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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 March 31, 2005
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) 235-2000
--------------
(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
April 20, 2005 - 20,709,423 shares
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements (Unaudited)
Consolidated statements of financial condition --
March 31, 2005, and December 31, 2004 3
Consolidated statements of income --
three months ended March 31, 2005 and 2004 4
Consolidated statement of changes in shareholders' equity
three months ended March 31, 2005 and 2004 5
Consolidated statements of cash flows --
three months ended March 31, 2005 and 2004 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 18
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 19
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits 20
SIGNATURES 21
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited - Dollars in thousands)
March 31, December 31,
2005 2004
--------------------------------
ASSETS
Cash and due from banks $ 86,955 $ 78,255
Federal funds sold and
interest bearing deposits with other banks 26,252 220,131
Investment securities available-for-sale
(amortized cost of $740,662 and $790,404
at March 31, 2005 and December 31, 2004, respectively) 733,786 789,923
Mortgages held for sale 79,591 55,711
Loans and leases - net of unearned discount:
Commercial and agricultural loans 431,750 425,018
Auto, light truck and environmental equipment 269,361 263,637
Medium and heavy duty truck 274,097 267,834
Aircraft financing 423,017 444,481
Construction equipment financing 200,601 196,516
Loans secured by real estate 579,388 583,437
Consumer loans 100,781 99,245
--------------------------------
Total loans and leases 2,278,995 2,280,168
Reserve for loan and lease losses (62,647) (63,672)
--------------------------------
Net loans and leases 2,216,348 2,216,496
Equipment owned under operating leases,
net of accumulated depreciation 44,552 47,257
Net premises and equipment 37,581 37,314
Accrued income and other assets 116,388 118,628
--------------------------------
Total assets $ 3,341,453 $ 3,563,715
================================
LIABILITIES
Deposits:
Noninterest bearing $ 402,004 $ 378,867
Interest bearing 2,187,935 2,428,136
--------------------------------
Total deposits 2,589,939 2,807,003
Federal funds purchased and securities
sold under agreements to repurchase 194,247 216,751
Other short-term borrowings 97,401 82,911
Long-term debt and mandatorily redeemable securities 18,027 17,964
Subordinated notes 59,022 59,022
Accrued expenses and other liabilities 56,188 53,464
--------------------------------
Total liabilities 3,014,824 3,237,115
SHAREHOLDERS' EQUITY
Preferred stock; no par value - -
Common stock; no par value 7,578 7,578
Capital surplus 214,001 214,001
Retained earnings 120,387 115,830
Cost of common stock in treasury (11,096) (10,512)
Accumulated other comprehensive loss (4,241) (297)
--------------------------------
Total shareholders' equity 326,629 326,600
--------------------------------
Total liabilities and shareholders' equity $ 3,341,453 $ 3,563,715
================================
The accompanying notes are a part of the consolidated financial statements.
3
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited - Dollars in thousands, except per share amounts)
Three Months Ended March 31,
-------------------------------------
2005 2004
-------------------------------------
Interest income:
Loans and leases $ 33,637 $ 32,454
Investment securities, taxable 3,818 4,289
Investment securities, tax-exempt 1,264 1,317
Other 77 65
-------------------------------------
Total interest income 38,796 38,125
Interest expense:
Deposits 12,316 9,823
Short-term borrowings 1,702 1,257
Subordinated notes 964 961
Long-term debt and mandatorily redeemable securities 210 322
-------------------------------------
Total interest expense 15,192 12,363
-------------------------------------
Net interest income 23,604 25,762
(Recovery of)/provision for loan and lease losses (421) 101
-------------------------------------
Net interest income after
provision for loan and lease losses 24,025 25,661
Noninterest income:
Trust fees 3,246 3,090
Service charges on deposit accounts 3,963 3,706
Mortgage banking income 2,767 (891)
Equipment rental income 4,015 5,824
Other income 2,800 2,542
Investment securities and other investment gains (losses) 904 (252)
-------------------------------------
Total noninterest income 17,695 14,019
-------------------------------------
Noninterest expense:
Salaries and employee benefits 18,544 15,754
Net occupancy expense 2,102 1,833
Furniture and equipment expense 2,642 2,584
Depreciation - leased equipment 3,323 4,536
Supplies and communication 1,343 1,432
Loan and lease collection and repossession (recovery)/expense (134) 1,055
Other expense 3,854 5,148
-------------------------------------
Total noninterest expense 31,674 32,342
-------------------------------------
Income before income taxes 10,046 7,338
Income tax expense 3,102 2,259
-------------------------------------
Net income $ 6,944 $ 5,079
=====================================
Other comprehensive income, net of tax:
Change in unrealized (depreciation) appreciation of
available-for-sale securities (3,944) 1,909
-------------------------------------
Total comprehensive income $ 3,000 $ 6,988
=====================================
Per common share:
Basic net income per common share $ 0.34 $ 0.25
=====================================
Diluted net income per common share $ 0.33 $ 0.24
=====================================
Dividends $ 0.120 $ 0.100
=====================================
Basic weighted average common shares outstanding 20,719,596 20,727,035
=====================================
Diluted weighted average common shares outstanding 21,041,812 21,035,918
=====================================
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, 2004 $314,691 $7,578 $214,001 $100,534 ($9,777) $2,355
- ------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income, net of tax:
Net Income 5,079 - - 5,079 - -
Change in unrealized appreciation
of available-for-sale securities, net of tax 1,909 - - - - 1,909
-----
Total Comprehensive Income 6,988 - - - - -
Issuance of 28,327 common shares
under stock based compensation plans,
including related tax effects 409 - - (10) 419 -
Cost of 7,169 shares of common
stock acquired for treasury (154) - - - (154) -
Cash dividend ($.100 per share) (2,074) - - (2,074) - -
- ------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2004 $319,860 $7,578 $214,001 $103,529 ($9,512) $4,264
==============================================================================================================================
Balance at January 1, 2005 $326,600 $7,578 $214,001 $115,830 ($10,512) ($297)
- ------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income, net of tax:
Net Income 6,944 - - 6,944 - -
Change in unrealized appreciation
of available-for-sale securities, net of tax (3,944) - - - - (3,944)
------
Total Comprehensive Income 3,000 - - - - -
Issuance of 15,866 common shares
under stock based compensation plans,
including related tax effects 326 - - 101 225 -
Cost of 35,675 shares of common
stock acquired for treasury (809) - - - (809) -
Cash dividend ($0.12 per share) (2,488) - - (2,488) - -
- ------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2005 $326,629 $7,578 $214,001 $120,387 ($11,096) ($4,241)
==============================================================================================================================
The accompanying notes are a part of the consolidated financial statements.
5
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited - Dollars in thousands)
Three Months Ended March 31,
-------------------------------
2005 2004
------------- -----------
Operating activities:
Net income $ 6,944 $ 5,079
Adjustments to reconcile net income to net cash
from operating activities:
Provision for loan and lease (recoveries) losses (421) 101
Depreciation of premises and equipment 4,659 5,777
Amortization of investment security premiums
and accretion of discounts, net 1,388 1,426
Amortization of mortgage servicing rights 1,803 1,919
Mortgage servicing asset (recoveries) impairment charges (1,089) 3,227
Deferred income taxes 7,007 4,309
Realized investment securities (gains) losses (904) 252
Change in mortgages held for sale (23,880) (21,435)
(Increase) decrease in interest receivable (296) 943
Increase in interest payable 99 762
Change in other assets 1,823 (5,541)
Change in other liabilities (1,932) (3,788)
Other (47) (617)
---------- -----------
Net cash from operating activities (4,846) (7,586)
Investing activities:
Proceeds from sales and maturities of investment securities 90,913 64,205
Purchases of investment securities (41,655) (28,949)
Net change in short-term investments 193,879 300
Loans sold or participated to others (18) 45
Net change in loans and leases 587 54,741
Net change in equipment owned under operating leases (618) 2,775
Purchases of premises and equipment (1,664) (191)
---------- -----------
Net cash from investing activities 241,424 92,926
Financing activities:
Net change in demand deposits, NOW
accounts and savings accounts (205,568) (116,527)
Net change in certificates of deposit (11,496) 33,302
Net change in short-term borrowings (8,014) (32,233)
Proceeds from issuance of long-term debt 312 396
Payments on long-term debt (95) (73)
Net proceeds from issuance of treasury stock 326 409
Acquisition of treasury stock (809) (154)
Cash dividends (2,534) (2,113)
---------- -----------
Net cash from financing activities (227,878) (116,993)
Net change in cash and cash equivalents 8,700 (31,653)
Cash and cash equivalents, beginning of year 78,255 109,787
---------- -----------
Cash and cash equivalents, end of period $ 86,955 $ 78,134
========== ===========
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 (2004 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, 2004 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 cost under the Executive
Incentive Plan and the Restricted Stock Award Plan is reflected in net income.
For the stock option plans, the stock option agreement, and the Employee Stock
Purchase Plan, no compensation cost is reflected in net income as all options
granted under these plans had an exercise price equal to, or approximating, 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," 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 5 - Stock-Based Compensation use the fair value method of SFAS No. 123 to
measure compensation cost for stock-based employee compensation plans.
Note 2. Recent Accounting Pronouncements
Accounting for Stock-Based Compensation: On December 16, 2004, the FASB
issued SFAS No. 123(R), "Share-Based Payment", which is a revision of SFAS No.
123, "Accounting for Stock-Based Compensation." SFAS No. 123(R) supersedes APB
No. 25, "Accounting for Stock Issued to Employees," and amends SFAS No. 95,
"Statement of Cash Flows." Generally, the approach in SFAS No. 123(R) is similar
to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the income statement based on their fair values. Pro forma
disclosure is no longer an alternative. Originally, SFAS No. 123(R) was required
to be adopted no later than July 1, 2005.
On April 14, 2005, the SEC issued an amendment to SFAS No. 123(R), which
allows companies to implement SFAS 123(R) at the beginning of their next fiscal
year, instead of the next reporting period, that begins after June 15, 2005. The
new rule does not change the accounting required by SFAS No. 123(R), it only
changes the dates for compliance with the standard. Early adoption is permitted
7
in periods in which financial statements have not yet been issued. 1st Source
expects to adopt SFAS No. 123(R) on January 1, 2006.
SFAS No. 123(R) permits public companies to adopt its requirements using
one of two methods:
1. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the
requirements of SFAS No. 123(R) for all share-based payments granted
after the effective date, and (b) based on the requirements of SFAS
No. 123 for all awards granted to employees prior to the effective
date of SFAS No. 123(R) that remain unvested on the effective date.
2. A "modified retrospective" method which includes the requirements of
the modified prospective method described above, but also permits
entities to restate based on the amounts previously recognized under
SFAS No. 123 for purposes of pro forma disclosures either (a) all
prior periods presented, or (b) prior interim periods of the year of
adoption.
1st Source has not made a determination as to which method it will utilize
upon adoption of SFAS No. 123(R). As permitted by SFAS No. 123, 1st Source
currently accounts for share-based payments to employees using APB Opinion No.
25's intrinsic value method and, as such, generally recognizes no compensation
cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)'s
fair value method may have a significant impact on our results of operations,
although it will have no impact on our overall financial position. The impact of
adoption of SFAS No. 123(R) cannot be predicted at this time because it will
depend on levels of share-based payments granted in the future. However, had we
adopted SFAS No. 123(R) in prior periods, the impact of the standard would have
approximated the impact of SFAS No. 123 as described in the disclosure of pro
forma net income and earnings per share in Note 5 of the consolidated financial
statements. SFAS No. 123(R) also requires the benefits of tax deductions in
excess of recognized compensation cost to be reported as a financing cash flow,
rather than as an operating cash flow as required under current literature. This
requirement will reduce net operating cash flows and increase net financing cash
flows in periods after adoption. 1st Source cannot estimate what those amounts
will be in the future (because they depend on, among other things, when
employees exercise stock options).
Note 3. 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 identified special attention loans and
leases (classified loans and leases and internal watch list credits), percentage
allocations for special attention loans and leases without specific reserves,
formula reserves for each business lending division portfolio, including a
higher percentage reserve allocation for special attention loans and leases
without a specific reserve, and reserves for pooled homogenous loans and leases.
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 4. Financial Instruments with Off-Balance-Sheet Risk
To meet the financing needs of its customers, 1st Source and its
subsidiaries are parties to financial instruments with off-balance-sheet risk in
the normal course of business. These off-balance-sheet financial instruments
8
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 1st Source to
guarantee the performance of a customer to a third party. The credit risk
involved and collateral obtained in issuing letters of credit is essentially the
same as that involved in extending loan commitments to customers.
As of March 31, 2005 and December 31, 2004, 1st Source had commitments
outstanding to originate and purchase mortgage loans aggregating $137.08 million
and $106.61 million, respectively. Outstanding commitments to sell mortgage
loans aggregated $128.34 million at March 31, 2005, and $83.82 million at
December 31, 2004. Standby letters of credit totaled $89.97 million and $90.67
million at March 31, 2005, and December 31, 2004, respectively. Standby letters
of credit have terms ranging from six months to one year.
Note 5. Stock-Based Compensation
The following pro forma information presents net income and earnings per
share for the three months ended March 31, 2005 and 2004 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
3 Months Ended
March 31
-------------- -----------
2005 2004
-------------- -----------
Net income, as reported (000's) $ 6,944 $ 5,079
Add: Stock-based employee compensation cost
included in reported net income, net of related
tax effects 916 422
Deduct: Total stock-based employee compensation
cost determined under fair value based method
for all awards, net of related tax effects
(938) (451)
Pro forma net income $ 6,922 $ 5,050
Earnings per share:
Basic--as reported $0.34 $0.25
Basic--pro forma $0.33 $0.24
Diluted--as reported $0.33 $0.24
Diluted--pro forma $0.33 $0.24
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,"
"should," 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 2004, 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 March 31,
2005, as compared to December 31, 2004, and the results of operations for the
three months ended March 31, 2005 and 2004. 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 2004 Annual Report.
10
FINANCIAL CONDITION
1st Source's assets at March 31, 2005, were $3.34 billion, down 6.24% from
December 31, 2004. Total loans and leases were down 0.05% and total deposits
decreased 7.73% over the comparable figures at the end of 2004.
Nonperforming assets at March 31, 2005, were $25.67 million compared to
$33.21 million at December 31, 2004, a decrease of 22.71%. Nonperforming assets
decreased due to a decrease in aircraft non-accrual loans and repossessed
aircraft. At March 31, 2005, nonperforming assets were 1.10% of net loans and
leases compared to 1.42% at December 31, 2004.
Accrued income and other assets were as follows:
(Dollars in Thousands)
March 31, December 31,
2005 2004
----------- -------------
Accrued income and other assets:
Bank owned life insurance cash surrender value $ 33,755 $ 33,552
Accrued interest receivable 12,801 12,505
Mortgage servicing assets 21,896 21,414
Other real estate 2,006 1,878
Repossessions 1,459 4,382
Intangible assets 22,931 23,588
All other assets 21,540 21,309
------------ -------------
Total accrued income and other assets $ 116,388 $ 118,628
============ =============
CAPITAL
As of March 31, 2005, total shareholders' equity was $326.63 million, up
0.01% from the $326.60 million at December 31, 2004. In addition to net income
of $6.94 million, other significant changes in shareholders' equity during the
first three months of 2005 included $0.81 million in treasury stock purchases,
and $2.49 million of dividends paid. The accumulated other comprehensive income
component of shareholders' equity totaled ($4.24) million at March 31, 2005,
compared to ($0.30) million at December 31, 2004. 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 9.78% as of March 31, 2005, compared to 9.16% at December 31, 2004.
Book value per common share rose to $15.77 at March 31, 2005, up from $15.76 at
December 31, 2004.
1st Source declared and paid dividends per common share of $0.12 during
the first quarter of 2005. The trailing four quarters dividend payout ratio,
representing dividends per share divided by diluted earnings per share, was
34.38%. 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. These
guidelines require all banks to maintain a minimum leverage capital ratio of
4.00% for adequately capitalized banks and 5.00% for well-capitalized banks. 1st
Source's leverage capital ratio was 11.01% at March 31, 2005.
11
The Federal Reserve Board has established risk-based capital guidelines
for U.S. banking organizations. The guidelines establish a conceptual framework
calling for risk weights to be assigned to on and off-balance sheet items in
arriving at risk-adjusted total assets, with the resulting ratio compared to a
minimum standard to determine whether a bank has adequate capital. The minimum
standard risk-based capital ratios effective in 2005 are 4.00% for adequately
capitalized banks and 6.00% for well-capitalized banks for Tier 1 risk-based
capital and 8.00% and 10.00%, respectively, for total risk-based capital. 1st
Source's Tier 1 risk-based capital ratio on March 31, 2005 was 13.78% and the
total risk-based capital ratio was 15.08%.
LIQUIDITY AND INTEREST RATE SENSITIVITY
The Bank's liquidity is monitored and closely managed by the
Asset/Liability Committee (ALCO), which is 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.
1st Source's 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. At March 31,
2005, the consolidated statement of financial condition was rate sensitive by
$71.3 million more liabilities than assets scheduled to reprice within one year,
or approximately 0.96%.
RESULTS OF OPERATIONS
Net income for the three month period ended March 31, 2005, was $6.94
million, compared to $5.08 million for the same period in 2004. Diluted net
income per common share was $0.33 for the three month period ended March 31,
2005, compared to $0.24 for the same period in 2004. Return on average common
shareholders' equity was 8.60% for the three months ended March 31, 2005,
compared to 6.43% in 2004. The return on total average assets was 0.84% for the
three months ended March 31, 2005, compared to 0.63% in 2004.
The increase in net income for the three months ended March 31, 2005, over
the first three months of 2004, was primarily the result of an increase in
mortgage banking income, a credit provision for loan and lease losses, and a
decrease in loan and lease collection and repossession expenses, offset by a
decrease in net interest income, and an increase in salaries and employee
benefit expense. Details of the changes in the various components of net income
are further discussed below.
12
NET INTEREST INCOME
The taxable equivalent net interest income for the three months ended
March 31, 2005, was $24.25 million, a decrease of 8.39% over the same period in
2004. The net interest margin on a fully taxable equivalent basis' was 3.15% for
the three months ended March 31, 2005, compared to 3.53% for the three months
ended March 31, 2004. 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 fifteen basis points for the three months ended March
31, 2005, versus a reduction of eight basis points for the three months ended
March 31, 2004.
Total average earning assets increased 3.60% for the three month period
ended March 31, 2005, over the comparative period in 2004. Average loan and
lease outstandings also increased 3.60% for the three month period, compared to
the same period in 2004, due primarily to increased loan outstandings in
commercial loans and medium and heavy duty truck financings offset by decreases
in aircraft and construction equipment financings. Total average investment
securities increased 14.96% for the three month period over one year ago due to
an increase in United States treasury and municipal securities offset by a
reduction in other securities. For the three month period, average mortgages
held for sale decreased 19.33%, as demand for mortgage loans was lower in the
first quarter of 2005. Other investments, which include federal funds sold, time
deposits with other banks and trading account securities, increased for the
three month period over one year ago as excess funds were invested. The taxable
equivalent yields on total average earning assets were 5.12% and 5.18% for the
three month period ended March 31, 2005 and 2004, respectively.
Average interest-bearing deposits increased 7.66% for the three month
period over the same period in 2004. The rate on average interest-bearing
deposits was 2.26% and 1.92% for the three month periods ended March 31, 2005
and 2004, due to an increase in public funds and brokered deposits. These higher
cost deposits were pursued due to increased funding needs. The rate on average
interest-bearing funds was 2.39% and 1.98% for the three months ended March 31,
2005 and 2004, respectively.
The following table sets forth consolidated information regarding average
balances and rates.
13
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
(Dollars in thousands)
Three months ended March 31,
--------------------------------
2005 2004
--------------------------------- ----------------------------
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
--------------------------------- ----------------------------
ASSETS:
Investment securities:
Taxable $ 596,070 $ 3,818 2.60% $ 569,634 $ 4,289 3.03%
Tax exempt (1) 181,472 1,851 4.14% 171,170 1,957 4.60%
Mortgages - held for sale 55,214 783 5.75% 68,443 907 5.33%
Net loans and leases (2 & 3) 2,278,249 32,916 5.86% 2,199,040 31,620 5.78%
Other investments 13,744 77 2.27% 7,843 65 3.33%
--------------------------------- ----------------------------
Total Earning Assets 3,124,749 39,445 5.12% 3,016,130 38,838 5.18%
Cash and due from banks 80,430 77,275
Reserve for loan and lease losses (63,661) (70,141)
Other assets 197,149 227,295
---------- -----------
Total $3,338,667 $3,250,559
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing deposits $2,211,167 $ 12,316 2.26% $2,053,841 $ 9,823 1.92%
Short-term borrowings 292,806 1,702 2.36% 380,694 1,257 1.33%
Subordinated notes 59,022 964 6.62% 56,444 961 6.85%
Long-term debt and
mandatorily redeemable securities 17,923 210 4.75% 23,061 322 5.62%
--------------------------------- ----------------------------
Total Interest-bearing Liabilities 2,580,918 15,192 2.39% 2,514,040 12,363 1.98%
Noninterest-bearing deposits 377,925 359,952
Other liabilities 52,289 58,996
Shareholders' equity 327,535 317,571
---------- -----------
Total $3,338,667 $3,250,559
========== ===========
-------- ---------
Net Interest Income $ 24,253 $ 26,475
======== =========
Net Yield on Earning Assets on a Taxable
----- -----
Equivalent Basis 3.15% 3.53%
===== =====
(1) Interest income includes the effects of taxable equivalent adjustments,
using a 35% rate. Tax equivalent adjustments were $587 in 2005 and $640 in
2004.
(2) Loan and lease income includes fees on loans and leases of ($196) in 2005
and $826 in 2004. Loan and lease income also includes the effects of
taxable equivalent adjustments, using 35% rate for 2005 and 2004. The tax
equivalent adjustments were $62 in 2005 and $73 in 2004.
(3) For purposes of this computation, nonaccruing loans and leases are included
in the daily average loan and lease amounts outstanding.
14
PROVISION AND RESERVE FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses for the three month periods ended
March 31, 2005 and 2004, was ($0.42) million and $0.10 million, respectively.
Net charge-offs of $0.60 million were recorded for the first quarter 2005,
compared to $0.10 million for the same quarter a year ago.
In the first quarter 2005, 1st Source continued to experience moderate
improvement in credit quality. Loan and lease delinquencies were 0.57% on March
31, 2005, as compared to 1.17% on March 31, 2004, and 0.70% at the end of 2004.
The reserve for loan and lease losses as a percentage of loans and leases
outstanding at the end of the period was 2.75% as compared to 3.22% one year ago
and 2.79% at December 31, 2004. A summary of loan and lease loss experience
during the three month periods ended March 31, 2005 and 2004, is provided below.
Summary of Reserve for
Loan and Lease Losses
-----------------------------
Three Months Ended March 31,
-----------------------------
2005 2004
------------- --------------
Reserve for loan and lease losses - beginning balance $ 63,672 $ 70,045
Charge-offs (2,203) (1,573)
Recoveries 1,599 1,472
------------- --------------
Net charge-offs (604) (101)
(Recovery of)/provision for loan and lease losses (421) 101
------------- --------------
Reserve for loan and lease losses - ending balance $ 62,647 $ 70,045
============= ==============
Loans and leases outstanding at end of period $ 2,278,995 $ 2,176,113
Average loans and leases outstanding during period 2,278,249 2,199,040
Reserve for loan and lease losses as a percentage of
loans and leases outstanding at end of period 2.75% 3.22%
Ratio of net charge-offs during period to
average loans and leases outstanding 0.11% 0.02%
NONPERFORMING ASSETS
Nonperforming assets were as follows:
(Dollars in thousands)
March 31, December 31, March 31,
2005 2004 2004
------------- ------------- -----------
Loans and leases past due 90 days or more $ 206 $ 481 $ 230
Nonaccrual and restructured loans and leases 21,281 25,253 23,356
Other real estate 1,438 1,307 2,541
Repossessions 1,459 4,382 6,234
Equipment owned under operating leases 1,282 1,785 280
------------- ------------- -----------
Total nonperforming assets $ 25,666 $ 33,208 $ 32,641
============= ============= ===========
15
Nonperforming assets totaled $25.67 million at March 31, 2005, decreasing
22.71% from $33.21 million at December 31, 2004, and decreasing 21.37% from
$32.64 million at March 31, 2004. The decrease during the first quarter 2005 was
primarily related to a decrease in aircraft and construction equipment
nonaccrual loans and leases and repossessed aircraft. Nonperforming assets as a
percentage of total loans and leases improved to 1.10% at March 31, 2005, from
1.42% at December 31, 2004, and 1.45% at March 31, 2004.
As of March 31, 2005, 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 consist of aircraft, automobiles, light trucks, construction
equipment and environmental equipment at March 31, 2005. At the time of
repossession, the recorded amount of the loan or lease is written down, if
necessary, to the estimated value of the equipment or vehicle by a charge to the
reserve for loan and lease 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 or lease 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 (gains) losses upon
disposition of repossessions for the three month period ended March 31, 2005 and
2004, totaled ($0.52) million and $0.14 million, respectively.
Supplemental Loan and Lease Information as of March 31, 2005
(Dollars in thousands) Other real estate Year-to-date
Loans and leases owned and net credit losses/
outstanding Nonaccrual repossessions recoveries
-------------- ------------- ----------------- ----------------
Commercial and agricultural loans $ 431,750 $ 6,880 $ - $ (58)
Auto, light truck and environmental equipment 269,361 2,096 609 472
Medium and heavy duty truck 274,097 123 - (2)
Aircraft financing 423,017 6,666 800 (538)
Construction equipment financing 200,601 3,805 - 18
Loans secured by real estate 579,388 1,378 1,438 111
Consumer loans 100,781 333 50 241
-------------- ------------- ----------------- ----------------
Total $2,278,995 $ 21,281 $ 2,897 $ 244
============== ============= ================= ================
For financial statements purposes, non-accrual loans and leases are included in
loan and lease outstandings, whereas repossessions and other real estate are
included in other assets. Net credit losses include net charge-offs on loans and
leases and valuation adjustments and gains and losses on disposition of
repossessions and defaulted operating leases.
16
NONINTEREST INCOME
Noninterest income for the three-month periods ended March 31, 2005 and
2004, was $17.70 million and $14.02 million, respectively. The predominant
factor behind the increase in 2005 was an increase in mortgage banking income.
(Dollars in thousands)
Three Months Ended March 31,
-----------------------------
2005 2004
-----------------------------
Noninterest income:
Trust fees $ 3,246 $ 3,090
Service charges on deposit accounts 3,963 3,706
Mortgage banking income 2,767 (891)
Insurance commissions 1,164 962
Equipment rental income 4,015 5,824
Other income 1,636 1,580
Investment securities and other investment gains (losses) 904 (252)
--------- ---------
Total noninterest income $ 17,695 $ 14,019
========= =========
Mortgage banking income increased primarily due to mortgage servicing
rights recovery of $1.09 million in the first quarter of 2005 versus impairment
of $3.23 million for the same period in 2004. Mortgage banking income was
negatively impacted during the first quarter of 2005 by reduced origination
volumes and decreased gains on sales of loans into the secondary market as
compared to the first quarter of 2004.
Trust fees, service charges on deposit accounts, and insurance commission
income increased slightly during the first quarter of 2005 as compared to the
first quarter 2004. Equipment rental income decreased due to the decrease in the
operating lease portfolio. Investment security and other investment gains were
mainly due to the effects of market value adjustments of venture capital
investments.
NONINTEREST EXPENSE
Noninterest expense for the three-month periods ended March 31, 2005 and
2004, was $31.67 million and $32.34 million, respectively. The decrease in
noninterest expense in 2005 was primarily due to decreased loan and lease
collection and repossession expense, offset by increased salaries and employee
benefits and net occupancy expense.
17
(Dollars in thousands)
Three Months Ended March 31,
-----------------------------
2005 2004
-----------------------------
Noninterest expense:
Salaries and employee benefits $ 18,544 $ 15,754
Net occupancy expense 2,102 1,833
Furniture and equipment expense 2,642 2,584
Depreciation - leased equipment 3,323 4,536
Professional fees 799 1,561
Supplies and communication 1,343 1,432
Business development and marketing expense 608 632
Intangible asset amortization 658 658
Loan and lease collection and
repossession (recovery)/expense (134) 1,055
Other 1,789 2,297
--------- ---------
Total noninterest expense $ 31,674 $ 32,342
========= =========
The increase in salaries and employee benefits was caused primarily by higher
executive incentive and compensated absences accruals and increased group
insurance costs for the first quarter 2005 versus the first quarter of 2004.
Professional fees decreased as of March 31, 2005, as compared to March 31, 2004.
The decrease was primarily due to settlement of the lawsuit described in the
2003 Form 10-K Item 3, Legal Proceedings and the associated legal fees. Loan and
lease collection and repossession expense decreased on a year-over-year basis as
gains on disposition of repossessed assets increased and valuation adjustments
related to repossessed assets decreased.
Net occupancy expense increased for the first quarter of 2005 as compared
to the first quarter of 2004. During the first quarter 2005, 1st Source reviewed
its lease accounting practices in light of the views expressed by the Office of
the Chief Accountant of the SEC in a February 7, 2005 letter to the American
Institute of Certified Public Accountants. As a result of its review, 1st Source
recorded a one-time, net charge of $0.27 million to correct its accounting for
straight-line rent and depreciation of leasehold improvements.
Furniture and equipment expense, supplies and communication, and business
development and marketing expense, all remained comparable to 2004 levels.
Leased equipment depreciation decreased due to the decrease in the operating
lease portfolio. Other expenses increased primarily due to favorable market
value adjustments on derivatives in 2005 versus unfavorable market value
adjustments for 2004.
INCOME TAXES
The provision for income taxes for the three months ended March 31, 2005,
was $3.10 million, compared to $2.26 million for the comparable period in 2003.
The provision for income taxes for the three months ended March 31, 2005 and
2004, is at a rate which management believes approximates the effective rate for
the year.
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, 2004. 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,
2004.
18
ITEM 4.
CONTROLS AND PROCEDURES
As of the end of the period covered by this report, 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 (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 March 31, 2005, 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.
In addition, there were no changes in 1st Source's internal control (as
defined in Exchange Act Rule 13a-15(f))over financial reporting during the first
fiscal quarter of 2005 that have materially affected, or are reasonably likely
to materially affect, 1st Source's internal controls over financial reporting.
PART II.
OTHER INFORMATION
ITEM 1. Legal Proceedings.
1st Source and its subsidiaries are involved in various legal proceedings
incidental to the conduct of their businesses. Management does not expect that
the outcome of any such proceedings will have a material adverse effect on 1st
Source's consolidated financial position or results of operations.
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 the plans or programs
- ---------------------------------------------------------------------------------------------------------------------------------
January 01 - 31, 2005 0 0 0 648,659
February 01 - 28, 2005 35,675 22.69 35,675 612,984
March 01 - 31, 2005 0 0 0 612,984
(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 426,006 shares.
ITEM 3. Defaults Upon Senior Securities.
None
19
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.
20
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 April 28, 2005 /s/CHRISTOPHER J. MURPHY III
- ---- -------------- ----------------------------
Christopher J. Murphy III
Chairman of the Board,
President and CEO
DATE April 28, 2005 /s/LARRY E. LENTYCH
- ---- -------------- -------------------
Larry E. Lentych
Treasurer and Chief Financial Officer
Principal Accounting Officer
21