UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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 N. Michigan Street
South Bend, Indiana 46601
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (574) 235-2000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
9% Cumulative Trust Preferred Securities and related guarantee - $25 par value
(Title of Class)
Floating Rate Cumulative Trust Preferred Securities and
related guarantee - $25 par value
(Title of Class)
Common Stock - without par value
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|
The aggregate market value of the voting common stock held by non-affiliates of
the registrant as of June 28, 2002 was $281,076,980.
The number of shares outstanding of each of the registrant's classes of stock as
of February 5, 2003: Common Stock, without par value - 21,191,171 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the annual proxy statement for the 2003 annual meeting of
shareholders to be held April 22, 2003, are incorporated by reference into Part
III.
TABLE OF CONTENTS
Part I
Item 1. Business......................................................................................... 3
Item 2. Properties....................................................................................... 8
Item 3. Legal Proceedings................................................................................ 8
Item 4. Submission of Matters to a Vote of Security Holders.............................................. 8
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............................ 9
Item 6. Selected Financial Data.......................................................................... 9
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 10
Item 7A. Quantitative and Qualitative Disclosures about Market Risk....................................... 19
Item 8. Financial Statements and Supplementary Data...................................................... 20
Consolidated Statements of Financial Condition
Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders' Equity
Consolidated Statements of Cash Flow
Notes to Consolidated Financial Statements
Report of Independent Auditors
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............. 40
Part III
Item 10. Directors and Executive Officers of the Registrant............................................... 41
Item 11. Executive Compensation........................................................................... 41
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters... 41
Item 13. Certain Relationships and Related Transactions................................................... 41
Item 14. Controls and Procedures.......................................................................... 41
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................. 42
Signatures ................................................................................................. 44
Certifications ............................................................................................. 45
PART I
ITEM 1. BUSINESS.
GENERAL
1st Source Corporation is an Indiana corporation and registered bank holding
company headquartered in South Bend, Indiana which commenced operations as a
bank holding company in 1971. As used herein, unless the context otherwise
requires, the term "1st Source" refers to 1st Source Corporation and its
subsidiaries. At December 31, 2002, 1st Source had assets of $3.41 billion,
deposits of $2.71 billion and total shareholders' equity of $309.43 million.
1st Source, through its principal subsidiary 1st Source Bank (hereafter known as
"Bank"), delivers a comprehensive range of consumer and commercial banking
services to individual and business customers through 63 banking locations in
the Northern Indiana-Southwestern Michigan market area. The Bank also competes
for business nationwide by offering specialized financing services for used
private and cargo aircraft, automobiles for leasing and rental agencies, heavy
duty trucks, construction and environmental equipment. The Bank, which was
chartered as an Indiana state bank in 1922, is a member of the Federal Reserve
System and its deposits are insured by the Federal Deposit Insurance Corporation
(FDIC) to the extent provided by law. The Bank is headquartered in South Bend,
Indiana, which is in Northern Indiana, approximately 95 miles east of Chicago
and 140 miles north of Indianapolis. Its principal market area consists of
seventeen counties in Northern Indiana and Southwestern lower Michigan.
The principal executive office of 1st Source is located at 100 North Michigan
Street, South Bend, Indiana 46601 and its telephone number is 574 235-2000.
Access to 1st Source's annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and all amendments to those reports is
available at www.1stsource.com soon after the material is electronically filed
with the SEC.
BANKING AND FINANCIAL SERVICES
The organization offers a broad range of consumer and commercial banking
services through its lending operations, retail branches and fee based
businesses.
Commercial, Agricultural and Real Estate Loans -- 1st Source's commercial and
agriculture loans (excluding Specialty Finance Group loans) at December 31,
2002, were $428.37 million and were 18.42% of total loans outstanding. The
primary focus of this lending area is with privately-held or closely-controlled
firms in 1st Source's regional market area of Northern Indiana and Southwest
Michigan.
Loans secured by real estate amounted to $567.95 million, which was 24.42% of
total loans outstanding, at December 31, 2002. The primary focus of this lending
area is commercial real estate and residential mortgage lending in the regional
market area of Northern Indiana and Southwest Michigan. Most of the residential
mortgages are sold into the secondary market and serviced by 1st Source's
mortgage subsidiary, Trustcorp Mortgage Company (Trustcorp). Mortgage loans
held-for-sale were $146.64 million at December 31, 2002.
1st Source offers both fixed-rate and adjustable-rate consumer mortgage loans
secured by the properties, substantially all of which are located in 1st
Source's primary market area. Adjustable-rate mortgage loans help reduce 1st
Source's exposure to changes in interest rates. During periods of rising
interest rates the risk of default on adjustable-rate mortgage loans may
increase as a result of repricing and the increased payments required from the
borrower.
Commercial and commercial real estate loans generally involve higher credit
risks than residential real estate and consumer loans. Because payments on loans
secured by commercial real estate or equipment are often dependent upon the
successful operation and management of the collateral, repayment of such loans
may be influenced to a great extent by conditions in the market or the economy.
1st Source seeks to minimize these risks through its underwriting standards,
which require such loans to be qualified on the basis of the collateral's income
and debt service ratio. 1st Source obtains extensive financial information and
performs detailed credit risk analysis on its customers. 1st Source's credit
policy sets different maximum exposure limits depending on its relationship and
previous experience with each customer. Credit criteria may include, but are not
limited to, customer trade route, assessments of net worth, asset ownership,
bank and trade credit reference, credit bureau report, and operational history.
Consumer Loans -- 1st Source's consumer loans at December 31, 2002, amounted to
$111.01 million and 4.77% of total loans outstanding. Consumer loans are
primarily all other non-real estate loans to individuals in 1st Source's
regional market area.
Consumer loans can entail risk, particularly in the case of loans that are
unsecured or secured by rapidly depreciating assets. In these cases, any
repossessed collateral may not provide an adequate source of repayment of the
outstanding loan balance. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Speciality Finance Group Loans and Leases -- 1st Source's Specialty Finance
Group provides a broad range of comprehensive lease and equipment finance
products addressing the financing needs of diverse companies. This Group can be
broken down into three areas: truck and automobile financing, aircraft financing
and construction equipment financing. The finance receivables generally provide
for monthly payments and may include prepayment penalty provisions.
Truck and automobile financing consists of financings to automobile rental and
leasing companies, heavy duty truck operating and leasing companies, and
environmental companies. Truck and automobile financing at December 31, 2002 had
outstandings of $445.20 million, an increase of 29.41% over the December 31,
2001 balance of $344.01 million. The increase was mainly due to growth in the
financing receivables of heavy duty trucks, as this portfolio increased from
$131.23 million at December 31, 2001 to $197.24 million at December 31, 2002.
Truck and automobile finance receivables generally range from $50,000 to $15
million with fixed or variable interest rates and terms of two to seven years.
Aircraft financing consists of financings to aircraft dealers, charters,
air cargo carriers, and corporate aircraft users. Aircraft financing at December
31, 2002 had outstandings of $323.80 million, a decrease of 37.07% from December
31, 2001 balance of $514.57 million. Aircraft finance receivables generally
range from $100,000 to $15 million with fixed or variable interest rates and
terms of two to seven years.
Construction equipment financing includes financing of equipment to construction
related companies. Construction equipment financing at December 31, 2002 had
outstandings of $303.13 million, a decrease of 7.58% from the December 31, 2001
balance of $328.00 million. Construction equipment finance receivables generally
range from $50,000 to $7 million with fixed or variable interest rates and terms
of three to seven years.
Aircraft and auto loans totaling approximately $400 million are securitized.
Loan sale and servicing income resulting from securitization activities totaled
$4.83 million in 2002.
1st Source also generates equipment rental income through the leasing of
construction equipment, various automobiles and other equipment to customers
through operating leases, where 1st Source retains ownership of the property
being leased. Total equipment rental income for 2002 totaled $28.77 million with
depreciation on this equipment amounting to $23.49 million.
This loan category is subject to the same credit risk as mentioned above in the
discussion under Commercial, Agricultural and Real Estate Loans. In addition,
1st Source's leasing and equipment-financing activity is subject to the risk of
cyclical downturns and other adverse economic developments affecting these
industries and markets. This area of lending, with transportation in particular,
is dependent upon general economic conditions and the strength of the travel and
transportation industries. The industry appeared to be experiencing the
beginning of a cyclical downturn in early 2001 and this downturn was exacerbated
by the terrorist attacks of September 11, 2001 and their aftermath. An economic
slowdown in recent periods has had a negative impact on 1st Source's equipment
finance origination as well as credit quality in certain industry segments such
as the transportation industry. For a further discussion of business risk, see
Part I, Item I, Business - section titled "Business Risks."
1st Source markets its specialty finance services with sales officers based in
26 locations nationwide. 1st Source markets its financing and leasing services
directly to the equipment end users for the acquisition or leasing of equipment,
and for capital loans.
1st Source's marketing activities are relationship driven and service oriented.
1st Source focuses on providing prompt, responsive and customized service to its
customers and business prospects with a team of dedicated marketing and
management personnel who solicit business from the users of the equipment, as
well as from dealers and manufacturers. 1st Source's relationship managers and
executive personnel have, on average, twenty years of experience in the
industries they serve. Management believes that the knowledge base and
relationships built by this team enables 1st Source to compete effectively. The
team's experience with the customer and prospect base, equipment values, resale
markets, and local economic and industry conditions places 1st Source in a
strong competitive position. 1st Source's initiatives include making timely
credit decisions, arranging financing structures which meet the customers' needs
as well as 1st Source's underwriting criteria, providing direct contact between
customers and 1st Source executives with decision-making authority, and
providing swift and knowledgeable responses to customers' inquiries and issues
encountered in the ordinary course of their business.
1st Source obtains business in several ways. Officers travel throughout their
own geographic territories calling directly on prospects - one on one. Officers
receive referrals from present customers, as well as from dealers,
manufacturers, and some select, targeted advertising. Officers also attend
numerous trade shows.
1st Source has developed relationships with over 100 manufacturers, whereby on a
non-exclusive basis, the manufacturers refer customers to 1st Source for
financing. However, 1st Source does not provide a captive finance service, and
thus has no expressed or written agreements or obligations with any
manufacturers. All prospects referred undergo the same credit and documentation
criteria as other customers.
Deposits -- Through its network of 63 banking centers located in 17 counties in
Indiana and Michigan, 1st Source generates deposits to fund its lending
activities. Total deposits at December 31, 2002 were $2.71 billion. To enhance
customer service, 1st Source offers banking services, in addition to its
traditional branches, through its network of 73 automated teller machines, bank
by phone services and online personal and business financial products. Service
charges on deposit accounts totaled $14.95 million for 2002.
Fee Based Businesses -- 1st Source maintains various fee based businesses to
complement net interest income.
Trust fees are generated from employee benefit services, personal and agency
trusts and estate planning. In 2002, trust fees were $10.25 million.
Mortgage loan sale and servicing income for 2002 amounted to $2.57 million.
Income from loan sale and servicing is generated from the mortgage banking
operations of Trustcorp. Trustcorp serviced approximately $2.30 billion of
mortgage loans at December 31, 2002. During 2002, $7.33 million of impairment
charges were recognized on Trustcorp's servicing portfolio.
Insurance commissions from 1st Source's property and casualty insurance agency
totaled $2.43 million for 2002.
SERVICES OFFERED BY THE NON-BANKING SUBSIDIARIES
1st Source's other subsidiaries include 1st Source Leasing, Inc., a leasing
subsidiary; 1st Source Insurance, Inc., a general property and casualty
insurance agency in South Bend; 1st Source Capital Corporation, a licensed small
business investment company; 1st Source Capital Trust I, II and III,
subsidiaries created to issue $54.75 million of Trust Preferred Securities;
Michigan Transportation Finance Corporation, 1st Source Specialty Finance, Inc.,
SFG Equipment Leasing, Inc., 1st Source Intermediate Holding, LLC ,1st Source
Commercial Aircraft Leasing Inc. and SFG Equipment Leasing Corporation I,
companies that manage the assets of the Specialty Finance Group; 1st Source
Funding, LLC, a qualified special purpose entity established for purposes of
administering securitization
activity; Trustcorp Mortgage Company, a mortgage banking company with seven
offices in Indiana, Ohio and Michigan and 1st Source Corporation Investment
Advisors, Inc., a registered investment advisory subsidiary that provides
investment management services to the 1st Source Monogram Funds and the trust
and investment clients of 1st Source Bank. 1st Source's one inactive subsidiary
is FBT Capital Corporation.
COMPETITION
The activities in which 1st Source and the Bank engage are highly competitive.
These activities and the geographic markets served primarily involve competition
with other banks, some of which are affiliated with large bank holding companies
headquartered outside of 1st Source's principal market. Larger financial
institutions competing within 1st Source's principal market, but headquartered
elsewhere, include Bank One, Fifth Third Bank, Key Bank, National City Bank,
Standard Federal Bank and Wells Fargo Bank. Competition among financial
institutions is based upon interest rates offered on deposit accounts, interest
rates charged on loans and other credit and service charges, the quality of
services rendered, the convenience of banking facilities and, in the case of
loans to large commercial borrowers, relative lending limits.
In addition to competing with other banks within its primary service areas, the
Bank also competes with other financial intermediaries, such as credit unions,
industrial loan associations, securities firms, insurance companies, small loan
companies, finance companies, mortgage companies, real estate investment trusts,
certain governmental agencies, credit organizations and other enterprises.
Additional competition for depositors' funds comes from United States Government
securities, private issuers of debt obligations and suppliers of other
investment alternatives for depositors. Many of 1st Source's non-bank
competitors are not subject to the same extensive federal regulations that
govern bank holding companies and banks. Such non-bank competitors may, as a
result, have certain advantages over 1st Source in providing some services.
1st Source competes against these financial institutions by offering innovative
products and highly personalized services. 1st Source also relies on a history
in the market dating back to 1863, relationships that long-term employees have
with their customers and the capacity for quick local decision-making.
EMPLOYEES
1st Source employs approximately 1,233 persons on a full-time equivalent basis.
1st Source provides a wide range of employee benefits and considers employee
relations to be good.
REGULATION AND SUPERVISION
General -- 1st Source and the Bank are extensively regulated under federal and
state law. These laws and regulations are intended to protect depositors, not
shareholders. To the extent that the following information describes statutory
or regulatory provisions, it is qualified in its entirety by reference to the
particular statutory and regulatory provisions. Any change in applicable laws or
regulations may have a material effect on the business and prospects of 1st
Source. The operations of 1st Source may be affected by legislative changes and
by the policies of various regulatory authorities. 1st Source is unable to
predict the nature or the extent of the effects on its business and earnings
that fiscal or monetary policies, economic controls or new federal or state
legislation may have in the future.
1st Source is a registered bank holding company under the Bank Holding Company
Act of 1956 (BHCA) and, as such, is subject to regulation, supervision and
examination by the Board of Governors of the Federal Reserve System (Federal
Reserve). 1st Source is required to file annual reports with the Federal Reserve
and to provide the Federal Reserve such additional information as it may
require.
The Bank, as an Indiana state bank and member of the Federal Reserve System, is
supervised by the Indiana Department of Financial Institutions (DFI) and the
Federal Reserve. As such, the Bank is regularly examined by and subject to
regulations promulgated by the DFI and the Federal Reserve. Because the FDIC
provides deposit insurance to the Bank, the Bank is also subject to supervision
and regulation by the FDIC (even though the FDIC is not its primary federal
regulator).
Bank and Bank Holding Company Regulation -- As noted above, both 1st Source and
the Bank are subject to extensive regulation and supervision.
Bank Holding Company Act -- Under the BHCA, as amended, the activities of a bank
holding company, such as 1st Source, are limited to business so closely related
to banking, managing or controlling banks as to be a proper incident thereto.
1st Source is also subject to capital requirements applied on a consolidated
basis in a form substantially similar to those required of the Bank. The BHCA
also requires a bank holding company to obtain approval from the Federal Reserve
before (i) acquiring, or holding more than 5% voting interest in any bank or
bank holding company, (ii) acquiring all or substantially all of the assets of
another bank or bank holding company, or (iii) merging or consolidating with
another bank holding company.
The BHCA also restricts non-bank activities to those which, by statute or by
Federal Reserve regulation or order, have been identified as activities closely
related to the business of banking or of managing or controlling banks. As
discussed below, the Gramm-Leach-Bliley Act, which was enacted in 1999,
established a new type of bank holding company known as a "financial holding
company," that has powers that are not otherwise available to bank holding
companies.
Financial Institutions Reform, Recovery and Enforcement Act of 1989 -- The
Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA)
reorganized and reformed the regulatory structure applicable to financial
institutions generally.
The Federal Deposit Insurance Corporation Improvement Act of 1991 -- The Federal
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) was adopted to
supervise and regulate a wide variety of banking issues. In general, FDICIA
provides for the recapitalization of the Bank Insurance Fund (BIF), deposit
insurance reform, including the implementation of risk-based deposit insurance
premiums, the establishment of five capital levels for financial institutions
("well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized") that would
impose more scrutiny and restrictions on less capitalized institutions, along
with a number of other supervisory and regulatory issues.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 -- Congress
enacted the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(hereafter known as "Interstate Act") in September 1994. Beginning in September
1995, bank holding companies have the right to expand, by acquiring existing
banks, into all states, even those which had theretofore restricted entry. The
legislation also provides that, subject to future action by individual states, a
holding company has the right to convert the banks which it owns in different
states to branches of a single bank. The states of Indiana and Michigan have
adopted the interstate branching provisions of the Interstate Act.
Economic Growth and Regulatory Paperwork Reduction Act of 1996 -- The Economic
Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA) was signed into
law on September 30, 1996. EGRPRA streamlined the non-banking activities
application process for well-capitalized and wellmanaged bank holding companies.
Gramm-Leach-Bliley Act of 1999 -- The Act is intended to modernize the banking
industry by removing barriers to affiliation among banks, insurance companies,
the securities industry and other financial service providers. It provides
financial organizations with the flexibility of structuring such affiliations
through a holding company structure or through a financial subsidiary of a bank,
subject to certain limitations. The Act establishes a new type of bank holding
company, known as a financial holding company, that may engage in an expanded
list of activities that are "financial in nature," which include securities and
insurance brokerage, securities underwriting, insurance underwriting and
merchant banking. The Act also sets forth a system of functional regulation that
makes the Federal Reserve the "umbrella supervisor" for holding companies, while
providing for the supervision of the holding company's subsidiaries by other
federal and state agencies. A bank holding company may not become a financial
holding company if any of its subsidiary financial institutions are not
well-capitalized or well-managed. Further, each bank subsidiary of the holding
company must have received at least a satisfactory Community Reinvestment Act
(CRA) rating. The Act also expands the types of financial activities a national
bank may conduct through a financial subsidiary, addresses state regulation of
insurance, generally prohibits unitary thrift holding companies organized after
May 4, 1999 from participating in new financial activities, provides privacy
protection for nonpublic customer information of financial institutions,
modernizes the Federal Home Loan Bank system and makes miscellaneous regulatory
improvements. The Federal Reserve and the Secretary of the Treasury must
coordinate their supervision regarding approval of new financial activities to
be conducted through a financial holding company or through a financial
subsidiary of a bank. While the provisions of the Act regarding activities that
may be conducted through a financial subsidiary directly apply only to national
banks, those provisions indirectly apply to state-chartered banks. In addition,
the Bank is subject to other provisions of the Act, including those relating to
CRA and privacy, regardless of whether 1st Source elects to become a financial
holding company or to conduct activities through a financial subsidiary of the
Bank. 1st Source does not, however, currently intend to file notice with the
Board to become a financial holding company or to engage in expanded financial
activities through a financial subsidiary of the Bank.
Regulations Governing Capital Adequacy -- The federal bank regulatory agencies
use capital adequacy guidelines in their examination and regulation of bank
holding companies and banks. If the capital falls below the minimum levels
established by these guidelines, the bank holding company or bank may be denied
approval to acquire or establish additional banks or nonbank businesses or to
open facilities. The various regulatory capital requirements that 1st Source is
subject to are disclosed in Part II, Item 8, Financial Statements and
Supplementary Data -- Note N of the Notes to Consolidated Financial Statements.
Management of 1st Source believes that the risk-weighting of assets and the
risk-based capital guidelines do not have a material adverse impact on 1st
Source's operations or on the operations of the Bank.
Community Reinvestment Act -- The Community Reinvestment Act of 1977 requires
that, in connection with examinations of financial institutions within their
jurisdiction, the federal banking regulators must evaluate the record of the
financial institutions in meeting the credit needs of their local communities,
including low and moderate income neighborhoods, consistent with the safe and
sound operation of those banks. These factors are also considered in evaluating
mergers, acquisitions and applications to open a branch or facility.
Regulations Governing Extensions of Credit -- The Bank is subject to certain
restrictions imposed by the Federal Reserve Act on extensions of credit to the
bank holding company or its subsidiaries, or investments in their securities and
on the use of their securities as collateral for loans to any borrowers.
These regulations and restrictions may limit the ability of 1st Source to obtain
funds from the Bank for its cash needs, including funds for acquisitions and for
payment of dividends, interest and operating expenses. Further, under the BHCA
and certain regulations of the Federal Reserve, a bank holding company and its
subsidiaries are prohibited from engaging in certain tying arrangements in
connection with any extension of credit, lease or sale of property or furnishing
of services.
The Bank is also subject to certain restrictions imposed by the Federal Reserve
Act on extensions of credit to executive officers, directors, principal
shareholders or any related interest of such persons. Extensions of credit (i)
must be made on substantially the same terms, including interest-rates and
collateral, and following credit underwriting procedures that are not less
stringent than, as those prevailing at the time for comparable transactions with
persons not covered above and who are not employees and (ii) must not involve
more than the normal risk of repayment or present other unfavorable features.
The Bank is also subject to certain lending limits and restrictions on
overdrafts to such persons.
Reserve Requirements -- The Federal Reserve requires all depository institutions
to maintain reserves against their transaction accounts and non-personal time
deposits. Reserves of 3% must be maintained against total transaction accounts
of $41.30 million or less (subject to adjustment by the Federal Reserve) and 10%
must be maintained against that portion of total transaction accounts in excess
of such amount.
Dividends -- The ability of the Bank to pay dividends and management fees is
limited by various state and federal laws, by the regulations promulgated by its
primary regulators and by the principles of prudent bank management.
Monetary Policy and Economic Control -- The commercial banking business in which
1st Source engages is affected not only by general economic conditions, but also
by the monetary policies of the Federal Reserve. Changes in the discount rate on
member bank borrowing, availability of borrowing at the "discount
window," open market operations, the imposition of changes in reserve
requirements against member banks deposits and assets of foreign branches and
the imposition of and changes in reserve requirements against certain borrowings
by banks and their affiliates are some of the instruments of monetary policy
available to the Federal Reserve. These monetary policies are used in varying
combinations to influence overall growth and distributions of bank loans,
investments and deposits, and such use may affect interest rates charged on
loans or paid on deposits. The monetary policies of the Federal Reserve have had
a significant effect on the operating results of commercial banks and are
expected to do so in the future. The monetary policies of the Federal Reserve
are influenced by various factors, including inflation, unemployment, short-term
and long-term changes in the international trade balance and in the fiscal
policies of the U.S. Government. Future monetary policies and the effect of such
policies on the future business and earnings of 1st Source and the Bank cannot
be predicted.
Pending Legislation -- Because of concerns relating to competitiveness and the
safety and soundness of the banking industry, Congress often considers a number
of wide-ranging proposals for altering the structure, regulation and competitive
relationships of the nation's financial institutions. It cannot be predicted
whether or in what form any proposals will be adopted or the extent to which the
business of 1st Source may be affected thereby.
BUSINESS RISKS
Like all other banking and financial service companies, 1st Source's business
and results of operations are subject to a number of risks, many of which are
outside of 1st Source's control. In addition to the other information in this
report, readers should carefully consider that the following important factors,
among others, could materially impact 1st Source's business and future results
of operations.
1st Source's success depends on its ability to compete effectively in the
competitive financial services industry -- The financial services industry is
competitive and 1st Source and its operating subsidiaries encounter strong
competition for deposits, loans and other financial services in all of its lines
of business. 1st Source's principal competitors include other commercial banks,
savings banks, credit unions, savings and loan associations, mutual funds, money
market funds, finance companies, trust companies, insurers, leasing companies,
mortgage companies, private issuers of debt obligations, venture capital firms,
and suppliers of other investment alternatives, such as securities firms and
insurance companies. Some of its non-bank competitors are not subject to the
same degree of regulation as 1st Source and its subsidiaries are and have
advantages over 1st Source in providing certain services. Many of 1st Source's
competitors are significantly larger and have greater access to capital and
other resources. In recent years there has been substantial consolidation among
companies in the financial services industry. Such consolidation may increase
competition. Further, 1st Source's ability to compete effectively is dependent
on its ability to adapt successfully to technological and other changes within
the banking and financial services industry generally.
1st Source's business may be adversely affected by the highly regulated
environment in which it operates -- 1st Source and its subsidiaries operate in a
heavily regulated and rapidly changing legislative and regulatory environment.
1st Source's failure to comply with the many requirements of state and federal
law could lead to termination or suspension of its licenses, rights of
rescission for borrowers, class action lawsuits and administrative enforcement
actions. Recently enacted and future legislation and regulations may have
significant impact on the financial services industry. Regulatory or legislative
changes could increase 1st Source's costs of doing business, restrict its access
to new products or markets, cause 1st Source to change some of its products or
the way it operates its different lines of business, adversely affect its
operations or the manner in which it conducts its business and, on the whole,
adversely affect the profitability of its business.
1st Source may be adversely affected by a general deterioration in economic
conditions -- The risks associated with 1st Source's business are greater in
periods of a slowing economy or recession. Economic declines may be accompanied
by a decrease in demand for consumer and commercial credit and declining real
estate and other asset values. Declining real estate and other asset values,
particularly transportation related equipment, may reduce the ability of
borrowers to use such equity to support borrowings. Delinquencies, foreclosures
and losses generally increase during economic slow-downs or recessions.
Additionally, 1st Source's servicing costs and credit losses may also increase
in periods of economic slow-down or recession.
1st Source is subject to credit risk inherent in its loan portfolios -- In the
financial services industry, there is always a risk that certain borrowers may
not repay borrowings. 1st Source maintains a reserve for loan losses to absorb
the level of losses that it estimates to be probable in its portfolios. However,
its reserve for loan losses may not be sufficient to cover the loan losses that
it may actually incur. If 1st Source experiences defaults by borrowers in any of
its businesses, 1st Source's earnings could be negatively affected. Changes in
local economic conditions could adversely affect credit quality in its local
business loan portfolio, and changes in national economic conditions could
adversely affect the quality of its Specialty Finance Group's portfolio.
Certain 1st Source lending product lines are experiencing slow-downs -- 1st
Source has specialty national businesses in commercial loans secured by
transportation and construction equipment, including the financing of aircraft
for dealers and air cargo operators and the financing of vehicles for the rental
and leasing industries. 1st Source's aircraft and auto rental businesses have
been adversely affected by the slow down in the technology and automotive
manufacturing markets (large users of air cargo services), the reaction by the
financial markets and the fall-off of durable goods manufacturing, all of which
were exacerbated by the events of September 11, 2001. These market conditions
have caused aircraft and used automobile values to drop precipitously. Customers
who rely on the use of aircraft or automobiles to produce income have been
negatively affected, and 1st Source has experienced substantial loan losses in
the last several quarters in its aircraft and auto rental financing units. Since
some of the relationships in these industries are large (up to $15 million),
further and continued slow-downs in these industries can adversely affect 1st
Source.
1st Source may be adversely affected by interest rate changes -- Although 1st
Source actively manages its interest rate sensitivity, such management is not an
exact science. Rapid increases or decreases in interest rates could adversely
affect its net interest margin if changes in its cost of funds do not correspond
to changes in income yields. Such fluctuations could also continue to negatively
impact its mortgage banking operations, which are very interest rate sensitive,
by increasing the runoff rates in the servicing portfolio, reducing loan
origination activities or increasing its funding costs. An increase in interest
rates that adversely affects the ability of borrowers to pay the principal or
interest on loans may lead to an increase in nonperforming assets and a
reduction of interest accrued into income, which could have a material adverse
effect on 1st Source's results of operations. 1st Source recorded non-cash
valuation adjustments in 2002 for impairment of the carrying value of the
mortgage servicing portfolio held by Trustcorp.
Provisions in 1st Source's restated articles of incorporation, by-laws and
Indiana law may delay or prevent an acquisition of 1st Source by a third
party -- 1st Source's restated articles of incorporation, by-laws and Indiana
law contain provisions that may make it more difficult for a third party to
acquire 1st Source without the consent of its board of directors. These
provisions could also discourage proxy contests and may make it more difficult
for shareholders to elect their own representatives as directors and take other
corporate actions.
Among other provisions, 1st Source's articles of incorporation authorize its
board of directors to issue shares of preferred stock and to determine its
terms, preferences and other rights without shareholder approval. The issuance
of preferred stock could discourage a third party from acquiring control of the
company.
1st Source's by-laws do not permit cumulative voting of shareholders in the
election of directors, allowing the holders of a majority of its outstanding
shares to control the election of all its directors. 1st Source's by-laws also
provide that only its board of directors, and not its shareholders, may adopt,
alter, amend and repeal its by-laws.
Indiana law provides several limitations that may discourage potential acquirers
from purchasing its common shares. In particular, Indiana law prohibits business
combinations with a person who acquires 10% or more of its common shares during
the five-year period after the acquisition of 10% by that person or entity,
unless the acquirer receives prior approval for the acquisition of the shares or
business combination from its board of directors.
1st Source could be held responsible for environmental liabilities of properties
acquired through foreclosure -- Environmentally related hazards have become a
source of high risk and potentially unlimited liability for financial
institutions relative to their loans. Environmentally contaminated properties
owned by an institution's borrowers may result in a drastic reduction in the
value of the collateral securing the institution's loans to such borrowers, high
environmental clean up costs to the borrower affecting its ability to repay the
loans, the subordination of any lien in favor of the institution to a state or
federal lien securing clean up costs, and liability to the institution for clean
up costs if it forecloses on the contaminated property or becomes involved in
the management of the borrower. To minimize this risk, 1st Source may require an
environmental examination of and report with respect to the property of any
borrower or prospective borrower if circumstances affecting the property
indicate a potential for contamination, taking into consideration the potential
loss to the institution in relation to the burdens to the borrower. Such
examination must be performed by an engineering firm experienced in
environmental risk studies and acceptable to the institution, and the costs of
such examinations and reports are the responsibility of the borrower. These
costs may be substantial and may deter a prospective borrower from entering into
a loan transaction with 1st Source. 1st Source is not aware of any borrower who
is currently subject to any environmental investigation or clean up proceeding
which is likely to have a material adverse effect on the financial condition or
results of operations of 1st Source.
ITEM 2. PROPERTIES.
1st Source's headquarters building is located in downtown South Bend. In 1982,
the land was leased from the City of South Bend on a 49-year lease, with a
50-year renewal option. The building is part of a larger complex, including a
300-room hotel and a 500-car parking garage. 1st Source sold the building and
entered into a leaseback agreement with the purchaser for a term of 30 years.
The bank building is a structure of approximately 160,000 square feet, with 1st
Source and its subsidiaries occupying approximately 70% of the available office
space and approximately 30% presently subleased to unrelated tenants.
1st Source also owns property and or buildings on which 41 of the Bank
subsidiary's 63 banking centers are located, including the facilities in Allen,
Elkhart, Fulton, Kosciusko, LaPorte, Marshall, Porter, St. Joseph and Starke
Counties in the state of Indiana and Berrien County in the state of Michigan, as
well as a computer operations center. In 1995, 1st Source reacquired its former
headquarters building through foreclosure. It has been refurbished for
additional tenants and 1st Source use. The remaining properties utilized by the
Bank are leased from unrelated parties.
ITEM 3. LEGAL PROCEEDINGS.
1st Source and its subsidiaries are defendants in various legal proceedings
arising in the normal course of business. In the opinion of management, based
upon present information including the advice of legal counsel, the ultimate
resolution of these proceedings will not have a material effect on 1st Source's
consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
1st Source's common stock is traded on the Nasdaq Stock Market under the
symbol "SRCE." The following table sets forth for each quarter the high and low
sales prices for the common stock of 1st Source, as reported by Nasdaq, and the
cash dividends paid per share for each quarter. The amounts shown in the table
below have been adjusted for all stock dividends.
2002 Sales Price Cash Dividends 2001 Sales Price Cash Dividends
Common Stock Prices (quarter ended) High Low Paid High Low Paid
- -------------------------------------------------------------------------------------------------------------------
March 31 $ 25.45 $ 19.75 $ .090 $ 20.00 $ 16.31 $ .086
June 30 26.89 21.00 .090 28.07 17.26 .085
September 30 24.58 13.54 .090 25.03 18.40 .090
December 31 17.81 10.90 .090 22.71 19.65 .090
===================================================================================================================
As of December 31, 2002, there were 1,086 holders of record of 1st Source common stock.
Federal laws and regulations contain restrictions on the ability of 1st
Source and the Bank to pay dividends. For information regarding restrictions on
dividends, see Part I, Item 1, Business - Regulation and Supervision - Dividends
and Part II, Item 8, Financial Statements and Supplementary Data - Note N of the
Notes to Consolidated Financial Statements.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data should be read in conjunction with
1st Source's Consolidated Financial Statements and the accompanying notes
presented elsewhere herein.
(Dollars in thousands, except per share amounts) 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------
Interest income $ 199,503 $ 245,566 $ 238,222 $ 202,070 $ 196,840
Interest expense 80,817 126,957 134,288 104,401 105,962
- --------------------------------------------------------------------------------------------------------------
Net interest income 118,686 118,609 103,934 97,669 90,878
Provision for loan losses 39,657 25,745 11,836 3,969 6,856
- --------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 79,029 92,864 92,098 93,700 84,022
Noninterest income 73,117 87,026 68,553 58,659 49,705
Noninterest expense 140,741 121,683 104,513 99,536 85,941
- --------------------------------------------------------------------------------------------------------------
Income before income taxes 11,405 58,207 56,138 52,823 47,786
Income taxes 1,366 19,709 18,565 17,055 16,329
- --------------------------------------------------------------------------------------------------------------
Net income $ 10,039 $ 38,498 $ 37,573 $ 35,768 $ 31,457
- --------------------------------------------------------------------------------------------------------------
Assets at year end $3,407,468 $3,562,691 $3,182,181 $2,872,945 $2,733,592
Long-term debt at year end 16,878 11,939 12,060 12,174 13,189
Shareholders' equity at year end 309,429 306,190 270,572 238,820 216,793
Basic net income per common share* 0.48 1.85 1.81 1.71 1.50
Diluted net income per common share* 0.47 1.82 1.79 1.69 1.47
Cash dividends per common share* .360 .351 .334 .284 .252
Dividend payout ratio 76.60% 19.29% 18.66% 16.80% 17.14%
Return on average assets 0.29% 1.14% 1.24% 1.31% 1.23%
Return on average common equity 3.23% 13.14% 14.88% 15.74% 15.30%
Average common equity to average assets 8.95% 8.69% 8.31% 8.29% 8.06%
==============================================================================================================
*All per share amounts have been restated for stock dividends.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The purpose of this analysis is to provide the reader with information relevant
to understanding and assessing 1st Source's results of operations for each of
the past three years and financial condition for each of the past two years. In
order to fully appreciate this analysis the reader is encouraged to review the
consolidated financial statements and statistical data presented in this
document.
FORWARD-LOOKING STATEMENTS
This report, including Management's Discussion and Analysis of Financial
Condition and Results of Operations, contains "forward-looking statements" about
1st Source. 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
forwardlooking 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 laws, regulations or accounting
principles generally accepted in the United States; 1st Source's competitive
position within its markets served; increasing consolidation within the banking
industry; unforeseen changes in interest rates; unforeseen changes in loan
prepayment assumptions; unforeseen downturns in the local, regional or national
economies or in the industries in which 1st Source has credit concentrations;
and the matters described under Part I, Item 1, Business - Business Risks. 1st
Source undertakes no obligation to publicly update or revise any forward-looking
statements.
CRITICAL ACCOUNTING POLICIES
1st Source's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and follow general
practices within the industries in which it operates. Application of these
principles requires management to make estimates, assumptions, and judgments
that affect the amounts reported in the financial statements and accompanying
notes. These estimates, assumptions, and judgments are based on information
available as of the date of the financial statements; accordingly, as this
information changes, the financial statements could reflect different estimates,
assumptions, and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions, and judgments and as such have a greater
possibility of producing results that could be materially different than
originally reported. Estimates, assumptions, and judgments are primarily
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent on a
future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by third-party sources, when
available. When third-party information is not available, valuation adjustments
are estimated in good faith by management primarily through the use of internal
cash flow modeling techniques. The most significant accounting policies followed
by 1st Source are presented in Note A to the consolidated financial statements.
These policies, along with the disclosures presented in the other financial
statement notes and in this financial review, provide information on how
significant assets and liabilities are valued in the financial statements and
how those values are determined. Based on the valuation techniques used and the
sensitivity of financial statement amounts to the methods, assumptions, and
estimates underlying those amounts, management has identified the determination
of the reserve for loan losses, the valuation of retained interests, the
valuation of mortgage servicing rights and the valuation of repossessed assets
to be the accounting areas that require the most subjective or complex
judgments, and as such could be most subject to revision as new information
becomes available. Any material effect on the financial statements during the
twelve months of 2002 related to these critical accounting areas is discussed in
management's discussion and analysis of financial condition and results of
operations. In addition, the sensitivities of valuations to adverse changes in
the factors and assumptions used in estimating certain fair values are discussed
in the notes to the consolidated financial statements. The remainder of this
management's discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes presented in Part II, Item
8, Financial Statements and Supplementary Data.
EARNINGS SUMMARY
Net income in 2002 was $10.04 million, down from $38.50 million in 2001 and
$37.57 million in 2000. Diluted net income per common share was $0.47 in 2002,
$1.82 in 2001 and $1.79 in 2000 after giving retroactive recognition to stock
dividends. Return on average total assets was 0.29% in 2002, compared to 1.14%
in 2001 and 1.24% in 2000. Return on average common equity was 3.23% in 2002
versus 13.14% in 2001 and 14.88% in 2000.
Net income in 2002 was unfavorably affected by loan charge-offs, costs to secure
and dispose of collateral and impairment charges for mortgage servicing rights,
repossessed assets and the securitization retained asset. Offsetting these, 1st
Source was moderately successful in generating additional noninterest income in
core services and products.
Dividends declared on common stock in 2002 amounted to $.360 per share, compared
to $.351 in 2001 and $.334 in 2000. The level of earnings reinvested and
dividend payouts are based on management's assessment of future growth
opportunities and the level of capital necessary to support them.
Net Interest Income -- Net interest income, the difference between income from
earning assets and the interest cost of funding those assets, is 1st Source's
primary source of earnings. Net interest income, on a fully taxable equivalent
basis, decreased 0.09% in 2002, following a 13.34% increase in 2001.
Net interest margin, the ratio of net interest income to average earning assets,
is affected by movements in interest rates and changes in the mix of earning
assets and the liabilities that fund those assets. Net interest margin on a
fully taxable equivalent basis was 3.87% in 2002 compared to 3.95% in 2001 and
3.87% in 2000. The net interest margin was negatively impacted in 2002,
primarily due to carrying higher nonperforming assets, a moderate change in the
mix of our earning assets and a slowed economy.
The yield on earning assets in 2002 was 6.43%, compared to 8.07% in 2001 and
8.69% in 2000. Average earning assets in 2002 increased 2.15%, following a
10.80% increase in 2001. The effective rate on interest bearing liabilities was
2.95% in 2002, compared to 4.68% for 2001 and 5.48% for 2000.
The following table provides an analysis of net interest income and illustrates
the interest income earned and interest expense charged for each major component
of interest earning assets and interest bearing liabilities. The net interest
spread is the difference between the average yield earned on assets and the
average rate incurred on liabilities:
Year ended December 31 2002 2001 2000
Interest Interest Interest
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
(Dollars in thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate
ASSETS
Investment securities
Taxable $ 486,835 $ 21,360 4.39% $ 434,154 $ 26,708 6.01% $ 384,564 $ 25,094 6.53%
Tax exempt (1) 152,343 8,865 5.82 151,993 9,925 6.53 167,682 11,413 6.81
Net loans (2,3) 2,451,538 171,336 6.99 2,464,798 212,067 8.60 2,207,382 203,905 9.24
Other investments 58,916 1,078 1.83 32,462 820 2.53 23,256 1,455 6.26
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 3,149,632 202,639 6.43 3,083,407 248,890 8.07 2,782,884 241,867 8.69
Cash and due from banks 91,217 99,453 97,096
Reserve for loan losses (59,171) (50,895) (41,441)
Other assets 284,704 237,978 201,552
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $3,466,382 $3,369,943 $3,040,091
====================================================================================================================================
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest bearing deposits $2,408,801 $ 71,084 2.95% $2,330,988 $108,069 4.64% $2,066,846 $109,866 5.32%
Short-term borrowings 270,747 5,659 2.09 325,456 14,455 4.44 327,941 19,664 6.00
Guaranteed preferred
beneficial interests in the
Company's subordinated
debentures 46,010 3,249 7.06 44,750 3,560 7.96 44,750 3,863 8.63
Long-term debt 13,066 825 6.31 12,078 873 7.23 12,193 895 7.34
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest bearing liabilities 2,738,624 80,817 2.95 2,713,272 126,957 4.68 2,451,730 134,288 5.48
Noninterest bearing deposits 362,509 305,373 285,361
Other liabilities 54,837 58,312 50,426
Shareholders' equity 310,412 292,986 252,574
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $3,466,382 $3,369,943 $3,040,091
====================================================================================================================================
Net interest income $121,822 $121,933 $107,579
====================================================================================================================================
Net interest margin on a tax
equivalent basis 3.87% 3.95% 3.87%
====================================================================================================================================
(1) Interest income includes the effects of tax equivalent adjustments, using a 35% rate. Tax equivalent adjustments were $2,828
in 2002, $3,058 in 2001 and $3,457 in 2000.
(2) Loan income includes fees on loans of $5,042 in 2002, $6,394 in 2001 and $6,043 in 2000. Loan income also includes the
effects of tax equivalent adjustments, using a 35% rate. Tax equivalent adjustments were $308 in 2002, $266 in 2001 and
$188 in 2000.
(3) For purposes of this computation, nonaccruing loans are included in the average loan balance outstanding.
The following table shows changes in tax equivalent interest earned and interest paid, resulting from
changes in volume and changes in rates:
Increase (Decrease) due to *
(Dollars in thousands) Volume Rate Net
- ----------------------------------------------------------------------------------------------------------------------
2002 compared to 2001
Interest earned on:
Loans $ (1,254) $(39,477) $(40,731)
Investment securities:
Taxable 3,867 (8,585) (4,718)
Tax-exempt 21 (1,081) (1,060)
Interest-bearing deposits with other banks 1 (5) (4)
Federal funds sold and other money market investments 393 (131) 262
- ----------------------------------------------------------------------------------------------------------------------
Total earning assets $ 3,028 $(49,279) $(46,251)
======================================================================================================================
Interest paid on:
Savings deposits 5,465 (12,835) (7,370)
Other time deposits (3,191) (26,424) (29,615)
Short-term borrowings (2,124) (6,672) (8,796)
Guaranteed preferred beneficial interests in the Company's
subordinated debentures 107 (418) (311)
Long-term debt 88 (136) (48)
- ----------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 345 $(46,485) $(46,140)
======================================================================================================================
Net interest income $ 2,683 $ (2,794) $ (111)
======================================================================================================================
2001 compared to 2000
Interest earned on:
Loans $ 19,917 $(11,755) $ 8,162
Investment securities:
Taxable 2,569 (1,585) 984
Tax-exempt (1,031) (457) (1,488)
Interest-bearing deposits with other banks (1) (2) (3)
Federal funds sold and other money market investments 1,442 (2,074) (632)
- ----------------------------------------------------------------------------------------------------------------------
Total earning assets $ 22,896 $(15,873) $ 7,023
======================================================================================================================
Interest paid on:
Savings deposits 2,919 (8,686) (5,767)
Other time deposits 8,168 (4,198) 3,970
Short-term borrowings (131) (5,078) (5,209)
Guaranteed preferred beneficial interests in the Company's
subordinated debentures (3) (300) (303)
Long-term debt (9) (13) (22)
- ----------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 10,944 $(18,275) $ (7,331)
======================================================================================================================
Net interest income $ 11,952 $ 2,402 $ 14,354
======================================================================================================================
* The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to
the relationship of the absolute dollar amounts of the change in each.
Noninterest Income -- Noninterest income continues to represent a considerable
source of income for 1st Source. Excluding gains/losses on investments, total
noninterest income amounted to $75.95 million in 2002, $86.59 million in 2001
and $66.23 million in 2000.
Trust fees in 2002 were $10.25 million, compared to $9.67 million in 2001 and
$9.61 million in 2000. Trust fees increased 6.00% in 2002, following a 0.62%
increase in 2001. The increase in 2002 is reflective of the increase in assets
under management and the performance of 1st Source's fund managers.
Service charges on deposit accounts increased by 27.60% resulting in $14.95
million of income for 2002. The $11.71 million recorded in 2001 was an increase
of 45.10% from the $8.07 million of service charges on deposit accounts
generated in 2000. Generally, overdraft fees, business service fees and debit
card fees accounted for the increase in service charges on deposit accounts for
both 2002 and 2001. The fee income increases were due to transaction account
volume, attributed primarily to the branch acquisitions in 2001, business
account maintenance charges and fewer fees waived.
Loan servicing and sale income generated from 1st Source's aircraft and auto
loan securitization and mortgage banking activities decreased 71.16% to $7.41
million in 2002. The $25.68 million recorded in 2001 represented a 59.19%
increase over 2000. Loan securitization income was $4.83 million during 2002,
compared to $5.71 million during 2001. In 2002, the securitization facility
increased $50 million, bringing the outstanding servicing portfolio of aircraft
and auto loans to $400 million, compared to $350 million for year-end 2001.
Gains of $8.96 million were recognized on the sale of mortgage loans and
servicing in 2002, compared to gains of $19.34 million in 2001. The reduced
gains on the sale of mortgage loans and servicing is reflective of a sale of
approximately $1.0 billion of mortgage servicing rights early in 2001, resulting
in an $11.06 million gain. In addition, mortgage servicing fee income net of
amortization and impairment write-offs of mortgage servicing rights was $(6.38)
million for 2002, and $625,000 for 2001. The decline is the result of a $7.33
million
impairment charge on the mortgage servicing rights portfolio in 2002. The
increased level of refinancings in 2002 increased mortgage loan prepayment
rates, resulting in a lower estimated value of mortgage servicing assets.
Equipment rental income generated from operating leases increased to $28.77
million in 2002, a 9.62% increase over 2001. The $26.25 million recorded in 2001
was a 23.68% increase over 2000. Revenues from operating leases for construction
equipment, automobiles and other equipment and the related depreciation on the
equipment have increased in the past few years as 1st Source has experienced
increases in this line of business. However, this growth slowed significantly in
2002 due to the weaker economy.
Other income experienced moderate growth of 9.80% during 2002, compared to an
18.67% increase in 2001. The increase for 2002 was primarily due to a $562,000
gain recorded on trading account securities.
The investment losses of $2.84 million in 2002, include a $1.49 million
impairment charge on the securitization retained asset; while $1.96 million of
the gain in 2000 was due to the sale of foreign bonds. The balance of the net
investment securities and other investment (losses) gains in 2002, 2001 and 2000
were primarily the result of valuation adjustments on venture capital and other
investments.
Noninterest Expense -- 1st Source experienced increases in noninterest expense
of 15.66% and 16.43% for 2002 and 2001, respectively. The leading factors
contributing to the increase in noninterest expense were reflected in the
effects of a full year of operations relating to the 2001 branch acquisitions,
an increase in collection and repossession expenses, higher depreciation charges
on leased equipment, valuation adjustments and intangible asset amortization.
Cost control across all business units and better utilization of resources
continue to be a major focus at 1st Source.
Salaries and employee benefits increased 7.64% in 2002, following a 14.74%
increase in 2001. Salaries and wages increased 12.76% in 2002 and 17.78% in
2001. The increase in 2002 from the prior year was due to the first full year of
operations for the branches acquired in 2001 and, in part, to higher commissions
paid to mortgage originators. The number of full-time equivalent employees stood
at 1,233 at the end of 2002, compared to 1,260 and 1,070 at the end of 2001 and
2000, respectively. A major contributor to the increase in the number of
full-time equivalent employees was the acquisition of 17 branches in 2001.
Employee benefits decreased 12.70% in 2002, following a 4.04% increase in 2001.
The change in employee benefits was primarily the result of lower executive
incentives offset by an increase in group insurance expense of 24.47% in 2002,
following an 18.99% increase in 2001.
Occupancy expense in 2002 increased 10.69% from 2001, following a 9.70% increase
in 2001. The 2002 increase was due to the 17 branches acquired in 2001, 13 of
which were acquired in the 4th quarter.
Furniture and equipment expense, including depreciation, increased in 2002 by
13.70%, following a 6.24% increase in 2001. The increase in 2002 is attributed
primarily to upgrades in hardware and computer systems and increased computer
processing charges. Approximately 30.00% of the 2002 increase is related to the
new branches.
Depreciation on operating leases increased 11.70% in 2002, following a 25.27%
increase in 2001 due to the continued expansion of our operating lease
portfolio.
Supplies and communications expense increased 1.30% in 2002, following a 15.86%
increase in 2001. The slight increase in 2002 was primarily due to effective
cost controls over printing and supplies while continuing to provide the
materials and up-to-date communication resources necessary to achieve optimal
service for customers.
Business development and marketing expense decreased 31.04% in 2002, following
an increase of 18.06% in 2001. The increase in 2001 was in part due to
advertising and marketing campaigns related to the branch acquisitions. During
2002, 1st Source continued to engage in effective targeting of advertising and
marketing campaigns. Charitable contributions decreased in 2002 compared to
2001.
An increase of 96.36% occurred in other expenses during 2002, compared to a
23.88% increase in 2001. The primary cause of the increase is due to $8.98
million of additional collection and repossession expenses and valuation
adjustments on repossessed assets and nonperforming operating leases. In
addition, intangible asset amortization increased $1.92 million in 2002 due to
the 2001 branch acquisitions and Trustcorp accrued $0.98 million for a fraud
loss. The increases in other expenses were offset by decreases in professional
consulting fees and check forgery losses.
Income Taxes -- 1st Source recognized income tax expense of $1.37 million in
2002, compared to $19.71 million in 2001 and $18.57 million in 2000. The
effective tax rate in 2002 was 11.98% compared to 33.86% in 2001 and 33.07% in
2000. The lower effective tax rate in 2002 compared to 2001 was due to tax
exempt income remaining constant while net income before tax declined. For
detailed analysis of 1st Source's income taxes see Part II, Item 8, Financial
Statements and Supplementary Data - Note K of the Notes to Consolidated
Financial Statements.
FINANCIAL CONDITION
Loan Portfolio -- The following table shows 1st Source's loan distribution at
the end of each of the last five years as of December 31:
(Dollars in thousands) 2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------
Commercial and agricultural loans $ 428,367 $ 460,373 $ 496,303 $ 455,560 $ 408,897
Truck and automobile financing 445,195 344,014 259,382 215,390 188,268
Aircraft financing 323,802 514,573 508,278 422,076 328,494
Construction equipment financing 303,126 328,004 272,250 244,745 205,850
Loans secured by real estate 567,950 586,580 593,287 526,929 465,855
Mortgages held-for-sale 146,640 173,515 51,754 64,472 165,060
Consumer loans 111,012 128,305 127,808 134,017 119,272
- ----------------------------------------------------------------------------------------
Total loans $2,326,092 $2,535,364 $2,309,062 $2,063,189 $1,881,696
========================================================================================
At December 31, 2002, 10.62% of total loans was concentrated with borrowers in trucking
and truck leasing.
Average loans, net of unearned discount, decreased 0.54% in 2002, following an
11.66% increase in 2001. Loans, net of unearned discount, at December 31, 2002
were $2.33 billion and were 68.22% of total assets, compared to $2.54 billion or
71.16% of total assets at December 31, 2001.
Commercial and agricultural lending outstandings, excluding those secured by
real estate, decreased 6.95% during 2002. Many of the industries 1st Source
serves experienced a marked decline in business activity in 2002, resulting in
reduced loan needs.
Truck and automobile financing increased 29.41% in 2002. The largest increase
was in medium and heavy duty truck loans which experienced growth of $66 million
or slightly over 50% in 2002. This increase is due to the addition of sales
people in this area. Other loans in this category include automobile and
environmental equipment financing which grew by 13% and 5%, respectively.
Aircraft financing at year-end 2002 declined 37.07% from year-end 2001. Aircraft
financing has been negatively impacted by the slowed economy and the events of
September 11, 2001. Another factor contributing to the decrease was the
securitization of an additional $50 million of fixed rate aircraft loans,
removing them from the balance sheet.
Construction equipment financing decreased 7.58% in 2002. This division has also
been negatively impacted by the slowing economy.
Real estate loans decreased 5.99% during 2002. This decrease was due to declines
in the year-end balances of residential mortgage loans held for sale and
portfolio mortgage loans. Residential mortgage loan production which was strong
during the year, declined toward the end of 2002 compared to 2001.
Consumer loans decreased 13.48% as greater marketing efforts were offset by
customers utilizing mortgage refinances to make home improvements and to payoff
consumer debt. In addition, consumers took advantage of 0% financing offered by
new car dealers.
The following table shows the maturities of loans in the categories of
commercial and agriculture, truck and automobile, aircraft and construction
equipment outstanding as of December 31, 2002. The amounts due after one year
are also classified according to the sensitivity to changes in interest rates.
(Dollars in thousands) 0 - 1 Year 1 - 5 Years Over 5 Years Total
- ----------------------------------------------------------------------------------------------
Commercial and agricultural loans $ 319,372 $ 101,615 $ 7,380 $ 428,367
Truck and automobile financing 149,061 290,067 6,067 445,195
Aircraft financing 121,047 185,445 17,310 323,802
Construction equipment financing 105,788 196,184 1,154 303,126
- ----------------------------------------------------------------------------------------------
Total $ 695,268 $ 773,311 $31,911 $1,500,490
==============================================================================================
Rate Sensitivity (Dollars in thousands) Fixed Rate Variable Rate Total
- ----------------------------------------------------------------------------------------------
1 - 5 Years $506,591 $266,720 $773,311
Over 5 Years 9,561 22,350 31,911
- ----------------------------------------------------------------------------------------------
Total $516,152 $289,070 $805,222
==============================================================================================
CREDIT EXPERIENCE
Reserve for Loan Losses -- 1st Source's reserve for loan losses is provided for
by direct charges to operations. Losses on loans are charged against the reserve
and likewise, recoveries during the period for prior losses are credited to the
reserve. Management evaluates the adequacy of the reserve periodically,
reviewing all loans over a fixed-dollar amount where the internal credit rating
is at or below a predetermined classification, actual and anticipated loss
experience, current economic events in specific industries and other pertinent
factors including general economic conditions. Determination of the reserve is
inherently subjective as it requires significant estimates, including the
amounts and timing of expected future cash flows or fair value of collateral on
collateral-dependent impaired loans, estimated losses on pools of homogeneous
loans based on historical loss experience and consideration of economic trends,
all of which may be susceptible to significant change. Management of 1st Source
reviews the status of the loan portfolio to identify borrowers that might
develop financial problems, in order to aid borrowers in the handling of their
accounts and to mitigate losses. See Part II, Item 8, Financial Statements and
Supplementary Data - Note A of the Notes to Consolidated Financial Statements
for additional information on management's evaluation of the adequacy of the
reserve for loan losses.
The reserve for loan losses at December 31, 2002 totaled $59.22 million and was
2.55% of loans, compared to $57.62 million or 2.27% of loans at December 31,
2001 and $44.64 million or 1.93% of loans at December 31, 2000. It is
management's opinion that the reserve for loan losses is adequate to absorb
losses inherent in the loan portfolio as of December 31, 2002.
The provision for loan losses for 2002 was $39.66 million, compared to $25.75
million in 2001 and $11.84 million in 2000. The increase in the provision for
loan losses in 2002 compared to 2001 reflects the continued weakness of the
economy and the aftermath of September 11, 2001, as problem loans grew and
charge-offs increased. Net charge-offs of $38.06 million, $13.36 million and
$7.40 million were recorded in 2002, 2001 and 2000, respectively.
The higher net charge-offs occurred primarily with loans to aircraft dealers and
operators, and rental car businesses. Net charge-offs to aircraft dealers were
$21.78 million, $2.11 million and $4.20 million in 2002, 2001 and 2000,
respectively. Net charge-offs to aircraft operators were $4.70 million, $3.10
million and $0 in 2002, 2001 and 2000, respectively. While net charge-offs of
business and personal aircraft loans were $0.16 million, $0.28 million and $0.56
million in 2002, 2001 and 2000, respectively.
The following table summarizes the 1st Source's loan loss experience for each of
the last five years ended December 31:
(Dollars in thousands) 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------
Amounts of loans outstanding at end of period $2,326,092 $2,535,364 $2,309,062 $2,063,189 $1,881,696
- -----------------------------------------------------------------------------------------------------------------------------
Average amount of net loans outstanding during period $2,451,538 $2,464,798 $2,207,382 $1,949,172 $1,853,537
- -----------------------------------------------------------------------------------------------------------------------------
Balance of reserve for loan losses at beginning of period $ 57,624 $ 44,644 $ 40,210 $ 38,629 $ 35,424
- -----------------------------------------------------------------------------------------------------------------------------
Charge-offs:
Commercial and agricultural loans 2,698 5,014 1,818 885 1,295
Truck and automobile financing 7,151 753 109 3 1,422
Aircraft financing 27,401 5,584 4,987 - -
Construction equipment financing 2,326 762 393 510 249
Loans secured by real estate 18 117 30 148 323
Consumer loans 2,127 2,102 1,738 1,481 1,510
- -----------------------------------------------------------------------------------------------------------------------------
Total charge-offs 41,721 14,332 9,075 3,027 4,799
- -----------------------------------------------------------------------------------------------------------------------------
Recoveries:
Commercial and agricultural loans 1,312 328 298 85 256
Truck and automobile financing 616 71 631 52 418
Aircraft financing 759 92 230 - -
Construction equipment financing 465 129 50 34
Loans secured by real estate 25 - 2 50 47
Consumer loans 481 351 462 418 427
- -----------------------------------------------------------------------------------------------------------------------------
Total recoveries 3,658 971 1,673 639 1,148
- -----------------------------------------------------------------------------------------------------------------------------
Net charge-offs (recoveries) 38,063 13,361 7,402 2,388 3,651
Provisions charged to operating expense 39,657 25,745 11,836 3,969 6,856
Reserves acquired in acquisitions - 596 - - -
- -----------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 59,218 $ 57,624 $ 44,644 $ 40,210 $ 38,629
=============================================================================================================================
Ratio of net charge-offs (recoveries) to average net
loans outstanding 1.55% 0.54% 0.34% 0.12% 0.20%
=============================================================================================================================
The reserve for loan losses has been allocated according to the amount deemed
necessary to provide for the possibility of losses being incurred within the
categories of loans set forth in the table below. The amount of such components
of the reserve at December 31 and the ratio of such loan categories to total
outstanding loan balances, are as follows:
2002 2001 2000 1999 1998
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loams
in Each in Each in Each in Each in Each
Category Category Category Category Category
Reserve to Total Reserve to Total Reserve to Total Reserve to Total Reserve to Total
(Dollars in thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- ----------------------------------------------------------------------------------------------------------------------------
Commercial and agricultural loans $11,163 18.42% $14,247 18.16% $15,532 21.49% $ 9,495 22.08% $10,468 21.73%
Truck and automobile financing 11,006 19.14 9,924 13.57 5,764 11.23 4,308 10.44 4,910 10.00
Aircraft financing 21,603 13.92 19,987 20.29 12,884 22.01 15,530 20.46 11,255 17.46
Construction equipment financing 9,394 13.03 6,463 12.94 5,304 11.79 5,406 11.86 5,446 10.94
Loans secured by real estate 3,656 30.72 4,268 29.98 2,692 27.94 3,091 28.66 3,769 33.53
Consumer loans 2,396 4.77 2,735 5.06 2,468 5.54 2,380 6.50 2,781 6.34
- ----------------------------------------------------------------------------------------------------------------------------
Total $59,218 100.00% $57,624 100.00% $44,644 100.00% $40,210 100.00% $38,629 100.00%
============================================================================================================================
Nonperforming Assets -- 1st Source's policy is to discontinue the accrual of
interest on loans on which principal or interest is past due and remains unpaid
for 90 days or more, except for mortgage loans, which are placed on nonaccrual
at the time the loan is placed in foreclosure. Nonperforming assets amounted to
$64.12 million at December 31, 2002, compared to $43.29 million at December 31,
2001 and $25.00 million at December 31, 2000. Impaired loans totaled $60.10
million, $45.40 million and $37.01 million at December 31, 2002, 2001 and 2000,
respectively. During 2002, interest income which would have been recorded on
nonaccrual loans under their original terms was $3.92 million, compared to $4.86
million in 2001. Interest income that was recorded on nonaccrual loans was $1.08
million and $2.00 million in 2002 and 2001, respectively.
The overall increase in nonperforming assets for 2002 is primarily the result of
a growing inventory of repossessed assets. The increase in repossessions is
primarily attributed to defaulted loans to air cargo businesses and aircraft
dealers and operators. In addition, there has been a moderate increase in other
real estate.
Nonperforming Assets at December 31 (Dollars in thousands) 2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------------
Loans past due over 90 days $ 154 $ 453 $ 385 $ 254 $ 275
Nonaccrual loans and restructured loans 35,664 35,825 19,168 11,967 9,266
- ----------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 35,818 36,278 19,553 12,221 9,541
- ----------------------------------------------------------------------------------------------------------------------
Other real estate 4,362 3,137 1,698 1,167 424
Other assets 23,937 3,878 3,745 1,967 606
- ----------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $64,117 $43,293 $24,996 $15,355 $10,571
======================================================================================================================
Nonperforming loans to loans, net of unearned discount 1.54% 1.43% 0.85% 0.59% 0.51%
======================================================================================================================
Nonperforming assets to loans and leases, net of unearned discount 2.65% 1.63% 1.04% 0.72% 0.55%
======================================================================================================================
Potential Problem Loans -- At December 31, 2002, management was not aware of any
potential problem loans that would have a material effect on loan delinquency or
loan charge-offs. However, until general economic conditions begin to improve,
1st Source's management expects unfavorable trends in credit quality and
net-charge-offs to continue, particularly in the first half of 2003. Loans and
leases are subject to continual review and are given management's attention
whenever a problem situation appears to be developing.
INVESTMENT PORTFOLIO
Securities at year-end 2002 decreased 1.43% from 2001, following a 13.01%
increase from year-end 2000 to year-end 2001. Securities at December 31, 2002
were $647.62 million or 18.99% of total assets, compared to $657.04 million or
18.44% of total assets at December 31, 2001.
The carrying amounts of securities available-for-sale at the dates indicated
are summarized as follows:
December 31 (Dollars in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------
U.S. Treasury and government agencies and corporations $391,653 $434,867 $334,832
States and political subdivisions 156,010 144,000 151,501
Other 99,954 78,174 95,078
- -------------------------------------------------------------------------------------------------
Total securities available-for-sale $647,617 $657,041 $581,411
=================================================================================================
The following table shows the maturities of securities available-for-sale
at December 31, 2002, at the carrying amounts and the weighted average yields of
such securities:
(Dollars in thousands) Amount Yield(1)
- -------------------------------------------------------------------------------------------------
U.S. Treasuries and agencies
Under 1 year $169,961 3.61%
1 - 5 years 148,271 3.48
5 - 10 years 28,055 3.52
Over 10 years 45,366 3.20
- -------------------------------------------------------------------------------------------------
Total U.S. Treasuries and agencies $391,653 3.51%
- -------------------------------------------------------------------------------------------------
State and political subdivisions
Under 1 year 31,221 6.59%
1 - 5 years 98,289 5.50
5 - 10 years 24,676 5.00
Over 10 years 1,824 4.17
- -------------------------------------------------------------------------------------------------
Total state and political subdivisions $156,010 5.62%
- -------------------------------------------------------------------------------------------------
Other securities
Under 1 year 513 5.36%
1 - 5 years 854 6.46
5 - 10 years 5,118 3.05
Over 10 years - -
Retained interest in securitizations 21,457 13.82
Marketable equity securities 72,012 -
- -------------------------------------------------------------------------------------------------
Total other securities $ 99,954 -
- -------------------------------------------------------------------------------------------------
Total securities available-for-sale $647,617 -
=================================================================================================
(1) Weighted average yields are based on amortized cost. Yields on tax-exempt obligations are
calculated on a fully tax equivalent basis assuming a 35% tax rate. Marketable equity
securities are excluded.
DEPOSITS
The average daily amounts of deposits and rates paid on such deposits are
summarized as follows:
2002 2001 2000
December 31 (Dollars in thousands) Amount Rate Amount Rate Amount Rate
- ----------------------------------------------------------------------------------------------
Noninterest bearing demand deposits $ 362,509 -% $ 305,373 -% $ 285,361 -%
Interest bearing demand deposits 686,763 1.40 596,330 2.82 457,021 4.42
Savings deposits 232,067 1.20 165,820 1.78 236,724 2.26
Other time deposits 1,489,971 3.94 1,568,838 5.63 1,373,101 6.14
- ----------------------------------------------------------------------------------------------
Total $2,771,310 $2,636,361 $2,352,207
==============================================================================================
The amount of certificates of deposit of $100,000 or more and other time
deposits of $100,000 or more outstanding at December 31, 2002, by time remaining
until maturity is as follows:
(Dollars in thousands)
- --------------------------------------------------------------------------------
Under 3 months $ 117,859
4 - 6 months 39,907
7 - 12 months 64,423
Over 12 months 109,811
- --------------------------------------------------------------------------------
Total $ 332,000
================================================================================
SHORT-TERM BORROWINGS
The following table shows the distribution of 1st Source's short-term borrowings
and the weighted average interest rates thereon at the end of each of the last
three years. Also provided are the maximum amount of borrowings and the average
amount of borrowings, as well as weighted average interest rates for the last
three years.
Federal Funds
Purchased and
Security Other
Repurchase Commercial Short-Term Total
(Dollars in thousand) Agreements Paper Borrowings Borrowings
- ---------------------------------------------------------------------------------------------------------
2002
Balance at December 31, 2002 $212,040 $ 2,814 $ 45,824 $260,678
Maximum amount outstanding at any month-end 266,370 5,580 86,059 358,009
Average amount outstanding 218,009 4,023 48,715 270,747
Weighted average interest rate during the year 1.36% 1.64% 5.40% 2.09%
Weighted average interest rate for outstanding amounts
at December 31, 2002 0.65% 1.06% 1.76% 0.85%
- ---------------------------------------------------------------------------------------------------------
2001
Balance at December 31, 2001 $214,709 $ 4,992 $ 44,772 $264,473
Maximum amount outstanding at any month-end 298,717 17,545 144,951 461,213
Average amount outstanding 226,758 11,763 86,935 325,456
Weighted average interest rate during the year 3.19% 4.52% 7.68% 4.44%
Weighted average interest rate for outstanding amounts
at December 31, 2001 1.43% 1.79% 1.28% 1.41%
- ---------------------------------------------------------------------------------------------------------
2000
Balance at December 31, 2000 $192,307 $14,756 $126,327 $333,390
Maximum amount outstanding at any month-end 287,434 15,626 153,858 456,918
Average amount outstanding 193,311 13,038 121,592 327,941
Weighted average interest rate during the year 5.22% 6.13% 7.21% 6.00%
Weighted average interest rate for outstanding amounts
at December 31, 2000 5.44% 6.44% 6.75% 5.98%
=========================================================================================================
LIQUIDITY
Core Deposits -- 1st Source's major source of investable funds is provided by
stable core deposits consisting of all interest bearing and noninterest bearing
deposits, excluding brokered certificates of deposit and certain certificates of
deposit of $100,000 and over. In 2002, average core deposits equaled 66.56% of
average total assets, compared to 61.18% in 2001 and 62.41% in 2000. The
effective cost rate of core deposits in 2002 was 2.40%, compared to 3.76% in
2001 and 4.25% in 2000. During 2001, 1st Source Bank acquired a total of 17
branch offices with core and other deposits of $322 million.
Average demand deposits (noninterest bearing core deposits) increased 18.71% in
2002, compared to an increase of 7.01% in 2001. They represented 15.71% of total
core deposits in 2002, compared to 14.81% in 2001 and 15.04% in 2000.
Purchased Funds -- 1st Source's purchased funds are used to supplement core
deposits and include certain certificates of deposit of $100,000 and over,
brokered certificates of deposit, federal funds, securities sold under
agreements to repurchase, commercial paper and other short-term borrowings.
Purchased funds are raised from customers seeking short-term investments and are
used to manage the bank's interest rate sensitivity. During 2002, 1st Source's
reliance on purchased funds decreased to 21.19% of average total assets from
26.71% in 2001.
Loan Securitizations -- 1st Source sells many of the aircraft and auto loans it
originates through the issuance of securities backed by those loans in
securitization transactions. In a securitization, 1st Source sells and transfers
pools of loans to a qualified special purpose entity. The qualified special
purpose entity simultaneously sells and transfers its total interest in the
loans to a trust, which issues beneficial interests in the loans in the form of
securities which are sold through private placement transactions. The qualified
special purpose entity generally retains the right to receive any excess cash
flows of the trust. 1st Source sold $292 million of loans in 2002 and $230
million of loans in 2001 in conjunction with aircraft and auto loan
securitization transactions.
Shareholders' Equity -- Management continues to emphasize profitable asset
growth and retention of equity in the business. Average shareholders' equity
equated to 8.95% of average total assets in 2002 compared to 8.69% in 2001.
Shareholders' equity was 9.08% of total assets at year-end 2002, compared to
8.59% at year-end 2001. In accordance with SFAS No. 115, 1st Source includes
unrealized gain (loss) on available-for-sale securities, net of income taxes, as
accumulated other comprehensive income which is a component of shareholders'
equity. While regulatory capital adequacy ratios exclude unrealized gain (loss)
in the calculation thereof, it does impact 1st Source's equity as reported in
the audited financial statements. The unrealized gain on available-for-sale
securities, net of income taxes, was $4.59 and $5.61 million at December 31,
2002 and 2001, respectively.
Liquidity Risk Management -- The Asset/Liability management process incorporates
overall bank liquidity and interest rate sensitivity. The purpose of liquidity
management is to match the sources and uses of funds to anticipated customer
deposits, withdrawals and borrowing requirements, as well as to provide for the
cash flow needs of 1st Source. The primary source of liquidity is the investment
portfolio. At December 31, 2002, securities maturing in one year amounted to
$201.70 million, which represented 31.14% of the investment portfolio as
compared to 25.92% at year-end 2001. The liquidity of 1st Source is enhanced by
core deposit funding. 1st Source also has access to a variety of short-term and
long-term funding sources, borrowing capacity in the national markets and loan
securitizations.
Interest Rate Risk Management -- 1st Source's Asset/Liability Management
Committee monitors and manages the relationship of earning assets to interest
bearing liabilities and the responsiveness of asset yields, interest expense and
interest margins to changes in market interest rates. In the normal course of
business, 1st Source faces ongoing interest rate risks and uncertainties. 1st
Source occasionally utilizes interest rate swaps to partially manage the primary
market exposures associated with the interest rate risk related to underlying
assets, liabilities and anticipated transactions. There were no interest rate
swaps in place on December 31, 2002. At December 31, 2002, the consolidated
statement of financial condition was rate sensitive by $154.71 million more
assets than liabilities scheduled to reprice within one year or approximately
1.09%.
A hypothetical change in earnings was modeled by calculating an immediate
100 basis point (1.00%) change in interest rates across all maturities. This
analysis presents the hypothetical change in earnings of those rate sensitive
financial instruments held by 1st Source (excluding Trustcorp) at December 31,
2002. The aggregate hypothetical decrease in pre-tax earnings is estimated to be
$1.23 million on an annualized basis on all rate-sensitive financial
instruments, based on a hypothetical increase of a 100 basis point change in
interest rates. The aggregate hypothetical decrease in pre-tax earnings is
estimated to be $6.97 million on an annualized basis on all rate-sensitive
financial instruments based on a hypothetical decrease of a 100 basis point
change in interest rates. Actual results may differ materially from those
projected. The use of this methodology to quantify the market risk of the
balance sheet should not be construed as an endorsement of its accuracy or the
accuracy of the related assumptions.
Due to the nature of the mortgage banking business, 1st Source manages the
earning assets and interest-bearing liabilities of Trustcorp on a separate
basis. The predominant assets on Trustcorp's balance sheet are mortgage loans
held for sale, which are funded by short-term borrowings (normally less than 30
days) from non-affiliated banks. These borrowings are managed on a daily basis.
A portion of Trustcorp's other borrowings for working capital are funded by 1st
Source.
Trustcorp manages the interest rate risk related to loan commitments by entering
into contracts for future delivery of loans. See Part II, Item 8, Financial
Statements and Supplementary Data - Note M of the Notes to Consolidated
Financial Statements.
QUARTERLY RESULTS OF OPERATIONS
Three Months Ended (Dollars in thousands, except per share amounts) March 31 June 30 September 30 December 31
- -------------------------------------------------------------------------------------------------------------------------
2002
Interest income $52,539 $50,396 $48,859 $47,709
Interest expense 21,997 20,445 19,717 18,658
Net interest income 30,542 29,951 29,142 29,051
Provision for loan losses 11,809 10,750 8,765 8,333
Investment securities and other investment (losses) gains (488) - (600) (1,748)
Income before income taxes 5,169 3,481 2,474 281
Net income 4,208 2,767 2,101 963
Diluted net income per common share * 0.20 0.13 0.10 0.05
- -------------------------------------------------------------------------------------------------------------------------
2001
Interest income $62,461 $63,443 $61,218 $58,444
Interest expense 35,395 33,801 31,279 26,482
Net interest income 27,066 29,642 29,939 31,962
Provision for loan losses 6,611 3,715 9,476 5,943
Investment securities and other investment gains (losses) 1,032 52 - (645)
Income before income taxes 21,094 14,300 8,968 13,845
Net income 13,643 9,447 6,174 9,234
Diluted net income per common share * 0.65 0.44 0.29 0.44
=========================================================================================================================
* The computation of per share data gives retroactive recognition to a 5% stock dividend declared April 24, 2001.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
For information regarding Quantitative and Qualitative Disclosures about Market
Risk, see Part II, Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, Interest Rate Risk Management.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31 (Dollars in thousands) 2002 2001
- ----------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 120,894 $ 129,431
Federal funds sold and interest bearing deposits with other banks 81,881 17,038
Investment securities, available-for-sale
(amortized cost of $640,224 and $647,788 at December 31, 2002 and
2001, respectively) 647,617 657,041
Trading account securities 13,347 -
Loans, net of unearned discount:
Commercial and agricultural loans 428,367 460,373
Truck and automobile financing 445,195 344,014
Aircraft financing 323,802 514,573
Construction equipment financing 303,126 328,004
Loans secured by real estate 567,950 586,580
Mortgages held for sale 146,640 173,515
Consumer loans 111,012 128,305
- ----------------------------------------------------------------------------------------------------------------
Total loans 2,326,092 2,535,364
Reserve for loan losses (59,218) (57,624)
- ----------------------------------------------------------------------------------------------------------------
Net loans 2,266,874 2,477,740
Equipment owned under operating leases
(net of accumulated depreciation of $46,188 and $40,826 at
December 31, 2002 and 2001, respectively) 93,893 115,754
Net premises and equipment 40,899 41,923
Other assets 142,063 123,764
- ----------------------------------------------------------------------------------------------------------------
Total assets $3,407,468 $3,562,691
================================================================================================================
LIABILITIES
Deposits:
Noninterest bearing $ 419,289 $ 365,193
Interest bearing 2,293,616 2,517,613
- ----------------------------------------------------------------------------------------------------------------
Total deposits 2,712,905 2,882,806
- ----------------------------------------------------------------------------------------------------------------
Short-term borrowings:
Federal funds purchased and securities sold under agreements to repurchase 212,040 214,709
Other 48,638 49,764
- ----------------------------------------------------------------------------------------------------------------
Total short-term borrowings 260,678 264,473
- ----------------------------------------------------------------------------------------------------------------
Long-term debt 16,878 11,939
Guaranteed preferred beneficial interests in the Company's
subordinated debentures 54,750 44,750
Other liabilities 52,828 52,533
- ----------------------------------------------------------------------------------------------------------------
Total liabilities 3,098,039 3,256,501
================================================================================================================
SHAREHOLDERS' EQUITY
Preferred stock; no par value
Authorized 10,000,000 shares; none issued or outstanding - -
Common stock; no par value
Authorized 40,000,000 shares; issued 21,619,622 shares in 2002 and
21,587,919 shares in 2001, less unearned shares (239,138 -- 2002
and 206,915 -- 2001) 7,579 7,579
Capital surplus 214,001 214,001
Retained earnings 90,897 91,591
Cost of common stock in treasury (431,466 shares -- 2002 and
593,044 shares -- 2001) (7,637) (12,591)
Accumulated other comprehensive income 4,589 5,610
================================================================================================================
Total shareholders' equity 309,429 306,190
================================================================================================================
Total liabilities and shareholders' equity $3,407,468 $3,562,691
================================================================================================================
The accompanying notes are a part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31 (Dollars in thousands, except per share data) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------
Interest and fee income:
Loans $171,029 $211,801 $203,717
Investment securities, taxable 18,103 22,695 22,264
Investment securities, tax-exempt 6,037 6,867 7,955
Total investment securities 24,140 29,562 30,219
Other 4,334 4,203 4,286
- -----------------------------------------------------------------------------------------------------------------
Total interest income 199,503 245,566 238,222
- -----------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 71,084 108,069 109,866
Short-term borrowings 5,659 14,455 19,664
Guaranteed preferred beneficial interest in the Company's
subordinated debentures 3,249 3,560 3,863
Long-term debt 825 873 895
- -----------------------------------------------------------------------------------------------------------------
Total interest expense 80,817 126,957 134,288
- -----------------------------------------------------------------------------------------------------------------
Net interest income 118,686 118,609 103,934
Provision for loan losses 39,657 25,745 11,836
- -----------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 79,029 92,864 92,098
- -----------------------------------------------------------------------------------------------------------------
Noninterest income:
Trust fees 10,252 9,672 9,612
Service charges on deposit accounts 14,947 11,714 8,073
Loan servicing and sale income 7,406 25,679 16,131
Equipment rental income 28,773 26,249 21,224
Other income 14,575 13,273 11,185
Investment securities and other investment (losses) gains (2,836) 439 2,328
- -----------------------------------------------------------------------------------------------------------------
Total noninterest income 73,117 87,026 68,553
- -----------------------------------------------------------------------------------------------------------------
Noninterest expense:
Salaries and benefits employee 67,398 62,614 54,572
Net occupancy expense 6,861 6,199 5,651
Furniture and equipment expense 10,719 9,428 8,874
Depreciation -- leased equipment 23,494 21,034 16,790
Supplies and communications 6,582 6,498 5,608
Business development and marketing expense 3,006 4,359 3,692
Other expense 22,681 11,551 9,326
- -----------------------------------------------------------------------------------------------------------------
Total noninterest expense 140,741 121,683 104,513
- -----------------------------------------------------------------------------------------------------------------
Income before income taxes 11,405 58,207 56,138
Income taxes 1,366 19,709 18,565
- -----------------------------------------------------------------------------------------------------------------
Net income $ 10,039 $ 38,498 $ 37,573
- -----------------------------------------------------------------------------------------------------------------
Basic net income per common share $ 0.48 $ 1.85 $ 1.81
- -----------------------------------------------------------------------------------------------------------------
Diluted net income per common share $ 0.47 $ 1.82 $ 1.79
=================================================================================================================
The accompanying notes are a part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Cost of Accumulated
Common Other
Common Capital Retained Stock Comprehensive
(Dollars in thousands, except per share data) Total Stock Surplus Earnings in Treasury Income (Loss), Net
- ----------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2000 $238,820 $6,883 $179,905 $ 68,309 $(14,382) $(1,895)
- ----------------------------------------------------------------------------------------------------------------------------
Comprehensive income, net of tax:
Net income 37,573 - - 37,573 - -
Change in unrealized losses of
available-for-sale securities 4,116 - - - - 4,116
--------
Total comprehensive income 41,689 - - - - -
Cost of 282,903 shares of common
stock acquired for treasury (4,990) - - - (4,990) -
Cash dividends ($.334 per share) (6,956) - - (6,956) - -
5% common stock dividend
($9 cash paid in lieu of fractional shares) (9) 344 15,292 (15,645) - -
Other 2,018 - - (2,400) 4,418 -
- ----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 $270,572 $7,227 $195,197 $ 80,881 $(14,954) $ 2,221
- ----------------------------------------------------------------------------------------------------------------------------
Comprehensive income, net of tax:
Net income 38,498 - - 38,498 - -
Cumulative effect of change in
accounting principle 688 - - - - 688
Change in unrealized gains of
available-for-sale securities 2,701 - - - - 2,701
--------
Total comprehensive income 41,887 - - - - -
Cost of 71,514 shares of common
stock acquired for treasury (1,308) - - - (1,308) -
Cash dividends ($.351 per share) (7,297) - - (7,297) - -
5% common stock dividend
($10 cash paid in lieu of fractional shares) (10) 352 18,804 (19,166) - -
Other 2,346 - - (1,325) 3,671 -
- ----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $306,190 $7,579 $214,001 $ 91,591 $(12,591) $ 5,610
- ----------------------------------------------------------------------------------------------------------------------------
Comprehensive income, net of tax:
Net income 10,039 - - 10,039 - -
Change in unrealized gains of
available-for-sale securities (1,021) - - - - (1,021)
--------
Total comprehensive income 9,018 - - - - -
Cost of 128,276 shares of common
stock acquired for treasury (2,503) - - - (2,503) -
Cash dividends ($.360 per share) (7,537) - - (7,537) - -
Other 4,261 - - (3,196) 7,457 -
- ----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $309,429 $7,579 $214,001 $90,897 $ (7,637) $ 4,589
============================================================================================================================
The accompanying notes are a part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOW
Year Ended December 31 (Dollars in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------------
Operating activities:
Net income $ 10,039 $ 38,498 $ 37,573
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 39,657 25,745 11,836
Depreciation of premises and equipment 28,471 25,779 21,159
Amortization of investment security premiums and accretion of
discounts, net 4,460 1,811 757
Amortization of mortgage servicing rights 6,306 4,382 5,485
Mortgage servicing asset impairment charges 7,328 - -
Deferred income taxes (15,451) (2,259) 3,013
Realized investment securities losses (gains) 2,836 (439) (2,328)
Realized gains on securitized loans (7,964) (8,532) (8,880)
Decrease (increase) in interest receivable 4,465 3,607 (5,011)
(Decrease) increase in interest payable (6,117) (9,184) 17,148
Other 8,748 4,709 3,384
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 82,778 84,117 84,136
- -------------------------------------------------------------------------------------------------------------------------
Investing activities:
Proceeds from sales and maturities of investment securities
held-to-maturity - - 17,974
Proceeds from sales and maturities of investment securities
available-for-sale 320,110 336,978 191,490
Purchases of investment securities available-for-sale (319,841) (408,611) (222,091)
Net (increase) decrease in short-term investments (78,190) (15,987) 348
Loans sold or participated to others 682,998 236,741 259,126
Increase in loans net of principal collections (511,788) (446,405) (519,485)
Purchase of loans - (29,641) -
Net increase in equipment owned under operating leases (1,587) (48,385) (37,491)
Purchases of premises and equipment (4,510) (11,673) (3,905)
(Increase) decrease in other assets (10,222) 978 (206)
Net cash paid in purchase acquisition - (27,821) -
Other 512 (1,412) (535)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 77,482 (415,238) (314,775)
- -------------------------------------------------------------------------------------------------------------------------
Financing activities:
Net increase in demand deposits, NOW accounts and savings accounts 81,220 82,696 130,948
Purchase of demand deposits and savings accounts - 129,451 -
Net (decrease) increase in certificates of deposits (251,122) 15,845 204,325
Purchase of certificates of deposits - 192,090 -
Net decrease in short-term borrowings (3,794) (68,917) (76,352)
Proceeds from issuance of long-term debt 16,042 217 255
Payments on long-term debt (11,103) (338) (369)
Proceeds from issuance of trust-preferred securities 10,000 - -
Acquisition of treasury stock (2,503) (1,308) (4,990)
Cash dividends (7,537) (7,297) (6,956)
Other - (10) (9)
- -------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (168,797) 342,429 246,852
- -------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents (8,537) 11,308 16,212
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, beginning of year 129,431 118,123 101,911
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $120,894 $129,431 $118,123
=========================================================================================================================
The accompanying notes are a part of the consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A -- Accounting Policies
The principal line of business of 1st Source and subsidiaries is banking and
closely related activities. The following is a summary of significant accounting
policies followed in the preparation of the consolidated financial statements.
PRINCIPLES OF CONSOLIDATION -- The financial statements consolidate 1st Source
and its subsidiaries (principally the Bank and Trustcorp). All significant
intercompany balances and transactions have been eliminated. For purposes of the
parent company only financial information presented in Note Q, investments in
subsidiaries, are carried at 1st Source's equity in the underlying net assets.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS -- The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the reporting
period. Actual results could differ from those estimates.
SECURITIES -- Securities that 1st Source has the ability and positive intent to
hold to maturity are classified as investment securities held-to-maturity.
Held-tomaturity investment securities, when present, are carried at amortized
cost. Securities that may be sold in response to, or in anticipation of, changes
in interest rates and resulting prepayment risk, or for other factors, are
classified as available-for-sale and carried at fair value. Unrealized gains and
losses on these securities are reported net of applicable taxes, as a separate
component of accumulated other comprehensive income in shareholders' equity.
Debt and equity securities that are purchased and held principally for the
purpose of selling them in the near term and are classified as trading account
securities are carried at fair value with unrealized gains and losses reported
in earnings. Unrealized gains of $562,000 on trading account securities were
included in earnings at December 31, 2002. Realized gains and losses on the
sales of all securities are reported in earnings and computed using the specific
identification cost basis.
LOANS -- Loans are reported at the principal amount outstanding, net of unearned
income. Loans identified as held-for-sale are carried at the lower of cost or
market determined on an aggregate basis.
Interest on loans is included in interest income, using the accrual method over
the terms of the loans based upon principal balances outstanding. Loan
origination and commitment fees and direct loan origination costs, when
material, are deferred and the net amount amortized to interest income generally
over the contractual life of the related loan or commitment.
The accrual of interest on loans is discontinued when a loan becomes
contractually delinquent for 90 days, except for mortgage loans, which are
placed on nonaccrual at the time the loan is placed in foreclosure. When
interest accruals are discontinued, interest credited to income in the current
year is reversed and interest accrued in the prior year is charged to the
reserve for loan losses. Management may elect to continue the accrual of
interest when the net realizable value of collateral is sufficient to cover the
principal and accrued interest. While a loan is classified as nonaccrual and the
future collectibility of the recorded loan balance is doubtful, collections on
interest and principal are generally applied as a reduction to principal
outstanding.
A loan is considered impaired, based on current information and events, if it is
probable that 1st Source will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Interest on impaired loans, which are not classified as nonaccrual is
recognized on the accrual basis.
SECURITIZED ASSETS -- The guidelines set forth in Statement of Financial
Accounting Standards (SFAS) No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," are followed when
accounting for securitizations. When 1st Source sells loans in securitizations,
it retains servicing rights and interest-only strips. The interest-only strips
are capitalized as retained interests in the securitized assets. Gain or loss on
sale of the loans depends in part on the previous carrying amount of the loans
sold, in proportion to their fair value. 1st Source generally estimates fair
value based on the present value of future cash flows expected under
management's best estimates of certain key assumptions. Key assumptions used by
1st Source in its securitization model are as follows: discount rate (15%); loan
loss assumption for cash flow purposes (1.00%); interest earned on the trust
cash tied to the 30 day LIBOR; and future liquidations of securitized loans
based on an 18 month rolling historical average. In conjunction with its
securitization activities, 1st Source sold $292.24 million of aircraft and auto
loans in 2002 and $230.26 million in 2001. The securitization generated total
income of $8.09 million and $9.10 million in 2002 and 2001, respectively. Of
this amount, $4.83 million and $5.71 million, representing gains on sale and
servicing, for 2002 and 2001, respectively, were recorded in loan servicing and
sale income. The balance represents accretion of the discount on an effective
yield basis. The accretion, recorded as taxable investment security income, for
the years 2002 and 2001, was $3.26 million and $3.39 million, respectively.
Included in the consolidated statements of financial condition, as
available-for-sale securities, are the retained interests in the securitized
assets. The retained interests are assets of 1st Source Funding, LLC
("Funding"), a qualified special purpose subsidiary of the Bank, and represent
Funding's beneficial interests in certain assets of the 1st Source Master Trust
in accordance with 1st Source's loan securitization transactions. The recorded
fair value of the retained interests increased slightly to $21.46 million in
2002 from $21.17 million at year end 2001. Changes in fair value are recorded as
a component of other comprehensive income. In 2002, 1st Source recorded an
impairment charge of $1.49 million through security losses caused by a reduction
of the estimated discounted future cash flows expected from the securitization.
The following analysis shows the impact on the fair value of the retained
interests for unfavorable, hypothetical changes in the key assumptions used to
value the retained interests:
1. An increase in the loss assumption from 1.00% to 1.25% and 1.50% reduces the
fair value by $1.01 million and $2.02 million, respectively.
2. An increase in the discount rate from 15% to 18% and 20% reduces the fair
value by $1.45 million and $2.35 million, respectively.
3. A decrease of 0.75% and 1.25% in the trust cash earnings rate reduces the
fair value by $250,000 and $473,000, respectively.
4. An increase in future liquidations from the current assumption by 50% and
100% reduces the fair value by $334,000 and $466,000, respectively.
These results of the above analysis are hypothetical and should be used with
caution. As some of the figures indicate, changes in fair value based on
unfavorable variations in key assumptions generally cannot be projected, because
the relationship of the change in the assumption to the change in fair value
vary. Also, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated above without changing any other
assumption. In reality, changes in one factor may result in changes in another
(for example, increases in market interest rates may result in lower prepayments
and increased credit (losses), which might alter the results.
As of December 31, 2002, there were $387.79 million outstanding auto and
aircraft loans in the contracted $400 million revolving securitization facility.
This compares to outstanding loans of $346.28 million, at year end 2001. At year
end 2002, 0.23% of the outstanding securitized loans were delinquent 60 or more
days, compared to 1.68%, at year end 2001. Defaulted loans decreased from $15.06
million at year end 2001 to $11.49 million at year end 2002.
Charge-offs, net of recoveries, increased to $9.60 million in 2002, compared to
$4.83 million in 2001. Securitization guidelines require that defaulted loans be
charged-off after twelve months, regardless of collateral value.
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 judgement
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 (classified loans and internal watch list
credits), percentage allocations for special attention loans without specific
reserves, formula reserves for each business lending division 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 disposition and
forecasts of future economic and geopolitical events, all of which are subject
to judgement and will change.
Specific reserves are established for certain business and specialty finance
credits based on a regular analysis of special attention loans. This analysis is
performed by the Credit Policy Committee, the Loan Review Department, Credit
Administration and the Loan Workout Departments. The specific reserves are based
on an analysis of underlying collateral values, cash flow considerations and, if
applicable, guarantor capacity.
The formula reserves determined for each business lending division portfolio are
calculated quarterly by applying loss factors to outstanding loans and certain
unfunded commitments based upon a review of historical loss experience and
qualitative factors, which include but are not limited to, economic trends,
current market risk assessment by industry, recent loss experience in particular
segments of the portfolios, movement in equipment values collateralizing
specialized industry portfolios, concentrations of credit, delinquencies, trends
in volume, experience and depth of relationship managers and division
management, and the effects of changes in lending policies and practices,
including changes in quality of the loan origination, servicing and risk
management processes. Special attention loans without specific reserves receive
a higher percentage allocation ratio than credits not considered special
attention.
Pooled loans are smaller credits and are generally homogenous in nature, such as
consumer credits and residential mortgages. Pooled loan loss reserves are based
on historical net charge-offs, adjusted for delinquencies, the effects of
lending practices and programs and current economic conditions and projected
trends in the geographic markets which we serve.
Additional reserves are provided to recognize the exposure to inherent, but
undetected losses within the overall loan portfolio. This exposure is caused by
inherent delays in obtaining information regarding an individual borrower's or
segments of borrowers' financial condition or change in its or their specific
business condition; the judgmental nature of individual loan evaluations,
collateral assessments and the interpretation of economic trends; the volatility
of general economic or specific customer conditions; and the sensitivity of
assumptions used in establishing reserves for various loan portfolios.
Management believes a general reserve is needed to recognize the imprecision
inherent in the process of estimating expected credit losses.
A comprehensive analysis of the reserve is performed by management on a
quarterly basis. Although management determines the amount of each element of
the reserve separately and relies on this process as an important credit
management tool, the entire reserve is available for the entire loan portfolio.
The actual amount of losses incurred can vary significantly from the estimated
amounts both positively and negatively. Management's methodology includes
several factors intended to minimize the difference between estimated and actual
losses. These factors allow management to adjust its estimate of losses based on
the most recent information available.
The reserve is reduced by charge-offs on loans deemed uncollectible, while
recoveries of amounts previously charged off are credited to the reserve. A
provision for loan losses is charged to operations based on management's
periodic evaluation of the factors previously mentioned, as well as other
pertinent factors.
MORTGAGE SERVICING RIGHTS -- 1st Source recognizes as separate assets the rights
to service mortgage loans for others, whether the servicing rights are acquired
through a separate purchase or through the sale of originated loans with
servicing rights retained. These assets are amortized as reductions of mortgage
servicing fee income over the estimated servicing period in proportion to the
estimated servicing income to be received. For the years ended December 31,
2002, 2001 and 2000, $6.31 million, $4.38 million and $5.49 million,
respectively, of amortization expense has been recognized. Gains and losses on
the sale of mortgage servicing rights are recognized as noninterest income in
the period in which such rights are sold on a servicing released basis.
SFAS No. 140 allows companies to allocate a portion of the total cost of a
mortgage loan to servicing rights based on their relative fair value. The fair
value of the servicing rights is based on market prices, when available, or is
determined by estimating the present value of future net servicing income,
taking into consideration market loan prepayment speeds and discount rates. As
of December 31, 2002 and 2001, mortgage servicing rights have a carrying value
of $20.78 million and $20.14 million, respectively. The servicing rights had a
fair value of $21.41 million and $29.88 million, as of December 31, 2002 and
2001, respectively.
SFAS No. 140 also requires 1st Source to assess its capitalized servicing
rights for impairment based on their current fair value. For purposes of
impairment measurement, 1st Source stratifies its mortgage servicing portfolio
based on the predominant risk characteristics of the underlying servicing,
principally by loan type and interest rate. The current fair value of each
segment of the servicing portfolio is then determined and to the extent the
carrying value of the mortgage servicing rights exceeds fair value by individual
strata, a valuation allowance is recorded as a reduction of servicing income in
current earnings. For the year ended December 31, 2002, a $7.33 million
valuation allowance for impairment was recorded. There was no valuation
allowance as of December 31, 2001.
LEASED ASSETS -- 1st Source finances various types of construction equipment,
heavy duty trucks and automobiles under leases principally classified as
operating leases. Revenue consists of the contractual lease payments and is
recognized on a straight-line basis over the lease term, generally three to
seven years. Leased assets are being depreciated on a straight-line method over
the lease term to the estimate of the equipment's fair market value at lease
termination, also commonly referred to as "residual" value. These estimates are
reviewed periodically to ensure realization.
OTHER REAL ESTATE -- Other real estate acquired through partial or total
satisfaction of nonperforming loans is included in other assets and recorded at
the estimated fair value less anticipated selling costs based upon the
property's appraised value at the date of transfer, with any difference between
the fair value of the property and the carrying value of the loan charged to the
reserve for loan losses. Subsequent changes in value are reported as adjustments
to the carrying amount and are recorded in noninterest expense on the income
statement. Gains or losses not previously recognized resulting from the sale of
other real estate are recognized on the date of sale. As of December 31, 2002
and 2001, other real estate had carrying values of $4.36 million and $3.14
million, respectively.
REPOSSESSED ASSETS -- Repossessed assets consist of specialty finance equipment,
including aircraft, construction equipment and vehicles acquired through
foreclosure or in lieu of foreclosure. Repossessed assets are included in other
assets at the lower of cost or fair value of the equipment or vehicle. 1st
Source generally estimates fair value based on the best estimate of a
liquidation value. Sources typically include vehicle and equipment dealers,
valuation guides and other third parties, including appraisers. At the time of
foreclosure, the recorded amount of the loan is written down, if necessary, to
the fair value of the equipment or vehicle by a charge to the reserve for loan
losses. Subsequent write-downs are included in non-interest expense. Repossessed
assets total $21.34 million and $3.51 million, as of December 31, 2002 and 2001,
respectively.
PREMISES AND EQUIPMENT -- Premises and equipment are stated at cost, less
accumulated depreciation and amortization. The provision for depreciation is
computed generally by the straight-line method, primarily with useful lives of
5, 7, 15 and 31 1/2 years. Maintenance and repairs are charged to expense as
incurred, while improvements, which extend the useful life, are capitalized and
depreciated over the estimated remaining life.
GOODWILL AND INTANGIBLES -- Goodwill represents the excess of the cost of an
acquisition over the fair value of the net assets acquired. Other intangible
assets represent purchased assets that also lack physical substance but can be
distinguished from goodwill because of contractual or other legal rights or
because the asset is capable of being sold or exchanged either on its own or in
combination with a related contract, asset, or liability. On January 1, 2002,
1st Source adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under
the provisions of SFAS No. 142, goodwill is no longer ratably amortized into the
income statement over an estimated life but rather is tested at least annually
for impairment. Intangible assets which have finite lives continue to be
amortized over their estimated useful lives and also continue to be subject to
impairment testing. All of 1st Source's other intangible assets have finite
lives and are amortized on a straightline basis over varying periods not
exceeding 6 years. Prior to the adoption of SFAS No. 142, 1st Source's goodwill
was amortized on a straight-line basis over varying periods not exceeding 25
years. 1st Source performed the first required impairment test of goodwill and
determined that no impairment exists.
VENTURE CAPITAL INVESTMENT -- Venture capital investments are carried at
estimated fair value with changes in fair value recognized in investment
securities and other investment (losses) gains. The fair values of publicly
traded investments are determined using quoted market prices. For other
investments, fair value is determined by the General Partner. All valuations are
approved by the Valuation Committee of the Advisory Board of the Partnership.
Venture capital investments in Partnerships are included in other assets on the
balance sheet. The balances as of December 31, 2002 and 2001 are $3.35 million
and $3.90 million, respectively.
SHORT-TERM BORROWINGS -- 1st Source's short-term borrowings consist of federal
funds purchased, securities sold under agreement to repurchase, commercial
paper, U.S. Treasury demand notes and borrowings from non-affiliated banks.
Federal funds purchased and securities sold under agreements to repurchase
generally mature within 30 days of the transaction date. Commercial paper and
other short-term borrowings generally mature within 30 to 180 days.
Securities purchased under agreements to resell and securities sold under
agreements to repurchase are generally treated as collateralized financing
transactions and are recorded at the amounts at which the securities were
acquired or sold plus accrued interest. Securities, generally U.S. government
and Federal agency securities, pledged as collateral under these financing
arrangements cannot be sold or repledged by the secured party. The fair value of
collateral either received from or provided to a third party is continually
monitored and additional collateral obtained or requested to be returned to 1st
Source as deemed appropriate.
Under available line of credit agreements, 1st Source may borrow up to $3
million. At December 31, 2002 and 2001, there were no outstanding borrowings
under these lines, which were assigned to support commercial paper borrowings.
TRUST FEES -- Trust fees are recognized on the accrual basis.
INCOME TAXES -- 1st Source and its subsidiaries file a consolidated Federal
income tax return. The provision for incomes taxes is based upon income in the
financial statements, rather than amounts reported on 1st Source's income tax
return.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized as income or expense in the period that
includes the enactment date.
NET INCOME PER COMMON SHARE -- Net income per common share is computed in
accordance with SFAS No. 128, "Earnings per Share." Basic earnings per share is
computed by dividing net income by the weighted-average number of shares of
common stock outstanding, which were as follows (in thousands): 2002, 20,935;
2001, 20,767; and 2000, 20,769. Diluted earnings per share is computed by
dividing net income by the weighted-average number of shares of common stock
outstanding, plus the dilutive effect of outstanding stock options. The
weighted-average number of common shares, increased for the dilutive effect of
stock options, used in the computation of diluted earnings per share were as
follows (in thousands): 2002, 21,310; 2001, 21,170; and 2000, 20,982. The
computation of weighted-average number of shares gives retroactive effect to a
5% stock dividend declared April 24, 2001.
At December 31, 2002, the company had six stock-based employee compensation
plans, which are described more fully in Note H. These include two stock option
plans, a stock option agreement, the Employee Stock Purchase Plan, the Executive
Incentive Plan and the Restricted Stock Award Plan. 1st Source accounts for
those plans under the recognition and measurement principles of APB Option 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.
No stock-based employee compensation cost for the stock option plans, the stock
option agreement, or the Employee Stock Purchase Plan is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share if
the company had applied the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee compensation.
Year Ended December 31 (Dollars in thousands, except per share data) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------
Net income, as reported $10,039 $38,498 $37,573
Add:
Stock-based employee compensation expense included in reported net
income, net of related tax effects - 1,832 2,253
Deduct:
Stock-based employee compensation expense determined under fair value
based method for all awards, net of related tax effects (333) (2,124) (2,592)
- ----------------------------------------------------------------------------------------------------------
Pro forma net income $ 9,706 38,206 37,234
- ----------------------------------------------------------------------------------------------------------
Earnings per share:
Basic - as reported $ 0.48 $ 1.85 $ 1.81
Basic - pro forma $ 0.46 $ 1.84 $ 1.79
- ----------------------------------------------------------------------------------------------------------
Diluted - as reported $ 0.47 $ 1.82 $ 1.79
Diluted - pro forma $ 0.46 $ 1.81 $ 1.78
==========================================================================================================
FUNDS HELD IN TRUST FOR INVESTORS AND MORTGAGORS -- As of December 31, 2002 and
2001, serviced mortgage loans which were owned by investors aggregated $2.01
billion and $1.34 billion, respectively. Funds held in trust at 1st Source for
the payment of principal, interest, taxes and insurance premiums applicable to
mortgage loans being serviced for others, aggregated approximately $86.57
million and $42.25 million at December 31, 2002 and December 31, 2001,
respectively.
CASH FLOW INFORMATION -- For purposes of the consolidated and parent company
only statements of cash flows, 1st Source considers cash and due from banks as
cash and cash equivalents. Interest payments made by 1st Source were $86.93
million, $132.58 million and $113.28 million in 2002, 2001 and 2000,
respectively. Federal income tax (receipts) payments were $(3.47) million,
$19.74 million and $18.79 million in 2002, 2001 and 2000, respectively.
SEGMENT INFORMATION -- 1st Source's principal business is commercial banking and
mortgage banking conducted through its wholly-owned subsidiary, Trustcorp.
Trustcorp constitutes a segment by definition in accordance with SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information." The chief
operating decision makers of 1st Source rely on "operating earnings" for review
of the performance and for critical decision making purposes related to
Trustcorp. Operating earnings exclude gains or losses on the sale of servicing
rights or impairments or increases in the value of such rights that are due to
economic factors beyond the control of management. When excluding these items
from operating earnings Trustcorp does not meet any of the threshold tests for
reporting as a separate segment and, accordingly no disclosure is necessary in
the financial statements.
DERIVATIVE FINANCIAL INSTRUMENTS -- 1st Source occasionally enters into
derivative financial instruments as part of its interest rate risk management
strategies. These derivative financial instruments consist primarily of interest
rate swaps and forward sales. On January 1, 2001, 1st Source adopted SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended.
SFAS No. 133 requires that all derivative instruments be recorded on the balance
sheet, as either an asset or liability, at their fair value. The accounting for
the gain or loss resulting from the change in fair value depends on the intended
use of the derivative. For a derivative used to hedge changes in fair value of a
recognized asset or liability, or an unrecognized firm commitment, the gain or
loss on the derivative will be recognized in earnings together with the
offsetting loss or gain on the hedged item. This results in earnings recognition
only to the extent that the hedge is ineffective in achieving offsetting changes
in fair value. For a derivative used to hedge changes in cash flows associated
with forecasted transactions, the gain or loss on the effective portion of the
derivative will be deferred, and reported as accumulated other comprehensive
income, a component of shareholders' equity, until such time the hedged
transaction affects earnings. For derivative instruments not accounted for as
hedges, changes in fair value are required to be recognized in earnings. Prior
to 2001, these instruments were accounted for under the accrual basis of
accounting, whereby the income or expense was recorded as a component of
interest income. If a swap was terminated, the resulting gain or loss was
deferred and amortized over the remaining life of the derivative.
RECENT ACCOUNTING PRONOUNCEMENTS -- Consolidation of Variable Interest
Entities: In January 2003, the Financial Accounting Standards Board (FASB)
issued FASB Interpretation No. (FIN) 46, "Consolidation of Variable Interest
Entities." The objective of this interpretation is to provide guidance on how to
identify a variable interest entity (VIE) and determine when the assets,
liabilities, noncontrolling interests, and results of operations of a VIE need
to be included in a company's consolidated financial statements. A company that
holds variable interests in an entity will need to consolidate the entity if the
company's interest in the VIE is such that the company will absorb a majority of
the VIE's expected losses and/or receive a majority of the entity's expected
residual returns, if they occur. FIN 46 also requires additional disclosures by
primary beneficiaries and other significant variable interest holders. The
provisions of this interpretation became effective upon issuance. As of December
31, 2002, 1st Source had a variable interest in a securitization trust. This
trust is a qualifying special purpose entity, which is exempt from the
consolidation requirements of FIN 46. 1st Source does not expect the
requirements of FIN 46 to have a material impact on the results of operations,
financial position, or liquidity.
Guarantees: In November 2002, the FASB issued FIN 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This interpretation expands the disclosures to be made
by a guarantor in its financial statements about its obligations under certain
guarantees and requires the guarantor to recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN 45 clarifies the
requirements of SFAS No. 5, "Accounting for Contingencies," relating to
guarantees. In general, FIN 45 applies to contracts or indemnification
agreements that contingently require the guarantor to make payments to the
guaranteed party based on changes in an underlying that is related to an asset,
liability, or equity security of the guaranteed party. Certain guarantee
contracts are excluded from both the disclosure and recognition requirements of
this interpretation, including, among others, guarantees relating to employee
compensation, residual value guarantees under capital lease arrangements,
commercial letters of credit, loan commitments, subordinated interests in a
special purpose entity, and guarantees of a company's own future performance.
Other guarantees are subject to the disclosure requirements of FIN 45 but not to
the recognition provisions and include, among others, a guarantee accounted for
as a derivative instrument under SFAS No. 133, a parent's guarantee of debt owed
to a third party by its subsidiary or vice versa, and a guarantee which is based
on performance not price. The disclosure requirements of FIN 45 are effective
for 1st Source as of December 31, 2002, and require disclosure of the nature of
the guarantee, the maximum potential amount of future payments that the
guarantor could be required to make under the guarantee, and the current amount
of the liability, if any, for the guarantor's obligations under the guarantee.
The recognition requirements of FIN 45 are to be applied prospectively to
guarantees issued or modified after December 31, 2002. Significant guarantees
that have been entered into by 1st Source are disclosed in Note M. 1st Source
does not expect the requirements of FIN 45 to have a material impact on results
of operations, financial position, or liquidity.
Accounting for Stock-Based Compensation: In December 2002, the FASB issued
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," which provides guidance on how to transition from the intrinsic
value method of accounting for stock-based employee compensation under APB 25 to
SFAS No. 123's fair value method of accounting, if a company so elects. 1st
Source is reviewing SFAS No. 148 and has not yet made a decision on the adoption
of the fair value method of recording stock options under SFAS No. 123.
Acquisitions of Certain Financial Institutions: In October 2002, SFAS No. 147,
"Acquisitions of Certain Financial Institutions" was issued, which provides
guidance on the accounting for the acquisition of a financial institution and
supersedes the specialized accounting guidance provided in SFAS No. 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions." SFAS
No. 147 is effective immediately and requires companies to cease amortization of
unidentified intangible assets associated with certain branch acquisitions. Upon
adoption of SFAS No. 147, the amount of unidentifiable intangible assets
previously recorded was reclassified to goodwill. SFAS No. 147 also modifies
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
to include in its scope long-term customer-relationship intangible assets and
thus subject those intangible assets to the same undiscounted cash flow
recoverability test and impairment loss recognition and measurement provisions
required for other long-lived assets. While SFAS No. 147 may affect how future
business combinations, if undertaken, are accounted for and disclosed in the
financial statements, the issuance of the new guidance currently has no effect
on 1st Source's result of operations, financial position, or liquidity. 1st
Source does not have any assets subject to the specialized accounting guidance
provided in SFAS No. 72 or SFAS No. 147.
Accounting for Costs Associated with Exit or Disposal Activities: SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities," was issued
in July 2002 and becomes effective for 1st Source beginning January 1, 2003.
This statement requires a cost associated with an exit or disposal activity,
such as the sale or termination of a line of business, the closure of business
activities in a particular location, or a change in management structure, be
recorded as a liability at fair value when it becomes probable the cost will be
incurred and no future economic benefit will be gained by 1st Source for such
cost. Applicable costs include employee termination benefits, contract
termination costs, and costs to consolidate facilities or relocate employees.
SFAS No. 146 supersedes EITF Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity," which in
some cases required certain costs to be recognized before a liability was
actually incurred. The adoption of this standard is not expected to have a
material impact on 1st Source's results of operations, financial position, or
liquidity.
Rescission of SFAS No. 4, 44, and 64, Amendment of SFAS No. 13 and Technical
Corrections: In April 2002, SFAS No. 145 was issued, which updates, clarifies
and simplifies certain existing accounting pronouncements beginning at various
dates in 2002 and 2003. The statement rescinds SFAS No. 4 and SFAS No. 64, which
required net gains or losses from the extinguishments of debt to be classified
as an extraordinary item in the income statement. These gains and losses will
now be classified as extraordinary only if they meet the criteria for such
classification as outlined in APB Opinion 30, which allows for extraordinary
treatment if the item is material and both unusual and infrequent in nature. The
statement also rescinds SFAS No. 44 related to the accounting for intangible
assets for motor carriers and amends SFAS No. 13 to require certain lease
modifications that have economic effects similar to sale-leaseback transactions
to be accounted for as such. The changes required by SFAS No. 145 are expected
to have little or no impact on 1st Source's results of operations, financial
position, or liquidity.
Accounting for Long-Lived Assets: SFAS No. 144 was issued in October 2001 and
addresses how and when to measure impairment on long-lived assets and how to
account for long-lived assets that an entity plans to dispose of either through
sale, abandonment, exchange, or distribution to owners. The statement's
provisions supersede SFAS No. 121, which addressed asset impairment, and certain
provisions of APB Opinion 30 related to reporting the effects of the disposal of
a business segment and requires expected future operating losses from
discontinued operations to be recorded in the period in which the losses are
incurred rather than the measurement date. Under SFAS No. 144, more dispositions
may qualify for discontinued operations treatment in the income
statement. The provisions of SFAS No. 144 became effective for 1st Source on
January 1, 2002 and did not have a material impact on 1st Source's results of
operations, financial position, or liquidity.
Goodwill and Other Intangible Assets: On January 1, 2002, 1st Source
adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under the new
rules, goodwill and intangible assets deemed to have indefinite lives will no
longer be amortized but will be subject to annual impairment tests. Other
intangible assets, such as core deposit intangibles, will continue to be
amortized over their useful lives. Application of the nonamortization provisions
of the statement resulted in an increase in net income of approximately $220,000
or $0.01 per common share for 2002. The standard's adoption had no impact on 1st
Source's liquidity. If 1st Source had adopted SFAS No. 142 effective January 1,
2001, net income would have increased approximately $220,000 or $0.01 per common
share.
Asset Retirement Obligations: In August 2001, the FASB issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." SFAS No. 143 requires an entity
to record a liability for an obligation associated with the retirement of an
asset at the time the liability is incurred by capitalizing the cost as part of
the carrying value of the related asset and depreciating it over the remaining
useful life of that asset. The standard is effective for 1st Source beginning
January 1, 2003, and its adoption is not expected to have a material impact on
results of operations, financial position, or liquidity.
RECLASSIFICATIONS -- Certain amounts in the prior period consolidated financial
statements have been reclassified to conform with the current year presentation.
These reclassifications had no effect on total assets, shareholders' equity or
net income as previously reported.
Note B -- Fair Values of Financial Instruments
The fair values of 1st Source's financial instruments as of December 31, 2002 and 2001 are summarized in the table below.
2002 2001
Carrying or Carrying or
(Dollars in thousands) Contract Value Fair Value Contract Value Fair Value
- -------------------------------------------------------------------------------------------------------------------------
Assets:
Cash and due from banks $ 120,894 $ 120,894 $ 129,431 $ 129,431
Federal funds sold and interest bearing deposits with other banks 81,881 81,881 17,038 17,038
Securities available-for-sale 647,617 647,617 657,041 657,041
Trading account securities 13,347 13,347 - -
Loans, net of reserve for loan losses 2,266,874 2,321,470 2,477,740 2,564,094
- -------------------------------------------------------------------------------------------------------------------------
Liabilities:
Deposits 2,712,905 2,748,490 2,882,806 2,907,716
Short-term borrowings 260,678 260,678 264,473 264,473
Long-term debt 16,878 17,144 11,939 12,415
Guaranteed preferred beneficial interests in the Company's
subordinated debentures 54,750 51,393 44,750 41,490
Off-balance-sheet instruments * - (696) - (691)
=========================================================================================================================
* Represents estimated cash outflows required to currently settle the obligations at current market rates.
The following methods and assumptions were used by 1st Source in estimating the
fair value of its financial instruments:
CASH AND CASH EQUIVALENTS -- The carrying values reported in the consolidated
statements of financial condition for cash and due from banks, federal funds
sold and interest bearing deposits with other banks approximate their fair
values.
SECURITIES -- Fair values for securities are based on quoted market prices,
where available. If quoted market prices are not available, fair values are
estimated based on quoted market prices of comparable investments. Retained
interests in securitized assets are generally valued using discounted cash flow
techniques.
LOANS -- For variable rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. The fair values
for certain real estate loans (e.g., one-to-four single family residential
mortgage loans) are based on quoted market prices of similar loans sold in
conjunction with securitization transactions, adjusted for differences in loan
characteristics. The fair values of all other loans are estimated using
discounted cash flow analyses which use interest rates currently being offered
for loans with similar terms to borrowers of similar credit quality.
DEPOSITS -- The fair values for all deposits other than time deposits are equal
to the amounts payable on demand (the carrying value). Fair values of variable
rate time deposits are equal to their carrying values. Fair values for fixed
rate time deposits are estimated using discounted cash flow analyses using
interest rates currently being offered for deposits with similar remaining
maturities.
SHORT-TERM BORROWINGS -- The carrying values of federal funds purchased,
securities sold under repurchase agreements and other short-term borrowings
approximate their fair values.
LONG-TERM DEBT -- The fair values of 1st Source's long-term debt are estimated
using discounted cash flow analyses, based on 1st Source's current estimated
incremental borrowing rates for similar types of borrowing arrangements.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S SUBORDINATED
DEBENTURES (CUMULATIVE TRUST PREFERRED SECURITIES) -- Fair values are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are estimated based on quoted market prices of comparable
securities.
GUARANTEES AND LOAN COMMITMENTS -- Contract and fair values for certain of 1st
Source's off-balance-sheet financial instruments (guarantees and loan
commitments) are estimated based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties' credit standing.
OFF-BALANCE-SHEET INSTRUMENTS -- Fair values for off-balance-sheet instruments
are based on the net amount necessary to currently settle the transaction.
LIMITATIONS -- Fair value estimates are made at a discrete point in time based
on relevant market information and information about the financial instruments.
Because no market exists for a significant portion of 1st Source's financial
instruments, fair value estimates are based on judgments regarding future
expected loss experience, current economic conditions, risk characteristics of
various financial instruments and other such factors.
These estimates are subjective in nature and involve uncertainties and matters
of significant judgment and therefore cannot be determined with precision.
Changes in assumptions could significantly affect the estimates. In addition,
the fair value estimates are based on existing on and off-balance-sheet
financial instruments without attempting to estimate the value of anticipated
future business and of the assets and liabilities which are not considered
financial instruments. For example, 1st Source has a substantial annual trust
net fee income. Its trust operations are not considered financial instruments
and their value has not been incorporated into the fair value estimates.
Other significant assets and liabilities that are not considered financial
instruments include the mortgage banking operation, premises and equipment and
other assets. In addition, for investment and mortgage-backed securities, the
income tax ramifications related to the realization of unrealized gains and
losses can have a significant effect on fair value estimates and have not been
considered in many of the estimates. Also, the fair value estimates for deposits
do not include the benefit that results from the low-cost funding provided by
the deposit liabilities compared to the cost of borrowing funds in the market.
Note C -- Investment Securities
Securities available-for-sale at December 31, 2002 and 2001, are as follows:
Amortized Gross Gross
(Dollars in thousands) Cost Unrealized Gains Unrealized Losses Fair Value
- ----------------------------------------------------------------------------------------------------------------------
December 31, 2002
Debt securities:
U.S. Treasury and agency securities $321,798 $ 5,389 $ (1) $327,186
Obligations of states and political subdivisions 152,001 4,054 (45) 156,010
Mortgage-backed securities 63,880 597 (10) 64,467
Other securities 29,996 58 (2,112) 27,942
- ----------------------------------------------------------------------------------------------------------------------
Total debt securities 567,675 10,098 (2,168) 575,605
Equity securities 72,549 1,503 (2,040) 72,012
- ----------------------------------------------------------------------------------------------------------------------
Total investment securities $640,224 $11,601 $(4,208) $647,617
- ----------------------------------------------------------------------------------------------------------------------
December 31, 2001
Debt securities:
U.S. Treasury and agency securities $376,806 $ 5,019 $ (265) $381,560
Obligations of states and political subdivisions 141,346 2,724 (70) 144,000
Mortgage-backed securities 54,888 279 (132) 55,035
Other securities 34,620 1,633 (13) 36,240
- ----------------------------------------------------------------------------------------------------------------------
Total debt securities 607,660 9,655 (480) 616,835
Equity securities 40,128 1,173 (1,095) 40,206
- ----------------------------------------------------------------------------------------------------------------------
Total investment securities $647,788 $10,828 $(1,575) $657,041
======================================================================================================================
The contractual maturities of investments in debt securities available-for-sale
at December 31, 2002, are shown below. Expected maturities will differ from
contractual maturities, because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Amortized
December 31, 2002 (Dollars in thousands) Cost Fair Value
- ---------------------------------------------------------------------------------------
Due in one year or less $199,290 $201,694
Due after one year through five years 239,048 245,738
Due after five years through ten years 40,103 40,426
Due after ten years 1,785 1,824
Mortgage-backed securities 63,880 64,467
Retained interests in securitizations 23,569 21,456
- ---------------------------------------------------------------------------------------
Total debt securities $567,675 $575,605
=======================================================================================
Other equity securities classified as available-for-sale at December 31, 2002
and 2001 include securities such as Federal Reserve Bank and Federal Home Loan
Bank stock, which are not traded on established exchanges and have only
redemption capabilities. Fair values for such equity securities are considered
to approximate cost.
Gross losses of $1.75 million were recognized during 2002 on securities
available-for-sale. The gross loss in 2002 includes a $1.49 million impairment
charge on the securitization retained interest.
At December 31, 2002 and 2001, investment securities with carrying values of
$284.53 million and $301.08 million, respectively, were pledged as collateral to
secure government, public and trust deposits and for other purposes.
The mortgage-backed securities held by 1st Source consist primarily of FNMA,
GNMA and FHLMC pass-through certificates which are guaranteed by those
respective agencies of the United States government.
Note D -- Loans to Related Parties
1st Source and its subsidiaries have extended, and expect to extend in the
future, loans to officers and directors of 1st Source and its subsidiaries and
to their associates. In the opinion of management, these loans are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other parties and are
consistent with sound banking practices and within applicable regulatory and
lending limitations. The aggregate dollar amount of these loans was $22.84
million and $18.56 million at December 31, 2002 and 2001, respectively. During
2002, $18.13 million of new loans were made and repayments and other reductions
totaled $13.85 million.
Note E -- Reserve for Loan Losses
At December 31, 2002 and 2001, nonaccrual and restructured loans, substantially
all of which are collateralized, are $35.66 million and $35.83 million,
respectively. Interest income for the years ended December 31, 2002, 2001 and
2000 would have increased by approximately $2.63 million, $2.82 million and
$1.86 million, respectively, if these loans had earned interest at their full
contract rate.
As of December 31, 2002 and 2001, impaired loans totaled $60.10 million and
$45.40 million, respectively, of which $27.35 million and $27.70 million had
corresponding specific reserves for loan losses totaling $10.04 million and
$6.94 million, respectively. The remaining balances of impaired loans had no
specific reserves for loan losses associated with them. As of December 31, 2002,
a total of $33.13 million of the impaired loans are nonaccrual loans. For 2002,
2001 and 2000 the average recorded investment in impaired loans was $64.30
million, $45.69 million and $34.92 million, respectively, and interest income
recognized on impaired loans totaled $2.84 million, $3.40 million and $1.98
million, respectively.
Changes in the reserve for loan losses for each of the three years ended
December 31 are shown below.
(Dollars in thousands) 2002 2001 2000
- --------------------------------------------------------------------------------------------------------
Balance, beginning of year $ 57,624 $ 44,644 $ 40,210
Provision for loan losses 39,657 25,745 11,836
Charge-offs, net of recoveries of $3,658 in 2002, $971 in 2001
and $1,673 in 2000 (38,063) (13,361) (7,402)
Reserves related to loans acquired - 596 -
- --------------------------------------------------------------------------------------------------------
Balance, end of year $ 59,218 $ 57,624 $ 44,644
========================================================================================================
Note F -- Premises and Equipment
Premises and equipment as of December 31 consisted of the following:
December 31 (Dollars in thousands) 2002 2001
- ------------------------------------------------------------------------------------
Land $ 6,905 $ 6,789
Buildings and improvements 39,756 39,435
Furniture and equipment 32,548 29,317
- ------------------------------------------------------------------------------------
Total premises and equipment 79,209 75,541
Accumulated depreciation and amortization (38,310) (33,618)
- ------------------------------------------------------------------------------------
Net premises and equipment $ 40,899 $ 41,923
====================================================================================
Note G -- Long-Term Debt
Details of long-term debt are as follows:
December 31 (Dollars in thousands) 2002 2001
- -----------------------------------------------------------------------------------
Term loan* $ 15,000 $ 10,000
Federal Home Loan Bank borrowings (5.04% - 6.98%) 1,209 1,010
Other 669 929
- -----------------------------------------------------------------------------------
Total long-term debt $ 16,878 $ 11,939
===================================================================================
* Fixed rate at December 31, 2002 and 2001, was 4.76% and 7.40%, respectively.
Variable rate at December 31, 2002 was 3.11%.
Annual maturities of long-term debt outstanding at December 31, 2002 for the
next five years beginning in 2003 are as follows (in thousands): $467, $60, $91,
$131 and $15,076.
At December 31, 2002, the term loan included $10 million contractually based on
a fixed interest rate of 4.76% and $5 million contractually based on a variable
interest rate. Interest is payable quarterly with principal due at the October
31, 2007 maturity. The Term Loan Agreement contains, among other provisions,
certain covenants relating to existence and mergers, capital structure and
financial requirements.
At December 31, 2002, the Federal Home Loan Bank borrowings represent a source
of funding for certain residential mortgage activities and consist of six fixed
rate notes with maturities ranging from 2003 to 2022. These notes are
collateralized by $1.94 million of certain real estate loans.
Note H -- Common Stock
1st Source has adopted SFAS No. 123, "Accounting for Stock-Based Compensation,"
on a disclosure basis only. The disclosure requirements include reporting the
pro forma effect on net income and net income per share of compensation expense
attributable to the fair value of stock options and other stock-based
compensation which have been issued to employees under the Stock Option Plans
and the Employee Stock Purchase Plan. 1st Source is following APB No. 25 in
accounting for these plans. In addition, the Executive Incentive Plan (including
annual and special long-term awards) and the Restricted Stock Award Plan are
also accounted for under the provisions of APB No. 25. Compensation cost charged
against income for these plans was $0, $2.95 million and $3.64 million for the
years ended December 31, 2002, 2001 and 2000, respectively.
STOCK OPTION PLANS -- 1st Source's incentive stock option plans include the 1992
Stock Option Plan (the "1992 Plan"), the 2001 Stock Option Plan (the "2001
Plan") and a certain other stock option agreement which became effective January
1, 1992. As of December 31, 2002, an aggregate 2,758,582 shares of common stock
are reserved for issuance under the above plans. Under the 2001 Plan, the
exercise price of each option equals the market price of 1st Source stock on the
date of grant, and an option's term generally is 10 years, except for reload
options, which are given the remaining term of the original grant.
Options under the 2001 Plan generally vest in one to six years from date of
grant. Options are granted on a discretionary basis by the Executive
Compensation Committee (the "Committee") of the 1st Source Board of Directors.
The fair value of each option on the date of grant was estimated using the
Black-Scholes option pricing model. The following weighted-average assumptions
were used in the option pricing model for options granted in each of the last
two years: a risk-free interest rate of 3.61% for 2002 and 4.91% for 2001; an
expected dividend yield of 1.74% for 2002 and 1.77% for 2001; an expected
volatility factor of 35.32% for 2002 and 30.63% for 2001; and an expected option
life of 5.29 years for 2002 and 6.51 years for 2001.
The following table is a summary of the activity with respect to 1st Source's stock option
plans for the years ended December 31, 2000, 2001 and 2002:
Number of Weighted-Average
Shares Exercise Price
- --------------------------------------------------------------------------------------
Options outstanding, January 1, 2000 1,010,890 $17.09
- --------------------------------------------------------------------------------------
Options granted - -
Options exercised (37,783) 8.35
Options forfeited (5,927) 13.90
- --------------------------------------------------------------------------------------
Options outstanding, December 31, 2000 967,180 17.47
- --------------------------------------------------------------------------------------
Options granted 53,608 21.85
Options exercised (40,928) 9.09
Options forfeited (2,212) 10.60
- --------------------------------------------------------------------------------------
Options outstanding, December 31, 2001 977,648 18.07
- --------------------------------------------------------------------------------------
Options granted 23,673 19.93
Options exercised (175,039) 7.59
Options forfeited - -
- --------------------------------------------------------------------------------------
Options outstanding, December 31, 2002 826,282 20.34
- --------------------------------------------------------------------------------------
Options exercisable, December 31, 2002 768,338 $20.26
======================================================================================
The following table summarizes information about stock options outstanding at December 31, 2002:
Options Outstanding Options Exercisable
-------------------------------------------- ------------------------------
Weighted-Average
Exercise Price
Number of Remaining Contractual Weighted-Average Number of Weighted-Average
Range of Exercise Prices Shares Life (Years) Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------------------
$ 5.00 to $11.99 198,390 1.70 $ 6.85 198,390 $ 6.85
$12.00 to $29.99 269,520 4.98 15.95 212,789 14.52
$30.00 to $31.99 358,372 5.55 31.12 357,159 31.12
========================================================================================================================
EMPLOYEE STOCK PURCHASE PLAN -- 1st Source also has an employee stock purchase
plan for substantially all employees with at least two years of service on the
effective date of an offering under the plan. Eligible employees may elect to
purchase any dollar amount of stock, so long as such amount does not exceed 25%
of their base rate of pay and the aggregate stock accrual rate for all offerings
does not exceed $25,000 in any calendar year. Payment for the stock is made
through payroll deductions over the offering period, and employees may
discontinue the deductions at any time and exercise the option or take the funds
out of the program. The most recent offering began June 3, 2002 and runs through
June 1, 2004, with $325,368 in stock value to be purchased at $22.85 per share.
The fair value of the employees' purchase rights for the 2000, 2001 and 2002
offerings was estimated using the Black-Scholes model. The following assumptions
were used in the model in each of the last three years: a risk-free interest
rate of 3.19% for 2002 and 4.22% for 2001 and 6.61% for 2000; an expected
dividend yield of 1.52% for 2002 and 1.86% for 2001 and 1.08% for 2000; an
expected volatility factor of 43.07% for 2002 and 40.69% for 2001 and 18.23% for
2000; and an expected life of 2.00 years for 2002, 2001 and 2000.
Pro forma net income and diluted net income per common share, reported as if
compensation expense had been recognized under the fair value provisions of SFAS
No. 123 for the stock option and employee stock purchase plans, are as follows:
2002 2001 2000
- -----------------------------------------------------------------------------------
Net income (dollars in thousands) :
As reported $10,039 $38,498 $37,573
Pro forma 9,706 38,206 37,234
Diluted net income per common share:
As reported $ 0.47 $ 1.82 $ 1.79
Pro forma 0.46 1.81 1.78
===================================================================================
EXECUTIVE INCENTIVE PLAN -- 1st Source's Executive Incentive Plan is also
administered by the Committee. Awards under the plan include "Book Value" shares
of common stock. These shares are awarded annually based on weighted performance
criteria and vest over a period of five years. The plan shares may only be sold
to 1st Source and such sale is mandatory in the event of death, retirement,
disability or termination of employment. Grants under the plan for 2002, 2001
and 2000 are summarized at the top of page 34.
2002 2001 2000
- --------------------------------------------------------------------------------
Number of shares 59,824 51,168 62,492
Weighted-average grant-date fair value $14.73 $13.07 $11.46
================================================================================
SPECIAL LONG-TERM INCENTIVE AWARD -- During February 2001 and February 1996, 1st
Source granted special long-term incentive awards, including 1st Source common
stock, to participants in the Executive Incentive Plan. Shares granted under the
plan vest over a period of ten years. The first 10% was vested at the time of
the grants. Subsequent vesting requires (i) the participant to remain an
employee of 1st Source and (ii) that 1st Source be profitable on an annual
basis, based on the determination of the Committee.
RESTRICTED STOCK AWARD PLAN -- 1st Source also has a restricted stock award
plan for key employees. Awards under the plan are made to employees recommended
by the Chief Executive Officer and approved by the Committee. Shares granted
under the plan vest over a five to ten-year period and vesting is based upon
meeting certain criteria, including continued employment by 1st Source. Grants
under the plan for 2002, 2001 and 2000 are summarized below:
2002 2001 2000
- --------------------------------------------------------------------------------
Number of shares 1,000 22,737 2,481
Weighted-average grant-date fair value $22.89 $22.13 $18.50
================================================================================
Note I -- Guaranteed Preferred Beneficial Interests in the Company's
Subordinated Debentures
Wholly-owned subsidiary trusts of 1st Source have issued $54.75 million of
preferred securities and, in turn, purchased $56.44 million of 1st Source junior
subordinated debentures. The trusts hold the junior subordinated debentures of
the parent company, which are the only assets of the trusts. Both the debentures
and related income statement effects are eliminated in 1st Source's consolidated
financial statements.
The parent company has entered into contractual arrangements that, taken
collectively and in the aggregate, constitute a full and unconditional guarantee
by the parent company of the trusts' obligations under the preferred securities
issued. The preferred securities and related debentures are summarized as
follows at December 31, 2002:
Preferred Principal Amount Interest Maturity
(Dollars in thousands) Securities of Debentures Rate Date
- ------------------------------------------------------------------------------------------------
March 1997 issuance-fixed rate $27,500 $28,351 9.00% 03/31/27
March 1997 issuance-floating rate 17,250 17,783 3.41% 03/31/27
November 2002 issuance-floating rate 10,000 10,310 6.95% 11/15/32
- ------------------------------------------------------------------------------------------------
Total $54,750 $56,444
================================================================================================
The March 1997 issuance interest rate is equal to the sum of the three-month
Treasury adjusted to a constant maturity, plus 2.25%. The November 2002 issuance
interest rate is fixed at 6.95% until November 15, 2007, at which time it will
become floating at an interest rate equal to LIBOR, plus 3.35%.
Note J -- Employee Benefit Plans
1st Source maintains a defined contribution money purchase pension plan covering
the majority of its employees. Contributions to the plan are based on 2% of
participants' eligible compensation. For the years ended December 31, 2002, 2001
and 2000, total pension expense for this plan amounted to $704,000, $599,000 and
$506,000, respectively.
1st Source also maintains a defined contribution profit sharing and savings plan
covering the majority of its employees. The plan allows eligible employees to
make contributions by salary reduction pursuant to Section 401(k) of the
Internal Revenue Code. 1st Source is required under the plan to match 100% of
participant contributions up to 4% of compensation and one-half of any
additional participant contributions up to 6% of compensation, provided that 1st
Source is profitable for the respective plan year. 1st Source may also make
discretionary contributions to the plan, depending on its profitability.
Contribution expense for this plan for the years ended December 31, 2002, 2001
and 2000, amounted to $1.88 million, $1.89 million and $1.68 million,
respectively.
Trustcorp contributes to a defined contribution plan for all of its employees
who meet the general eligibility requirements of the plan. Contribution expense
for this plan for the years ended December 31, 2002, 2001 and 2000, amounted to
$145,000, $320,000 and $160,000, respectively.
In addition to the pension and profit sharing plans, 1st Source provides certain
health care and life insurance benefits for substantially all of its retired
employees. All of 1st Source's full-time employees become eligible for these
retiree benefits upon reaching age 55 with 20 years of credited service.
Generally, the medical plan pays a stated percentage of eligible medical
expenses reduced for any deductibles and payments made by government programs
and other group coverage. The lifetime maximum benefit payable under the medical
plan is $15,000 and $3,000 for life insurance.
1st Source's accrued postretirement benefit cost and net periodic postretirement
benefit cost recognized in the consolidated financial statements for the years
ended December 31, 2002, 2001 and 2000 were not material.
Note K Income Taxes
Income tax expense is comprised of the following:
(Dollars in thousands) 2002 2001 2000
- -----------------------------------------------------------------------------------------
Current:
Federal $(12,133) $ 14,714 $ 13,838
State (1,952) 2,736 1,714
- -----------------------------------------------------------------------------------------
Total current (14,085) 17,450 15,552
- -----------------------------------------------------------------------------------------
Deferred:
Federal 13,616 2,128 2,302
State 1,835 131 711
- -----------------------------------------------------------------------------------------
Total deferred 15,451 2,259 3,013
- -----------------------------------------------------------------------------------------
Total provision $ 1,366 $ 19,709 $ 18,565
=========================================================================================
Deferred tax assets and liabilities as of December 31, 2002 and 2001 consisted of the following:
(Dollars in thousands) 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Reserve for loan losses $ 28,041 $ 25,252
Accruals for employee benefits 3,379 3,466
Other 590 619
- ----------------------------------------------------------------------------------------------------------------------------
Total deferred tax assets 32,010 29,337
- ----------------------------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Differing depreciable bases in premises and leased equipment 33,897 19,902
Mortgage servicing 7,961 6,560
Net unrealized gains on securities available-for-sale 2,804 3,517
Asset securitization 4,085 818
Differing bases in assets related to acquisitions 839 504
Other 279 440
- ----------------------------------------------------------------------------------------------------------------------------
Total deferred tax liabilities 49,865 31,741
- ----------------------------------------------------------------------------------------------------------------------------
Net deferred tax liability $ 17,855 $ 2,404
============================================================================================================================
The reasons for the difference between income tax expense and the amount computed by applying the statutory federal income
tax rate (35 percent) to income before income taxes are as follows:
2002 2001 2000
Percent of Percent of Percent of
Pretax Pretax Pretax
Year Ended December 31 (Dollars in thousands) Amount Income Amount Income Amount Income
- ----------------------------------------------------------------------------------------------------------------
Statutory federal income tax $ 3,992 35.0% $20,372 35.0% $19,648 35.0%
(Decrease) increase in income taxes resulting from:
Tax-exempt interest income (2,069) (18.1) (2,195) (3.8) (2,403) (4.3)
State taxes, net of federal income tax benefit (76) (0.7) 1,863 3.2 1,576 2.8
Other (481) (4.2) (331) (0.5) (256) (0.4)
- ----------------------------------------------------------------------------------------------------------------
Total $ 1,366 12.0% $19,709 33.9% $18,565 33.1%
================================================================================================================
The tax expense (benefit) applicable to securities gains and losses for the years 2002, 2001 and 2000 was
$(1,076,000), $166,000 and $883,000, respectively.
The following is a summary of the income tax effect allocated to other comprehensive income:
2002 2001 2000
Year Ended December 31 Before-Tax Tax Net-of-Tax Before-Tax Tax Net-of-Tax Before-Tax Tax Net-of-Tax
(Dollars in thousands) Amount Expense Amount Amount Expense Amount Amount Expense Amount
- ------------------------------------------------------------------------------------------------------------------------------
Unrealized gains on
available-for-sale
securities (including effect
of change in
accounting principle) $ 977 $ 440 $ 537 $5,958 $2,299 $3,659 $9,248 $3,747 $5,501
Less, reclassification adjustment
for losses realized in net income 2,836 1,278 1,558 439 169 270 2,328 943 1,385
- ------------------------------------------------------------------------------------------------------------------------------
Other comprehensive (losses) income $(1,859) $ (838) $(1,021) $5,519 $2,130 $3,389 $6,920 $2,804 $4,116
==============================================================================================================================
Note L -- Leases
1st Source and its subsidiaries are obligated under operating leases for certain
office premises and equipment. The headquarters building is leased for a
remaining term of 9 years with options to renew for up to 15 additional years.
Approximately 30% of the facility is subleased to other tenants.
Future minimum rental commitments for all noncancellable operating leases total
approximately $2.59 million in 2003, $2.19 million in 2004, $1.59 million in
2005, $1.37 million in 2006, $1.26 million in 2007 and $5.41 million thereafter.
As of December 31, 2002, future minimum rentals to be received under
noncancellable subleases totaled $3.70 million.
Rental expense of office premises and equipment and related sublease income were
as follows:
Year Ended December 31 (Dollars in thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------
Gross rental expense $ 3,184 $ 2,866 $ 2,817
Sublease rental income (1,479) (1,340) (1,416)
- ----------------------------------------------------------------------------------------------------
Net rental expense $ 1,705 $ 1,526 $ 1,401
====================================================================================================
Note M -- Financial Instruments with Off-Balance-Sheet Risk
To meet the financing needs of its customers, 1st Source and its subsidiaries
are parties to financial instruments with off-balance-sheet risk in the normal
course of business. These off-balance-sheet financial instruments include
commitments to originate, purchase and sell loans 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.
Loan commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.
Trustcorp and the Bank 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.
Letters of credit are conditional commitments issued by 1st Source to guarantee
the performance of a customer to a third party. The credit risk involved and
collateral obtained in issuing letters of credit is essentially the same as that
involved in extending loan commitments to customers.
As of December 2002 and 2001, 1st Source and its subsidiaries had commitments
outstanding to originate and purchase loans aggregating $364.00 million and
$366.00 million, respectively. Outstanding commitments to sell loans aggregated
$240.00 million at December 31, 2002 and $228.00 million at December 31, 2001.
Standby letters of credit totaled $117.21 million and $114.12 million at
December 31, 2002 and 2001, respectively. Standby letters of credit have terms
ranging from six months to one year.
Note N -- Regulatory Matters
1st Source is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
result in certain mandatory and possible additional discretionary actions by
regulators that, if undertaken, could have a material effect on 1st Source's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, 1st Source must meet specific capital
guidelines that involve quantitative measures of 1st Source's assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. 1st Source's capital amounts and classification are
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require 1st Source to maintain minimum amounts and ratios of total and Tier I
capital to risk-weighted assets and of Tier I capital to average assets.
Management believes, as of December 31, 2002, that 1st Source meets all capital
adequacy requirements to which it is subject.
As of December 31, 2002, the most recent notification from the federal bank
regulators categorized the Bank, the largest of 1st Source's subsidiaries, as
"well capitalized" under the regulatory framework for prompt corrective action.
To be categorized as "well capitalized" 1st Source must maintain minimum total
riskbased, Tier I risk-based and Tier I leverage ratios as set forth in the
table. There are no conditions or events since that notification that management
believes will have changed the institution's category.
The actual capital amounts and ratios of 1st Source and its largest subsidiary,
the Bank, are presented in the table below:
To Be Well
Capitalized Under
Minimum Capital Prompt Corrective
Actual Adequacy Action Provisions
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------
As of December 31, 2002:
Total Capital (to Risk-Weighted Assets):
Consolidated $368,439 13.19% $223,394 8.00% $279,243 10.00%
1st Source Bank 334,202 12.10 220,906 8.00 276,132 10.00
Tier I Capital (to Risk-Weighted Assets):
Consolidated 331,695 11.88 111,697 4.00 167,546 6.00
1st Source Bank 298,276 10.80 110,453 4.00 165,679 6.00
Tier I Capital (to Average Assets):
Consolidated 331,695 9.49 139,831 4.00 174,789 5.00
1st Source Bank 298,276 8.79 135,745 4.00 169,681 5.00
==================================================================================================================
The Bank is required to maintain reserve balances with the Federal Reserve Bank.
The average amount of those reserve balances for the year ended December 31,
2002 and 2001 was approximately $4.75 million and $2.54 million, respectively.
Dividends that may be paid by a subsidiary bank to the parent company are
subject to certain legal and regulatory limitations and also may be affected by
capital needs, as well as other factors. Without regulatory approval, the Bank
can pay dividends in 2003 of $65.54 million, plus an additional amount equal to
its net profits for 2003, as defined by statute, up to the date of any such
dividend declaration.
Note O -- Commitments and Contingent Liabilities
1st Source and its subsidiaries are defendants in various legal proceedings
arising in the normal course of business. In the opinion of management, based
upon present information including the advice of legal counsel, the ultimate
resolution of these proceedings will not have a material effect on 1st Source's
consolidated financial position.
Note P -- Branch Acquisitions
During 2001, the Bank acquired a total of 17 branch offices; two in Michigan,
two in Northwestern Indiana and 13 in the Fort Wayne, Indiana market area. In
addition to the fixed assets, the purchases included $322 million of deposits.
The core deposits and other intangibles associated with the acquisitions total
$11.60 million and are being amortized on an accelerated basis over
approximately 5 years. The goodwill of $16.82 million will be subject to annual
impairment tests in accordance with SFAS No. 142.
Note Q -- 1st Source Corporation (Parent Company Only) Financial Information
Statements of Financial Condition
December 31 (Dollars in thousands) 2002 2001
- ------------------------------------------------------------------------------------------------------
ASSETS
Cash $ 2 $ 2
Short-term investments with bank subsidiary 5,079 4,412
Investment securities, available-for-sale
(amortized cost of $26,884 and $15,446 at December 31, 2002
and 2001, respectively) 27,595 15,599
Investments in:
Bank subsidiaries 328,124 319,009
Non-bank subsidiaries 10,700 11,092
Loan receivables:
Non-bank subsidiaries 5,000 9,096
Premises and equipment, net 4,288 4,627
Other assets 5,903 6,377
- ------------------------------------------------------------------------------------------------------
Total assets $ 386,691 $ 370,214
======================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Commercial paper borrowings $ 3,437 $ 4,992
Other liabilities 2,130 2,528
Long-term debt 71,695 56,504
- ------------------------------------------------------------------------------------------------------
Total liabilities 77,262 64,024
Shareholders' equity 309,429 306,190
- ------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 386,691 $ 370,214
======================================================================================================
Statements of Income
Year Ended December 31 (Dollars in thousands) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------
Income:
Dividends from bank and non-bank subsidiaries $ 7,578 $ 17,593 $ 8,260
Rental income from subsidiaries 2,763 2,697 2,664
Other 647 1,759 2,937
- ------------------------------------------------------------------------------------------------------
Total income 10,988 22,049 13,861
- ------------------------------------------------------------------------------------------------------
Expenses:
Interest on long-term debt 4,078 4,430 4,748
Interest on commercial paper and other short-term borrowings 66 537 800
Rent expense 1,059 1,065 1,059
Other 1,666 1,998 2,272
- ------------------------------------------------------------------------------------------------------
Total expenses 6,869 8,030 8,879
- ------------------------------------------------------------------------------------------------------
Income before income tax benefit and equity in
undistributed income of subsidiaries 4,119 14,019 4,982
Income tax benefit 1,332 1,508 1,273
- ------------------------------------------------------------------------------------------------------
Income before equity in undistributed income of subsidiaries 5,451 15,527 6,255
Equity in undistributed income of subsidiaries:
Bank subsidiaries 10,158 21,978 28,959
Non-bank subsidiaries (5,570) 993 2,359
- ------------------------------------------------------------------------------------------------------
Net income $10,039 $ 38,498 $37,573
======================================================================================================
Statements of Cash Flows
Year Ended December 31 (Dollars in thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
Operating activities:
Net income $ 10,039 $ 38,498 $ 37,573
Adjustments to reconcile net income to net cash provided by operating activities
Equity in undistributed income of subsidiaries (4,588) (22,971) (31,318)
Depreciation of premises and equipment 346 341 336
Realized and unrealized investment securities losses (gains) 1,349 645 (367)
Other 3,949 1,545 2,850
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 11,095 18,058 9,074
- ----------------------------------------------------------------------------------------------------------------------------------
Investing activities:
Proceeds from sales and maturities of investment securities 6,625 2,829 1,050
Purchases of investment securities (19,425) (3,325) (1,260)
Net change in premises and equipment 184 (281) (266)
(Increase) decrease in short-term investments with bank subsidiary (667) 1,991 (2,415)
Decrease (increase) in loans made to subsidiaries, net 4,096 (14) (82)
Capital contributions to subsidiaries (5,501) (1,000) -
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (14,688) 200 (2,973)
- ----------------------------------------------------------------------------------------------------------------------------------
Financing activities:
Net (decrease) increase in commercial paper and other short-term borrowings (1,555) (9,763) 5,950
Proceeds from issuance of subordinated notes 10,310 - -
Proceeds from issuance of long-term debt 15,048 217 2
Payments on long-term debt (10,169) (101) (92)
Acquisition of treasury stock (2,504) (1,308) (4,990)
Cash dividends (7,537) (7,298) (6,956)
Other - (10) (9)
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 3,593 (18,263) (6,095)
- ----------------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents 0 (5) 6
Cash and cash equivalents, beginning of year 2 7 1
Cash and cash equivalents, end of year $ 2 $ 2 $ 7
==================================================================================================================================
Report of Independent Auditors
To the Board of Directors and Shareholders of 1st Source Corporation:
We have audited the accompanying consolidated statements of financial condition
of 1st Source Corporation and Subsidiaries as of December 31, 2002 and 2001, and
the related consolidated statements of income, shareholders' equity, and cash
flows for each of the three years in the period ended December 31,
2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of 1st Source
Corporation and Subsidiaries at December 31, 2002 and 2001, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States.
/s/ Ernst & Young LLP
Columbus, Ohio
February 10, 2003
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information under the caption "Proposal Number 1: Election of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" of the
2003 Proxy Statement is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information under the caption "Remuneration of Executive Officers" of the
2003 Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS.
The information under the caption "Voting Securities and Principal Holders
Thereof" and "Proposal Number 1: Election of Directors" of the 2003 Proxy
Statement is incorporated herein by reference. The information under the caption
"Equity Compensation Plan Information" of the 2003 Proxy Statement is herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information under the caption "Proposal Number 1: Election of Directors" of
the 2003 Proxy Statement is incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES.
(a) Within 90 days prior to the date of 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 pursuant to Exchange Act Rule 13a-14. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that 1st Source's disclosure controls and procedures are effective in
timely alerting them to material information relating to 1st Source (including
its consolidated subsidiaries) required to be included in 1st Source's periodic
SEC filings.
(b) Subsequent to the date of this evaluation, there have been no changes in 1st
Source's internal controls or in other factors that could significantly affect
these controls, and no discoveries of any significant deficiencies or material
weaknesses in such controls that would require 1st Source to take corrective
actions.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements and Schedules:
The following Financial Statements and Supplementary Data are filed as part
of this annual report:
Consolidated statements of financial condition -- December 31, 2002 and
2001
Consolidated statements of income -- Years ended December 31, 2002, 2001
and 2000
Consolidated statements of shareholders' equity -- Years ended December
31, 2002, 2001 and 2000
Consolidated statements of cash flows -- Years ended December 31, 2002,
2001 and 2000
Notes to consolidated financial statements -- December 31, 2002, 2001
and 2000
Report of Ernst & Young LLP, Independent Auditors
Financial statement schedules required by Article 9 of Regulation S-X are
not required under the related instructions, or are inapplicable and,
therefore, have been omitted.
(b) Reports on Form 8-K -- None filed during the fourth quarter of 2002.
(c) Exhibits (numbered in accordance with Item 601 of Regulation S-K):
3(a) Articles of Incorporation of Registrant, as amended April 30, 1996,
and filed as exhibit to Form 10-K, dated December 31, 1996, and
incorporated herein by reference.
3(b) By-Laws of Registrant, as amended April 16, 1998, filed as exhibit
to Form 10-K, dated December 31, 1998, and incorporated herein by
reference.
4(a) Form of Common Stock Certificates of Registrant filed as exhibit to
Registration Statement 2-40481 and incorporated herein by
reference.
4(b)(1) Form of 9% Cumulative Trust Preferred Securities Indenture, dated
March 21, 1997, filed as exhibit to Form 10-K, dated December 31,
1997, and incorporated herein by reference.
4(b)(2) Form of 9% Cumulative Trust Preferred Securities Trust Agreement,
dated March 21, 1997, filed as exhibit to Form 10-K, dated December
31, 1997, and incorporated herein by reference.
4(b)(3) Form of 9% Cumulative Trust Preferred Securities Guarantee
Agreement, dated March 21, 1997, filed as exhibit to Form 10-K,
dated December 31, 1997, and incorporated herein by reference.
4(c)(1) Form of Floating Rate Cumulative Trust Preferred Securities
Indenture, dated March 21, 1997, filed as exhibit to Form 10-K,
dated December 31, 1997, and incorporated herein by reference.
4(c)(2) Form of Floating Rate Cumulative Trust Preferred Securities Trust
Agreement, dated March 21, 1997, filed as exhibit to Form 10-K,
dated December 31, 1997, and incorporated herein by reference.
4(c)(3) Form of Floating Rate Cumulative Trust Preferred Securities
Guarantee Agreement, dated March 21, 1997, filed as exhibit to Form
10-K, dated December 31, 1997, and incorporated herein by
reference.
4(d) Agreement to Furnish Long-term Debt Instruments, dated February 11,
2003, filed as an exhibit to Form 10-K, dated December 31, 2002,
and attached hereto.
10(a)(1) Employment Agreement of Christopher J. Murphy III, dated April 16,
1998, filed as exhibit to Form 10-K, dated December 31, 1998, and
incorporated herein by reference.
10(a)(2) Employment Agreement of Wellington D. Jones III, dated April 16,
1998, filed as exhibit to Form 10-K, dated December 31, 1998, and
incorporated herein by reference.
10(a)(3) Employment Agreement of Allen R. Qualey, dated April 16, 1998,
filed as exhibit to Form 10-K, dated December 31, 1998, and
incorporated herein by reference.
10(a)(4) Employment Agreement of Larry E. Lentych, dated April 16, 1998,
filed as exhibit to Form 10-K, dated December 31, 1998, and
incorporated herein by reference.
10(a)(5) Employment Agreement of Richard Q. Stifel, dated April 16, 1998,
filed as exhibit to Form 10-K, dated December 31, 1998, and
incorporated herein by reference.
10(a)(6) Employment Agreement of John B. Griffith, dated March 31, 2001,
filed as exhibit to Form 10-K, dated December 31, 2002, and
attached hereto.
10(b) 1st Source Corporation Employee Stock Purchase Plan dated April
17, 1997, filed as exhibit to Form 10-K, dated December 31, 1997,
and incorporated herein by reference.
10(c) 1st Source Corporation 1982 Executive Incentive Plan, amended
December 5, 2002, and filed as exhibit to Form S-8, dated December
6, 2002, and incorporated herein by reference.
10(d) 1st Source Corporation 1982 Restricted Stock Award Plan, amended
December 5, 2002, and filed as exhibit to Form S-8, dated December
6, 2002, and incorporated herein by reference.
10(e) 1st Source Corporation 2001 Stock Option Plan, filed as an exhibit
to 1st Source Corporation Proxy Statement dated March 7, 2001, and
incorporated herein by reference.
10(f) 1st Source Corporation Non-Qualified Stock Option Agreement with
Christopher J. Murphy III, dated January 1, 1992, as amended
December 11, 1997, filed as an exhibit to Form 10-K, dated
December 31, 1997, and incorporated herein by reference.
10(g)(1) 1st Source Corporation 1992 Stock Option Plan, dated April 23,
1992, as amended December 11, 1997, filed as exhibit to Form 10-K,
dated December 31, 1997, and incorporated herein by reference.
10(g)(2) An amendment to 1st Source Corporation 1992 Stock Option Plan,
dated July 18, 2000, and filed as exhibit to Form 10-K, dated
December 31, 2000, and incorporated herein by reference.
10(h) 1st Source Corporation 1998 Performance Compensation Plan, dated
February 19, 1998, filed as exhibit to Form 10-K, dated December
31, 1998, and incorporated herein by reference.
10(i) Consulting Agreement of Ernestine M. Raclin, dated April 14, 1998,
filed as exhibit to Form 10-K, dated December 31, 1998, and
incorporated herein by reference.
21 Subsidiaries of Registrant (unless otherwise indicated, each
subsidiary does business under its own name):
Name Jurisdiction
---- ------------
1st Source Bank Indiana
SFG Equipment Leasing, Inc.* Indiana
1st Source Insurance, Inc.* Indiana
1st Source Specialty Finance, Inc.* Indiana
FBT Capital Corporation (Inactive) Indiana
1st Source Leasing, Inc. Indiana
1st Source Capital Corporation* Indiana
Trustcorp Mortgage Company Indiana
1st Source Capital Trust I Delaware
1st Source Capital Trust II Delaware
1st Source Capital Trust III Delaware
Michigan Transportation Finance Corporation* Michigan
1st Source Intermediate Holding, LLC Delaware
1st Source Funding, LLC Delaware
1st Source Corporation Investment Advisors, Inc.* Indiana
SFG Commercial Aircraft Leasing, Inc.* Indiana
SFG Equipment Leasing Corporation I* Indiana
*Wholly-owned subsidiaries of 1st Source Bank
23(a) Consent of Ernst & Young LLP, Independent Auditors.
99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
attached hereto.
99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
attached hereto.
(d) Financial Statement Schedules -- None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
1st SOURCE CORPORATION
By /s/ CHRISTOPHER J. MURPHY III
-------------------------------------------------
Christopher J. Murphy III, Chairman of the Board,
President and Chief Executive Officer
Date: February 26, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ CHRISTOPHER J. MURPHY III Chairman of the Board, February 26, 2003
- ----------------------------- President and Chief
Christopher J. Murphy III Executive Officer
/s/ WELLINGTON D. JONES III Executive Vice President February 26, 2003
- ----------------------------- and Director
Wellington D. Jones III
/s/ LARRY E. LENTYCH Treasurer, Chief Financial February 26, 2003
- ----------------------------- Officer and Principal
Larry E. Lentych Accounting Officer
/s/ JOHN B. GRIFFITH Secretary February 26, 2003
- ----------------------------- and General Counsel
John B. Griffith
/s/ E. WILLIAM BEAUCHAMP, c.s.c. Director February 26, 2003
- --------------------------------
Reverend E. William Beauchamp, C.S.C.
/s/ DANIEL B. FITZPATRICK Director February 26, 2003
- -----------------------------
Daniel B. Fitzpatrick
/s/ LAWRENCE E. HILER Director February 26, 2003
- -----------------------------
Lawrence E. Hiler
/s/ WILLIAM P. JOHNSON Director February 26, 2003
- -----------------------------
William P. Johnson
/s/ REX MARTIN Director February 26, 2003
- -----------------------------
Rex Martin
/s/ DANE A. MILLER Director February 26, 2003
- -----------------------------
Dane A. Miller
/s/ TIMOTHY K. OZARK Director February 26, 2003
- -----------------------------
Timothy K. Ozark
/s/ RICHARD J. PFEIL Director February 26, 2003
- -----------------------------
Richard J. Pfeil
/s/ CLAIRE C. SKINNER Director February 26, 2003
- -----------------------------
Claire C. Skinner
/s/ TOBY S. WILT Director February 26, 2003
- -----------------------------
Toby S. Wilt
CERTIFICATIONS
I, Christopher J. Murphy, III, certify that:
1. I have reviewed this annual report on Form 10-K of 1st Source Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 26, 2003
By /s/ CHRISTOPHER J. MURPHY III
----------------------------------------------------
Christopher J. Murphy III, Chief Executive Officer
CERTIFICATIONS
I, Larry E. Lentych, certify that:
1. I have reviewed this annual report on Form 10-K of 1st Source Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 26, 2003
By /s/ LARRY E. LENTYCH
--------------------------------------------
Larry E. Lentych, Chief Financial Officer