ||||||||
|
Maximum
amount outstanding at any month-end
|
265,362 | 12,922 | 90,689 | 368,973 | ||||||||||||
|
Average
amount outstanding
|
211,973 | 7,997 | 45,854 | 265,824 | ||||||||||||
|
Weighted
average interest rate during the year
|
3.95 | % | 4.99 | % | 4.87 | % | 4.14 | % | ||||||||
|
Weighted
average interest rate for outstanding amounts at
|
||||||||||||||||
|
December
31, 2006
|
3.41 | % | 5.08 | % | 4.89 | % | 3.60 | % | ||||||||
Liquidity
Core Deposits — Our 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 2008, average core deposits equaled 66.31% of average total assets,
compared to 67.12% in 2007 and 63.27% in 2006. The effective cost rate of core
deposits in 2008 was 2.36%, compared to 3.25% in 2007 and 2.65% in
2006.
Average
demand deposits (noninterest bearing core deposits) increased 7.52% in 2008
compared to a decrease of 0.33% in 2007. These represented 12.93% of total core
deposits in 2008, compared to 12.60% in 2007, and 15.67% in 2006.
Purchased Funds — We use
purchased funds to supplement core deposits, which 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 2008, our reliance on purchased funds increased to 19.16% of
average total assets from 18.19% in 2007.
Shareholders’ Equity — Average
shareholders’ equity equated to 10.09% of average total assets in 2008 compared
to 9.85% in 2007. Shareholders’ equity was 10.16% of total assets at year-end
2008, compared to 9.68% at year-end 2007. In accordance with SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," we include unrealized gain (loss) on
available-for-sale securities, net of income taxes, as accumulated other
comprehensive income (loss) which is a component of shareholders’ equity. While
regulatory capital adequacy ratios exclude unrealized gain (loss), it does
impact our equity as reported in the audited financial statements. The
unrealized gain (loss) on available-for-sale securities, net of income taxes,
was $5.82 million and $2.52 million at December 31, 2008 and 2007, respectively.
Our sale of preferred shares under the TARP Capital Purchase Program subsequent
to year-end 2008 increased our shareholders' equity by approximately $111.00
million.
Liquidity Risk Management —
The Bank's liquidity is monitored and closely managed by the Asset/Liability
Management Committees (ALCO), whose members are comprised of the Bank's senior
management. Asset and liability management includes the management of interest
rate sensitivity and the maintenance of an adequate liquidity position. The
purpose of interest rate sensitivity management is to stabilize net interest
income during periods of changing interest rates.
Liquidity
management is the process by which the Bank ensure that adequate liquid funds
are available to meet financial commitments on a timely basis. Financial
institutions must maintain liquidity to meet day-to-day requirements of
depositors and borrowers, take advantage of market opportunities and provide a
cushion against unforeseen needs.
Liquidity
of the Bank is derived primarily from core deposits, principal payments received
on loans, the sale and maturity of investment securities, net cash provided by
operating activities, and access to other funding sources. The most stable
source of liability funded liquidity is deposit growth and retention of the core
deposit base. The principal source of asset-funded liquidity is
available-for-sale investment securities, cash and due from banks, Federal funds
sold, securities purchased under agreements to resell, and loans and interest
bearing deposits with other banks maturing within one year. Additionally,
liquidity is provided by repurchase agreements, and the ability to borrow from
the Federal Reserve Bank and Federal Home Loan Bank.
Interest Rate Risk Management
— ALCO 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, we face ongoing interest rate risks and uncertainties. We
occasionally utilize 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. At December
31, 2008, the aggregate hypothetical increase in pre-tax earnings was estimated
to be $2.95 million on an annualized basis on all rate-sensitive financial
instruments, based on a hypothetical increase of a 100 basis point change in
interest rates and the aggregate hypothetical decrease in pre-tax earnings was
estimated to be $9.94 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. At
December 31, 2007, the aggregate hypothetical decrease in pre-tax earnings was
estimated to be $0.44 million on an annualized basis on all rate-sensitive
financial instruments, based on a hypothetical increase of a 100 basis point
change in interest rates and the aggregate hypothetical increase in pre-tax
earnings was estimated to be $1.37 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.The earnings simulation model
excludes the earnings dynamics related to how fee income and noninterest expense
may be affected by changees in interest ratese. 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. At December 31, 2008,
the impact of these hypothetical fluctuations in interest rates on our
derivative holdings was not significant, and, as such, separate disclosure is
not presented.
We manage
the interest rate risk related to loan commitments by entering into contracts
for future delivery of loans with outside parties. See Part II, Item 8,
Financial Statements and Supplementary Data — Note P of the Notes to
Consolidated Financial Statements.
Off-Balance Sheet
Arrangements and Contractual Obligations
In the
ordinary course of operations, we enter into certain contractual obligations.
Such obligations include the funding of operations through debt issuances as
well as leases for premises and equipment. The following table summarizes our
significant fixed, determinable, and estimated contractual obligations, by
payment date, at December 31, 2008, except for obligations associated with
short-term borrowing arrangements. Payments for borrowings do not include
interest. Further discussion of the nature of each obligation is included in the
referenced note to the consolidated financial statements.
Contractual
obligations payments by period.
|
Indeterminate
|
||||||||||||||||||||||||||||
|
(Dollars
in thousands)
|
Note
|
0 –
1 Year
|
1 –
3 Years
|
3 –
5 Years
|
Over
5 Years
|
maturity
|
Total
|
|||||||||||||||||||||
|
Deposits
without stated maturity
|
- | $ | 1,849,388 | $ |
-
|
$ | - | $ | - | $ | - | $ | 1,849,388 | |||||||||||||||
|
Certificates
of deposit
|
- | 877,734 | 659,588 | 79,465 | 48,367 | - | 1,665,154 | |||||||||||||||||||||
|
Long-term
debt
|
K | 10,342 | 10,682 | 70 | 833 | 7,905 | 29,832 | |||||||||||||||||||||
|
Subordinated
notes
|
M | - | - | - | 89,692 | - | 89,692 | |||||||||||||||||||||
|
Operating
leases
|
P | 2,634 | 4,153 | 1,279 | 734 | - | 8,800 | |||||||||||||||||||||
|
Purchase
obligations
|
- | 19,371 | 6,164 | 4,626 | - | - | 30,161 | |||||||||||||||||||||
|
Total
contractual obligations
|
$ | 2,759,469 | $ | 680,587 | $ | 85,440 | $ | 139,626 | $ | 7,905 | $ | 3,673,027 | ||||||||||||||||
We
routinely enter into contracts for services. These contracts may require payment
for services to be provided in the future and may also contain penalty clauses
for early termination of the contract. We have made a diligent effort to
estimate such payments and penalties, where applicable. Additionally, where
necessary, we have made reasonable estimates as to certain purchase obligations
as of December 31, 2008. Our management has used the best information available
to make the estimations necessary to value the related purchase obligations. Our
management is not aware of any additional commitments or contingent liabilities
which may have a material adverse impact on our liquidity or capital resources
at year-end 2008. Subsequent to year-end 2008, we incurred new long-term
obligations under our preferred shares issued under the TARP Capital Purchase
Program.
We also
enter into derivative contracts under which we are required to either receive
cash from, or pay cash to, counterparties depending on changes in interest
rates. Derivative contracts are carried at fair value on the consolidated
balance sheet with the fair value representing the net present value of expected
future cash receipts or payments based on market interest rates as of the
balance sheet date. The fair value of the contracts change daily as market
interest rates change. Because the derivative assets and liabilities recorded on
the balance sheet at December 31, 2008 do not necessarily represent the amounts
that may ultimately be paid under these contracts, these assets and liabilities
are not included in the table of contractual obligations presented
above.
In
addition, due to the uncertainty with respect to the timing of future cash flows
associated the with our unrecognized tax benefits at December 31, 2008, we are
unable to make reasonably reliable estimates of the period of cash settlement
with the respective taxing authority. Therefore, $5.46 million of unrecognized
tax benefits have been excluded from the contractual obligations table above.
See Note O of the Notes to Consolidated Financial Statements for a discussion on
income taxes.
Assets
under management and assets under custody are held in fiduciary or custodial
capacity for our clients. In accordance with U. S. generally accepted accounting
principles, these assets are not included on our balance sheet.
We are
also party to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of our clients. These financial
instruments include commitments to extend credit and standby letters of credit.
Further discussion of these commitments is included in Part II, Item 8,
Financial Statements and Supplementary Data — Note P of the Notes to
Consolidated Financial Statements.
Quarterly Results of
Operations
|
Three Months Ended (Dollars in thousands, except
per share amounts)
|
March
31
|
June
30
|
September
30
|
December
31
|
|
2008
|
||||
|
Interest
income
|
$ 62,124
|
$ 58,579
|
$ 58,065
|
$ 56,540
|
|
Interest
expense
|
29,827
|
25,455
|
24,668
|
23,198
|
|
Net
interest income
|
32,297
|
33,124
|
33,397
|
33,342
|
|
Provision
for loan and lease losses
|
1,539
|
4,493
|
3,571
|
7,045
|
|
Investment
securities and other investment gains (losses)
|
623
|
(1,066)
|
(8,816)
|
(738)
|
|
Income
before income taxes
|
13,884
|
10,603
|
3,889
|
18,025
|
|
Net
income
|
9,354
|
7,245
|
4,472
|
12,315
|
|
Diluted
net income per common share
|
0.38
|
0.30
|
0.18
|
0.50
|
|
2007
|
||||
|
Interest
income
|
$ 55,953
|
$ 62,332
|
$ 68,330
|
$ 66,972
|
|
Interest
expense
|
29,681
|
33,461
|
36,632
|
34,903
|
|
Net
interest income
|
26,272
|
28,871
|
31,698
|
32,069
|
|
(Recovery
of) provision for loan and lease losses
|
(623)
|
1,247
|
3,660
|
3,250
|
|
Investment
securities and other investment gains (losses)
|
247
|
207
|
(154)
|
(3,428)
|
|
Income
before income taxes
|
12,581
|
12,248
|
8,495
|
8,359
|
|
Net
income
|
8,523
|
8,060
|
6,130
|
7,826
|
|
Diluted
net income per common share
|
0.37
|
0.34
|
0.25
|
0.32
|
Net
income was $12.32 million for the fourth quarter of 2008, compared to
the $7.83 million of net income reported for the fourth quarter of 2007. Diluted
net income per common share for the fourth quarter of 2008 amounted to $0.50,
compared to $0.32 per common share reported in the fourth quarter of
2007.
The net
interest margin was 3.30% for the fourth quarter of 2008 versus 3.21% for the
same period in 2007. Tax-equivalent net interest income was $34.24 million for
the fourth quarter
of 2008, up 3.33 percent from 2007’s fourth quarter.
Our
provision for loan and lease losses was $7.05 million in the fourth quarter of
2008 compared to provision for loan and lease losses of $3.25 million in the
fourth quarter of 2007. Net charge-offs were $2.88
million for the fourth quarter 2008, compared to net charge-offs of $1.48
million a year ago.
Noninterest
income for the fourth quarter of 2008 was $30.23 million, compared to $16.17
million for the fourth quarter of 2007. The predominate factors causing the
increase was the sale of certain assets of Investment Advisors for a gain of
$11.49 million, the recording of $0.56 million of impairment on Fannie Mae,
Freddie Mac, and other preferred equities versus $4.11 million of impairment on
these preferred equities in the fourth quarter of 2007. These increases were
partially offset by a decrease in mortgage banking income due to mortgage
servicing rights impairment of $1.97 million.
Noninterest
expense for the fourth quarter of 2008 was $38.50 million, an increase of 5.12%
as compared to the fourth quarter of 2007.
For
information regarding Quantitative and Qualitative Disclosures about Market
Risk, see Part II, Item 7, Management’s Discussion and Analysis of Financial
Condition and Results of Operations, Interest Rate Risk Management.
Report
of Independent Registered Public Accounting Firm
The
Board of Directors and Shareholders of 1st Source Corporation
We have
audited 1st Source Corporation’s internal control over financial reporting as of
December 31, 2008, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). 1st Source Corporation’s management is
responsible for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management’s Report on Internal Control
over Financial Reporting. Our responsibility is to express an opinion on the
company’s internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our
opinion, 1st Source Corporation maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based on the COSO criteria.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated
statements of
financial condition of 1st Source Corporation and subsidiaries as of December
31, 2008 and 2007, and the related consolidated statements of income,
shareholders’ equity, and cash flows for each of the three years in the period
ended December 31, 2008 and our report dated February 20, 2009 expressed an
unqualified opinion thereon.
/s/
Ernst & Young LLP
Chicago,
Illinois
February
20, 2009
Report
of Independent Registered Public Accounting Firm
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, 2008 and 2007, and
the related consolidated statements of income, shareholders' equity, and cash
flows for each of the three years in the period ended December 31,
2008. 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.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (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, 2008 and 2007, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2008, in conformity with U.S. generally accepted accounting
principles.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), 1st Source Corporation’s internal control
over financial reporting as of December 31, 2008, based on criteria established
in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated February 20,
2009 expressed an unqualified opinion
thereon.
/s/
Ernst & Young LLP
Chicago,
Illinois
February
20, 2009
|
December
31 (Dollars in
thousands)
|
2008
|
2007
|
||||||
|
ASSETS
|
||||||||
|
Cash
and due from banks
|
$ | 119,771 | $ | 153,137 | ||||
|
Federal
funds sold and interest bearing deposits with other banks
|
6,951 | 25,817 | ||||||
|
Investment
securities available-for-sale
|
||||||||
|
(amortized
cost of $715,380 and $775,922 at December 31, 2008 and December 31, 2007,
respectively)
|
724,754 | 779,981 | ||||||
|
Other
investments
|
18,612 | 14,937 | ||||||
|
Trading
account securities
|
100 | - | ||||||
|
Mortgages
held for sale
|
46,686 | 25,921 | ||||||
|
Loans
and leases, net of unearned discount:
|
||||||||
|
Commercial
and agricultural loans
|
643,440 | 593,806 | ||||||
|
Auto,
light truck and environmental equipment
|
353,838 | 305,238 | ||||||
|
Medium
and heavy duty truck
|
243,375 | 300,469 | ||||||
|
Aircraft
financing
|
632,121 | 587,022 | ||||||
|
Construction
equipment financing
|
375,983 | 377,785 | ||||||
|
Loans
secured by real estate
|
918,749 | 881,646 | ||||||
|
Consumer
loans
|
130,706 | 145,475 | ||||||
|
Total
loans and leases
|
3,298,212 | 3,191,441 | ||||||
|
Reserve
for loan and lease losses
|
(79,776 | ) | (66,602 | ) | ||||
|
Net
loans and leases
|
3,218,436 | 3,124,839 | ||||||
|
Equipment
owned under operating leases, net
|
83,062 | 81,960 | ||||||
|
Net
premises and equipment
|
40,491 | 45,048 | ||||||
|
Goodwill
and intangible assets
|
91,691 | 93,567 | ||||||
|
Accrued
income and other assets
|
113,620 | 101,897 | ||||||
|
Total
assets
|
$ | 4,464,174 | $ | 4,447,104 | ||||
|
LIABILITIES
|
||||||||
|
Deposits:
|
||||||||
|
Noninterest
bearing
|
$ | 416,960 | $ | 418,529 | ||||
|
Interest
bearing
|
3,097,582 | 3,051,134 | ||||||
|
Total
deposits
|
3,514,542 | 3,469,663 | ||||||
|
Short-term
borrowings:
|
||||||||
|
Federal
funds purchased and securities sold under agreements to
repurchase
|
272,529 | 303,429 | ||||||
|
Other
short-term borrowings
|
23,646 | 34,403 | ||||||
|
Total
short-term borrowings
|
296,175 | 337,832 | ||||||
|
Long-term
debt and mandatorily redeemable securities
|
29,832 | 34,702 | ||||||
|
Subordinated
notes
|
89,692 | 100,002 | ||||||
|
Accrued
expenses and other liabilities
|
80,269 | 74,401 | ||||||
|
Total
liabilities
|
4,010,510 | 4,016,600 | ||||||
|
SHAREHOLDERS' EQUITY
|
||||||||
|
Preferred
stock; no par value
|
||||||||
|
Authorized
10,000,000 shares; none issued or outstanding
|
- | - | ||||||
|
Common
stock; no par value
|
||||||||
|
Authorized
40,000,000 shares; issued 25,895,505 shares in 2008 and 25,927,510 shares
in 2007
|
||||||||
|
less
unearned shares (251,999 shares in 2008 and 284,004 shares in
2007)
|
342,982 | 342,840 | ||||||
|
Retained
earnings
|
136,877 | 117,373 | ||||||
|
Cost
of common stock in treasury (1,532,576 shares in 2008 and 1,551,396 shares
in 2007)
|
(32,019 | ) | (32,231 | ) | ||||
|
Accumulated
other comprehensive income
|
5,824 | 2,522 | ||||||
|
Total
shareholders' equity
|
453,664 | 430,504 | ||||||
|
Total
liabilities and shareholders' equity
|
$ | 4,464,174 | $ | 4,447,104 | ||||
|
The
accompanying notes are a part of the consolidated financial
statements.
|
||||||||
|
|
|||
|
Year
Ended December 31 (Dollars in
thousands, except per share data)
|
2008
|
2007
|
2006
|
|
Interest
income:
|
|||
|
Loans
and leases
|
$ 204,006
|
$ 216,186
|
$ 181,363
|
|
Investment
securities, taxable
|
22,170
|
25,136
|
19,177
|
|
Investment
securities, tax-exempt
|
7,707
|
7,608
|
5,183
|
|
Other
|
1,425
|
4,657
|
3,271
|
|
Total
interest income
|
235,308
|
253,587
|
208,994
|
|
Interest
expense:
|
|||
|
Deposits
|
86,903
|
115,113
|
85,067
|
|
Short-term
borrowings
|
7,626
|
10,935
|
11,011
|
|
Subordinated
notes
|
6,714
|
6,051
|
4,320
|
|
Long-term
debt and mandatorily redeemable securities
|
1,905
|
2,578
|
2,163
|
|
Total
interest expense
|
103,148
|
134,677
|
102,561
|
|
Net
interest income
|
132,160
|
118,910
|
106,433
|
|
Provision
for (recovery of provision for) loan and lease losses
|
16,648
|
7,534
|
(2,736)
|
|
Net
interest income after provision for (recovery of provision for) loan and
lease losses
|
115,512
|
111,376
|
109,169
|
|
Noninterest
income:
|
|||
|
Trust
fees
|
18,599
|
15,567
|
13,806
|
|
Service
charges on deposit accounts
|
22,035
|
20,470
|
19,040
|
|
Mortgage
banking income
|
2,994
|
2,868
|
11,637
|
|
Insurance
commissions
|
5,363
|
4,666
|
4,574
|
|
Equipment
rental income
|
24,224
|
21,312
|
18,972
|
|
Other
income
|
9,293
|
8,864
|
6,554
|
|
Gain
on sale of certain Investment Advisor assets
|
11,492
|
- | - |
|
Investment
securities and other investment (losses) gains
|
(9,997)
|
(3,128)
|
2,002
|
|
Total
noninterest income
|
84,003
|
70,619
|
76,585
|
|
Noninterest
expense:
|
|||
|
Salaries
and employee benefits
|
76,965
|
73,944
|
66,605
|
|
Net
occupancy expense
|
9,698
|
9,030
|
7,492
|
|
Furniture
and equipment expense
|
15,095
|
15,145
|
12,316
|
|
Depreciation
- leased equipment
|
19,450
|
17,085
|
14,958
|
|
Professional
fees
|
8,446
|
4,575
|
3,998
|
|
Supplies
and communications
|
6,782
|
5,987
|
5,496
|
|
Business
development and marketing expense
|
3,749
|
4,788
|
4,008
|
|
Loan
and lease collection and repossession expense
|
1,162
|
1,123
|
704
|
|
Other expense
|
11,767
|
8,635
|
10,634
|
|
Total
noninterest expense
|
153,114
|
140,312
|
126,211
|
|
Income
before income taxes
|
46,401
|
41,683
|
59,543
|
|
Income
taxes
|
13,015
|
11,144
|
20,246
|
|
Net
income
|
$ 33,386
|
$ 30,539
|
$ 39,297
|
|
Basic
net income per common share
|
$ 1.38
|
$ 1.30
|
$ 1.74
|
|
Diluted
net income per common share
|
$ 1.37
|
$ 1.28
|
$ 1.72
|
|
The
accompanying notes are a part of the consolidated financial
statements.
|
|
|
||||||||||||||||||||
|
(Dollars
in thousands, except per share data)
|
Total
|
Common Stock |
Retained Earnings |
Cost
of Common |
Accumulated Other |
|||||||||||||||
|
Balance
at January 1, 2006
|
$ | 345,576 | $ | 221,579 | $ | 139,601 | $ | (12,364 | ) | $ | (3,240 | ) | ||||||||
|
Comprehensive
income, net of tax:
|
||||||||||||||||||||
|
Net
income
|
39,297 | - | 39,297 | - | - | |||||||||||||||
|
Change
in unrealized losses of
|
||||||||||||||||||||
|
available-for-sale
securities, net of tax
|
2,980 | - | - | - | 2,980 | |||||||||||||||
|
Total
comprehensive income
|
42,277 | - | - | - | - | |||||||||||||||
|
Issuance
of 95,032 common shares per
|
||||||||||||||||||||
|
stock
based compensation awards, including
|
||||||||||||||||||||
|
related
tax effects
|
814 | - | 364 | 450 | - | |||||||||||||||
|
Cost
of 335,038 shares of common
|
||||||||||||||||||||
|
stock
acquired for treasury
|
(7,657 | ) | - | - | (7,657 | ) | - | |||||||||||||
|
Cash
dividend ($.534 per share)
|
(12,094 | ) | - | (12,094 | ) | - | - | |||||||||||||
|
10%
common stock dividend
|
||||||||||||||||||||
|
($12
cash paid in lieu of fractional shares)
|
(12 | ) | 67,584 | (67,596 | ) | - | - | |||||||||||||
|
Balance
at December 31, 2006
|
$ | 368,904 | $ | 289,163 | $ | 99,572 | $ | (19,571 | ) | $ | (260 | ) | ||||||||
|
Comprehensive
income, net of tax:
|
||||||||||||||||||||
|
Net
income
|
30,539 | - | 30,539 | - | - | |||||||||||||||
|
Change
in unrealized losses of
|
||||||||||||||||||||
|
available-for-sale
securities, net of tax
|
2,782 | - | - | - | 2,782 | |||||||||||||||
|
Total
comprehensive income
|
33,321 | - | - | - | - | |||||||||||||||
|
Issuance
of 40,349 common shares per
|
||||||||||||||||||||
|
stock
based compensation awards, including
|
||||||||||||||||||||
|
related
tax effects
|
545 | - | 384 | 161 | - | |||||||||||||||
|
Cost
of 569,310 shares of common
|
||||||||||||||||||||
|
stock
acquired for treasury
|
(12,821 | ) | - | - | (12,821 | ) | - | |||||||||||||
|
Cash
dividend ($.560 per share)
|
(13,122 | ) | - | (13,122 | ) | - | - | |||||||||||||
|
Issuance
of 2,124,974 shares of common
|
||||||||||||||||||||
|
stock
for FINA Bancorp purchase
|
53,677 | 53,677 | - | - | - | |||||||||||||||
|
Balance
at December 31, 2007
|
$ | 430,504 | $ | 342,840 | $ | 117,373 | $ | (32,231 | ) | $ | 2,522 | |||||||||
|
Comprehensive
income, net of tax:
|
||||||||||||||||||||
|
Net
income
|
33,386 | - | 33,386 | - | - | |||||||||||||||
|
Change
in unrealized losses of
|
||||||||||||||||||||
|
available-for-sale
securities, net of tax
|
3,302 | - | - | - | 3,302 | |||||||||||||||
|
Total
comprehensive income
|
36,688 | - | - | - | - | |||||||||||||||
|
Issuance
of 18,820 common shares per
|
||||||||||||||||||||
|
stock
based compensation awards, including
|
||||||||||||||||||||
|
related
tax effects
|
341 | - | 129 | 212 | - | |||||||||||||||
|
Stock
based compensation
|
142 | 142 | - | - | - | |||||||||||||||
|
Cash
dividend ($.580 per share)
|
(14,011 | ) | - | (14,011 | ) | - | - | |||||||||||||
|
Balance
at December 31, 2008
|
$ | 453,664 | $ | 342,982 | $ | 136,877 | $ | (32,019 | ) | $ | 5,824 | |||||||||
|
The
accompanying notes are a part of the consolidated financial
statements.
|
||||||||||||||||||||
|
|
||||||||||||
|
Year
Ended December 31 (Dollars in
thousands)
|
2008
|
2007
|
2006
|
|||||||||
|
Operating
activities:
|
||||||||||||
|
Net
income
|
$ | 33,386 | $ | 30,539 | $ | 39,297 | ||||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||||||
|
Provision
for (recovery of provision for) loan and lease losses
|
16,648 | 7,534 | (2,736 | ) | ||||||||
|
Depreciation
of premises and equipment
|
5,312 | 5,364 | 4,797 | |||||||||
|
Depreciation
of equipment owned and leased to others
|
19,450 | 17,085 | 14,958 | |||||||||
|
Amortization
of investment security premiums and accretion of discounts,
net
|
2,232 | (356 | ) | (259 | ) | |||||||
|
Amortization
of mortgage servicing rights
|
2,838 | 2,403 | 4,587 | |||||||||
|
Mortgage
servicing asset impairment/(recoveries)
|
1,913 | 143 | (12 | ) | ||||||||
|
Deferred
income taxes
|
(10,779 | ) | (4,558 | ) | (3,885 | ) | ||||||
|
Investment
securities and other investment losses (gains)
|
9,997 | 3,128 | (2,002 | ) | ||||||||
|
Change
in mortgages held for sale
|
(20,765 | ) | 24,238 | 17,065 | ||||||||
|
Purchase
of trading account securities
|
(100 | ) | - | - | ||||||||
|
Change
in interest receivable
|
1,383 | (1,296 | ) | (3,616 | ) | |||||||
|
Change
in interest payable
|
(6,710 | ) | (380 | ) | 10,577 | |||||||
|
Change
in other assets
|
(15,980 | ) | (8,587 | ) | 8,378 | |||||||
|
Change
in other liabilities
|
21,345 | 4,003 | (4,306 | ) | ||||||||
|
Other
|
4,070 | 5,101 | 1,253 | |||||||||
|
Net
change in operating activities
|
64,240 | 84,361 | 84,096 | |||||||||
|
Investing
activities:
|
||||||||||||
|
Cash
paid for acquisition, net
|
- | (55,977 | ) | - | ||||||||
|
Proceeds
from sales of investment securities
|
8,548 | 121,671 | 65,682 | |||||||||
|
Proceeds
from maturities of investment securities
|
519,847 | 496,324 | 322,073 | |||||||||
|
Purchases
of investment securities
|
(480,082 | ) | (518,041 | ) | (456,706 | ) | ||||||
|
Net
change in short-term investments
|
15,191 | 195,337 | 3,599 | |||||||||
|
Net
change in loans and leases
|
(110,246 | ) | (252,929 | ) | (236,266 | ) | ||||||
|
Net
change in equipment owned under operating
leases
|
(20,552 | ) | (22,734 | ) | (33,015 | ) | ||||||
|
Net
increase in premises and equipment
|
(3,726 | ) | (14,467 | ) | (5,553 | ) | ||||||
|
Net
change in investing activities
|
(71,020 | ) | (50,816 | ) | (340,186 | ) | ||||||
|
Financing
activities:
|
||||||||||||
|
Net
change in demand deposits, NOW accounts and savings
accounts
|
(72,780 | ) | (14,260 | ) | (101,390 | ) | ||||||
|
Net
change in certificates of deposit
|
117,659 | (86,502 | ) | 404,087 | ||||||||
|
Net
change in short-term borrowings
|
(41,656 | ) | 96,930 | (54,751 | ) | |||||||
|
Proceeds
from issuance of long-term debt
|
10,826 | 1,159 | 21,922 | |||||||||
|
Proceeds
from issuance of subordinated notes
|
- | 58,764 | - | |||||||||
|
Payments
on subordinated notes
|
(10,310 | ) | (17,784 | ) | - | |||||||
|
Payments
on long-term debt
|
(16,413 | ) | (11,225 | ) | (1,306 | ) | ||||||
|
Net
proceeds from issuance of treasury stock
|
341 | 545 | 814 | |||||||||
|
Acquisition
of treasury stock
|
- | (12,821 | ) | (7,657 | ) | |||||||
|
Cash
dividends
|
(14,253 | ) | (13,345 | ) | (12,315 | ) | ||||||
|
Net
change in financing activities
|
(26,586 | ) | 1,461 | 249,404 | ||||||||
|
Net
change in cash and cash equivalents
|
(33,366 | ) | 35,006 | (6,686 | ) | |||||||
|
Cash
and cash equivalents, beginning of year
|
153,137 | 118,131 | 124,817 | |||||||||
|
Cash
and cash equivalents, end of year
|
$ | 119,771 | $ | 153,137 | $ | 118,131 | ||||||
|
Supplemental
Information:
|
||||||||||||
|
Cash
paid for:
|
||||||||||||
|
Interest
|
$ | 109,858 | $ | 137,397 | $ | 91,985 | ||||||
|
Income
taxes
|
19,187 | 13,314 | 29,364 | |||||||||
|
The
accompanying notes are a part of the consolidated financial
statements.
|
||||||||||||
Note
A — Accounting Policies
The
principal line of business of 1st Source and our 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 our subsidiaries
(principally the Bank). All significant intercompany balances and transactions
have been eliminated. For purposes of the parent company only financial
information presented in Note T, investments in subsidiaries are carried at
equity in our underlying net assets.
Use of Estimates in the Preparation
of Financial Statements — Financial statements prepared in accordance
with U. S. generally accepted accounting principles require our 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.
Business Combinations —
Business combinations are accounted for under the purchase method of accounting.
Under the purchase method, assets and liabilities of the business acquired are
recorded at their estimated fair values as of the date of acquisition with any
excess of the cost of the acquisition over the fair value of the net tangible
and intangible assets acquired recorded as goodwill. Results of operations of
the acquired business are included in the income statement from the date of
acquisition. Refer to Note C - Acquisitions for further discussion.
Cash Flow — For purposes of
the consolidated and parent company only statements of cash flows, we consider
cash and due from banks as cash and cash equivalents.
Securities — Securities that
we have the ability and positive intent to hold to maturity are classified as
investment securities held-to-maturity. Held-to-maturity investment securities,
when present, are carried at amortized cost. We currently hold no securities
classified as held-to-maturity. Securities that may be sold in response to, or
in anticipation of, changes in interest rates and resulting prepayment risk, or
for other factors, are classified as available-for-sale and are carried at fair
value. Unrealized gains and losses on these securities are reported, net of
applicable taxes, as a separate component of accumulated other comprehensive
income (loss) in shareholders’ equity. Other investments consists solely of
shares of Federal Home Loan Bank and Federal Reserve Bank stock. These
investments are carried at cost and reviewed for impairment at least annually or
sooner if events or changes in circumstances indicate the carrying value may not
be reasonable.
Available-for-sale
and held-to-maturity securities are reviewed quarterly for possible
other-than-temporary impairment. The review includes an analysis of the facts
and circumstances of each individual investment such as length of time the fair
value has been below cost, the expectation for that security's performance, the
credit worthiness of the issuer, and our intent and ability to hold the security
for a time necessary to recover the amortized cost. A decline in value that is
determined to be other-than-temporary is recorded as a loss in the Consolidated
Statements of Income.
Debt and
equity securities that are purchased and held principally for the purpose of
selling them in the near term are classified as trading account securities and
are carried at fair value with unrealized gains and losses reported in earnings.
Realized gains and losses on the sales of all securities are reported in
earnings and computed using the specific identification cost basis.
Loans and Leases — Loans are
stated at the principal amount outstanding, net of unamortized deferred loan
origination fees and costs and net of unearned income. Interest income is
accrued as earned based on unpaid principal balances. Origination fees and
direct loan and lease origination costs are deferred and the net amount
amortized to interest income over the estimated life of the related loan or
lease. Loan commitment fees are deferred and amortized into other income over
the commitment period.
Direct
financing leases are carried at the aggregate of lease payments plus estimated
residual value of the leased property, less unearned income. Interest income on
direct financing leases is recognized over the term of the lease to achieve a
constant periodic rate of return on the outstanding investment.
The
accrual of interest on loans and leases is discontinued when a loan or lease
becomes contractually delinquent for 90 days, or when an individual analysis of
a borrower's credit worthiness indicates a credit should be placed on
nonperforming status, except for residential mortgage loans and consumer loans
that are well secured and in the process of collection. Residential mortgage
loans are placed in 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 and lease losses. However, in some cases, 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. When a
loan or lease is classified as nonaccrual and the future collectibility of the
recorded loan or lease balance is doubtful, collections on interest and
principal are applied as a reduction to principal outstanding.
A loan or
lease is considered impaired, based on current information and events, if it is
probable that we will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan or lease
agreement. Interest on impaired loans and leases, which are not classified as
nonaccrual, is recognized on the accrual basis. We evaluate loans and leases
exceeding $100,000 for impairment in accordance with the provisions of Statement
of Financial Accounting Standards No. 114, "Accounting by Creditors for
Impairment of a Loan," (SFAS No. 114) which requires an allowance to be
established as a component of the allowance for loan and lease losses when it is
probable all amounts due will not be collected pursuant to the contractual terms
of the loan and lease and the recorded investment in the loan or lease exceeds
its fair value. Fair value is measured using either the present value of
expected future cash flows discounted at the loan’s effective interest rate, the
observable market price of the loan, or the fair value of the collateral, if the
loan is collateral dependent.
1st
Source Bank sells mortgage loans to the Government National Mortgage Association
(GNMA) in the normal course of business and retains the servicing rights. The
GNMA programs under which the loans are sold allow us to repurchase individual
delinquent loans that meet certain criteria from the securitized loan pool. At
our option, and without GNMA's prior authorization, we may repurchase a
delinquent loan for an amount equal to 100% of the remaining principal balance
on the loan. Under SFAS No. 140, once we have the unconditional ability to
repurchase a delinquent loan, we are deemed to have regained effective control
over the loan and we are required to recognize the loan on our balance sheet and
record an offsetting liability, regardless of our intent to repurchase the loan.
At December 31, 2008 and 2007, residential real estate portfolio loans included
$5.72 million and $2.91 million, respectively, of loans available for repurchase
under the GNMA optional repurchase programs with the offsetting liability
recorded within other short-term borrowings.
Mortgage Banking Activities —
Loans held for sale are primarily composed of performing one-to-four family
residential mortgage loans originated for resale. Prior to January 1, 2008, all
loans held for sale were carried at the lower of cost or fair value as
determined on an aggregate basis. Effective January 1, 2008,
management
has elected to carry mortgage loans originated with the intent to sell at
fair value pursuant to SFAS 159. Fair value is measured using an income approach
and utilizing an appropriate current market yield and a loan commitment closing
rate based on historical analysis.
We
recognize the rights to service mortgage loans for others as separate assets,
whether the servicing rights are acquired through a separate purchase or through
the sale of originated loans with servicing rights retained. We allocate a
portion of the total cost of a mortgage loan to servicing rights based on the
fair value. The fair value of the servicing rights is based on market prices,
when available, or is determined by estimating the present value of future net
servicing income, taking into consideration market loan prepayment speeds and
discount rates. These assets are 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.
Mortgage
servicing assets are evaluated for impairment in accordance with SFAS No. 140.
For purposes of impairment measurement, mortgage servicing assets are stratified
based on the predominant risk characteristics of the underlying servicing,
principally by loan type and interest rate. The fair value of each tranche of
the servicing portfolio is estimated by calculating the present value of
estimated future net servicing cash flows, taking into consideration actual and
expected mortgage loan prepayment rates, discount rates, servicing costs, and
other economic factors. If temporary impairment exists within a tranche, a
valuation allowance is established through a charge to income equal to the
amount by which the carrying value exceeds the fair value. If it is later
determined all or a portion of the temporary impairment no longer exists for a
particular tranche, the valuation allowance is reduced through a recovery of
income.
Mortgage
servicing assets are also reviewed for other-than-temporary impairment.
Other-than-temporary impairment exists when recoverability of a recorded
valuation allowance is determined to be remote considering historical and
projected interest rates, prepayments, and loan pay-off activity. When this
situation occurs, the unrecoverable portion of the valuation allowance is
applied as a direct write-down to the carrying value of the mortgage servicing
asset. Unlike a valuation allowance, a direct write-down permanently reduces the
carrying value of the mortgage servicing asset and the valuation allowance,
precluding subsequent recoveries.
As part
of mortgage banking operations, we enter into commitments to purchase or
originate loans whereby the interest rate on these loans is determined prior to
funding ("rate lock commitments"). Similar to loans held for sale, the fair
value of rate lock commitments is subject to change primarily due to changes in
interest rates. Under our risk management policy, these fair values are hedged
primarily by selling forward contracts on agency securities. The rate lock
commitments on mortgage loans intended to be sold and the related hedging
instruments are recorded at fair value with changes in fair value recorded in
current earnings. The fair value of rate lock commitments is determined using
current secondary market prices for underlying loans with similar coupons,
maturity and credit quality, subject to the anticipated loan funding
probability, or fallout factor.
Reserve for Loan and Lease
Losses — The reserve for loan and lease losses is maintained at a level
believed to be adequate by management to absorb probable losses inherent in the
loan and lease portfolio. The determination of the reserve requires significant
judgment reflecting management’s best estimate of probable loan and lease losses
related to specifically identified loans and leases as well as probable losses
in the remainder of the various loan and lease portfolios. The methodology for
assessing the appropriateness of the reserve consists of several key elements,
which include: specific reserves for impaired loans with the impairment reserve
determined in accordance with SFAS 114, percentage allocations for special
attention loans and leases (classified loans and leases and internal watch list
credits) without specific reserves, formula reserves for each business lending
division portfolio, and reserves for pooled homogenous loans and leases.
Management’s evaluation is based upon a continuing review of these portfolios,
estimates of customer performance, collateral values and dispositions, and
assessments of economic and geopolitical events, all of which are subject to
judgment and will change.
Specific
reserves are established for certain business and specialty finance credits
based on a regular analysis of special attention loans and leases. This analysis
is performed by the Credit Policy Committee, the Loan Review Department, Credit
Administration, and the Loan Workout Departments. The specific reserves are
determined in accordance with SFAS 114 and are based on an analysis of
underlying collateral values, cash flow considerations and, if applicable,
guarantor capacity.
The
formula reserves determined for each business lending division portfolio are
calculated quarterly by applying loss factors to outstanding loans and leases
and certain unfunded commitments based upon a review of historical loss
experience and qualitative factors, which include but are not limited to,
economic trends, current market risk assessment by industry, recent loss
experience in particular segments of the portfolios, movement in equipment
values collateralizing specialized industry portfolios, concentrations of
credit, delinquencies, trends in volume, experience and depth of relationship
managers and division management, and the effects of changes in lending policies
and practices, including changes in quality of the loan and lease origination,
servicing and risk management processes. Special attention loans and leases
without specific reserves receive a higher percentage allocation ratio than
credits not considered special attention.
Pooled
loans and leases are smaller credits and are homogenous in nature, such as
consumer credits and residential mortgages. Pooled loan and lease loss reserves
are based on historical net charge-offs, adjusted for delinquencies, the effects
of lending practices and programs and current economic conditions,
and current trends in the geographic markets which we serve.
A
comprehensive analysis of the reserve is performed by management on a quarterly
basis. Although management determines the amount of each element of the reserve
separately and relies on this process as an important credit management tool,
the entire reserve is available for the entire loan and lease portfolio. The
actual amount of losses incurred can vary significantly from the estimated
amounts both positively and negatively. Management’s methodology includes
several factors intended to minimize the difference between estimated and actual
losses. These factors allow management to adjust our estimate of losses based on
the most recent information available.
Loans and
leases, which are deemed uncollectible, are charged off and deducted from the
reserve, while recoveries of amounts previously charged off are credited to the
reserve. A (recovery of) provision for loan and lease losses is credited or
charged to operations based on management’s periodic evaluation of the factors
previously mentioned, as well as other pertinent factors.
Equipment Owned Under Operating
Leases — We finance various types of construction equipment, medium and
heavy duty trucks, and automobiles under leases classified as operating leases.
Revenue consists of the contractual lease payments and is recognized on a
straight-line basis over the lease term. Lease terms range from 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 referred to as "residual" value. For automobile leases, fair
value was based upon published industry market guides. For other equipment
leases, fair value may be based upon observable market prices, third-party
valuations, or prices received on sales of similar assets at the end of the
lease term. These residual values are reviewed periodically to ensure the
recorded amount does not exceed the fair market value at the lease
termination.
Other Real Estate — Other real
estate acquired through partial or total satisfaction of nonperforming loans is
included in other assets and recorded at the
estimated
fair value less anticipated selling costs based upon the property’s appraised
value at the date of transfer, with any difference between the fair value of the
property less cost
to sell,
and the carrying value of the loan charged to the reserve for loan losses. Other
real estate also includes bank premises qualifying as held for sale under SFAS
No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." Bank premises are
transferred at the lower of carrying value or estimated fair value
less anticipated selling costs. Fair value write-downs, property maintenance
costs, and gains or losses recognized upon the sale of foreclosed assets are
recognized in noninterest expense on the income statement. Gains or losses not
previously recognized resulting from the sale of other real estate are
recognized on the date of sale. As of December 31, 2008 and 2007, other real
estate had carrying values of $4.74 million and $4.82 million,
respectively.
Repossessed Assets —
Repossessed assets may include fixtures and equipment, inventory and
receivables, and aircraft, construction equipment, and vehicles acquired through
foreclosure or in lieu of foreclosure from our business banking activities and
our specialty finance activities. Repossessed assets are included in other
assets at the lower of cost or fair value of the equipment or vehicle. We
estimate fair value based on the best estimate of an orderly liquidation value.
Valuation resources typically include vehicle and equipment dealers, valuation
guides, and other third parties, including appraisers. At the time of
foreclosure, the recorded amount of the loan or lease is written down, if
necessary, to the fair value of the equipment or vehicle by a charge to the
reserve for loan and lease losses. Subsequent write-downs are included in
noninterest expense. Gains or losses not previously recognized resulting from
the sale of repossessed assets are recognized on the date of sale. Repossessed
assets totaled $1.67 million and $2.29 million, as of December 31, 2008 and
2007, respectively.
Premises and Equipment —
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. The provision for depreciation is computed by the straight-line
method, primarily with useful lives ranging from three to 31.5 years.
Maintenance and repairs are charged to expense as incurred, while improvements,
which extend the useful life, are capitalized and depreciated over the estimated
remaining life.
Long-lived
depreciable assets are evaluated periodically for impairment when events or
changes in circumstances indicate the carrying amount may not be recoverable.
Impairment exists when the expected undiscounted future cash flows of a
long-lived asset are less than its carrying value. In that event, we recognize a
loss in the amount of the difference between the carrying amount and the
estimated fair value of the asset based on a quoted market price, if applicable,
or a discounted cash flow analysis. Impairment losses are recorded in other
noninterest expense in the income statement.
Goodwill and Intangibles —
Goodwill represents the excess of the cost of an acquisition over the fair value
of the net assets acquired. Other intangible assets represent purchased assets
that also lack physical substance but can be distinguished from goodwill because
of contractual or other legal rights or because the asset is capable of being
sold or exchanged either on its own or in combination with a related contract,
asset, or liability. Goodwill is reviewed for impairment at least annually
or on an interim basis if an event occurs or circumstances change that would
more likely than not reduce the carrying amount. Intangible assets that have
finite lives continue to be amortized over their estimated useful lives and also
continue to be subject to impairment testing. All of our other intangible assets
have finite lives and are amortized on a straight-line basis over varying
periods not exceeding eight years. We performed the required annual impairment
test of goodwill during the first quarter of 2008 and determined that no
impairment exists.
Venture
Capital Investment — We account for
our investments in venture capital partnerships for which we own three percent
or more of the partnership on the equity method based upon the guidance
included in EITF D-46. The venture capital partnerships which we have
investments in, account for their investments at fair value pursuant to the
guidance in the AICPA Investment Company Guide. As a result, our investments in
these venture capital partnerships reflect the underlying fair value of the
partnerships’ investments. We account for our investments in venture capital
partnerships that are owned three percent and greater under this method. We
account for our investments in venture capital partnerships that are owned less
than three percent at the lower of cost or market. Venture capital
investments in partnerships are included in other assets on the balance sheet.
The balances as of December 31, 2008 and 2007 were $1.86 million and $1.65
million, respectively.
Short-Term Borrowings — Our
short-term borrowings consist of Federal funds purchased, securities sold under
agreements to repurchase, commercial paper, U.S. Treasury demand notes, Federal
Home Loan Bank notes, and borrowings from non-affiliated banks. Federal funds
purchased, securities sold under agreements to repurchase, and other short-term
borrowings mature within one to 365 days of the transaction date. Commercial
paper matures within seven to 270 days. Other short-term borrowings on the
balance sheet include our liability related to mortgage loans available for
repurchase under GNMA optional repurchase programs.
Securities
purchased under agreements to resell and securities sold under agreements to
repurchase are treated as collateralized financing transactions and are recorded
at the amounts at which the securities were acquired or sold plus accrued
interest. The fair value of collateral either received from or provided to a
third party is continually monitored and additional collateral obtained or
requested to be returned to us as deemed appropriate.
Trust Fees — Trust fees are
recognized on the accrual basis.
Income Taxes — 1st Source and
our subsidiaries file a consolidated Federal income tax return. The provision
for incomes taxes is based upon income in the consolidated financial statements,
rather than amounts reported on our income tax return. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized as income or expense in the period that
includes the enactment date. A
valuation allowance, if needed, reduces deferred tax assets to the expected
amount most likely to be realized. Realization of deferred tax assets is
dependent upon the generation of a sufficient level of future taxable income and
recoverable taxes paid in prior years. Although realization is not
assured, we believe it is more likely than not that all of the deferred tax
assets will be realized.
Positions
taken in our tax returns may be subject to challenge by the taxing authorities
upon examination. Uncertain tax positions are initially recognized in the
financial statements when it is more likely than not the position will be
sustained upon examination by the tax authorities. Such tax positions are both
initially and subsequently measured as the largest amount of tax benefit that is
greater than 50% likely of being realized upon settlement with the tax
authority, assuming full knowledge of the position and all relevant facts. We
provide for interest and, in some cases, penalties on tax positions that may be
challenged by the taxing authorities. Interest expense is recognized beginning
in the first period that such interest would begin accruing. Penalties are
recognized in the period that we claim the position in the tax return. Interest
and penalties on income tax uncertainties are classified within income tax
expense in the income statement.
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): 2008, 24,106; 2007, 23,516; and 2006, 22,537. 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): 2008, 24,388; 2007, 23,810; and 2006,
22,830.
Stock-Based
Employee Compensation — We adopted the
provisions of SFAS No. 123(R) on January 1, 2006. SFAS
No. 123(R) eliminates the ability to account for stock-based compensation
using APB No. 25 and requires that such transactions be recognized as
compensation cost in the income statement based on their fair values on the
measurement date, which, for our purposes, is the date of grant. We transitioned
to fair-value based accounting for stock-based compensation using the modified
prospective application and, therefore, have not restated results for prior
periods. This transition method applies to new awards for service periods
beginning on or after January 1, 2006, and to awards modified, repurchased, or
cancelled after January 1, 2006. Additionally, compensation cost for the portion
of awards for which the requisite service has not been rendered (generally
referring to non-vested award) which were granted prior to January 1, 2006 will
be recognized as the remaining requisite service is rendered during the period
of and/or the periods after the adoption of SFAS No. 123(R).
Segment Information — In our
management's opinion, 1st Source has one principal business segment, commercial
banking. While our chief decision makers monitor the revenue streams of various
products and services, the identifiable segments' operations are managed and
financial performance is evaluated on a company-wide basis. Accordingly, all of
our financial service operations are considered by management to be aggregated
in one reportable operating segment.
Derivative Financial
Instruments — We occasionally enter into derivative financial instruments
as part of our interest rate risk management strategies. These derivative
financial instruments consist primarily of interest rate swaps. Under the
guidance of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended, all derivative
instruments are recorded on the balance sheet, as either an asset or liability,
at their fair value. The accounting for the gain or loss resulting from the
change in fair value depends on the intended use of the derivative. For a
derivative used to hedge changes in fair value of a recognized asset or
liability, or an unrecognized firm commitment, the gain or loss on the
derivative will be recognized in earnings together with the offsetting loss or
gain on the hedged item. This results in an earnings impact only to the extent
that the hedge is ineffective in achieving offsetting changes in fair value. If
it is determined that the derivative instrument is not highly effective as a
hedge, hedge accounting is discontinued and the adjustment to fair value of the
derivative instrument is recorded in earnings. For a derivative used to hedge
changes in cash flows associated with forecasted transactions, the gain or loss
on the effective portion of the derivative will be deferred, and reported as
accumulated other comprehensive income, a component of shareholders’ equity,
until such time the hedged transaction affects earnings. For derivative
instruments not accounted for as hedges, changes in fair value are recognized in
noninterest income/expense. Deferred gains and losses from derivatives that are
terminated and were in a cash flow hedge are amortized over the shorter of
the original remaining term of the derivative or the remaining life of the
underlying asset or liability.
Fair Value Measurements — We
record certain assets and liabilities at fair value. Fair value is defined as
the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date. Securities available for sale, trading securities, mortgage
loans held for sale, and derivative instruments are carried at fair value on a
recurring basis. Fair value measurements are also utilized to determine the
initial value of certain assets and liabilities, to perform impairment
assessments, and for disclosure purposes. We use quoted market prices and
observable inputs to the maximum extent possible when measuring fair value. In
the absence of quoted market prices, various valuation techniques are utilized
to measure fair value. When possible, observable market data for identical or
similar financial instruments are used in the valuation. When market data is not
available, fair value is determined using valuation models that incorporate
management’s estimates of the assumptions a market participant would use in
pricing the asset or liability.
Fair
value measurements are classified within one of three levels based on the
observability of the inputs used to determine fair value, as
follows:
Level 1 —
The valuation is based on quoted prices in active markets for identical
instruments.
Level 2 —
The valuation is based on observable inputs such as quoted prices for similar
instruments in active markets, quoted prices for identical or similar
instruments in markets that are not active, and model-based valuation techniques
for which all significant assumptions are observable in the market.
Level 3 —
The valuation is based on unobservable inputs that are supported by minimal or
no market activity and that are significant to the fair value of the instrument.
Level 3 valuations are typically performed using pricing models, discounted cash
flow methodologies, or similar techniques that incorporate management’s own
estimates of assumptions that market participants would use in pricing the
instrument, or valuations that require significant management judgment or
estimation.
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 — Recent Accounting Pronouncements
FASB Clarifies Application of Fair
Value Accounting:
On October 10, 2008, the Financial Accounting Standards Board (FASB) issued FASB
Staff Position (FSP) FAS 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not
Active.” The FSP clarifies the application of FASB Statement
No. 157, Fair Value Measurements, in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. The
FSP was effective upon issuance, including prior periods for which
financial statements have not been issued. The provisions of FSP FAS 157-3 did
not have an impact on our financial condition or results of
operations.
GAAP Hierarchy: In May 2008,
the FASB issued Statement No. 162, "The Hierarchy of Generally Accepted
Accounting Principles" (SFAS No. 162). This standard identifies the
sources of accounting principles and the framework for selecting the principles
to be used in the preparation of financial statements of nongovernmental
entities that are presented in conformity with generally accepted accounting
principles (GAAP) in the United States (the GAAP hierarchy). The provisions of
SFAS No. 162 did not impact our financial condition and results of
operations.
Disclosures About Derivative
Instruments and Hedging Activities: In March 2008, the FASB issued
Statement No. 161, “Disclosures About Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No.
133” (SFAS No. 161). SFAS No. 161 requires qualitative disclosures about
objectives and strategies for using derivatives, quantitative disclosures about
fair value amounts of and gains and losses on derivative instruments, and
disclosures about credit-risk-related contingent features in derivative
agreements. SFAS No. 161 is effective for fiscal years beginning after November
15, 2008. We are assessing the potential disclosure effects of SFAS No.
161.
Business Combinations: In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations.” SFAS
No. 141R broadens the guidance of SFAS No. 141, extending its applicability to
all transactions and other events in which one entity obtains control over one
or more other businesses. It broadens the fair value measurement and recognition
of assets acquired, liabilities assumed, and interests transferred as a result
of business combinations. SFAS No. 141R expands on required
disclosures to improve the statement users’ abilities to evaluate the nature and
financial effects of business combinations. SFAS No. 141R is effective for the
first annual reporting period beginning on or after December 15, 2008. The
provisions of SFAS No. 141R will only impact us if we are party to a business
combination closing on or after January 1, 2009.
Written Loan Commitments Recorded at
Fair Value Through Earnings: In November 2007, the
Securities and Exchange Commission issued Staff Accounting Bulletin No. 109 (SAB
109), “Written Loan Commitments Recorded at Fair Value through Earnings,” an
amendment of SAB 105, “Application of Accounting Principles to Loan
Commitments.” Under SAB 109, the expected net future cash flows of associated
loan servicing activities should be included in the measurement of written loan
commitments accounted for at fair value through earnings. The guidance in SAB
109 is applied on a prospective basis to derivative loan commitments issued or
modified in fiscal quarters beginning after December 15, 2007. We adopted the
provisions of SAB 109 on January 1, 2008. Details related to the adoption of SAB
109 and the impact on our financial statements are more fully discussed in Note
S – Fair Value.
Fair Value Option: In February
2007, the Financial Accounting Standards Board (FASB) issued Statement No. 159,
“The Fair Value Option for
Financial Assets and Financial Liabilities – Including an Amendment of FASB No.
115” (SFAS No. 159). The fair value option permits companies to choose to
measure eligible items at fair value at specified election dates. Companies will
report unrealized gains and losses on items for which the fair value option has
been elected in earnings after adoption. SFAS No. 159 requires additional
disclosures related to the fair value measurements included in the companies’
financial statements. This statement is effective for financial statements
issued for fiscal years beginning after November 15, 2007. We adopted the
provisions of SFAS No. 159 on January 1, 2008. Details related to the adoption
of SFAS No. 159 and the impact on our financial statements are more fully
discussed in Note S – Fair Value.
Fair Value Measurements: In September 2006, the FASB
issued SFAS No. 157, “Fair Value Measurements.”
This standard clarifies the principle that fair value should be based on the
assumptions that market participants would use when pricing an asset or
liability. Additionally, it establishes a fair value hierarchy that prioritizes
the information used to develop those assumptions. We adopted the provisions of
SFAS No. 157 on January 1, 2008. Details related to the adoption of SFAS No. 157
and the impact on our financial statements are more fully discussed in Note S –
Fair Value.
Noncontrolling Interests in
Consolidated Financial Statements: In December 2007, the
Financial Accounting Standards Board (FASB) issued Statement No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51” (SFAS No.
160). SFAS No. 160 requires that a noncontrolling interest in a subsidiary be
reported separately within equity and the amount of consolidated net income
specifically attributable to the noncontrolling interest be identified in the
consolidated financial statements. It also calls for consistency in the manner
of reporting changes in the parent’s ownership interest and requires fair value
measurement of any noncontrolling equity investment retained in a
deconsolidation. SFAS No. 160 is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008. We do not
expect the provisions of SFAS No. 160 to have a material impact on our financial
condition and results of operations.
Note
C — Acquisitions
On May
31, 2007, we acquired FINA Bancorp (FINA), the parent company of First National
Bank, Valparaiso (First National), for $134.19 million. First National is a full
service bank that had 26 banking facilities located in Porter, LaPorte and
Starke Counties of Indiana. Pursuant to the definitive agreement, FINA
shareholders were able to choose whether to receive 1st Source common stock
and/or cash pursuant to the election procedures described in the definitive
agreement. Under the terms of the transaction, FINA was acquired in exchange for
2,124,974 shares of 1st Source common stock valued at $53.68 million and $80.51
million in cash. The value of the common stock was $25.26 per share. We believe
that the purchase of FINA is a natural extension of our service area and is
consistent with our growth and market expansion initiatives. The results of
operations for First National have been included in the consolidated financial
statements since the date of the acquisition.
The
acquisition was accounted for under the purchase method of accounting, and
accordingly, the purchase price has been allocated to the tangible and
identified intangible assets purchased and the liabilities assumed based upon
the estimated fair values at the date of acquisition. Identified intangible
assets and purchase accounting fair value adjustments are being amortized under
various methods over the expected lives of the corresponding assets and
liabilities. Goodwill will not be amortized, but will be reviewed for impairment
on an annual basis.
The
following table shows the excess purchase price over carrying value of new
assets acquired, purchase price allocation and resulting goodwill recorded to
date.
|
(Dollars
in thousands)
|
||||
|
Purchase
price
|
$ | 134,193 | ||
|
Carrying
value of net assets acquired
|
68,676 | |||
|
Excess
of purchase price over carrying value of net assets
acquired
|
65,517 | |||
|
Purchase
accounting adjustments
|
||||
|
Securities
|
(44 | ) | ||
|
Loans
|
1,707 | |||
|
Premises
and equipment
|
1,765 | |||
|
Mortgage
servicing rights
|
(511 | ) | ||
|
Other
assets
|
337 | |||
|
Deposits
|
(1,489 | ) | ||
|
Severance
and exit costs
|
3,098 | |||
|
Other
liabilities
|
503 | |||
|
Deferred
taxes
|
1,944 | |||
|
Subtotal
|
72,827 | |||
|
Core
deposit intangibles
|
(8,689 | ) | ||
|
Other
identifiable intangible assets
|
(254 | ) | ||
|
Goodwill
|
$ | 63,884 | ||
The
following table summarized the estimated fair value of net asset acquired
related to the FINA acquisition.
|
(Dollars
in thousands)
|
||||
|
Assets:
|
||||
|
Cash
and cash equivalents
|
$ | 171,308 | ||
|
Securities
|
184,494 | |||
|
Loans,
net of reserve for loan losses
|
235,709 | |||
|
Premises
and equipment
|
14,277 | |||
|
Mortgage
servicing rights
|
1,086 | |||
|
Goodwill
and other intangibles
|
72,827 | |||
|
Other
assets
|
8,623 | |||
|
Total
assets
|
688,324 | |||
|
Liabilities:
|
||||
|
Deposits
|
(521,630 | ) | ||
|
Borrowings
|
(18,184 | ) | ||
|
Other
liabilities
|
(14,317 | ) | ||
|
Total
liabilities
|
(554,131 | ) | ||
|
Fair
value of net assets acquired
|
$ | 134,193 | ||
Note
D — Investment Securities
Investment
securities available-for-sale were as follows:
|
Amortized
|
Gross
|
Gross
|
||||||||||||||
|
(Dollars
in thousands)
|
Cost
|
Unrealized
Gains
|
Unrealized
Losses
|
Fair
Value
|
||||||||||||
|
December
31, 2008
|
||||||||||||||||
|
U.S.
Treasury and government agencies securities
|
$ | 293,461 | $ | 2,892 | $ | (2 | ) | $ | 296,351 | |||||||
|
States
and political subdivisions
|
198,640 | 3,995 | (1,686 | ) | 200,949 | |||||||||||
|
Mortgage-backed
securities
|
207,954 | 3,553 | (1,499 | ) | 210,008 | |||||||||||
|
Other
securities
|
15,325 | 2,142 | (21 | ) | 17,446 | |||||||||||
|
Total
investment securities available-for-sale
|
$ | 715,380 | $ | 12,582 | $ | (3,208 | ) | $ | 724,754 | |||||||
|
December
31, 2007
|
||||||||||||||||
|
U.S.
Treasury and government agencies securities
|
$ | 284,214 | $ | 1,556 | $ | (134 | ) | $ | 285,636 | |||||||
|
States
and political subdivisions
|
258,260 | 1,162 | (544 | ) | 258,878 | |||||||||||
|
Mortgage-backed
securities
|
199,382 | 988 | (1,274 | ) | 199,096 | |||||||||||
|
Other
securities
|
34,066 | 2,832 | (527 | ) | 36,371 | |||||||||||
|
Total
investment securities available-for-sale
|
$ | 775,922 | $ | 6,538 | $ | (2,479 | ) | $ | 779,981 | |||||||
The
contractual maturities of investments in securities available-for-sale at
December 31, 2008, are shown below. Expected maturities will differ from
contractual maturities, because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
|
Amortized
|
||||||||
|
(Dollars
in thousands)
|
Cost
|
Fair
Value
|
||||||
|
Due
in one year or less
|
$ | 214,840 | $ | 215,607 | ||||
|
Due
after one year through five years
|
168,928 | 172,036 | ||||||
|
Due
after five years through ten years
|
99,918 | 102,337 | ||||||
|
Due
after ten years
|
19,344 | 18,299 | ||||||
|
Mortgage-backed
securities
|
207,954 | 210,008 | ||||||
|
Equity
securities
|
4,396 | 6,467 | ||||||
|
Total
investment securities available for sale
|
$ | 715,380 | $ | 724,754 | ||||
At
December 31, 2008, the mortgage-backed securities we held consisted primarily of
GNMA, FNMA and FHLMC pass-through certificates which are guaranteed by those
respective agencies of the United States government. At December 31, 2008, other
securities we held consisted primarily of other equity investments, FNMA and
FHLMC preferred securities, and a corporate note.
Gross
losses of $11.05 million, $4.12 million, and $0.45 million and gross gains of
$0.83 million, $1.06 million, and $0.61 million were recognized on investment
securities available-for-sale, in 2008, 2007, and 2006, respectively. The gross
losses in 2008 and 2007 include $10.82 million and $4.11 million, respectively,
in other-than-temporary impairment on preferred stock issued by the FNMA, the
FHLMC, Farmer Mac common stock and various corporate preferred stocks. We did
not record any other-than-temporary impairment on any securities for 2006. There
were $0.10 million in trading securities outstanding at December 31, 2008 and no
trading securities outstanding at December 31, 2007.
The
following tables summarize our gross unrealized losses and fair value by
investment category and age:
|
Less
than 12 Months
|
12
months or Longer
|
Total
|
||||||||||||||||||||||
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
|||||||||||||||||||
|
(Dollars
in thousands)
|
Value
|
Losses
|
Value
|
Losses
|
Value
|
Losses
|
||||||||||||||||||
|
December
31, 2008
|
||||||||||||||||||||||||
|
U.S.
Treasury and government agencies securities
|
$ | 19,998 | $ | (2 | ) | $ | - | $ | - | $ | 19,998 | $ | (2 | ) | ||||||||||
|
States
and political subdivisions
|
29,594 | (1,686 | ) | - | - | 29,594 | (1,686 | ) | ||||||||||||||||
|
Mortgage-backed
securities
|
14,840 | (229 | ) | 34,721 | (1,270 | ) | 49,561 | (1,499 | ) | |||||||||||||||
|
Other
securities
|
504 | (19 | ) | 2 | (2 | ) | 506 | (21 | ) | |||||||||||||||
|
Total
temporarily impaired securities
|
$ | 64,936 | $ | (1,936 | ) | $ | 34,723 | $ | (1,272 | ) | $ | 99,659 | $ | (3,208 | ) | |||||||||
|
December
31, 2007
|
||||||||||||||||||||||||
|
U.S.
Treasury and government agencies securities
|
$ | 5,058 | $ | (5 | ) | $ | 47,856 | $ | (129 | ) | $ | 52,914 | $ | (134 | ) | |||||||||
|
States
and political subdivisions
|
30,209 | (137 | ) | 70,039 | (407 | ) | 100,248 | (544 | ) | |||||||||||||||
|
Mortgage-backed
securities
|
64,965 | (627 | ) | 27,680 | (647 | ) | 92,645 | (1,274 | ) | |||||||||||||||
|
Other
securities
|
921 | (229 | ) | 6,715 | (298 | ) | 7,636 | (527 | ) | |||||||||||||||
|
Total
temporarily impaired securities
|
$ | 101,153 | $ | (998 | ) | $ | 152,290 | $ | (1,481 | ) | $ | 253,443 | $ | (2,479 | ) | |||||||||
At
December 31, 2008, we do not believe any individual unrealized loss represented
other-than-temporary impairment. The unrealized losses were primarily
attributable to changes in interest rates. We have both the intent and the
ability to hold these securities for a time necessary to recover the amortized
cost.
At
December 31, 2008 and 2007, investment securities with carrying values of
$434.12 million and $403.82 million, respectively, were pledged as collateral to
secure government deposits, security repurchase agreements, and for other
purposes.
Note
E — Loans and Lease Financings
Total
loans and leases outstanding were recorded net of unearned income and deferred
loan fees and costs at December 31, 2008 and 2007, and totaled $3.30 billion and
$3.19 billion, respectively. At December 31, 2008 and 2007, net deferred loan
and lease costs were $4.58 million and $6.30 million, respectively.
The loan
and lease portfolio includes direct financing leases, which are included in
auto, light truck and environmental equipment, medium and heavy duty truck,
aircraft financing, and construction equipment financing on the consolidated
balance sheet.
A summary
of the gross investment in lease financing and the components of the investment
in lease financing at December 31, 2008 and 2007, follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
Direct
finance leases:
|
||||||||
|
Rentals
receivable
|
$ | 183,818 | $ | 157,658 | ||||
|
Estimated
residual value of leased assets
|
33,711 | 44,775 | ||||||
|
Gross
investment in lease financing
|
217,529 | 202,433 | ||||||
|
Unearned
income
|
(31,630 | ) | (29,402 | ) | ||||
|
Net
investment in lease financing
|
$ | 185,899 | $ | 173,031 | ||||
At
December 31, 2008, the minimum future lease payments receivable for each of the
years 2009 through 2013 were $44.87 million, $37.02 million, $28.34 million,
$18.99 million, and $12.72 million, respectively.
In the
ordinary course of business, we have extended loans to certain directors,
executive officers, and principal shareholders of equity securities of 1st
Source and to their affiliates. In the opinion of management, these loans are
made on substantially the same terms, including interest rates and collateral,
as those prevailing at the time for comparable transactions with other parties
and are consistent with sound banking practices and within applicable regulatory
and lending limitations. The aggregate dollar amounts of these loans were $9.16
million and $5.51 million at December 31, 2008 and 2007, respectively. During
2008, $10.54 million of new loans were made and repayments and other reductions
totaled $6.89 million.
Note
F — Reserve for Loan and Lease Losses
Changes
in the reserve for loan and lease losses for each of the three years ended
December 31 are shown below.
|
(Dollars
in thousands)
|
2008
|
2007
|
2006
|
|||||||||
|
Balance,
beginning of year
|
$ | 66,602 | $ | 58,802 | $ | 58,697 | ||||||
|
Provision
for (recovery of provision for) loan and lease losses
|
16,648 | 7,534 | (2,736 | ) | ||||||||
|
Charge-offs
|
(8,393 | ) | (7,367 | ) | (3,954 | ) | ||||||
|
Recoveries
|
4,919 | 5,254 | 6,795 | |||||||||
|
Reserves
acquired in acquisitions
|
- | 2,379 | - | |||||||||
|
Balance,
end of year
|
$ | 79,776 | $ | 66,602 | $ | 58,802 | ||||||
At
December 31, 2008 and 2007, nonaccrual and restructured loans and leases,
substantially all of which are collateralized, were $36.55 million and $10.14
million, respectively. Interest income for the years ended December 31, 2008,
2007, and 2006, would have increased by approximately $1.54 million, $0.72
million, and $1.28 million, respectively, if these loans and leases had earned
interest at their full contract rate.
As of
December 31, 2008 and 2007, impaired loans and leases totaled $30.94 million and
$6.19 million respectively, of which $21.36 million and $1.26 million had
corresponding specific reserves for loan and lease losses totaling $4.54 million
and $0.11 million, respectively. The remaining balances of impaired loans and
leases had no specific reserves for loan and lease losses associated with them.
As of December 31, 2008, a total of $30.65 million of the impaired loans and
leases were nonaccrual loans and leases. For 2008, 2007, and 2006 the average
recorded investment in impaired loans and leases was $15.25 million, $8.35
million and $11.39 million, respectively, and interest income recognized on
impaired loans and leases totaled $1.68 million, $0.04 million, and $0.56
million, respectively.
Note
G — Operating Leases
We
finance various types of construction equipment, medium and heavy duty trucks,
automobiles, and miscellaneous production equipment under leases principally
classified as operating leases. The equipment underlying the operating
leases is reported at cost, net of accumulated depreciation, in the
consolidated balance sheet. These operating lease arrangements require the
lessee to make a fixed monthly rental payment over a specified lease term,
typically from three to seven years. Rental income is earned on the
operating lease assets and reported as noninterest income. These operating lease
assets are depreciated over the term of the lease to the estimated fair value of
the asset at the end of the lease. The depreciation of these operating lease
assets is reported as a component of noninterest expense. At the end of the
lease, the operating lease asset is either purchased by the lessee or returned
to us.
Operating
lease equipment at December 31, 2008 and 2007, was $83.06 million and $81.96
million, respectively, net of accumulated depreciation of $39.65 million and
$31.42 million, respectively. Depreciable lives for operating lease equipment
generally range from three to seven years.
The
minimum future lease rental payments due from clients on operating lease
equipment at December 31, 2008, totaled $63.52 million, of which $22.85 million
is due in 2009, $18.33 million in 2010, $13.04 million in 2011, $6.91 million in
2012, $2.11 million in 2013, $0.24 million in 2014, and $0.04 million in 2015.
Depreciation expense related to operating lease equipment for the year ended
December 31, 2008 was $19.45 million.
Note
H — Premises and Equipment
Premises
and equipment as of December 31 consisted of the following:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
Land
|
$ | 10,788 | $ | 6,981 | ||||
|
Buildings
and improvements
|
47,832 | 52,443 | ||||||
|
Furniture
and equipment
|
35,861 | 35,397 | ||||||
|
Total
premises and equipment
|
94,481 | 94,821 | ||||||
|
Accumulated
depreciation and amortization
|
(53,990 | ) | (49,773 | ) | ||||
|
Net
premises and equipment
|
$ | 40,491 | $ | 45,048 | ||||
Depreciation
and amortization of properties and equipment totaled $5.31 million in 2008,
$5.36 million in 2007, and $4.80 million in 2006.
Note
I - Mortgage Servicing Assets
The
unpaid principal balance of residential mortgage loans serviced for third
parties was $0.78 billion at December 31, 2008, compared to $0.76 billion at
December 31, 2007, and $0.65 billion at December 31, 2006.
Changes
in the carrying value of mortgage servicing assets and the associated valuation
allowance follow:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
Mortgage
servicing assets:
|
||||||||
|
Balance
at beginning of period
|
$ | 7,440 | $ | 7,590 | ||||
|
Additions
|
5,488 | 4,987 | ||||||
|
Acquired
in acquisition
|
- | 1,086 | ||||||
|
Amortization
|
(2,838 | ) | (2,403 | ) | ||||
|
Sales
|
(3,382 | ) | (3,820 | ) | ||||
|
Carrying
value before valuation allowance at end of period
|
6,708 | 7,440 | ||||||
|
Valuation
allowance:
|
||||||||
|
Balance
at beginning of period
|
(161 | ) | (18 | ) | ||||
|
Impairment
(charges) recoveries
|
(1,912 | ) | (143 | ) | ||||
|
Balance
at end of period
|
$ | (2,073 | ) | $ | (161 | ) | ||
|
Net
carrying value of mortgage servicing assets at end of
period
|
$ | 4,635 | $ | 7,279 | ||||
|
Fair
value of mortgage servicing assets at end of period
|
$ | 4,715 | $ | 9,010 | ||||
Amortization
includes a decrease in mortgage servicing asset value due to normal passage of
time and loans that paid off during the period.
Mortgage
servicing assets are evaluated for impairment and a valuation allowance is
established through a charge to income when the carrying value of the mortgage
servicing assets exceeds the fair value. Other-than-temporary impairment is
recognized when the recoverability of a recorded valuation allowance is
determined to be remote taking into consideration historical and projected
interest rates and loan pay-off activity. When this situation occurs, the
unrecoverable portion of the valuation allowance is applied as a direct
write-down to the carrying value of the mortgage servicing asset. Unlike a
valuation allowance, a direct write-down permanently reduces the carrying value
of the mortgage servicing asset and the valuation allowance, precluding
subsequent recoveries. During 2008, management determined that it was not
necessary to permanently write-down any previously established valuation
allowance. At December 31, 2008, the fair value of mortgage servicing assets
exceeded the carrying value reported in the consolidated balance sheet by $0.08
million. This difference represents increases in the fair value of certain
mortgage servicing assets accounted for under SFAS No. 140 that could not be
recorded above cost basis.
The key
economic assumptions used to estimate the fair value of the mortgage servicing
rights as of December 31 follow:
|
2008
|
2007
|
|||||||
|
Expected
weighted-average life (in years)
|
3.02 | 3.19 | ||||||
|
Weighted-average
constant prepayment rate (CPR)
|
40.40 | % | 17.28 | % | ||||
|
Weighted-average
discount rate
|
8.45 | % | 8.57 | % | ||||
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, were
approximately $13.21 million and $6.27 million at December 31, 2008 and December
31, 2007, respectively. Mortgage loan contractual servicing fees, including late
fees and ancillary income, were $3.05 million, $2.85 million, and $5.37 million
for 2008, 2007, and 2006, respectively. Mortgage loan contractual servicing fees
are included in Mortgage banking income on the consolidated statement of
income.
Note
J — Intangible Assets and Goodwill
At
December 31, 2008, intangible assets consisted of goodwill of $83.33 million and
other intangible assets of $8.36 million, net of accumulated amortization of
$2.43 million. At December 31, 2007, intangible assets consisted of goodwill of
$83.68 million and other intangible assets of $9.89 million, net of accumulated
amortization of $13.21 million. Intangible asset amortization was $1.39 million,
$0.87 million, and $1.91 million for 2008, 2007, and 2006, respectively.
Amortization on other intangible assets is expected to total $1.36 million,
$1.35 million, $1.32 million, $1.23 million, and $1.02 million in 2009, 2010,
2011, 2012, and 2013, respectively.
A summary
of core deposit intangible and other intangible assets as of December 31
follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
Core
deposit intangibles:
|
||||||||
|
Gross
carrying amount
|
$ | 10,537 | $ | 15,655 | ||||
|
Less:
accumulated amortization
|
(2,378 | ) | (5,999 | ) | ||||
|
Net
carrying amount
|
$ | 8,159 | $ | 9,656 | ||||
|
Other
intangibles:
|
||||||||
|
Gross
carrying amount
|
$ | 254 | $ | 7,454 | ||||
|
Less:
accumulated amortization
|
(50 | ) | (7,219 | ) | ||||
|
Net
carrying amount
|
$ | 204 | $ | 235 | ||||
Note
K — Long-Term Debt and Mandatorily Redeemable Securities
Details
of long-term debt and mandatorily redeemable securities as of December 31, 2008
and 2007, are as follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
||||||
|
Term
loan
|
$ | 10,000 | $ | - | ||||
|
Federal
Home Loan Bank borrowings (4.73%–6.54%)
|
10,981 | 26,005 | ||||||
|
Mandatorily
redeemable securities
|
7,905 | 7,188 | ||||||
|
Other
long-term debt
|
946 | 1,509 | ||||||
|
Total
long-term debt and mandatorily redeemable securities
|
$ | 29,832 | $ | 34,702 | ||||
Annual
maturities of long-term debt outstanding at December 31, 2008, for the next five
years beginning in 2009, are as follows (in thousands): $10,342; $10,481; $201;
$34; and $36.
During
2007, we entered into a line of credit agreement whereby 1st Source may borrow
up to $30.00 million. At December 31, 2007, there were no outstanding borrowings
under this line. During 2008, $10.00 million was drawn on this line
and converted to a term loan bearing a fixed interest rate of 4.28%. Interest is
payable quarterly with principal due at the October 30, 2010, maturity. The Loan
Agreement contains, among other provisions, certain covenants relating to
capital structure financial requirements. $20.00 million remains
available on the line of credit at December 31, 2008. The line of credit matures
on October 30, 2010.
At
December 31, 2008, the Federal Home Loan Bank borrowings represented a source of
funding for certain residential mortgage activities and consisted of six fixed
rate notes with maturities ranging from 2009 to 2022. These notes were
collateralized by $13.73 million of certain real estate loans.
Mandatorily
redeemable securities as of December 31, 2008, of $7.91 million reflected the
"book value" shares under the 1st Source Executive Incentive Plan. See Note L -
Employee Stock Benefit Plans for additional information. Dividends paid on these
shares and changes in book value per share are recorded as other interest
expense. Total interest expense recorded for 2008, 2007, and 2006 was $0.66
million, $0.80 million, and $0.66 million, respectively.
Note
L — Employee Stock Benefit Plans
As of
December 31, 2008, we had five stock-based employee compensation plans. These
plans include two stock option plans, namely, the 1992 Stock Option Plan, and
the 2001 Stock Option Plan; two executive stock award plans, namely, the
Executive Incentive Plan, and the Restricted Stock Award Plan; and the Employee
Stock Purchase Plan. These stock-based employee compensation plans were
established to help retain and motivate key employees. All of the plans have
been approved by the shareholders of 1st Source Corporation. The Executive
Compensation and Human Resources Committee (the "Committee") of the 1st Source
Corporation Board of Directors has sole authority to select the employees,
establish the awards to be issued, and approve the terms and conditions of each
award under the stock-based compensation plans.
A
combined summary of activity regarding our active stock option plans and stock
award plans is presented in the following table.
|
Non-Vested
Stock
|
Stock
Options
|
|||||
|
Awards
Outstanding
|
Outstanding
|
|||||
|
Weighted-
|
Weighted-
|
|||||
|
Shares
|
|
Average
|
Average
|
|||
|
Available
|
Number
of
|
Grant-Date
|
Number
of
|
Exercise
|
||
|
for
Grant
|
Shares
|
Fair
Value
|
Shares
|
Price
|
||
|
Balance,
January 1, 2006
|
2,410,958
|
373,049
|
$ 13.35
|
580,848
|
$ 24.19
|
|
|
Shares
authorized --2006 EIP
|
76,442
|
-
|
-
|
-
|
-
|
|
|
Granted
|
(97,123)
|
94,264
|
16.65
|
2,859
|
29.46
|
|
|
Stock
options exercised
|
-
|
-
|
-
|
(71,062)
|
12.78
|
|
|
Stock
awards vested
|
-
|
(37,269)
|
15.57
|
-
|
-
|
|
|
Forfeited
|
17,382
|
(19,896)
|
13.46
|
(23,170)
|
20.74
|
|
|
Canceled
|
-
|
-
|
-
|
-
|
-
|
|
|
Balance,
December 31, 2006
|
2,407,659
|
410,148
|
13.90
|
489,475
|
26.04
|
|
|
Shares
authorized --2007 EIP
|
97,250
|
-
|
-
|
-
|
-
|
|
|
Granted
|
(131,796)
|
129,100
|
18.90
|
2,696
|
28.40
|
|
|
Stock
options exercised
|
-
|
-
|
-
|
(20,654)
|
15.63
|
|
|
Stock
awards vested
|
-
|
(48,530)
|
15.43
|
-
|
-
|
|
|
Forfeited
|
555
|
(20,516)
|
12.33
|
-
|
-
|
|
|
Canceled
|
-
|
-
|
-
|
-
|
-
|
|
|
Balance,
December 31, 2007
|
2,373,668
|
470,202
|
15.18
|
471,517
|
26.51
|
|
|
Shares
authorized --2008 EIP
|
64,847
|
-
|
-
|
-
|
-
|
|
|
Granted
|
(66,847)
|
66,847
|
17.96
|
-
|
-
|
|
|
Stock
options exercised
|
-
|
-
|
-
|
-
|
-
|
|
|
Stock
awards vested
|
-
|
(37,070)
|
16.92
|
-
|
-
|
|
|
Forfeited
|
15,902
|
(64,508)
|
15.10
|
(390,569)
|
28.17
|
|
|
Canceled
|
-
|
-
|
-
|
-
|
-
|
|
|
Balance,
December 31, 2008
|
2,387,570
|
435,471
|
$ 15.47
|
80,948
|
$ 18.51
|
|
Stock Option Plans — Our
incentive stock option plans include the 1992 Stock Option Plan (the "1992
Plan") and the 2001 Stock Option Plan (the "2001 Plan"). As of December 31,
2008, there were 16,693 stock options remaining exercisable under the 1992 Plan,
all of which will expire no later than January 2011. We have not issued any
awards from the 1992 Plan since 2001, as the 1992 Plan was terminated, except
for outstanding options, after the 2001 Plan was approved by the shareholders.
Options under the 2001 Plan vest in one to eight years from date of grant. As of
December 31, 2008, there were 64,255 shares available for issuance upon exercise
and 2,119,922 shares available for issuance under the 2001 Plan.
Each
award from all plans is evidenced by an award agreement that specifies the
option price, the duration of the option, the number of shares to which the
option pertains, and such other provisions as the Committee determines. The
option price is equal to the fair market value of a share of 1st Source
Corporation's common stock on the date of grant. Options granted expire at such
time as the Committee determines at the date of grant and in no event does the
exercise period exceed a maximum of ten years. Upon merger, consolidation, or
other corporate consolidation in which 1st Source Corporation is not the
surviving corporation, as defined in the plans, all outstanding options
immediately vest.
Proceeds
from stock option exercises totaled $0.32 million in 2007 and $0.91 million in
2006. There were no stock option exercises during 2008. All shares
issued in connection with stock option exercises and non-vested stock awards are
issued from available treasury stock.
The total
intrinsic value of outstanding stock options and outstanding exercisable stock
options was $0.44 million and $0.35 million at December 31, 2008. The total
intrinsic value of stock options exercised was $0.27 million in 2007 and $0.96
million in 2006. The total fair value of share awards vested was $0.66 million
during 2008, $0.98 million in 2007, and $0.67 million in 2006.
Other
information regarding stock options outstanding and exercisable as of December
31, 2008, is as follows:
|
Options
Outstanding
|
Options
Exercisable
|
|||||
|
Weighted-Average
|
||||||
|
Number
of
|
Remaining
Contractual
|
Weighted-Average
|
Number
of
|
Weighted-Average
|
||
|
Range
of Exercise Prices
|
Shares
|
Life
(Years)
|
Exercise
Price
|
Shares
|
Exercise
Price
|
|
|
$12.04
to $17.99
|
29,508
|
3.73
|
$13.38
|
21,258
|
$13.90
|
|
|
$18.00
to $26.99
|
45,885
|
2.26
|
20.55
|
45,885
|
20.55
|
|
|
$27.00
to $29.46
|
5,555
|
2.81
|
28.95
|
5,555
|
28.95
|
|
As stated
in Note A - Accounting Policies, effective January 1, 2006, we adopted the fair
value recognition provisions of SFAS No. 123(R). SFAS 123(R) requires
that stock-based compensation to employees be recognized as compensation cost in
the income statement based on their fair values on the measurement date, which,
for 1st Source, is the date of grant. Stock-based compensation expense is
recognized ratably over the requisite service period for all awards. As a result
of applying the provisions of SFAS 123(R) during 2006, we recognized additional
stock-based compensation expense related to stock options of $15,364 for 2008,
$65,174 for 2007 and $61,606 for 2006 (not subject to tax). The increase in
stock-based compensation expense related to stock options had an immaterial
impact on basic or diluted earnings per share during 2008, 2007 and
2006.
The fair
value of each option on the date of grant was estimated using the Black-Scholes
option pricing model. Expected volatility is based on the historical volatility
estimated over a period at least equal to the estimated term of the options. In
estimating the fair value of stock options under the Black-Scholes valuation
model, separate groups of employees that have similar historical exercise
behavior are considered separately. The expected term of the options granted is
derived based on past experience and represents the period of time that options
granted are expected to be outstanding. The following weighted-average
assumptions were used in the option pricing model for options granted in 2007
and 2006 (no options were granted in 2008): a risk-free interest rate
of 4.10% for 2007 and 4.87% for 2006; an expected dividend yield of 1.94% for
2007 and 2.02% for 2006; an expected volatility factor of 30.46% for 2007 and
35.73% for 2006; and an expected option life of 4.67 years for 2007 and 5.23
years for 2006. The weighted-average grant date per share fair value of options
granted was $7.67 for 2007 and $9.75 for 2006.
Stock Award Plans — Our
incentive stock award plans include the Executive Incentive Plan (EIP) and the
Restricted Stock Award Plan (RSAP). The EIP is also administered by the
Committee. Awards under the EIP include "book value" shares and "market value"
shares of common stock. These shares are awarded annually based on weighted
performance criteria and generally vest over a period of five years. The EIP
book value shares may only be sold to 1st Source and such sale is mandatory in
the event of death, retirement, disability, or termination of employment. The
RSAP is designed for key employees. Awards under the RSAP are made to employees
recommended by the Chief Executive Officer and approved by the Committee. Shares
granted under the RSAP vest over a five- to ten-year period and vesting is based
upon meeting certain various criteria, including continued employment with 1st
Source.
Stock-based
compensation expense totaled $2.46 million in 2008, $1.83 million in 2007, and
$0.41 million in 2006. The total income tax benefit recognized in the
accompanying consolidated statements of income related to stock-based
compensation was $0.93 million in 2008, $0.69 million in 2007, and $0.16 million
in 2006. Unrecognized stock-based compensation expense related to stock options
totaled $28,482 at December 31, 2008. At such date, the weighted-average period
over which this unrecognized expense was expected to be recognized was 2.3
years. Unrecognized stock-based compensation expense related to non-vested stock
awards was $2.18 million at December 31, 2008. At such date, the
weighted-average period over which this unrecognized expense was expected to be
recognized was 3.77 years.
The fair
value of non-vested stock awards for the purposes of recognizing stock-based
compensation expense is market price of the stock on the measurement date,
which, for our purposes is the date of the award.
Employee Stock Purchase Plan —
We offer an Employee Stock Purchase Plan (ESPP) 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. The purchase price for shares offered is the lower of the closing
market bid price for the offering date or the average market bid price for the
five business days preceding the offering date. The purchase price and discount
to the actual market closing price on the offering date for the 2008, 2007, and
2006 offerings were $20.70 (0.05%), $25.58 (1.69%), and $25.70 (3.45%),
respectively. 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 2, 2008 and runs through June 1, 2010, with $356,134 in
stock value to be purchased at $20.70 per share.
Note
M — Subordinated Notes
As of
December 31, 2008, we sponsored two trusts, 1st Source Capital Trust IV and 1st
Source Master Trust (Capital Trusts) of which 100% of the common equity is owned
by 1st Source. The Capital Trusts were formed for the purpose of issuing
corporation-obligated mandatorily redeemable capital securities (the capital
securities) to third-party investors and investing the proceeds from the sale of
the capital securities solely in junior subordinated debenture securities of 1st
Source (the subordinated notes). The subordinated notes held by each Capital
Trust are the sole assets of that Capital Trust. The Capital Trusts are reported
in the financial statements as unconsolidated subsidiaries in accordance with
FIN 46. The junior subordinated debentures are reflected as subordinated notes
in the consolidated balance sheet.
Distributions
on the capital securities issued by the Capital Trusts are payable quarterly at
a rate per annum equal to the interest rate being earned by the Capital Trust on
the subordinated notes held by that Capital Trust. The capital securities are
subject to mandatory redemption, in whole or in part, upon repayment of the
subordinated notes. We have entered into agreements which, taken collectively,
fully and unconditionally guarantee the capital securities subject to the terms
of each of the guarantees. The capital securities held by the Capital Trusts
qualify as Tier 1 capital under Federal Reserve Board guidelines.
The
subordinated notes are summarized as follows, at December 31, 2008:
|
Amount
of
|
|||||||||
|
Subordinated
|
Interest
|
Maturity
|
|||||||
|
(Dollars
in thousands)
|
Notes
|
Rate
|
Date
|
||||||
|
September
2004 issuance-fixed rate
|
$ | 30,928 | 7.66 | % |
12/15/34
|
||||
|
June
2007 issuance-fixed rate
|
41,238 | 7.22 | % |
06/15/37
|
|||||
|
August
2007 issuance-fixed rate
|
17,526 | 7.10 | % |
09/15/37
|
|||||
|
Total
|
$ | 89,692 | |||||||
Note
N — Employee Benefit Plans
Effective
October 1, 2006, we amended the 1st Source Corporation Employees’ Profit Sharing
Plan and Trust, which was renamed the 1st Source Corporation Employee Stock
Ownership and Profit Sharing Plan (as amended, the “Plan”). The Plan includes an
employee stock ownership component, which is designed to invest in and hold 1st
Source common stock, and a 401(k) plan component, which holds all Plan assets
not invested in 1st Source common stock. The Plan now also includes a number of
new features that encourage diversification of investments with more
opportunities to change investment elections and contribution
levels.
Employees
are eligible to participate in the Plan on the first day of employment. After
one year and 1,000 hours of service worked, we are required under the 401(k)
component of the Plan to match dollar for dollar participant contributions up to
4% of compensation, plus 50 cents per dollar of the next 2% deferrals. We will
also contribute to the Plan an amount designated as a fixed profit sharing
contribution. The amount of fixed profit sharing contribution is equal to two
percent of compensation. Additionally, each year we may, in our sole discretion,
make additional contributions to the 401(k) component of the Plan. As of
December 31, 2008 and 2007, there were 1,191,749 and 1,302,924 shares,
respectively, of 1st Source Corporation common stock held in relation to
employee benefit plans.
Our
contribution is allocated among the participants on the basis of compensation.
Each participant’s account is credited with cash or shares of 1st Source common
stock based on that participant’s compensation earned during the year. After
completing five years of service in which they worked at least 1,000 hours per
year, a participant will be completely vested in their Plan account. Plan
participants are entitled to receive distributions from their Plan accounts only
upon termination of service, which includes retirement or death.
Contribution
expense for the years ended December 31, 2008, 2007, and 2006, amounted to $2.90
million, $2.74 million, and $2.39 million, respectively.
Contributions
to the defined contribution money purchase pension plan are based on 2% of
participants’ eligible compensation. For the years ended December 31, 2008,
2007, and 2006, total pension expense for this plan amounted to $1.37 million,
$1.06 million, and $0.85 million, respectively.
Through
April 30, 2007, Trustcorp contributed to a defined contribution plan for all of
its employees who met the general eligibility requirements of the plan.
Contribution expense for this plan for the years ended December 31, 2007, and
2006, amounted to $0.03 million and $0.09 million, respectively. Effective May
1, 2007, this plan was merged into the 1st Source Corporation
Employee Stock Ownership and Profit Sharing Plan.
First
National contributed to a defined contribution plan for all of its employees who
met general eligibility requirements of the plan. Contribution expense for this
plan for the year ended December 31, 2007 was $0.09 million. Effective January
2, 2008, this plan was merged into the 1st Source Corporation Employee Stock
Ownership and Profit Sharing Plan.
In
addition to the 1st Source Corporation Employee Stock Ownership and Profit
Sharing Plan, we provide certain health care and life insurance benefits for
substantially all of our retired employees. All of our full-time employees
become eligible for these retiree benefits upon reaching age 55 with 20 years of
credited service. 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 for life insurance is $3,000.
Our net
periodic postretirement benefit cost recognized in the consolidated financial
statements for the years ended December 31, 2008, 2007, and 2006 amounted to
$0.13 million, $(0.01) million, and $0.12 million, respectively. Our accrued
postretirement benefit cost was not material at December 31, 2008, 2007, and
2006.
Note
O — Income Taxes
Income
tax expense was comprised of the following:
|
Year
Ended December 31 (Dollars in
thousands)
|
2008
|
2007
|
2006
|
|||||||||
|
Current:
|
||||||||||||
|
Federal
|
$ | 21,112 | $ | 14,630 | $ | 22,350 | ||||||
|
State
|
2,682 | 1,072 | 1,781 | |||||||||
|
Total
current
|
23,794 | 15,702 | 24,131 | |||||||||
|
Deferred:
|
||||||||||||
|
Federal
|
(9,446 | ) | (4,191 | ) | (3,434 | ) | ||||||
|
State
|
(1,333 | ) | (367 | ) | (451 | ) | ||||||
|
Total
deferred
|
(10,779 | ) | (4,558 | ) | (3,885 | ) | ||||||
|
Total
provision
|
$ | 13,015 | $ | 11,144 | $ | 20,246 | ||||||
The
reasons for the difference between income tax expense and the amount computed by
applying the statutory federal income tax rate (35%) to income before income
taxes are as follows:
|
2008
|
2007
|
2006
|
|||||||
|
Percent
of
|
Percent
of
|
Percent
of
|
|||||||
|
Pretax
|
Pretax
|
Pretax
|
|||||||
|
Year
Ended December 31 (Dollars in
thousands)
|
Amount
|
Income
|
Amount
|
Income
|
Amount
|
Income
|
|||
|
Statutory
federal income tax
|
$ 16,240
|
35.0
|
%
|
$ 14,589
|
35.0
|
%
|
$ 20,840
|
35.0
|
%
|
|
(Decrease)
increase in income taxes resulting from:
|
|||||||||
|
Tax-exempt
interest income
|
(2,412)
|
(5.2)
|
(2,380)
|
(5.7)
|
(1,669)
|
(2.8)
|
|||
|
State
taxes, net of federal income tax benefit
|
877
|
1.9
|
458
|
1.1
|
865
|
1.5
|
|||
|
Dividends
received deduction
|
(171)
|
(0.4)
|
(343)
|
(0.8)
|
(270)
|
(0.5)
|
|||
|
Other
|
(1,519)
|
(3.2)
|
(1,180)
|
(2.9)
|
480
|
0.8
|
|||
|
Total
|
$ 13,015
|
28.1
|
%
|
$ 11,144
|
26.7
|
%
|
$ 20,246
|
34.0
|
%
|
|
The
tax (benefit) expense applicable to securities gains for the years 2008,
2007, and 2006 was $(3,786,000) , $(1,185,000), and $758,000,
respectively.
|
|||||||||
|
Deferred
tax assets and liabilities as of December 31, 2008 and 2007 consisted of
the following:
|
|
(Dollars
in thousands)
|
2008
|
2007
|
|
Deferred
tax assets:
|
||
|
Reserve
for loan and lease losses
|
$ 30,583
|
$ 25,649
|
|
Securities
valuation reserve
|
5,935
|
2,762
|
|
Accruals
for employee benefits
|
3,323
|
3,693
|
|
Other
|
521
|
586
|
|
Total
deferred tax assets
|
40,362
|
32,690
|
|
Deferred
tax liabilities:
|
||
|
Differing
depreciable bases in premises and leased equipment
|
29,782
|
30,558
|
|
Net
unrealized gains on securities available-for-sale
|
3,550
|
1,537
|
|
Differing
bases in assets related to acquisitions
|
2,168
|
2,095
|
|
Capitalized
loan costs
|
1,879
|
2,833
|
|
Mortgage
servicing
|
1,206
|
2,174
|
|
Other
|
1,192
|
1,674
|
|
Total
deferred tax liabilities
|
39,777
|
40,871
|
|
Net
deferred tax asset/(liability)
|
$ 585
|
$ (8,181)
|
No
valuation allowance for deferred tax assets was recorded at December 31, 2008
and 2007 as we believe it is more likely than not that all of the deferred tax
assets will be realized.
-44-
A
reconciliation of the beginning and ending amount of unrecognized tax benefits
is as follows:
|
(Dollars
in thousands)
|
2008
|
2007
|
|
Balance,
beginning of year
|
$ 7,063
|
$ 5,795
|
|
Additions
based on tax positions related to the current year
|
1,271
|
1,268
|
|
Additions
for tax positions of prior years
|
693
|
-
|
|
Reductions
for tax positions of prior years
|
(136)
|
-
|
|
Reductions
due to lapse in statute of limitations
|
(1,290)
|
-
|
|
Settlements
|
-
|
-
|
|
Balance,
end of year
|
$ 7,601
|
$ 7,063
|
The total
amount of unrecognized tax benefits that would affect the effective tax rate if
recognized was $4.19 million at December 31, 2008 and $4.25 million at December
31, 2007. Interest and penalties are recognized through the income tax
provision. For the years 2008 and 2007, we recognized approximately $0.14
million and $0.26 million in interest, net of tax effect, and penalties,
respectively. Interest and penalties of approximately $1.27 million and $1.13
million were accrued at December 31, 2008 and 2007, respectively.
Tax years
that remain open and subject to audit include the federal 2005–2008 years and
the Indiana 2002–2008 years. Additionally, we have an open tax examination with
the Indiana Department of Revenue for the tax years 2002-2004. As a
result of the expiration of the statute of limitations in both federal and state
tax jurisdictions as well as the closing of tax audits, it is reasonably
possible that within the next 12 months there will be a reduction of
unrecognized tax benefits that will affect the effective tax rate and increase
earnings in an amount ranging from $0 to $3.20 million.
Note
P — Contingent Liabilities, Commitments, and Financial Instruments with
Off-Balance-Sheet Risk
Contingent Liabilities —1st
Source and our subsidiaries are defendants in various legal proceedings arising
in the normal course of business. In the opinion of management, based upon
present information including the advice of legal counsel, the ultimate
resolution of these proceedings will not have a material effect on our
consolidated financial position or results of operations.
Commitments — 1st Source and
our subsidiaries are obligated under operating leases for certain office
premises and equipment. In 1982, we sold the headquarters building and entered
into a leaseback agreement with the purchaser. At December 31, 2008, the
remaining term of the lease was four years with options to renew for up to 15
additional years. Approximately 35% of the facility is subleased to other
tenants.
Future
minimum rental commitments for all noncancellable operating leases total
approximately, $2.63 million in 2009, $2.23 million in 2010, $1.92 million in
2011, $0.89 million in 2012, $0.38 million in 2013, and $0.73 million,
thereafter. As of December 31, 2008, future minimum rentals to be received under
noncancellable subleases totaled $3.45 million.
Rental
expense of office premises and equipment and related sublease income were as
follows:
|
Year Ended December
31 (Dollars in
thousands)
|
2008
|
2007
|
2006
|
|||||||||
|
Gross
rental expense
|
$ | 3,116 | $ | 3,255 | $ | 3,250 | ||||||
|
Sublease
rental income
|
(1,523 | ) | (1,640 | ) | (1,626 | ) | ||||||
|
Net
rental expense
|
$ | 1,593 | $ | 1,615 | $ | 1,624 | ||||||
Financial Instruments with
Off-Balance-Sheet Risk —To meet the financing needs of our clients, 1st
Source and our 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,
and standby letters of credit. 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.
Our
exposure to credit loss in the event of nonperformance by the other party to the
financial instruments for loan commitments and standby letters of credit is
represented by the dollar amount of those instruments. We use the same credit
policies and collateral requirements in making commitments and conditional
obligations as we do for on-balance-sheet instruments.
Loan
commitments 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.
The Bank
grants mortgage loan commitments to borrowers, subject to normal loan
underwriting standards. The interest rate risk associated with these loan
commitments is managed by entering into contracts for future deliveries of
loans.
Letters
of credit are conditional commitments issued to guarantee the performance of a
client to a third party. The credit risk involved in and collateral obtained
when issuing letters of credit are essentially the same as those involved in
extending loan commitments to clients.
As of
December 31, 2008 and 2007, 1st Source had commitments outstanding to originate
and purchase mortgage loans aggregating $93.32 million and $31.70 million,
respectively. Outstanding commitments to sell loans aggregated $97.56 million at
December 31, 2008, and $45.53 million at December 31, 2007. Standby letters of
credit totaled $82.18 million and $61.79 million at December 31, 2008 and 2007,
respectively. Standby letters of credit generally have terms ranging from six
months to one year.
Note
Q — Derivative Financial Instruments
We have
certain interest rate derivative positions that are not designated as hedging
instruments. These derivative positions relate to transactions in which we enter
into an interest rate swap with a client while at the same time entering into an
offsetting interest rate swap with another financial institution. In connection
with each transaction, we agree to pay interest to the client on a notional
amount at a variable interest rate and receive interest from the client on the
same notional amount at a fixed interest rate. At the same time, we agree to pay
another financial institution the same fixed interest rate on the same notional
amount and receive the same variable interest rate on the same notional amount.
The transaction allows our client to effectively convert a variable rate loan to
a fixed rate. Because the terms of the swaps with our customers and the
other financial institution offset each other, with the only difference
being counterparty credit risk, changes in the fair value of the underlying
derivative contracts are not materially different and do not
significantly impact our results of operations. At December 31, 2008 and
2007, the notional amount of non-hedging interest rate swaps was $421.28 million
and $196.52 million, respectively.
Note
R — Regulatory Matters
We are
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 our financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, we must meet specific capital guidelines that involve
quantitative measures of our assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. Our 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 us to
maintain minimum amounts and ratios of total capital and Tier I capital to
risk-weighted assets and of Tier I capital to average assets. We believe that we
meet all capital adequacy requirements to which we are subject.
The most
recent notification from the Federal bank regulators categorized 1st Source
Bank, the largest of our subsidiaries, as "well capitalized" under the
regulatory framework for prompt corrective action. To be categorized as "well
capitalized" we must maintain minimum total risk-based, Tier I risk-based, and
Tier I leverage ratios as set forth in the table below. There are no conditions
or events since that notification that we believe will have changed the
institution’s category.
As
discussed in Note M, the capital securities held by the Capital Trusts qualify
as Tier 1 capital under Federal Reserve Board guidelines.
The
actual and required capital amounts and ratios for 1st Source Corporation and
1st Source Bank as of December 31, 2008, are presented in the table
below:
|
To
Be Well
|
|||||||||
|
Capitalized
Under
|
|||||||||
|
Minimum
Capital
|
Prompt
Corrective
|
||||||||
|
Actual
|
Adequacy
|
Action
Provisions
|
|||||||
|
(Dollars
in thousands)
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|||
|
Total
Capital (to Risk-Weighted Assets):
|
|||||||||
|
1st
Source Corporation
|
$ 490,612
|
13.26
|
%
|
$ 296,077
|
8.00
|
%
|
$ 370,096
|
10.00
|
%
|
|
1st
Source Bank
|
486,335
|
13.19
|
%
|
294,906
|
8.00
|
%
|
368,633
|
10.00
|
%
|
|
Tier
I Capital (to Risk-Weighted Assets):
|
|||||||||
|
1st
Source Corporation
|
443,000
|
11.97
|
%
|
148,038
|
4.00
|
%
|
222,058
|
6.00
|
%
|
|
1st
Source Bank
|
439,835
|
11.93
|
%
|
147,453
|
4.00
|
%
|
221,180
|
6.00
|
%
|
|
Tier
I Capital (to Average Assets):
|
|||||||||
|
1st
Source Corporation
|
443,000
|
10.16
|
%
|
174,328
|
4.00
|
%
|
217,910
|
5.00
|
%
|
|
1st
Source Bank
|
439,835
|
10.13
|
%
|
173,592
|
4.00
|
%
|
216,990
|
5.00
|
%
|
The Bank
is required to maintain noninterest bearing cash balances with the Federal
Reserve Bank. The average balance of these deposits for the years ended December
31, 2008 and 2007, was approximately $3.33 million and $4.21 million,
respectively.
Dividends
that may be paid by a subsidiary bank to the parent company are subject to
certain legal and regulatory limitations and also may be affected by capital
needs, as well as other factors. Without regulatory approval, the Bank can pay
dividends in 2009 of up to $21.36 million, plus an additional amount equal to
its net profits for 2009, as defined by statute, up to the date of any such
dividend declaration.
Due to
our mortgage activities, 1st Source Bank is required to maintain minimum net
worth capital requirements established by various governmental agencies. 1st
Source Bank's net worth requirements are governed by the Department of Housing
and Urban Development and GNMA. As of December 31, 2008, 1st Source Bank met its
minimum net worth capital requirements.
Note
S — Fair Values of Financial Instruments
Effective
January 1, 2008, we adopted SFAS No. 159, which allows an entity the option to
irrevocably elect fair value accounting for certain financial assets and
liabilities, as well as other commitments and obligations, on an
instrument-by-instrument basis.
We
elected fair value accounting for new mortgages held for sale originations
starting on January 1, 2008. We believe the election for mortgages held for sale
(which are hedged with free-standing derivatives (economic hedges) will reduce
certain timing differences and better match changes in the value of these assets
with changes in the value of derivatives used as economic hedges for these
assets. There was no transition adjustment required upon adoption of SFAS No.
159 for mortgages held for sale because we continued to account for mortgages
held for sale originated prior to January 1, 2008 at the lower of cost or fair
value. At December 31, 2008, mortgages held for sale carried at fair value
totaled $46.69 million. At December 31, 2008, there were no mortgages held for
sale that were originated prior to January 1, 2008.
The
following table reflects the differences between fair value carrying amount of
mortgages held for sale measured at fair value and the aggregate unpaid
principal amount we are contractually entitled to receive at maturity on
December 31, 2008:
|
(Dollars
in thousands)
|
Fair
value carrying amount
|
Aggregate
unpaid principal
|
Excess
of fair value carrying amount over (under) unpaid
principal
|
|||||||||
|
Mortgages
held for sale reported at fair value:
|
||||||||||||
|
Total
Loans
|
$ | 46,686 | $ | 45,141 | $ | 1545 | (1) | |||||
|
Nonaccrual
Loans
|
- | - | - | |||||||||
|
Loans
90 days or more past due and still accruing
|
- | - | - | |||||||||
|
(1)
The excess of fair value carrying amount over unpaid principal includes
changes in fair value at and subsequent to funding, gains and losses on
the related loan commitment prior to
|
||||
|
funding,
and premiums on acquired loans.
|
||||
Effective
with the adoption of SFAS 157, we determine the fair values of our financial
instruments based on the fair value hierarchy established in that standard,
which requires an entity to maximize the use of quoted price and observable
inputs and to minimize the use of unobservable inputs when measuring fair value.
The following is a description of the valuation methodologies used for financial
instruments measured at fair value on a recurring basis:
Investment
securities available for sale are valued primarily by a third party pricing
agent and both the market and income valuation approaches are implemented using
the following types of inputs:
|
·
|
U.S.
treasuries are priced using the market approach and utilizing live data
feeds from active market exchanges for identical
securities.
|
|
·
|
Government-sponsored
agency debt securities and corporate bonds are primarily priced using
available market information through processes such as benchmark curves,
market valuations of like securities, sector groupings and matrix
pricing.
|
|
·
|
Other
government-sponsored agency securities, mortgage-backed securities and
some of the actively traded REMICs and CMOs, are primarily priced using
available market information including benchmark yields, prepayment
speeds, spreads and volatility of similar
securities.
|
|
·
|
Other
inactive government-sponsored agency securities are primarily priced using
consensus pricing and dealer
quotes.
|
|
·
|
State
and political subdivisions are largely grouped by characteristics, i.e.,
geographical data and source of revenue in trade dissemination systems.
Since some securities are not traded daily and due to other grouping
limitations, active market quotes are often obtained using benchmarking
for like securities. Local tax anticipation warrants, with very little
market activity, are priced using an appropriate market yield
curve.
|
|
·
|
Marketable
equity (common) securities are primarily priced using the market approach
and utilizing live data feeds from active market exchanges for identical
securities.
|
|
·
|
Marketable
equity (preferred) securities are primarily priced using available market
information through processes such as benchmark curves, benchmarking of
like securities, sector groupings and matrix
pricing.
|
Trading
account securities are priced using the market approach and utilizing live data
feeds from active market exchanges for identical securities.
Mortgages
held for sale and the related loan commitments and forward contracts (hedges)
are valued using an income approach and utilizing an appropriate current market
yield and a loan commitment closing rate based on historical
analysis.
Interest
rate swap positions, both assets and liabilities, are valued by a third-party
pricing agent using an income approach and utilizing models that use as their
basis readily observable market parameters. This valuation process considers
various factors including interest rate yield curves, time value and volatility
factors.
The table
below presents the balance of assets and liabilities at December 31, 2008
measured at fair value on a recurring basis.
|
(Dollars
in thousands)
|
Level
1
|
Level
2
|
Level
3
|
Total
|
||||||||||||
|
Assets:
|
||||||||||||||||
|
Investment
securities available for sale
|
$ | 84,870 | $ | 620,468 | $ | 19,416 | $ | 724,754 | ||||||||
|
Trading
account securities
|
100 | - | - | 100 | ||||||||||||
|
Mortgages
held for sale
|
- | 46,686 | - | 46,686 | ||||||||||||
|
Accrued
income and other assets (interest rate swap agreements)
|
- | 22,663 | - | 22,663 | ||||||||||||
|
Total
|
$ | 84,970 | $ | 689,817 | $ | 19,416 | $ | 794,203 | ||||||||
|
Liabilities:
|
||||||||||||||||
|
Accrued
expenses and other liabilities (interest rate swap
agreements)
|
$ | - | $ | 23,003 | $ | - | $ | 23,003 | ||||||||
|
Total
|
$ | - | $ | 23,003 | $ | - | $ | 23,003 | ||||||||
The
changes in Level 3 assets and liabilities measured at fair value on a recurring
basis are summarized as follows:
|
Investment
securities
|
||||
|
(Dollars
in thousands)
|
available
for sale
|
|||
|
Beginning
balance January 1, 2008
|
$ | 42,212 | ||
|
Total
gains or losses (realized/unrealized)
|
||||
|
Included
in earnings
|
747 | |||
|
Included
in other comprehensive income
|
(1,362 | ) | ||
|
Purchases
and issuances
|
24,714 | |||
|
Settlements
|
- | |||
|
Maturities
|
(49,998 | ) | ||
|
Transfers
in and/or out of Level 3
|
3,103 | |||
|
Ending
balance December 31, 2008
|
$ | 19,416 | ||
There
were no gains or losses for the period included in earnings attributable to the
change in unrealized gains or losses relating to assets and liabilities still
held at December 31, 2008.
We may be
required, from time to time, to measure certain other financial assets at fair
value on a nonrecurring basis. These other financial assets include loans
measured for impairment under SFAS 114, venture capital partnership investments
and mortgage servicing rights. For assets measured at fair value on a
nonrecurring basis the following represents impairment charges recognized on
these assets during the year ended December 31, 2008: impaired loans $2.54
million; venture capital partnership investments $0.13 million; mortgage
servicing rights $1.91 million.
For
assets measured at fair value on a nonrecurring basis on hand at December 31,
2008, the following table provides the level of valuation assumptions used to
determine each valuation and the fair value measurement of the related
assets.
|
(Dollars
in thousands)
|
Level
1
|
Level
2
|
Level
3
|
Total
|
|
Loans
|
$ -
|
$ -
|
$ 6,191
|
$ 6,191
|
|
Accrued
income and other assets (venture capital partnership
investments)
|
-
|
-
|
2,253
|
2,253
|
|
Accrued
income and other assets (mortgage servicing rights)
|
-
|
-
|
4,715
|
4,715
|
|
Total
|
$ -
|
$ -
|
$ 13,159
|
$ 13,159
|
The fair
values of our financial instruments as of December 31, 2008 and 2007 are
summarized in the table below.
|
2008
|
2007
|
|||
|
Carrying
or
|
Carrying
or
|
|||
|
(Dollars
in thousands)
|
Contract
Value
|
Fair
Value
|
Contract
Value
|
Fair
Value
|
|
Assets:
|
||||
|
Cash
and due from banks
|
$ 119,771
|
$ 119,771
|
$ 153,137
|
$ 153,137
|
|
Federal
funds sold and interest bearing deposits with other banks
|
6,951
|
6,951
|
25,817
|
25,817
|
|
Investment
securities, available-for-sale
|
724,754
|
724,754
|
779,981
|
779,981
|
|
Other
investments and trading account securities
|
18,712
|
18,712
|
14,937
|
14,937
|
|
Mortgages
held for sale
|
46,686
|
46,686
|
25,921
|
25,921
|
|
Loans
and leases, net of reserve for loan and lease losses
|
3,218,436
|
3,239,567
|
3,124,839
|
3,144,394
|
|
Interest
rate swaps
|
22,663
|
22,663
|
4,573
|
4,573
|
|
Liabilities:
|
||||
|
Deposits
|
$ 3,514,542
|
$ 3,486,609
|
$ 3,469,663
|
$
3,468,360
|
|
Short-term
borrowings
|
296,175
|
296,175
|
337,832
|
337,832
|
|
Long-term
debt and mandatorily redeemable securities
|
29,832
|
29,674
|
34,702
|
34,900
|
|
Subordinated
notes
|
89,692
|
73,972
|
100,002
|
89,959
|
|
Interest
rate swaps
|
23,003
|
23,003
|
4,573
|
4,573
|
|
Off-balance-sheet
instruments *
|
-
|
297
|
-
|
406
|
|
*
Represents estimated cash outflows required to currently settle the
obligations at current market rates.
|
||||
SFAS 107,
"Disclosures about Fair Value of Financial Instruments," requires disclosure of
the fair value of financial assets and financial liabilities, including those
financial assets and financial liabilities that are not measured and reported at
fair value on a recurring basis or non-recurring basis. The methodologies for
estimating the fair value of financial asset and financial liabilities that are
measured at fair value on a recurring or non-recurring basis are discussed
above. The estimated fair value approximates carrying value for cash and cash
equivalents. The methodologies for other financial assets and financial
liabilities are discussed below:
Loans and Leases — For variable rate loans and
leases 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 and leases are estimated using discounted
cash flow analyses which use interest rates currently being offered for loans
and leases 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, including our liability related to mortgage loans
available for repurchase under GNMA optional repurchase programs, approximate
their fair values.
Long-Term Debt and Mandatorily Redeemable
Securities — The fair values of long-term debt are estimated using
discounted cash flow analyses, based on our current estimated incremental
borrowing rates for similar types of borrowing arrangements. The carrying values
of mandatorily redeemable securities are based on approximate fair
values.
Subordinated Notes — Fair values are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are estimated based on calculated market prices of
comparable securities.
Off-Balance-Sheet Instruments — Contract and
fair values for certain of our off-balance-sheet financial instruments
(guarantees and loan commitments) are estimated based on fees currently charged
to enter into similar agreements, taking into account the remaining terms of the
agreements and the counterparties’ credit standing.
Limitations — Fair value estimates are made at
a specific point in time based on relevant market information and information
about the financial instruments. Because no market exists for a significant
portion of our 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 do not reflect any premium or discount that could result from offering
for sale at one time our entire holdings of a particular financial
instrument. These estimates are subjective in nature and require
considerable judgment to interpret market data. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts we
could realize in a current market exchange, nor are they intended to represent
the fair value of 1st Source as a whole. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts. The fair value estimates presented
herein are based on pertinent information available to management as of the
respective balance sheet date. Although management is not aware of
any factors that would significantly affect the estimated fair value amounts,
such amounts have not been comprehensively revalued since the presentation
dates, and therefore, estimates of fair value after the balance sheet date may
differ significantly from the amounts presented herein.
Other
significant assets, such as premises and equipment, other assets, and
liabilities not defined as financial instruments, are not included in the above
disclosures. 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
T — 1st Source Corporation (Parent Company Only) Financial
Information
|
STATEMENTS
OF FINANCIAL CONDITION
|
||||||||
|
December
31 (Dollars in
thousands)
|
2008
|
2007
|
||||||
|
ASSETS
|
||||||||
|
Cash
|
$ | 2 | $ | 32 | ||||
|
Short-term
investments with bank subsidiary
|
15,368 | 11,220 | ||||||
|
Investment
securities, available-for-sale
|
||||||||
|
(amortized
cost of $4,742 and $8,907 at December 31, 2008 and 2007,
respectively)
|
6,811 | 11,075 | ||||||
|
Trading
account securities
|
100 | - | ||||||
|
Investments
in:
|
||||||||
|
Bank
subsidiaries
|
534,586 | 514,988 | ||||||
|
Non-bank
subsidiaries
|
3,091 | 4,127 | ||||||
|
Premises
and equipment, net
|
2,264 | 2,237 | ||||||
|
Other
assets
|
6,803 | 9,509 | ||||||
|
Total
assets
|
$ | 569,025 | $ | 553,188 | ||||
|
LIABILITIES AND SHAREHOLDERS’
EQUITY
|
||||||||
|
Commercial
paper borrowings
|
$ | 5,344 | $ | 11,475 | ||||
|
Other
liabilities
|
1,739 | 3,086 | ||||||
|
Long-term
debt and mandatorily redeemable securities
|
108,278 | 108,123 | ||||||
|
Total
liabilities
|
115,361 | 122,684 | ||||||
|
Shareholders’
equity
|
453,664 | 430,504 | ||||||
|
Total
liabilities and shareholders’ equity
|
$ | 569,025 | $ | 553,188 | ||||
|
STATEMENTS
OF INCOME
|
|||||
|
Year
Ended December 31 (Dollars in
thousands)
|
2008
|
2007
|
2006
|
||
|
Income:
|
|||||
|
Dividends
from bank and non-bank subsidiaries
|
$ 17,468
|
$ 58,051
|
$ 15,045
|
||
|
Rental
income from subsidiaries
|
2,412
|
2,442
|
2,542
|
||
|
Other
|
994
|
2,077
|
1,788
|
||
|
Investment
securities and other investment (losses) gains
|
(1,053)
|
3
|
2,346
|
||
|
Total
income
|
19,821
|
62,573
|
21,721
|
||
|
Expenses:
|
|||||
|
Interest
on long-term debt and mandatorily redeemable securities
|
7,773
|
7,294
|
5,495
|
||
|
Interest
on commercial paper and other short-term borrowings
|
209
|
639
|
418
|
||
|
Rent
expense
|
1,060
|
1,057
|
1,059
|
||
|
Other
|
1,850
|
1,572
|
1,148
|
||
|
Total
expenses
|
10,892
|
10,562
|
8,120
|
||
|
Income
before income tax benefit and equity in undistributed (distributed in
excess of) income of subsidiaries
|
8,929
|
52,011
|
13,601
|
||
|
Income
tax benefit
|
3,308
|
2,380
|
220
|
||
|
Income
before equity in undistributed (distributed in excess of) income of
subsidiaries
|
12,237
|
54,391
|
13,821
|
||
|
Equity
in undistributed (distributed in excess of) income of
subsidiaries:
|
|||||
|
Bank
subsidiaries
|
21,235
|
(23,028)
|
23,448
|
||
|
Non-bank
subsidiaries
|
(86)
|
(824)
|
2,028
|
||
|
Net
income
|
$ 33,386
|
$ 30,539
|
$ 39,297
|
||
|
STATEMENTS
OF CASH FLOW
|
|||
|
Year
Ended December 31 (Dollars in
thousands)
|
2008
|
2007
|
2006
|
|
Operating
activities:
|
|||
|
Net
income
|
$ 33,386
|
$ 30,539
|
$ 39,297
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|||
|
Equity
(undistributed) distributed in excess of income of
subsidiaries
|
(21,149)
|
23,852
|
(25,476)
|
|
Depreciation
of premises and equipment
|
377
|
316
|
289
|
|
Realized
and unrealized investment securities losses (gains)
|
1,053
|
(3)
|
(2,346)
|
|
Change
in trading account securities
|
(100)
|
-
|
-
|
|
Other
|
2,732
|
(629)
|
705
|
|
Net
change in operating activities
|
16,299
|
54,075
|
12,469
|
|
Investing
activities:
|
|||
|
Proceeds
from sales and maturities of investment securities
|
2,879
|
18,752
|
1,817
|
|
Purchases
of investment securities
|
-
|
(10,499)
|
(3,754)
|
|
Net
change in premises and equipment
|
(405)
|
(410)
|
(288)
|
|
Change
in short-term investments with bank subsidiary
|
(4,148)
|
3,222
|
(2,880)
|
|
Change
in loans made to subsidiaries, net
|
-
|
3,030
|
2,970
|
|
Capital
contributions to subsidiaries
|
-
|
-
|
1,400
|
|
Return
of capital from subsidiaries
|
5,950
|
5,106
|
-
|
|
Cash
paid for acquisition, net
|
-
|
(78,348)
|
-
|
|
Net
change in investing activities
|
4,276
|
(59,147)
|
(735)
|
|
Financing
activities:
|
|||
|
Net
change in commercial paper and other short-term borrowings
|
(6,131)
|
3
|
6,673
|
|
Proceeds
from issuance of subordinated notes
|
-
|
58,764
|
-
|
|
Payments
on subordinated notes
|
(10,310)
|
(17,784)
|
-
|
|
Proceeds
from issuance of long-term debt
|
10,000
|
-
|
874
|
|
Payments
on long-term debt
|
(252)
|
(10,259)
|
(123)
|
|
Net
proceeds from issuance of treasury stock
|
341
|
545
|
814
|
|
Acquisition
of treasury stock
|
-
|
(12,821)
|
(7,657)
|
|
Cash
dividends
|
(14,253)
|
(13,345)
|
(12,315)
|
|
Net
change in financing activities
|
(20,605)
|
5,103
|
(11,734)
|
|
Net
change in cash and cash equivalents
|
(30)
|
31
|
-
|
|
Cash
and cash equivalents, beginning of year
|
32
|
1
|
1
|
|
Cash
and cash equivalents, end of year
|
$ 2
|
$ 32
|
$ 1
|
Note
U — Subsequent Event
On
January 23, 2009, we entered into a Letter Agreement with the United States
Department of the Treasury ("Treasury"), pursuant to which we issued (i) 111,000
shares of the Registrant’s Fixed Rate Cumulative Perpetual Preferred Stock,
Series A (the "Series A Preferred Stock") and (ii) a warrant (the "Warrant") to
purchase 837,947 shares of the our common stock, without par value (the "Common
Stock"), for an aggregate purchase price of $111,000,000 in cash.
The
Series A Preferred Stock will qualify as Tier 1 capital and will pay cumulative
dividends at a rate of 5% per annum for the first five years, and 9% per annum
thereafter. The Series A Preferred Stock is non-voting except with respect to
certain matters affecting the rights of the holders thereof, and may be redeemed
by us after three years. Prior to the end of three years, the Series A Preferred
Stock may be redeemed by us only with proceeds from the sale of qualifying
equity securities of 1st Source Corporation.
The
Warrant has a 10-year term and is immediately exercisable upon its issuance,
with an exercise price, subject to anti-dilution adjustments, equal to $19.87
per share of the Common Stock.
In
addition, we may not increase the quarterly dividends we pay on our common stock
above $0.16 per share during the three-year period ending January 23, 2012,
without the consent of the U.S. Treasury Department, unless the Treasury
Department no longer holds shares of the Series A Preferred Stock.
Notwithstanding
the foregoing, The American Recovery and Reinvestment Act of 2009 (“ARRA”),
which was signed into law by President Obama on February 17, 2009, provides that
the Secretary of the Treasury shall permit a recipient of funds under the
Troubled Assets Relief Program, subject to consultation with the recipient’s
appropriate Federal banking agency, to repay such assistance without regard to
whether the recipient has replaced such funds from any other source or to any
waiting period. ARRA further provides that when the recipient repays such
assistance, the Secretary of the Treasury shall liquidate the warrants
associated with the assistance at the current market price. While Treasury has
not yet issued implementing regulations, it appears that ARRA will permit 1st
Source, if it so elects and following consultation with the FRB, to redeem the
Series A Preferred Stock at any time without
restriction.
None
1st
Source carried out an evaluation, under the supervision and with the
participation of our management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934) pursuant to Exchange Act Rule 13a-14. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that, at December 31, 2008, our disclosure controls and procedures
were effective in ensuring that information required to be disclosed by 1st
Source in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission’s rules and forms and are designed to ensure
that information required to be disclosed in those reports is accumulated and
communicated to management as appropriate to allow timely decisions regarding
required disclosure.
In
addition, there were no changes in our internal control over financial reporting
(as defined in Exchange Act Rule 13a-15(f)) during the fourth fiscal quarter of
2008 that have materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting.
MANAGEMENT
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management
of 1st Source Corporation ("1st Source") is responsible for establishing and
maintaining adequate internal control over financial reporting. 1st Source’s
internal control over financial reporting includes policies and procedures
pertaining to 1st Source’s ability to record, process, and report reliable
information. Actions are taken to correct any deficiencies as they are
identified through internal and external audits, regular examinations by bank
regulatory agencies, 1st Source’s formal risk management process, and other
means. 1st Source’s internal control system is designed to provide reasonable
assurance to 1st Source’s management and Board of Directors regarding the
preparation and fair presentation of 1st Source’s published financial
statements.
All
internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation. Further, because of changes in conditions, the
effectiveness of internal control may vary over time.
1st
Source’s management assessed the effectiveness of internal control over
financial reporting as of December 31, 2008. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control – Integrated
Framework. Based on management’s assessment, we believe that, as of
December 31, 2008, 1st Source’s internal control over financial reporting is
effective based on those criteria.
Ernst
& Young LLP, independent registered public accounting firm, has issued an
attestation report on management’s assessment of 1st Source’s internal control
over financial reporting. This report appears on page
26.
By /s/ CHRISTOPHER J. MURPHY
III
Christopher J. Murphy III, Chairman,
President and Chief Executive Officer
By /s/ LARRY E.
LENTYCH
Larry E. Lentych, Treasurer and Chief
Financial Officer
South
Bend, Indiana
None
Part
III
The
information under the caption "Proposal Number 1: Election of Directors," "Board
Committees and Other Corporate Governance Matters," and "Section 16(a)
Beneficial Ownership Reporting Compliance" of the 2009 Proxy Statement is
incorporated herein by reference.
The
information under the caption "Compensation Discussion and Analysis" of the 2009
Proxy Statement is incorporated herein by reference.
The
information under the caption "Voting Securities and Principal Holders Thereof"
and "Proposal Number 1: Election of Directors" of the 2009 Proxy Statement is
incorporated herein by reference.
EQUITY
COMPENSATION INFORMATION:
|
Number
of Securities
|
||||
|
Remaining
Available
|
||||
|
for
Future Issuance
|
||||
|
Number
of Securities to be
|
Weighted-average
|
Under
Equity
|
||
|
Issued
upon Exercise of
|
Exercise
Price of
|
Compensation
Plans
|
||
|
Outstanding
Options,
|
Outstanding
Options,
|
[excluding
securities
|
||
|
Warrants
and Rights
|
Warrants
and Rights
|
reflected
in column (a)]
|
||
|
Equity
compensation plans
|
||||
|
approved
by shareholders
|
||||
|
1992
stock option plan
|
16,693
|
$19.36
|
-
|
|
|
2001
stock option plan
|
64,255
|
18.29
|
2,119,922
|
|
|
1997
employee stock purchase plan
|
23,121
|
22.34
|
159,034
|
|
|
1982
executive incentive plan
|
-
|
-
|
95,824
|
(1)(2)
|
|
1982
restricted stock award plan
|
-
|
-
|
171,824
|
(1)
|
|
Total
plans approved by shareholders
|
104,069
|
$19.36
|
2,546,604
|
|
|
Equity
compensation plans
|
||||
|
not
approved by shareholders
|
-
|
-
|
-
|
|
|
Total
equity compensation plans
|
104,069
|
$19.36
|
2,546,604
|
|
|
(1)Amount is to be awarded by grants
administered by the Executive Compensation Committee of the 1st Source
Board of Directors.
|
||||
|
(2)Amount includes market value
stock only. Book value shares used for annual awards may only be sold to
1st Source
|
||||
The
information under the caption "Proposal Number 1: Election of Directors" of the
2009 Proxy Statement is incorporated herein by reference.
The
information under the caption "Relationship with Independent Registered Public
Accounting Firm" of the 2009 Proxy Statement is incorporated herein by
reference.
PART
IV
Item
15. Exhibits, Financial Statement
Schedules.
(a)
Financial Statements and Schedules:
The
following Financial Statements and Supplementary Data are filed as part of this
annual report:
Reports
of Independent Registered Public Accounting Firm
Consolidated
statements of financial condition — December 31, 2008 and 2007
Consolidated
statements of income — Years ended December 31, 2008, 2007, and
2006
Consolidated
statements of shareholders’ equity — Years ended December 31, 2008, 2007, and
2006
Consolidated
statements of cash flows — Years ended December 31, 2008, 2007, and
2006
Notes to
consolidated financial statements — December 31, 2008, 2007, and
2006
Financial
statement schedules required by Article 9 of Regulation S-X are not required
under the related instructions, or are inapplicable and, therefore, have been
omitted.
(b)
Exhibits (numbered in accordance with Item 601 of Regulation S-K):
|
3(a)
|
Articles
of Incorporation of Registrant, as amended April 30, 1996, and filed as
exhibit to Form 10-K, dated December 31, 1996, and incorporated herein by
reference.
|
|
3(b)
|
By-Laws
of Registrant, as amended January 29, 2004, filed as exhibit to Form 10-K,
dated December 31, 2003, and incorporated herein by
reference.
|
|
3(c)
|
Certificate
of Designations for Series A Preferred Stock, dated January 23, 2009,
filed as exhibit to Form 8-K, dated January 23, 2009, and incorporated
herein by reference.
|
|
4(a)
|
Form
of Common Stock Certificates of Registrant filed as exhibit to
Registration Statement 2-40481 and incorporated herein by
reference.
|
|
4(b)
|
1st
Source agrees to furnish to the Commission, upon request, a copy of each
instrument defining the rights of holders of Senior and Subordinated debt
of 1st Source.
|
|
4(c)
|
Form
of Certificate for Series A Preferred Stock, dated January 23, 2009, filed
as exhibit to Form 8-K, dated January 23, 2009, and incorporated herein by
reference.
|
|
4(d)
|
Warrant
for Purchase of Shares of Common Stock, dated January 23, 2009, filed as
exhibit to Form 8-K, dated January 23, 2009, and incorporated herein by
reference.
|
|
10(a)(1)
|
Employment
Agreement of Christopher J. Murphy III, dated January 1, 2008, filed as
exhibit to Form 8-K, dated March 17, 2008, and incorporated herein by
reference.
|
|
|
10(a)(2)
|
Employment
Agreement of Wellington D. Jones III, dated January 1, 2008, filed as
exhibit to Form 8-K, dated March 17, 2008, and incorporated herein by
reference.
|
|
|
10(a)(4)
|
Employment
Agreement of Larry E. Lentych, dated January 1, 2008, filed as exhibit to
Form 8-K, dated March 17, 2008, and incorporated herein by
reference.
|
|
|
10(a)(5)
|
Employment
Agreement of Richard Q. Stifel, dated January 1, 2008, filed as exhibit to
Form 8-K, dated March 17, 2008, and incorporated herein by
reference.
|
|
|
10(a)(6)
|
Employment
Agreement of John B. Griffith, dated January 1, 2008, filed as exhibit to
Form 8-K, dated March 17, 2008, and incorporated herein by
reference.
|
|
|
10(b)
|
1st
Source Corporation Employee Stock Purchase Plan dated April 17, 1997,
filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated
herein by reference.
|
|
|
10(c)
|
1st
Source Corporation 1982 Executive Incentive Plan, amended January 17,
2003, and filed as exhibit to Form 10-K, dated December 31, 2003, and
incorporated herein by reference.
|
|
|
10(d)
|
1st
Source Corporation 1982 Restricted Stock Award Plan, amended January
17, 2003, and filed as exhibit to Form 10-K, dated December 31, 2003, and
incorporated herein by reference.
|
|
|
10(e)
|
1st
Source Corporation 2001 Stock Option Plan, amended July 27, 2006, and
filed as an exhibit to 1st Source Corporation Proxy Statement dated March
7, 2001, and incorporated herein by reference.
|
|
|
10(g)(1)
|
1st
Source Corporation 1992 Stock Option Plan, amended July 27, 2006, and
dated April 23, 1992, as amended December 11, 1997, filed as exhibit to
Form 10-K, dated December 31, 1997, and incorporated herein by
reference.
|
|
|
10(g)(2)
|
An
amendment to 1st Source Corporation 1992 Stock Option Plan, dated July 18,
2000, and filed as exhibit to Form 10-K, dated December 31, 2000, and
incorporated herein by reference.
|
|
|
10(h)
|
1st
Source Corporation 1998 Performance Compensation Plan, dated February 19,
1998, filed as exhibit to Form 10-K, dated December 31, 1998, and
incorporated herein by reference.
|
|
|
10(j)
|
Contract
with Fiserv Solutions, Inc. dated November 23, 2005, filed as exhibit to
Form 10-K, dated, December 31, 2005, and incorporated herein by
reference.
|
|
|
10(k)
|
Letter
Agreement dated January 23, 2009 by and between 1st Source Corporation and
the United States Department of the Treasury, including the
Securites Purchase Agreement – Standard Terms, filed as exhibit to Form
8-K, dated January 23, 2009, and incorporated herein by
reference.
|
|
|
10(l)
|
Form
of CPP Compensation Limitation Agreement, dated January 23, 2009, filed as
exhibit to Form 8-K, dated January 23, 2009, and incorporated herein by
reference.
|
|
|
21
|
Subsidiaries
of Registrant (unless otherwise indicated, each subsidiary does business
under its own name):
|
|
|
Name
|
Jurisdiction
|
|
|
1st
Source Bank
|
Indiana
|
|
|
SFG
Equipment Leasing, Inc. *
|
Indiana
|
|
|
1st
Source Insurance, Inc. *
|
Indiana
|
|
|
1st
Source Specialty Finance, Inc. *
|
Indiana
|
|
|
FBT
Capital Corporation (Inactive)
|
Indiana
|
|
|
1st
Source Leasing, Inc.
|
Indiana
|
|
|
1st
Source Capital Corporation *
|
Indiana
|
|
|
Trustcorp
Mortgage Company
|
Indiana
|
|
|
1st
Source Capital Trust IV
|
Delaware
|
|
|
1st
Source Master Trust
|
Delaware
|
|
|
Michigan
Transportation Finance Corporation *
|
Michigan
|
|
|
1st
Source Intermediate Holding, LLC
|
Delaware
|
|
|
1st
Source Funding, LLC
|
Delaware
|
|
|
1st
Source Corporation Investment Advisors, Inc. *
|
Indiana
|
|
|
SFG
Commercial Aircraft Leasing, Inc. *
|
Indiana
|
|
|
SFG
Equipment Leasing Corporation I*
|
Indiana
|
|
|
Washington
and Michigan Insurance, Inc.*
|
Arizona
|
|
|
*Wholly-owned
subsidiaries of 1st Source Bank
|
||
|
23
|
Consent
of Ernst & Young LLP, Independent Registered Public Accounting
Firm.
|
|
|
31.1
|
Certification
of Christopher J. Murphy III, Chief Executive Officer (Rule
13a-14(a)).
|
|
|
31.2
|
Certification
of Larry E. Lentych, Chief Financial Officer (Rule
13a-14(a)).
|
|
|
32.1
|
Certification
of Christopher J. Murphy III, Chief Executive Officer.
|
|
|
32.2
|
Certification
of Larry E. Lentych, Chief Financial
Officer.
|
|
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
1st
SOURCE CORPORATION
By
/s/ CHRISTOPHER J.
MURPHY III
Christopher
J. Murphy III, Chairman of the Board,
President
and Chief Executive Officer
Date:
February 20, 2009
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
|
Signature
|
Title
|
Date
|
|
/s/
CHRISTOPHER J. MURPHY III
|
Chairman
of the Board,
|
February
20, 2009
|
|
Christopher
J. Murphy III
|
President
and Chief Executive Officer
|
|
|
/s/
WELLINGTON D. JONES III
|
Executive
Vice President
|
February
20, 2009
|
|
Wellington
D. Jones III
|
and
Director
|
|
|
/s/
LARRY E. LENTYCH
|
Treasurer,
Chief Financial Officer
|
February
20, 2009
|
|
Larry
E. Lentych
|
and
Principal Accounting Officer
|
|
|
/s/
JOHN B. GRIFFITH
|
Secretary
|
February
20, 2009
|
|
John
B. Griffith
|
and
General Counsel
|
|
|
/s/
DANIEL B. FITZPATRICK
|
Director
|
February
20, 2009
|
|
Daniel
B. Fitzpatrick
|
||
|
/s/
TERRY L. GERBER
|
Director
|
February
20, 2009
|
|
Terry
L. Gerber
|
||
|
/s/
LAWRENCE E. HILER
|
Director
|
February
20, 2009
|
|
Lawrence
E. Hiler
|
||
|
/s/
WILLIAM P. JOHNSON
|
Director
|
February
20, 2009
|
|
William
P. Johnson
|
||
|
/s/
CRAIG A. KAPSON
|
Director
|
February
20, 2009
|
|
Craig
A. Kapson
|
||
|
/s/
REX MARTIN
|
Director
|
February
20, 2009
|
|
Rex
Martin
|
||
|
/s/
DANE A. MILLER
|
Director
|
February
20, 2009
|
|
Dane
A. Miller
|
||
|
/s/
TIMOTHY K. OZARK
|
Director
|
February
20, 2009
|
|
Timothy
K. Ozark
|
||
|
/s/
JOHN T. PHAIR
|
Director
|
February
20, 2009
|
|
John
T. Phair
|
||
|
/s/
MARK D. SCHWABERO
|
Director
|
February
20, 2009
|
|
Mark
D. Schwabero
|
||
-54-