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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission file number 0-6233
1st SOURCE CORPORATION
(Exact name of registrant as specified in its charter)
INDIANA 35-1068133
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 North Michigan Street South Bend, Indiana 46601
(Address of principal executive offices) (Zip Code)
(574)235-2702
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No______
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No ______
Number of shares of common stock outstanding as of
October 21, 2004 - 20,725,707 shares
1
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements (Unaudited)
Consolidated statements of financial condition --
September 30, 2004, and December 31, 2003 3
Consolidated statements of income --
three months and nine months ended September 30, 2004 and 2003 4
Consolidated statements of changes in shareholders' equity --
nine months ended September 30, 2004 and 2003 5
Consolidated statements of cash flows --
nine months ended September 30, 2004 and 2003 6
Notes to the Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 19
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits 20
SIGNATURES 20
2
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited - Dollars in thousands)
September 30, December 31,
2004 2003
---------------------------------
ASSETS
- ------
Cash and due from banks $ 69,842 $ 109,787
Federal funds sold and
interest bearing deposits with other banks 52,934 1,355
Investment securities, available-for-sale
(amortized cost of $774,626 and $759,945
at September 30, 2004 and December 31, 2003, respectively) 777,553 763,763
Trading account securities 4,926 -
Mortgages held for sale 74,253 60,215
Loans, net of unearned discount:
Commercial and agricultural loans 446,185 402,905
Auto, light truck and environmental equipment 267,818 269,490
Medium and heavy duty truck 249,090 221,562
Aircraft financing 450,785 489,155
Construction equipment financing 204,576 219,562
Loans secured by real estate 559,460 533,749
Consumer loans 97,317 94,577
--------------------------------
Total loans 2,275,231 2,231,000
Reserve for loan losses (68,189) (70,045)
---------------------------------
Net loans 2,207,042 2,160,955
Equipment owned under operating leases
(net of accumulated depreciation) 47,454 70,305
Net premises and equipment 37,577 38,431
Accrued income and other assets 118,957 125,342
---------------------------------
Total assets $ 3,390,538 $ 3,330,153
=================================
LIABILITIES
- -----------
Deposits:
Noninterest bearing $ 380,536 $ 396,026
Interest bearing 2,073,685 2,091,189
---------------------------------
Total deposits 2,454,221 2,487,215
Federal funds purchased and securities
sold under agreements to repurchase 368,370 276,040
Other short-term borrowings 109,642 114,814
Long-term debt and mandatorily redeemable securities 22,973 22,802
Subordinated notes 59,022 56,444
Accrued expenses and other liabilities 53,252 58,147
---------------------------------
Total liabilities 3,067,480 3,015,462
SHAREHOLDERS' EQUITY
- --------------------
Preferred stock; no par value - -
Common stock; no par value 7,578 7,578
Capital surplus 214,001 214,001
Retained earnings 110,244 100,534
Cost of common stock in treasury (10,571) (9,777)
Accumulated other comprehensive income 1,806 2,355
---------------------------------
Total shareholders' equity 323,058 314,691
---------------------------------
Total liabilities and shareholders' equity $ 3,390,538 $ 3,330,153
=================================
The accompanying notes are a part of the consolidated financial statements.
3
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited - Dollars in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- ---------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Interest income:
Loans $ 32,144 $ 33,063 $ 96,502 $ 105,776
Investment securities, taxable 3,793 4,205 12,188 13,449
Investment securities, tax-exempt 1,260 1,386 3,835 4,266
Other 23 337 134 782
----------- ----------- ----------- -----------
Total interest income 37,220 38,991 112,659 124,273
Interest expense:
Deposits 9,833 11,919 29,253 38,877
Short-term borrowings 1,826 1,386 4,366 4,148
Subordinated notes 975 961 2,898 2,842
Long-term debt and
mandatorily redeemable securities 363 181 823 566
----------- ----------- ----------- -----------
Total interest expense 12,997 14,447 37,340 46,433
----------- ----------- ----------- -----------
Net interest income 24,223 24,544 75,319 77,840
Provision for loan losses 237 4,078 820 14,529
----------- ----------- ----------- -----------
Net interest income after
provision for loan losses 23,986 20,466 74,499 63,311
Noninterest income:
Trust fees 3,072 2,643 9,302 8,019
Service charges on deposit accounts 4,272 4,010 12,093 11,656
Mortgage banking (loss)/income (828) 6,453 4,517 15,795
Equipment rental income 4,270 6,217 15,021 19,443
Other income 3,364 2,665 7,747 9,587
Investment securities and
other investment losses (3,744) (3,134) (4,034) (3,689)
----------- ----------- ----------- -----------
Total noninterest income 10,406 18,854 44,646 60,811
----------- ----------- ----------- -----------
Noninterest expense:
Salaries and employee benefits 16,622 17,195 48,242 52,732
Net occupancy expense 1,764 1,726 5,322 5,375
Furniture and equipment expense 2,416 2,601 7,697 7,919
Depreciation - leased equipment 3,533 4,789 11,952 15,197
Supplies and communication 1,396 1,532 4,279 4,601
Loan collection and repossession expense 1,313 295 3,189 5,861
Other expense 5,330 4,566 15,980 13,096
----------- ----------- ----------- -----------
Total noninterest expense 32,374 32,704 96,661 104,781
----------- ----------- ----------- -----------
Income before income taxes 2,018 6,616 22,484 19,341
Income tax (benefit)/expense (1,290) 1,973 5,379 5,548
----------- ----------- ----------- -----------
Net income $ 3,308 $ 4,643 $ 17,105 $ 13,793
=========== =========== =========== ===========
Other comprehensive income, net of tax:
Change in unrealized
appreciation (depreciation) of
available-for-sale securities 7,045 (1,103) (549) (419)
----------- ----------- ----------- -----------
Total comprehensive income $ 10,353 $ 3,540 $ 16,556 $ 13,374
=========== =========== =========== ===========
Per common share:
Basic net income per common share $ 0.16 $ 0.23 $ 0.83 $ 0.66
=========== =========== =========== ===========
Diluted net income per common share $ 0.16 $ 0.22 $ 0.82 $ 0.65
=========== =========== =========== ===========
Dividends $ 0.110 $ 0.090 $ 0.310 $ 0.270
=========== =========== =========== ===========
Basic weighted average common shares outstanding 20,682,707 20,677,678 20,703,344 20,915,465
=========== =========== =========== ===========
Diluted weighted average common shares outstanding 20,953,401 21,036,474 20,968,643 21,246,855
=========== =========== =========== ===========
The accompanying notes are a part of the consolidated financial statements.
4
1st SOURCE CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited - Dollars in thousands)
Net
Unrealized
Appreciation
Cost of (Depreciation)
Common of Securities
Common Capital Retained Stock Available-
Total Stock Surplus Earnings in Treasury For-Sale
- ------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2003 $309,429 $7,579 $214,001 $90,897 ($7,637) $4,589
- ------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income, net of tax:
Net Income 13,793 - - 13,793 - -
Change in unrealized appreciation
of available-for-sale securities (419) - - - - (419)
--------------
Total Comprehensive Income 13,374 - - - - -
Effects of SFAS 150 -399,241 Mandatorily
redeemable shares reclassed as liabilities (5,897) - - (955) (4,942) -
Issuance of 159,872 common shares
under stock based compensation plans,
including related tax effects 2,183 (1) - (482) 2,666 -
Cost of 29,881 shares of common
stock acquired for treasury (438) - - - (438) -
Cash dividend ($.270 per share) (5,680) - - (5,680) - -
- ------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2003 $312,971 $7,578 $214,001 $97,573 ($10,351) $4,170
==============================================================================================================================
Balance at January 1, 2004 $314,691 $7,578 $214,001 $100,534 ($9,777) $2,355
- ------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income, net of tax:
Net Income 17,105 - - 17,105 - -
Change in unrealized appreciation
of available-for-sale securities (549) - - - - (549)
--------------
Total Comprehensive Income 16,556 - - - - -
Issuance of 222,532 common shares
under stock based compensation plans,
including related tax effects 3,177 - - (976) 4,153 -
Cost of 213,884 shares of common
stock acquired for treasury (4,947) - - - (4,947) -
Cash dividend ($0.31 per share) (6,419) - - (6,419) - -
- ------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2004 $323,058 $7,578 $214,001 $110,244 ($10,571) $1,806
==============================================================================================================================
The accompanying notes are a part of the consolidated financial statements.
5
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited - Dollars in thousands)
Nine Months Ended September 30,
------------------------------------
2004 2003
----------------- ----------------
Operating activities:
Net income $ 17,105 $ 13,793
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 820 14,529
Depreciation of premises and equipment 15,556 19,030
Amortization of investment security premiums
and accretion of discounts, net 4,982 4,317
Amortization of mortgage servicing rights 9,589 5,999
Mortgage servicing asset impairment charges (1,954) 2,596
Deferred income taxes 2,959 (2,501)
Unrealized investment securities losses 3,669 2,743
Realized investment securities losses 365 946
Change in mortgages held for sale (14,038) 79,144
Change in trading account securities (4,926) 2,525
Decrease in interest receivable 611 1,621
Decrease in interest payable (473) (3,711)
Change in other assets (1,861) 6,645
Change in other liabilities (7,041) 7,566
Other 82 1,023
----------------- ----------------
Net cash from operating activities 25,445 156,265
Investing activities:
Proceeds from sales and maturities of investment securities 170,424 271,360
Purchases of investment securities (194,120) (393,548)
Net change in short-term investments (51,579) 15,772
Loans sold or participated to others - 49,784
Net change in loans (46,907) 98,522
Net change in equipment owned under operating leases 10,899 3,781
Purchases of premises and equipment (2,737) (2,147)
----------------- ----------------
Net cash (used in)/from investing activities (114,020) 43,524
Financing activities:
Net change in demand deposits, NOW
accounts and savings accounts (48,906) (105,435)
Net change in certificates of deposit 15,912 (114,433)
Net change in short-term borrowings 87,158 6,260
Proceeds from issuance of long-term debt 500 784
Proceeds from issuance of subordinated notes 30,929 -
Payments on subordinated notes (28,351) -
Payments on long-term debt (301) (668)
Proceeds from issuance of treasury stock 3,177 2,183
Acquisition of treasury stock (4,947) (438)
Cash dividends (6,541) (5,680)
----------------- ----------------
Net cash from/(used in)financing activities 48,630 (217,427)
Net change in cash and cash equivalents (39,945) (17,638)
Cash and cash equivalents, beginning of year 109,787 120,894
----------------- ----------------
Cash and cash equivalents, end of period $ 69,842 $ 103,256
================= ================
The accompanying notes are a part of the consolidated financial statements.
6
1ST SOURCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Basis of Presentation
The accompanying unaudited consolidated financial statements reflect all
adjustments (all of which are normal and recurring in nature) which are, in the
opinion of management, necessary for a fair presentation of the consolidated
financial position, the results of operations, changes in shareholders' equity,
and cash flows for the periods presented. These unaudited consolidated financial
statements have been prepared according to the rules and regulations of the
Securities and Exchange Commission (SEC) and, therefore, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with U. S. generally accepted accounting principles have been
omitted. The Notes to the Consolidated Financial Statements appearing in 1st
Source Corporation's (1st Source) Annual Report on Form 10-K (2003 Annual
Report), which include descriptions of significant accounting policies, should
be read in conjunction with these interim financial statements. The balance
sheet at December 31, 2003, has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by U. S. generally accepted accounting principles for
complete financial statements. Certain amounts in the prior period consolidated
financial statements have been reclassified to conform with the current year
presentation.
1st Source accounts for its stock-based compensation plans under the
recognition and measurement principles provided in Accounting Principles Board
Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations. Stock-based employee compensation expense for the Executive
Incentive Plan and the Restricted Stock Award Plan is recognized in net income.
For the stock option plans, the stock option agreement, and the Employee Stock
Purchase Plan, no compensation expense is recognized in net income as all
options granted under these plans had an exercise price equal to the market
value of the underlying common stock on the date of grant.
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS No.148, requires pro forma
disclosures of net income and earnings per share for companies not adopting its
fair value accounting method for stock-based employee compensation. The pro
forma disclosures presented in Note 6 - Stock-Based Compensation use the fair
value method of SFAS No. 123 to measure compensation expense for stock-based
employee compensation plans.
Note 2. Recent Accounting Pronouncements
THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO
CERTAIN INVESTMENTS: (Emerging Issues Task Force (EITF) No. 03-01.) The EITF
reached a consensus about the criteria that should be used to determine when an
investment is considered impaired, whether that impairment is
other-than-temporary, and the measurement of an impairment loss and how that
criteria should be applied to investments accounted for under SFAS No. 115,
"ACCOUNTING IN CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES." EITF 03-01
also included accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. Additionally, EITF 03-01 includes new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
Financial Accounting Standards Board (FASB) delayed the accounting provisions of
EITF 03-01; however the disclosure requirements remain effective for annual
reports ending after June 15, 2004. 1st Source will evaluate the impact of EITF
03-01 once final guidance is issued.
7
APPLICATION OF ACCOUNTING PRINCIPLES TO LOAN COMMITMENTS: SEC Staff
Accounting Bulletin (SAB) No. 105, "APPLICATION OF ACCOUNTING PRINCIPLES TO LOAN
COMMITMENTS," summarizes the views of the staff of the SEC regarding the
application of generally accepted accounting principles to loan commitments
accounted for as derivative instruments. SAB No.105 provides that the fair value
of recorded loan commitments that are accounted for as derivatives under SFAS
No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES," should
not incorporate the expected future cash flows related to the associated
servicing of the future loan. In addition, SAB No. 105 requires registrants to
disclose their accounting policy for loan commitments. The provisions of SAB No.
105 must be applied to loan commitments accounted for as derivatives that are
entered into after March 31, 2004. The adoption of this accounting standard did
not have a material impact on 1st Source's financial statements.
ACCOUNTING FOR STOCK-BASED COMPENSATION: On March 31, 2004, the FASB issued
the Exposure Draft, SHARE-BASED PAYMENT, which is a proposed amendment to SFAS
No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION." In this draft, the FASB
formally proposed to require companies to recognize the fair value of stock
options and other stock-based compensation to employees for future reporting
periods in the income statement based on their fair values. The final standard
would be effective for public companies for interim or annual periods beginning
after June 15, 2005. 1st Source is in the process of evaluating the impact of
the exposure draft.
Note 3. Investments Securities - Other-Than-Temporary Impairment
As part of its strategy to manage interest rate risk, 1st Source had
purchased floating rate preferred stock issued by the Federal National Home
Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation
(FHLMC). As prevailing interest rates have declined, the market value of these
securities has also decreased. In the quarter ended September 30, 2004, 1st
Source recognized a $3.67 million non-cash pre-tax charge to expense for the
other-than-temporary decline in value. 1st Source accounts for these securities
in accordance with SFAS No. 115, which requires that if the decline in fair
market value below cost is determined to be other-than-temporary, the unrealized
loss must be realized as expense in the income statement. Based on a number of
factors, including the magnitude of the decline in the market value and the
length of time the market value had been below cost, 1st Source concluded that
the decline in value was other-than-temporary. Accordingly, the
other-than-temporary impairment was recognized in the income statement as an
investment securities loss. A corresponding reduction in unrealized losses, net
of tax, in shareholders' equity was recorded totaling $2.26 million. Gross
unrealized losses on debt securities that have been in a continuous unrealized
loss position for twelve months or longer were $0.96 million at September 30,
2004. Because 1st Source has the ability and intent to hold these investments
until a market price recovery, which may be at maturity, 1st Source does not
consider these investments to be other-than-temporarily impaired at September
30, 2004.
Note 4. Reserve for Loan Losses
The reserve for loan losses is maintained at a level believed to be
adequate by management to absorb probable losses inherent in the loan portfolio.
The determination of the reserve requires significant judgment reflecting
management's best estimate of probable loan losses related to specifically
identified loans as well as probable losses in the remainder of the various loan
portfolios. The methodology for assessing the appropriateness of the reserve
consists of several key elements, which include: specific reserves for
identified special attention loans (substandard loans and leases and internal
watch list credits), percentage allocations for special attention loans without
specific reserves, formula reserves for each business lending division
8
portfolio, including a higher percentage reserve allocation for special
attention loans without a specific reserve, and reserves for pooled homogenous
loans. Management's evaluation is based upon a continuing review of these
portfolios, estimates of future customer performance, collateral values and
dispositions and consideration of current economic trends, all of which are
subject to judgment and will change.
Note 5. Financial Instruments with Off-Balance-Sheet Risk
To meet the financing needs of its customers, in the normal course of
business 1st Source and its subsidiaries are parties to financial instruments
with off-balance-sheet risk. 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. 1st Source's 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. 1st Source uses the same credit policies and collateral
requirements in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
Trustcorp Mortgage Company and 1st Source Bank (Bank), subsidiaries of 1st
Source, grant 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. Loan commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The credit risk
involved and collateral obtained in issuing letters of credit is essentially the
same as that involved in extending loan commitments to customers.
As of September 30, 2004, and December 31, 2003, 1st Source had commitments
outstanding to originate and purchase mortgage loans aggregating $189.66 million
and $143.92 million, respectively. Outstanding commitments to sell mortgage
loans aggregated $136.60 million at September 30, 2004, and $99.53 million at
December 31, 2003. Standby letters of credit totaled $91.75 million and $101.26
million at September 30, 2004, and December 31, 2003, respectively. Standby
letters of credit have terms ranging from six months to one year.
Note 6. Stock-Based Compensation
The following pro forma information presents net income and earnings per
share for the three and nine month periods ended September 30, 2004, and 2003 as
if the fair value method of SFAS No. 123, "Accounting for Stock-Based
Compensation," as amended by SFAS No. 148, had been used to measure compensation
cost for stock-based compensation plans. For the purposes of these pro forma
disclosures, the estimated fair value of stock options and restricted stock
awards is amortized to expense over the related vesting periods.
9
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- ------------- -------------- ---------
2004 2003 2004 2003
---- ---- ---- ----
Net income $ 3,308 $ 4,643 $ 17,105 $ 13,793
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects 541 450 1,277 760
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
(569) (481) (1,487) (960)
-------- -------- ---------- --------
Pro forma net income $ 3,280 $ 4,612 $ 16,895 $ 13,593
========= ========= ======== ========
Earnings per share:
Basic--as reported $0.16 $0.23 $0.83 $0.66
===== ===== ===== =====
Basic--pro forma $0.16 $0.22 $0.82 $0.65
===== ===== ===== =====
Diluted--as reported $0.16 $0.22 $0.82 $0.65
===== ===== ===== =====
Diluted--pro forma $0.16 $0.22 $0.81 $0.64
===== ===== ===== =====
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for historical information contained herein, the matters discussed
in this document express "forward-looking statements." Generally, the words
"believe," "expect," "intend," "estimate," "anticipate," "project," "will" and
similar expressions indicate forward-looking statements. Those statements,
including statements, projections, estimates or assumptions concerning future
events or performance, and other statements that are other than statements of
historical fact, are subject to material risks and uncertainties. 1st Source
cautions readers not to place undue reliance on any forward-looking statements,
which speak only as of the date made. 1st Source may make other written or oral
forward-looking statements from time to time. Readers are advised that various
important factors could cause 1st Source's actual results or circumstances for
future periods to differ materially from those anticipated or projected in such
forward-looking statements. Such factors include, but are not limited to,
changes in law, regulations or U. S. generally accepted accounting principles;
1st Source's competitive position within its markets served; increasing
consolidation within the banking industry; unforeseen changes in interest rates;
unforeseen changes in loan prepayment assumptions; unforeseen downturns in or
major events affecting the local, regional or national economies or the
industries in which 1st Source has credit concentrations; and other matters
discussed in 1st Source's filings with the SEC, including its Annual Report on
Form 10-K for 2003, which filings are available from the SEC. 1st Source
undertakes no obligation to publicly update or revise any forward-looking
statements.
The following management's discussion and analysis is presented to provide
information concerning the financial condition of 1st Source as of September 30,
2004, as compared to December 31, 2003, and the results of operations for the
three and nine months ended September 30, 2004, and 2003. This discussion and
analysis should be read in conjunction with 1st Source's consolidated financial
statements and the financial and statistical data appearing elsewhere in this
report and 1st Source's 2003 Annual Report.
10
FINANCIAL CONDITION
1st Source's assets at September 30, 2004, were $3.39 billion, up 1.81% from
December 31, 2003. Total loans increased 1.98% and total deposits decreased
1.33% over the comparable figures at the end of 2003.
Nonperforming assets at September 30, 2004, were $35.97 million compared to
$36.83 million at December 31, 2003, a decrease of 2.32%. Nonperforming assets
increased $8.07 million during the third quarter of 2004, primarily as a result
of a $7.95 million dollar commercial loan placed in nonaccrual status. The
year-to-date decrease was due to a decrease in construction equipment and
aircraft nonaccrual loans and repossessed assets offset by the commercial loan
placed in nonaccrual in the third quarter. At September 30, 2004, nonperforming
assets were 1.55% of net loans and leases compared to 1.59% at December 31,
2003.
Accrued income and other assets were as follows:
(Dollars in thousands)
September 30, December 31,
2004 2003
-------------- -------------
Accrued income and other assets:
Bank owned life insurance cash surrender value $ 33,339 $ 27,376
Accrued interest receivable 12,930 13,541
Mortgage servicing assets 20,032 24,324
Other real estate 2,694 4,625
Repossessions 2,516 6,229
Intangible assets 24,246 25,740
All other assets 23,200 23,507
-------------- -------------
Total accrued income and other assets $ 118,957 $ 125,342
============== =============
CAPITAL
As of September 30, 2004, total shareholders' equity was $323.06 million,
up 2.66% from the $314.69 million at December 31, 2003. In addition to net
income of $17.11 million, other significant changes in shareholders' equity
during the first nine months of 2004 included $4.95 million in treasury stock
purchases, and $6.42 million of dividends paid. The accumulated other
comprehensive income component of shareholders' equity totaled $1.81 million at
September 30, 2004, compared to $2.36 million at December 31, 2003. The decrease
in accumulated other comprehensive income was a result of changes in unrealized
gain/loss on securities in the available-for-sale portfolio. The 1st Source
equity-to-assets ratio was 9.53% as of September 30, 2004, compared to 9.45% at
December 31, 2003. Book value per common share rose to $15.59 at September 30,
2004, up from $15.19 at December 31, 2003.
1st Source declared and paid dividends per common share of $0.11 during
the third quarter of 2004. The trailing four quarters dividend payout ratio was
37.96%. The dividend payout is continually reviewed by management and the Board
of Directors.
The banking regulators have established guidelines for leverage capital
requirements, expressed in terms of Tier 1 or core capital as a percentage of
average assets, to measure the soundness of a financial institution. In
addition, banking regulators have established risk-based capital guidelines for
U.S. banking organizations. The actual and required capital amounts and ratios
of 1st Source and the Bank, as of September 30, 2004, are presented in the table
below:
11
Required To Be Well
Capitalized Under
Minimum Required for Prompt Corrective
Actual Capital Adequacy Action Provisions
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------------------------------
Total Capital (to Risk-Weighted Assets):
1st Source $389,038 14.42% $215,883 8.00% $269,854 10.00%
Bank 363,800 13.82 210,551 8.00 263,189 10.00
Tier 1 Capital (to Risk-Weighted Assets):
1st Source 354,256 13.13 107,942 4.00 161,912 6.00
Bank 330,466 12.56 105,276 4.00 157,913 6.00
Tier 1 Capital (to Average Assets):
1st Source 354,256 10.70 132,374 4.00 165,468 5.00
Bank 330,466 10.23 129,251 4.00 151,564 5.00
LIQUIDITY AND INTEREST RATE SENSITIVITY
The Bank's liquidity is monitored and closely managed by the
Asset/Liability Committee (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 ensures 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 sources of asset funded liquidity are
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 bank lines of credit, repurchase agreements and the
ability to borrow from the Federal Reserve Bank and Federal Home Loan Bank.
Close attention is given to various interest rate sensitivity gaps and
interest rate spreads. Maturities of rate sensitive assets are evaluated
relative to the maturities of rate sensitive liabilities and interest rate
forecasts. At September 30, 2004, the consolidated statement of financial
condition was rate sensitive by $88.00 million more liabilities than assets
scheduled to reprice within one year or approximately 0.95%.
1ST SOURCE CAPITAL TRUST IV
During the third quarter of 2004, 1st Source completed a private placement
issuance of $30 million of trust preferred securities through 1st Source Capital
Trust IV (Capital Trust IV), a new unconsolidated subsidiary trust organized
under Delaware law. The trust preferred securities were issued at $25.00 per
share and bear a 7.66 percent per annum fixed rate of interest, payable
quarterly. The securities are redeemable after five years and are due in 2034.
The net proceeds of the trust preferred securities issuance were used by 1st
Source to redeem $27.5 million in 9.00 percent trust preferred securities issued
by 1st Source Capital Trust I (Capital Trust I) in 1997. In connection with the
formation of Capital Trust IV, $0.75 million of pre-tax capitalized debt
issuance costs were written off, and 1st Source will dissolve its
unconsolidated subsidiary Capital Trust I.
12
RESULTS OF OPERATIONS
Net income for the three and nine month periods ended September 30, 2004,
was $3.31 million and $17.11 million respectively, compared to $4.64 million and
$13.79 million for the same periods in 2003. Diluted net income per common share
was $0.16 and $0.82 respectively, for the three and nine month periods ended
September 30, 2004, compared to $0.22 and $0.65 for the same periods in 2003.
Return on average common shareholders' equity was 7.19% for the nine months
ended September 30, 2004, compared to 5.90% in 2003. The return on total average
assets was 0.70% for the nine months ended September 30, 2004, compared to 0.56%
in 2003.
The increase in net income for the nine months ended September 30, 2004,
over the first nine months of 2003, was primarily the result of a $13.71 million
decrease in the provision for loan losses and a $8.12 million decrease in
noninterest expense offset by a $2.52 million decrease in net interest income
and a $16.17 million decrease in noninterest income. Details of the changes in
the various components of net income are further discussed below.
NET INTEREST INCOME
The taxable equivalent net interest income for the three months ended
September 30, 2004, was $24.90 million, a decrease of $0.39 million over the
same period in 2003. The lower margin in 2004 was due primarily to the ongoing
impact of low market interest rates.
The net interest margin on a fully taxable equivalent basis was 3.18% for
the three months ended September 30, 2004, compared to 3.33% for the three
months ended September 30, 2003. The taxable equivalent net interest income for
the nine month period ended September 30, 2004, was $77.39 million, a decrease
of 3.39% over 2003, resulting in a net yield of 3.39%, compared to 3.57% for the
same period in 2003. The impact on net interest margin on a fully taxable
equivalent basis due to the recognition of fees on loans over the life of the
loans was a reduction of nine basis points for the nine months ended September
30, 2004, compared to a ten basis point reduction for the same period last year.
Total average earning assets increased 3.19% and 1.69%, respectively, for
the three and nine month periods ended September 30, 2004, over the comparative
periods in 2003. Average loan outstandings increased 8.51% and 4.79% for the
three and nine month periods, compared to the same periods in 2003, due
primarily to increased loan outstandings in commercial loans secured by aircraft
as a result of the fourth quarter 2003 purchase of the securitized aircraft loan
portfolio, which was offset by continued runoff in other areas of this loan
category and in the construction equipment portfolio. Total average investment
securities increased 12.84% and 11.95% for the three and nine month periods over
one year ago due to an increase in United States agency and municipal
securities. For the nine month period, average mortgages held for sale decreased
44.50%, as demand for mortgage loans was lower in 2004 due to the increased
mortgage rate environment. Other investments, which include federal funds sold
and trading account securities, decreased for the three and nine month periods
over 2003 as excess funds were used to purchase loans from the securitization
facility. The taxable equivalent yields on total average earning assets were
4.85% and 5.23% for the three month periods ended September 30, 2004 and 2003,
respectively, and 5.02% and 5.64% for the nine month periods ended September 30,
2004 and 2003, respectively.
Average interest bearing deposits decreased 5.32% and 6.26% for the three
and nine month periods, respectively, over the same periods in 2003. The rate on
average interest-bearing deposits was 1.93% and 2.21% for the three month
periods ended September 30, 2004 and 2003, and 1.91% and 2.39% for the nine
13
month periods ended September 30, 2004 and 2003, respectively, due to a decrease
in public funds and brokered deposits. These higher cost deposits were not
pursued due to lower funding needs. The rates on average interest-bearing funds
were 2.01% and 2.32% for the three months ended September 30, 2004 and 2003,
respectively. For the nine months ended September 30, 2004 and 2003, the rates
on average interest bearing funds were 1.97% and 2.49%, respectively.
The following table sets forth consolidated information regarding average
balances and rates.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
(Dollars in thousands)
Three months ended September 30,
2004 2003
---------------------------------------------------------------------
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
---------------------------------------------------------------------
ASSETS:
Investment securities:
Taxable $ 612,488 $ 3,793 2.46% $ 528,971 $ 4,205 3.15%
Tax exempt (1) 173,432 1,868 4.28% 167,492 2,054 4.86%
Mortgages held for sale 67,221 936 5.54% 120,369 1,738 5.73%
Net loans (2 & 3) 2,245,291 31,276 5.54% 2,069,261 31,398 6.02%
Other investments 11,768 23 0.78% 127,901 337 1.05%
-------------------------------- -------------------------------
Total Earning Assets 3,110,200 37,896 4.85% 3,013,994 39,732 5.23%
Cash and due from banks 83,698 84,814
Reserve for loan losses (69,921) (63,478)
Other assets 209,630 247,155
------------ -----------
Total $ 3,333,607 $3,282,485
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest bearing deposits $ 2,029,141 $ 9,833 1.93% $2,143,112 $ 11,919 2.21%
Short-term borrowings 465,433 1,826 1.56% 248,642 1,386 2.21%
Subordinated notes 56,864 975 6.82% 56,444 961 6.75%
Long-term debt and
mandatorily redeemable securities 22,866 363 6.32% 22,959 181 3.15%
-------------------------------- -------------------------------
Total Interest Bearing Liabilities 2,574,304 12,997 2.01% 2,471,157 14,447 2.32%
Noninterest bearing deposits 388,332 447,968
Other liabilities 52,735 53,170
Shareholders' equity 318,236 310,190
------------ -----------
Total $ 3,333,607 $3,282,485
============ ===========
-------- --------
Net Interest Income $ 24,899 $ 25,285
======== ========
Net Yield on Earning Assets on a Taxable
------ ------
Equivalent Basis 3.18% 3.33%
====== ======
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
(Dollars in thousands)
Nine months ended September 30,
2004 2003
--------------------------------------------------------------------
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
---------------------------------------------------------------------
ASSETS:
Investment securities:
Taxable $ 584,070 $ 12,188 2.79% $ 508,667 $ 13,449 3.53%
Tax exempt (1) 170,918 5,695 4.45% 165,753 6,304 5.08%
Mortgages held for sale 70,892 2,915 5.49% 127,735 5,582 5.84%
Net loans (2 & 3) 2,212,015 93,797 5.66% 2,110,811 100,417 6.36%
Other investments 14,508 134 1.23% 88,584 782 1.18%
-------------------------------- -------------------------------
Total Earning Assets 3,052,403 114,729 5.02% 3,001,550 126,534 5.64%
Cash and due from banks 79,716 87,313
Reserve for loan losses (70,046) (62,523)
Other assets 218,774 259,003
------------ ------------
Total $ 3,280,847 $ 3,285,343
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest bearing deposits $ 2,040,566 $ 29,253 1.91% $ 2,176,884 $ 38,877 2.39%
Short-term borrowings 406,101 4,366 1.44% 244,511 4,148 2.27%
Subordinated notes 56,585 2,898 6.84% 55,321 2,842 6.87%
Long-term debt and
mandatorily redeemable securities 23,005 823 4.78% 19,273 566 3.93%
-------------------------------- -------------------------------
Total Interest Bearing Liabilities 2,526,257 37,340 1.97% 2,495,989 46,433 2.49%
Noninterest bearing deposits 380,551 422,943
Other liabilities 56,167 53,770
Shareholders' equity 317,872 312,641
------------ ------------
Total $ 3,280,847 $ 3,285,343
============ ============
--------- ---------
Net Interest Income $ 77,389 $ 80,101
========= =========
Net Yield on Earning Assets on a Taxable
----- -----
Equivalent Basis 3.39% 3.57%
===== =====
(1) Interest income includes the effects of taxable equivalent adjustments,
using a 35% rate. Tax equivalent adjustments for the three month period were
$608 in 2004 and $668 in 2003 and for the nine month period were $1,860 in
2004 and $2,038 in 2003.
(2) Loan income includes fees on loans for the three month period of $133 in
2004 and $528 in 2003 and for the nine month period of $1,462 in 2004 and
$3,102 in 2003. Loan income also includes the effects of taxable equivalent
adjustments, using 35% rate for 2004 and 2003. The tax equivalent
adjustments for the three month period were $68 in 2004 and $73 in 2003 and
for the nine month period were $210 in 2004 and $223 in 2003.
(3) For purposes of this computation, nonaccruing loans are included in the
daily average loan amounts outstanding.
14
PROVISION AND RESERVE FOR LOAN LOSSES
The provision for loan losses for the three month periods ended September
30, 2004 and 2003 was $0.24 million and $4.08 million, respectively, and $0.82
million and $14.53 million for the nine month periods ended September 30, 2004
and 2003, respectively. Net charge-offs of $2.09 million were recorded for the
third quarter 2004, compared to $4.05 million for the same quarter a year ago.
Year-to-date net charge-offs of $2.68 million have been recorded in 2004,
compared to net charge-offs of $10.53 million through September 2003.
In the third quarter 2004, 1st Source continued to experience moderate
improvement in credit quality, even with the addition of a $7.95 million
commercial loan reclassed to nonaccrual loans. This improvement led to a decline
in the reserve for loan losses of $1.86 million. Loan delinquencies were 1.08%
on September 30, 2004, as compared to 1.14% on September 30, 2003, and 1.04% at
the end of 2003. Third quarter 2004 net charge-offs decreased as compared to
third quarter 2003. The reserve for loan losses as a percentage of loans
outstanding at the end of the period was 3.00% as compared to 3.13% one year ago
and 3.14% at December 31, 2003. A summary of loan loss experience during the
three and nine month periods ended September 30, 2004 and 2003, is provided
below.
(Summary of Reserve for Loan Losses)
-----------------------------------------------------------
(Dollars in Thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------------------
2004 2003 2004 2003
------------ ------------ ------------- -------------
Reserve for loan losses - beginning balance $ 70,045 $ 63,194 $ 70,045 $ 59,218
Charge-offs (2,632) (4,931) (7,059) (13,054)
Recoveries 539 881 4,383 2,529
------------ ------------ ------------- -------------
Net charge-offs (2,093) (4,050) (2,676) (10,525)
Provision for loan losses 237 4,078 820 14,529
------------ ------------ ------------- -------------
Reserve for loan losses - ending balance $ 68,189 $ 63,222 $ 68,189 $ 63,222
============ ============ ============= =============
Loans outstanding at end of period $ 2,275,231 $ 2,020,621 $ 2,275,231 $ 2,020,621
Average loans outstanding during period 2,245,291 2,069,261 2,212,015 2,110,811
Reserve for loan losses as a percentage of
loans outstanding at end of period 3.00% 3.13% 3.00% 3.13%
Ratio of net charge-offs during period to
average loans outstanding 0.37% 0.78% 0.16% 0.67%
NONPERFORMING ASSETS
Nonperforming assets were as follows:
(Dollars in thousands)
September 30, December 31, September 30,
2004 2003 2003
------------- ------------ -------------
Loans past due 90 days or more $ 361 $ 212 $ 353
Nonaccrual and restructured loans 30,958 27,085 32,865
Other real estate 2,117 3,010 3,111
Repossessions 2,516 6,263 9,369
Equipment owned under operating leases 20 257 305
------------- ------------ -------------
Total nonperforming assets $ 35,972 $ 36,827 $ 46,003
============= ============ =============
15
Nonperforming assets totaled $35.97 million at September 30, 2004,
decreasing 2.32% from $36.83 million at December 31, 2003 and decreasing 21.81%
from $46.00 million at September 30, 2003. The decrease during the first nine
months of 2004 was primarily related to a decrease in aircraft and construction
equipment nonaccrual loans and liquidation of repossessions, offset by the
addition of the commercial loan mentioned above to nonaccrual status.
Nonperforming assets as a percentage of total loans and leases improved to 1.55%
at September 30, 2004, from 1.59% at December 31, 2003 and 2.18% at September
30, 2003.
As of September 30, 2004, the Bank had a $3.69 million standby letter of
credit outstanding which supported bond indebtedness of a customer. Due to the
current financial condition of the customer, if this standby letter of credit is
funded, the Bank likely will foreclose on the real estate securing the
customer's reimbursement obligation. This likely will result in an increase in
other real estate for approximately the same amount as the funding.
Repossessions continue to consist primarily of aircraft and aircraft parts,
representing $1.69 million of the $2.52 million as of September 30, 2004. These
aircraft and related equipment have primarily come from defaulted loans to air
cargo operators and aircraft dealers. There are also automobiles, light trucks,
construction equipment and environmental equipment in repossessed assets at
September 30, 2004. At the time of repossession, the recorded amount of the loan
is written down, if necessary, to the estimated value of the equipment or
vehicle by a charge to the reserve for loan losses, unless the equipment is in
the process of immediate sale. Any subsequent write-downs are included in
noninterest expense.
Repossessed assets are valued by the loan and credit officers of the Bank
or, in certain circumstances, an independent third party. The estimated value
generally is determined on an orderly liquidation basis and is based on a
variety of available sources. These sources typically include vehicle and
equipment dealers, valuation guides and other third parties, including
appraisers. A number of variables can lead to a decrease in value after the
asset is repossessed. These include deterioration in the market value, discovery
of new or additional information about the asset, and validity or invalidity of
other liens against the asset. Valuation adjustments and net losses upon
disposition of repossessions for the three month period ended September 30,
2004, totaled $0.90 million as compared to the valuation adjustments and net
gains for the three month period ended September 30, 2003, of ($0.75) million,
respectively, and $1.28 million and $1.97 million for the nine month periods
ended September 30, 2004 and 2003, respectively.
SUPPLEMENTAL LOAN INFORMATION AS OF SEPTEMBER 30, 2004
(Dollars in thousands) Other real estate Year-to-date
Loan and net credit losses/
outstandings Non-accrual repossessions (recoveries)
--------------- -------------- ------------------- --------------------
Commercial and agricultural loans $ 446,185 $ 11,309 $ - $ 400
Auto, light truck, and environmental equipment 267,818 3,199 579 837
Medium and heavy duty truck 249,090 170 - 347
Aircraft financing 450,785 11,994 1,688 2,101
Construction equipment financing 204,576 2,417 215 (264)
Loans secured by real estate 559,460 1,422 2,117 117
Consumer loans 97,317 447 34 413
--------------- -------------- ------------------- --------------------
Total $ 2,275,231 $ 30,958 $ 4,633 $ 3,951
=============== ============== =================== ====================
16
For financial statements purposes, nonaccrual loans are included in loan
outstandings, whereas repossessions and other real estate are included in other
assets. Net credit losses include net charge-offs on loans and valuation
adjustments and gains and losses on disposition of repossessions and defaulted
operating leases.
NONINTEREST INCOME
Noninterest income for the three month periods ended September 30, 2004 and
2003 was $10.41 million and $18.85 million, respectively, and $44.65 million and
$60.81 million for the nine month periods ended September 30, 2004 and 2003,
respectively. The predominant factors behind the decrease in 2004 were a
reduction in mortgage banking income and equipment rental income.
(Dollars in thousands) Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- --------------------------
2004 2003 2004 2003
Noninterest income:
Trust fees $ 3,072 $ 2,643 $ 9,302 $ 8,019
Service charges on deposit accounts 4,272 4,010 12,093 11,656
Mortgage banking (loss)/income (828) 6,453 4,517 15,795
Insurance commissions 933 800 2,658 2,228
Equipment rental income 4,270 6,217 15,021 19,443
Securitization income - 841 - 2,438
Other income 2,431 1,024 5,089 4,921
Investment securities and other investment losses (3,744) (3,134) (4,034) (3,689)
---------- ---------- ---------- --------------
Total noninterest income $ 10,406 $ 18,854 $ 44,646 $ 60,811
========== ========== ========== ==============
For the three months ended September 30, 2004, mortgage banking income
decreased over the same period in 2003 due to mortgage servicing rights
impairment of $2.51 million in the third quarter of 2004 versus $2.82 million of
mortgage servicing rights impairment recovery for the same period in 2003. For
the nine months ended September 30, 2004, mortgage servicing rights impairment
was $1.95 million versus $2.60 million of impairment for the same period in
2003. For both the three and nine month periods ending September 30, 2004,
mortgage banking income was negatively impacted by reduced origination volumes
and decreased gains on sales of loans into the secondary market versus the same
periods in 2003.
Trust fees, insurance commissions and service charges on deposit accounts
increased in both the three and nine month periods ended September 30, 2004,
over the same periods in 2003. Trust fees increased due to growth in assets
under management and improvement in the equity markets. Insurance commissions
increased due to growth in commercial lines and higher premiums, while an
increase in income from consumer overdraft fees caused service charges on
deposit accounts to rise.
Equipment rental income decreased for both the three and nine month periods
ended September 30, 2004 over the same periods in 2003 due to the decrease in
the operating lease portfolio, while securitization income was eliminated in
2004 as 1st Source no longer has loans securitized. Other income increased
during the third quarter 2004 as a result of gain on trading account securities
in the amount of $0.61 million versus losses on trading account securities of
$0.31 million for the third quarter 2003. Other income on a year-over-year basis
remained relatively stable.
1st Source recorded impairment charges in the amount of $3.67 million and
$2.47 million for the third quarter of 2004 and 2003, respectively. During the
third quarter of 2004, 1st Source recognized a pre-tax other-than-temporary
impairment for investments in FNMA and FHLMC preferred stock that totaled $3.67
million. 1st Source accounts for these securities in accordance with SFAS No.
115. These securities are held as available-for-sale and the unrealized losses
17
had previously been recorded in accumulated comprehensive income. Under SFAS No.
115, if the decline in fair market value below cost is determined to be
other-than-temporary, the unrealized loss must be realized as expense on the
income statement. Based on a number of factors, including the magnitude of the
drop in market value below 1st Source's cost and the length of time the market
value had been below cost, 1st Source concluded that the decline in value was
other-than-temporary at the end of the third quarter of 2004. In the third
quarter of 2003, 1st Source recorded an impairment charge of $2.47 million to
the estimated value of its retained interest in the 1998 1st Source Master Trust
Securitization.
NONINTEREST EXPENSE
Noninterest expense for the three month periods ended September 30, 2004
and 2003 was $32.37 million and $32.70 million, respectively, and $96.66 million
and $104.78 million for the nine month periods ended September 30, 2004 and
2003, respectively. The decrease in noninterest expense in 2004 was primarily
due to decreased salaries and employee benefits, decreased depreciation on
leased equipment and, decreased loan collection and repossession expense, offset
by increased professional fees.
(Dollars in thousands) Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------------
2004 2003 2004 2003
Noninterest expense:
Salaries and employee benefits $ 16,622 $ 17,195 $ 48,242 $ 52,732
Net occupancy expense 1,764 1,726 5,322 5,375
Furniture and equipment expense 2,416 2,601 7,697 7,919
Depreciation - leased equipment 3,533 4,789 11,952 15,197
Professional fees 1,370 623 5,336 1,911
Supplies and communication 1,396 1,532 4,279 4,601
Business development and marketing expense 822 978 2,478 2,542
Intangible asset amortization 659 647 1,973 2,088
Loan collection and repossession expense 1,313 295 3,189 5,861
Other expense 2,479 2,318 6,193 6,555
---------- ---------- ----------- --------------
Total noninterest expense $ 32,374 $ 32,704 $ 96,661 $ 104,781
========== ========== =========== ==============
Salaries and employee benefits decreased on a year-over-year basis caused
primarily by the capitalization of $4.38 million in salaries and benefits in
connection with the deferral of loan origination costs in 2004, versus $1.40
million in 2003. Decreased mortgage commissions also contributed to the decrease
in salaries and employee benefits. These decreases were partially offset by
higher executive incentive accruals and increased group insurance costs.
Third quarter and year-to-date net occupancy expense, furniture and
equipment expense, supplies and communication, and business development and
marketing expense, and intangible asset amortization, all remained comparable to
2003 levels. Leased equipment depreciation decreased due to the decrease in the
operating lease portfolio. Loan collection and repossession expense decreased as
valuation adjustments and other expenses related to repossessed assets
decreased. Professional fees increased due to increased legal fees relating, in
part, to the lawsuit described in the 2003 Form 10-K Item 3, Legal Proceedings.
INCOME TAXES
For the three and nine months ended September 30, 2004, 1st Source
recognized an income tax (benefit)/expense of ($1.29) million and $5.38 million
respectively, for effective rates of (63.92)% and 23.92% respectively, compared
to $1.97 million and $5.55 million, for effective rates of 29.82% and 28.69%,
18
for the three and nine months ended September 30, 2003, respectively. During the
third quarter 2004, 1st Source recognized an income tax benefit in the amount of
$1.54 million which was related to dividend received deductions claimed for the
period starting in 2000 through third quarter 2004.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in market risks faced by 1st Source
since December 31, 2003. For information regarding 1st Source's market risk,
refer to 1st Source's Annual Report on Form 10-K for the year ended December 31,
2003.
ITEM 4.
CONTROLS AND PROCEDURES
1st Source carried out an evaluation, under the supervision and with the
participation of 1st Source's management, including 1st Source's Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of 1st Source's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that, at September 30, 2004, 1st
Source's disclosure controls and procedures are effective in accumulating and
communicating to management (including such officers) the information relating
to 1st Source (including its consolidated subsidiaries) required to be included
in 1st Source's periodic SEC filings.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.
1st Source reported in its Form 10-K filed February 19, 2004, on an
adversary proceeding filed against the Bank by Airmotive, Inc., by and through
the Official Unsecured Creditor's Committee of Airmotive, Inc. In early October,
the parties participated in a mediation that resulted in full settlement of the
litigation. The settlement remains subject to bankruptcy court approval, and a
hearing to consider approval is scheduled for mid-November. 1st Source has
previously reserved for the litigation and the settlement will not have any
impact on current earnings.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
(a) (b) (c) (d)
Total number of Maximum number(or approximate
Total number Average shares purchased dollar value) of shares
of shares price paid per as part of publicly announced that may yet be purchased under
Period purchased share plans or programs(1) the plans or programs
- -------------------------------------------------------------------------------------------------------------------------
July 01 - 31, 2004 0 0 0 752,052
August 01 - 31, 2004 102,982 24.84 102,982 649,070
September 01 - 30, 2004 0 0 0 649,070
(1)1st Source maintains a stock repurchase plan that was authorized by the
Board of Directors on October 23, 2001. Under the terms of the plan, 1st
Source may repurchase up to 1,038,990 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 389,920 shares.
19
ITEM 3. Defaults Upon Senior Securities.
None
ITEM 4. Submission of Matters to a Vote of Security Holders.
None
ITEM 5. Other Information.
None
ITEM 6. Exhibits
The following exhibits are filed with this report:
1. Exhibit 31.1 Certification of Chief Executive Officer required by Rule
13a-14(a).
2. Exhibit 31.2 Certification of Chief Financial Officer required by Rule
13a-14(a).
3. Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 of Chief
Executive Officer.
4. Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 of Chief
Financial Officer.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
1st Source Corporation
DATE October 28, 2004 /s/CHRISTOPHER J. MURPHY III
---------------- ---------------------------------
Christopher J. Murphy III
Chairman of the Board, President and CEO
DATE October 28, 2004 /s/LARRY E. LENTYCH
---------------- -------------------
Larry E. Lentych
Treasurer and Chief Financial Officer
Principal Accounting Officer
20