2 0 1 2 A N N U A L R E P O R T
CONTENTS
Corporate Description ..................................................................................
2012 in Brief .................................................................................................
i
i
Financial Highlights ......................................................................................
ii
Letter to Shareholders ...................................................................................
iii
2012 Banking Center Locations .................................................................... vii
Shareholders’ Information ............................................................................. viii
Financial Report ...........................................................................................
1
Officers and Directors ................................................................................... 72
C O R P O R A T E D E S C R I P T I O N
1st Source Corporation is the largest locally
controlled financial institution headquartered
in the northern Indiana-southwestern Michigan
area. While delivering a comprehensive range
of consumer and commercial banking services,
1st Source has distinguished itself with highly
personalized services. 1st Source also provides
nationally specialized financing services for new
and used private and cargo aircraft, automobiles
and light trucks for leasing and rental agencies,
medium and heavy duty trucks, construction
equipment, and environmental equipment.
At year-end, the Corporation had 76 banking
centers in 17 counties in Indiana and Michigan,
eight 1st Source Insurance offices, nine Trust and
Wealth Management locations, and 22 locations
nationwide for the 1st Source Specialty Finance
Group. With a history dating back to 1863,
1st Source is proud of its tradition of providing
superior service to clients while playing a
leadership role in the continued development of
the communities it serves.
2012 IN BRIEF
2012 net income of $49.63 million was up 2.98%
from the $48.20 million earned in 2011. Diluted
net income per common share for 2012 was
$2.02, up 3.06% from the $1.96 for 2011.
Return on average
total assets was 1.11%
compared to 1.09% a year ago. Return on average
common shareholders’ equity was 9.10% for
2012, compared to 9.51% for 2011. The average
common shareholders’ equity-to-assets ratio for
2012 was 12.20%, compared to 11.51% last year.
At year end, total assets were $4.55 billion, up
4.04% from a year earlier. Loans and leases were
up 7.67%, deposits were up 2.96% and common
shareholders’ equity was $558.66 million, an
increase of 6.63% from a year earlier.
The reserve for loan and lease losses at year end was
2.50% of total loans and leases. Nonperforming
loans and leases were 1.11% of total loans and
leases, while the reserve to nonperforming loans
was 2.26 times.
$50
40
30
20
10
0
$2.50
2.00
1.50
1.00
0.50
0
12%
8
4
0
NET INCOM E (in millions)
48.2
49.6
41.2
33.4
25.5
08
09
10
11
12
DILUTE D NET INCOM E PER COM M ON SHARE
1.96
2.02
1.37
1.21
0.79
08
09
10
11
12
RETURN ON AVERAGE COM M ON EQUITY
(as a percent)
7.52
6.10
4.07
9.51
9.10
08
09
10
11
12
RETURN ON AVERAGE TOTAL ASSETS
(as a percent)
1.09
1.11
0.91
0.76
0.57
08
09
10
11
12
1.20%
1.00
0.80
0.60
0.40
0.20
0
i
F I N A N C I A L H I G H L I G H T S
Earnings and Dividends
(Dollars in thousands, except per share amounts)
2012
2011
2010
2009
2008
Interest and other income
$ 263,277
$ 268,395
$ 287,317
$ 285,942
$ 319,311
Interest and other expense
187,597
194,606
226,841
254,424
272,910
Net income
Net income available to common shareholders
Common cash dividends
Per common share
Diluted net income
Cash dividends
Book value
49,633
49,633
16,522
48,195
48,195
15,921
41,244
29,655
15,076
25,490
19,074
14,520
33,386
33,386
14,253
$
2.02
$
1.96
$
1.21
$
0.79
$
1.37
0.66
23.04
0.64
21.64
0.61
20.12
0.59
19.30
Return on average common equity
9.10%
9.51%
6.10%
4.07%
Return on average total assets
1.11%
1.09%
0.91 %
0.57%
0.58
18.82
7.52 %
0.76 %
Statement of Condition
Average Balances: (Dollars in thousands)
Assets
Earning assets
Loans and leases
$ 4,472,879
$ 4,402,554
$ 4,543,702
$ 4,505,852
$ 4,400,523
4,174,443
4,090,297
4,207,485
4,199,512
4,068,614
3,209,490
3,078,581
3,109,508
3,154,820
3,263,276
Reserve for loan and lease losses
83,430
86,617
89,656
85,095
71,358
Investment securities
Deposits
Shareholders’ equity
882,392
899,896
914,253
835,025
713,812
3,574,211
3,555,454
3,605,195
3,573,648
3,374,270
545,631
506,939
590,464
566,464
444,148
ii
2 0 1 2 A N N U A L S H A R E H O L D E R S ’ L E T T E R
1st SOURCE HAD A GOOD YEAR IN 2012
and achieved record net income. As in past years, it strikes
me that while I am proud to report these results on behalf
of all of us at 1st Source who are working hard to meet our
clients’ needs, to exceed their expectations, and by doing
so to earn a good return for you, our shareholders, these
are results of “yesterday” and my real focus and concern
is the future. Just as in past years, we are challenged
by a sputtering economy, episodic and overreaching
regulation, and fierce competition. While we are proud of
what we have achieved, our attention is on the future and
continuing our success.
7.67%. Nonperforming assets dropped from $72.5 million
to $42.3 million. This improved our nonperforming assets
to loans and leases ratio to 1.25% from 2.28%. We added
$5.8 million to the loan and lease loss reserve, up from
$3.1 million the prior year, and incurred net charge-offs
of $4.1 million. Currently, the reserve is $83.3 million and
covers nonperforming loans and leases and other assets by
1.97 times, up from 1.13 times last year. Net charge-offs
to average loans and leases for 2012 and 2011 are relatively
low at 0.13% and 0.27%, respectively.
SOLID RETURNS, FORTRESS BALANCE SHEET
In 2012, 1st Source earned $49.6 million, up from $48.2
million last year, and was achieved with higher net interest
income, small increases in noninterest income and good
cost control. Due to considerably lower market interest
rates, total interest income from loans and investments was
$182.1 million, down from the $187.5
million the prior year. Interest costs
were down even more due to the lower
interest rate environment
fostered
by the Federal Reserve Bank and a
changing mix of our deposits. Interest
costs were $30.3 million compared
to $39.1 million the year before. The
combination of these two resulted
in an increase of net interest income
to $151.8 from the $148.4 million
reported a year earlier, up 2.27%.
FORBES 2013
BEST BANKS IN AMERICA
..............................................
1st Source Bank has been
recognized as number 25 on
the Forbes list of America’s Best
Banks in its annual review of
the nation’s 100 largest publicly
traded financial institutions.
Metrics of financial health
included profitability, asset
quality and capital adequacy.
In spite of the continuing slow economy and the
challenged markets in which we operate, we achieved
a return on average assets of 1.11%, up from 1.09% a
year earlier and a return on our strong average equity
base of 9.10%, down slightly from the 9.51% achieved
in 2011. We continue to believe
it is appropriate to operate with a
strong balance sheet to protect our
depositors, our borrowers, and our
shareholders. With strong capital and
appropriate reserves, our depositors
are assured that their deposits are safe
and secure; our borrowers are assured
we have the strength to help them
weather the storms and can work
with them in good times and bad; and
our shareholders know their dollars
are being properly deployed and not
subjected to the risks of over leverage.
At the close of 2012, our average common equity was
12.20% of average assets and common equity was 10.56%
of tangible assets. We closed 2012 strong and are ready to
take on the challenges of 2013.
Even with regulated reductions in
fees in some areas, noninterest income increased to $81.2
million from $80.9 million the year before. Noninterest
expenses were held in check during 2012 in spite of higher
salary and benefit costs from mortgage loan production,
compliance and risk management, and higher health care
costs. Total noninterest expense was $151.5 million for
2012, a decrease from the $152.4 million recorded in 2011.
STRONG CREDIT CULTURE
An area of great concern for the industry over the past few
years and one that has the most lasting impact on earnings,
costs, and losses is credit quality. 1st Source has a strong
credit culture and has avoided many of the traps other
community banks have fallen into. That is not to say that
we are immune from bad credits, it is just that we have
avoided some of the areas that created the most problems.
2012 was a good year for continuing to improve our credit
quality while growing our loan portfolios. During the year,
loans and leases grew to $3.3 billion from $3.1 billion, up
SERVING OUR CLIENTS
Our focus at 1st Source is to be distinctively convenient
to our customers, to provide straight talk and sound
advice, always keeping their best interests in mind while
serving them in a very personal way. Each product
change, each new banking center and installation of new
technology, and each session to better train our colleagues,
is undertaken to do just that. During 2012, we increased
convenience to our clients by opening longer hours –
earlier in the morning and later at night – in many of our
banking centers and in supermarket branches which are
open 7 days a week. We opened two brand new banking
centers in 2012, which replaced facilities in Nappanee and
Columbia City, Indiana. ATMs were improved, upgraded
iii
and brightly branded, replacing 49 machines and upgrading
10 across our 17 county market. We continued to improve our
personal checking accounts with upgraded online banking,
bill pay offerings and adding purchase rewards while giving
our clients easier access to the services they use the most. We
also added a financial planning software package to better
help them map out their financial futures. After much work
on security issues, we introduced mobile banking to our
clients so they can use their mobile devices to access their
account information and transfer funds within the bank.
MORTGAGE LEADER
One of the most important services we have provided to our
individual clients is mortgage financing and we continue
to be the market leader in providing mortgage products in
our primary market. We assisted over 2,000 customers in
2012 with either purchasing a home or refinancing their
current home. We also introduced Mortgage Express, an
online mortgage application and approval process that makes
it easier and more convenient for our clients to apply for a
mortgage at 1st Source.
NUMBER 1 IN SMALL BUSINESS LENDING
Small and mid-sized locally owned or operated businesses
are still the primary focus of our Business Banking area.
We could not be more proud that we again were #1 in the
State of Indiana for total Small Business Association (SBA
7a) loans for banks our size; we were #1 in the Northwest
Indiana SBA Region for number of SBA loans, as well as
the most dollars lent. Additionally, this is the 8th year in a
row that 1st Source ranked #1 in our market in both the
number and dollar amount of SBA 504 loans. We also could
not be more proud than to have been voted as the best bank
from which to obtain a business loan by the readers of the
Northwest Indiana Business Quarterly. We have partnered
with the Elevate Ventures initiative providing funding
to encourage the startup of new businesses or accelerated
growth of established businesses in our market. We have also
actively sponsored and promoted the commercialization of
intellectual property from the University of Notre Dame and
Indiana University School of Medicine with the 1st Source
Commercialization Award and the activities surrounding
the bestowal of that award. Additionally, we have worked
with the tenants of Notre Dame’s Innovation Park to
develop their businesses and grow them into our surrounding
communities. We have also contributed to The Corporate
Partnership for Economic Growth which is trying to bring
together the region’s organizations and resources for more
effective economic development.
RELATIONSHIP BANKING IN SPECIALTY FINANCE
In our national business lending areas, we have moved to
develop more robust interactions with our clients. We have
enjoyed relationships for many years providing financing and
leasing services and in some cases assisting in the acquisition
and disposition of vehicles. We have been somewhat impeded
by distance and geography from offering a full set of client
services. New technology and 24/7 service has allowed us
Steve Deranek, Regional Sales Manager; Bill Burton, Regional Vice President; Larry Thompson, Mayor of Nappanee; Kami Bunch, Branch Manager; Jeff Kitson, Nappanee
Area Chamber of Commerce; Chris Murphy, CEO; Jim Seitz, President; and Carol Sechrist, Operations Manager; celebrate the grand opening of our Nappanee banking center.
iv
to become much more full relationship oriented and we are
now able to provide our clients many of the same services our
regional clients have enjoyed for years. We have dedicated
new people and new resources to serving our national
clientele and are pleased with the results thus far.
BECOMING LEAN
We continue to grow along the learning curve on how best
to use lean tools to improve the way we do business, to
simplify our processes, to lower our costs, and to engage our
colleagues in making changes that benefit our clients and
our shareholders. Using value stream mapping and Kaizen
teams, we have tackled problems across the bank in areas
as diverse as consumer loan processing, IT project planning,
new employee hiring and on-boarding, and daily lean
management in the banking centers. While we are pleased
with our progress, we are still neophytes in using these tools
effectively and look forward to continuing to learn to better
affect positive change and sustain it in our business operations.
TACKLING CHALLENGES
regulation, and
I would be remiss if I did not relate some
of the challenges we continue to confront:
the economy,
fraud.
Clearly the economy, its slow growth,
and the government’s action to hold down
interest rates have a negative effect on our
net interest margins. The U.S. was an
overleveraged economy and we are now
paying for it. Lower rates being pursued
by the Fed are designed to encourage
borrowing and investing in an attempt to
fix the economy. They reward the borrower and punish the
saver. Quite the opposite of what you would have expected
as it was the overleveraged borrower that caused many of
the problems we face today. The government itself has not
learned this lesson and is creating deficits at alarming rates
and it is hard to believe that there will not be some high
price to pay down the road for not having dealt with this
issue. $16 trillion of debt is literally unfathomable and could
become an unbearable burden for generations to come. In
the meantime, low interest rates make it more difficult for
us to cover our costs as they continue to threaten net interest
margins.
shareholders expect. There is still an unholy alliance between
Wall Street and Washington and policies are promulgated
which tend to favor the big investment banks verses the more
local “Main Street” banks. This causes us to stay even closer
to our clients and provide unquestionably better service. The
actions of the Consumer Financial Protection Bureau will
have a significant impact in the years ahead and will also
continue to threaten revenue streams and increase costs. We
will just have to be more creative, effective, and efficient in
the way we serve clients.
As technology becomes more ubiquitous and as people
rely on it more, it becomes a broader target for criminal
elements. Mobile devices, credit and debit card systems,
Facebook and Twitter accounts, and a host of other social
media are subject to attack with information and identities
lifted and used by others for their financial benefit. Our
fraud costs and security costs have quickly increased trying
to thwart criminal intrusions and educate an unthinking and
sometimes uncaring populace. The cybercriminals are well
organized and well financed and billions of dollars a year are
either lost to them or spent trying to stop
them. We are being very careful of the
technologies we adopt and the systems
we put in place to deal with this, but it
will always be an area of concern.
DEVELOPING PEOPLE
1st Source has been going through
quite a bit of change in leadership over
the past few years. I report that I could
not be more pleased with the progress
our leadership team has made. People have stepped up
and taken responsibility. They understand and act on
their accountability. The group is working well together
and operating effectively as a team. Duke Jones, who had
completed a distinguished career as President of the Bank
in 2011, assumed the role of Vice Chairman of the Board
and agreed to assist me with the transitions in our leadership
team. That transitional role has now ended and he is fully
retired from active management responsibility. Duke could
not have been a better partner to work with over these
many years and he leaves a distinguished legacy of caring
and focused operations oriented leadership. He continues to
serve in his role as Vice Chairman of the Board.
our attention is
on the future
and continuing
our success
At the same time, the blizzard of new regulation and new
costs coming in the Patient Protection and Affordable Care
Act, as well as the Dodd Frank Wall Street Reform and
Consumer Protection Act, to name just two, are changing the
revenue/cost equation for our business. They are both causing
substantial increases in the cost of operations. We must work
ever harder and smarter to achieve the positive returns our
In October, Jim Seitz, a 32-year veteran of 1st Source, was
elected President of the Bank. Jim earned his new position
by demonstrating his leadership skills since being promoted
to Executive Vice President, by exercising his people
skills and successfully managing a variety of staff and line
functions. Jim was identified as a talented individual years
ago and given successively greater responsibility. He was
v
viChristopher J. Murphy IIIChairman and Chief Executive Officer1st Source Corporationsent to the Executive MBA Program at the University of Notre Dame to prepare him for the more analytical aspects of management. Jim started as a Branch Manager of our Maple Lane Banking Center, and after a number of additional assignments, became Regional Manager and served as the Supervisor of Banking Centers and Director of Online Banking. Over his career, he has led Branch Administration, Consumer Lending and Mortgage, Electronic and Mobile Banking, Deposit Operations, corporate wide marketing and recently all Regional Presidents. Through his hard work and straightforward approach to people, he has earned the respect and trust of colleagues and customers alike. Throughout his career, he has always done what was in the best interest of the bank, its clients and his colleagues, often sublimating his own needs. He has been dedicated and committed to the success of 1st Source and all of its people. He has jumped into his responsibilities with great zeal.IN GRATITUDE At the close of the year, Larry Lentych retired as Chief Financial Officer of 1st Source Corporation and Andrea Short was promoted to that position. Larry has been a fine partner and started with the bank 38 years ago, becoming Chief Financial Officer in 1991. During his time at 1st Source, he served on nearly every significant Senior Committee and chaired the Risk Management Committee. He lived our values and leaves a wonderful legacy of service and professionalism. Andrea Short began her career with 1st Source as Tax Director in 1998. In September 2001, she was promoted to Controller responsible for all finance and accounting functions of 1st Source Corporation and its subsidiaries and affiliates. She has distinguished herself as a focused and action oriented professional. In recent years, she has been given significant assignments in lean management, budgeting, and planning and has performed well in each area. As a result of both of their promotions from within, a cascading effect occurred. I could not be more pleased with the depth of our bench and the ability to promote deserving people from within the company. They have proven their dedication to 1st Source, have lived our values, and are ready to accept additional responsibility. Of course, we are also willing to go outside when it makes sense to do so. We continue to focus on career development, succession planning and investment in developing a strong management team for the long term that believes and lives 1st Source’s values of integrity, teamwork, quality service, community leadership, and superior financial performance.Before closing, I want to recognize one person who left our Board of Directors this year having served for over 20 years. I had the pleasure of negotiating over a number of years back in the late 1980s with Larry Hiler in an attempt to convince him to merge his bank with ours. It took many conversations, many meetings, and some hard bargaining. I developed a great respect for his business acumen and his personal integrity and recommended him to our Board as a potential good candidate. He joined us in 1992 when his bank became a part of 1st Source. He has been an excellent, aggressive, engaged, caring, and professional board member. We will miss his wise counsel and his business knowledge.Thank you for your support of 1st Source. We will continue to focus on growing the Bank by providing distinctive convenience, providing straight talk and sound advice while keeping our client’s best interests in mind, and doing so in a very personal way. viiKalamazooFort WayneSouth BendMishawakaBerrienCassSt. JosephAllenDeKalbElkhartFultonHuntingtonKosciuskoLa GrangeLaPorteMarshallNoblePorterPulaskiSt. JosephStarkeSteubenWellsWhitleyNew HavenElkhartGrangerDunlapGoshenNilesSt. JosephStevensvilleMichigan CityLaPortePortageValparaisoKnoxWinamacDowagiacNew CarlisleWalkertonNorth LibertyPlymouthArgosRochesterWarsawLaPazBremenOsceolaMiddleburyColumbiaCityHuntingtonBlufftonNappanee46969946980/9080/902424224303035313133332012121316639992156023695118555167KalamazooWhiteTippecanoeCass421MiamiWabashLafayetteWestvilleChestertonPortage Ave. Cleveland Rd. 203120 31 933 933 331 80/902323MishawakaIronwood Dr. Mishawaka Ave. Grape Rd. McKinley Ave. Lincoln Way West Lincoln Way East Main St. Michigan St. Western Ave. NotreDame304694696969242727303393032793032733Anthony Blvd.Clinton St. State Blvd. Bluffton Rd. New HavenState Blvd. Tillman Rd. Lafayette St. Maplecrest Rd. Jefferson Blvd. Dupont Rd. Hatzell Rd. Coliseum Blvd. Coldwater Rd. ValparaisoUniversityValparaisoIndiana Ave.E. Evans Ave.Glendale Blvd.County Road 400 NorthRoosevelt Rd.N. Campbell St.N. Valparaiso St.N. Washington St.E. LincolnwayN. Calumet Ave.302Silhavy Rd.Franklin St.130Sturdy Rd.49ChicagoIndianapolisDetroitMilwaukeeClevelandSouth BendFort WayneLouisvilleWisconsinIllinoisMichiganOhioKentuckyIndianaHebron4KoutsLaCrosse2012 BANKING CENTER LOCATIONS S H A R E H O L D E R S ’ I N F O R M A T I O N
2012 Stock Performance & Dividends
1st Source Corporation common stock is traded on the Over-The-Counter Market and is listed on the Nasdaq Global Select
Market under the symbol “SRCE.” 1st Source is also listed on the National Market System tables in many daily papers under
the symbol “1stSrc.”
High and low common stock prices, cash dividends paid for 2012 and book value were:
Quarter Ended
High
Low
Cash Dividends
Paid
March 31
June 30
September 30
December 31
$ 26.79
$ 23.54
$0 .16
24.86
23.97
23.15
20.51
21.40
19.70
0.16
0.17
0.17
Book value per common share at December 31, 2012: $23.04
Annual Meeting of Shareholders
The Annual Meeting of Shareholders has been called for 10:00 a.m. EDT, April 25, 2013, at 1st Source Center, 100 North
Michigan Street, South Bend, Indiana.
Entrance to the annual meeting is limited to shareholders only. If your shares are held in “street name” (that is, through a
broker), you must bring a recent copy of a brokerage statement reflecting your stock ownership as of February 19, 2013,
the record date.
Common Stock Listing
The Nasdaq Global Select Market
Market Symbol: “SRCE”
CUSIP #336901 10 3
1stsource.com
For the latest shareholder information, log on to www.1stsource.com.
Click on the “About Us” link and then “Investor Relations.”
If you would like to help us reduce printing costs by receiving reports electronically,
please e-mail us at shareholder!1stsource.com.
Transfer Agent, Registrar and Dividend Disbursing Agent
American Stock Transfer and Trust Company
6201 15th Avenue
Brooklyn, NY 11219
Independent Auditors
Ernst & Young LLP
155 North Wacker Drive
Chicago, IL 60606
Shareholder Inquiries
1st Source Corporation
Andrea G. Short, Chief Financial Officer
Post Office Box 1602
South Bend, IN 46634
(574) 235-2000
viii
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
X OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
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
(State or other jurisdiction of
incorporation or organization)
100 North Michigan Street
South Bend, Indiana
(Address of principal executive offices)
35-1068133
(I.R.S. Employer
Identification No.)
46601
(Zip Code)
Registrant’s telephone number, including area code: (574) 235-2000
Securities registered pursuant to Section 12(b) of the Act:
Title of Class
Name of Each Exchange on Which Registered
Common Stock — without par value
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
No X
No X
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for
such shorter period that the registrant was required to submit and post such files). Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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. X
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting com-
pany. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer X Non-accelerated filer
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
No X
The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2012 was $425,967,467
The number of shares outstanding of each of the registrant’s classes of stock as of February 8, 2013:
Common Stock, without par value – 24,357,874 shares
Portions of the annual proxy statement for the 2013 annual meeting of shareholders to be held April 25, 2013, are incorporated by reference into
Part III.
DOCUMENTS INCORPORATED BY REFERENCE
1 • SRCE
2012 Form 10-K
TABLE OF CONTENTS
Part I
Item 1.
Business .................................................................................................................................................................................................................................................................................................... 3
Item 1A.
Risk Factors ............................................................................................................................................................................................................................................................................................. 8
Item 1B.
Unresolved Staff Comments ......................................................................................................................................................................................................................................................11
Item 2.
Item 3.
Item 4.
Part II
Item 5.
Item 6.
Item 7.
Properties ..............................................................................................................................................................................................................................................................................................11
Legal Proceedings .............................................................................................................................................................................................................................................................................11
Mine Safety Disclosures ................................................................................................................................................................................................................................................................11
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities .............................................................. 12
Selected Financial Data ................................................................................................................................................................................................................................................................ 13
Management’s Discussion and Analysis of Financial Condition and Results of Operations .................................................................................................................. 13
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk ..................................................................................................................................................................................30
Item 8.
Financial Statements and Supplementary Data ............................................................................................................................................................................................................. 31
Reports of Independent Registered Public Accounting Firm ...................................................................................................................................................................... 31
Consolidated Statements of Financial Condition ................................................................................................................................................................................................32
Consolidated Statements of Income .........................................................................................................................................................................................................................33
Consolidated Statements of Comprehensive Income .....................................................................................................................................................................................34
Consolidated Statements of Shareholders’ Equity ............................................................................................................................................................................................34
Consolidated Statements of Cash Flow ...................................................................................................................................................................................................................35
Notes to Consolidated Financial Statements ........................................................................................................................................................................................................36
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ...............................................................................................................65
Item 9A.
Controls and Procedures .............................................................................................................................................................................................................................................................65
Item 9B.
Other Information ............................................................................................................................................................................................................................................................................66
Part III
Item 10.
Directors, Executive Officers and Corporate Governance .......................................................................................................................................................................................66
Item 11.
Executive Compensation ..............................................................................................................................................................................................................................................................66
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ....................................................................................67
Item 13.
Certain Relationships and Related Transactions, and Director Independence.............................................................................................................................................67
Item 14.
Principal Accounting Fees and Services .............................................................................................................................................................................................................................67
Part IV
Item 15.
Exhibits and Financial Statement Schedules ....................................................................................................................................................................................................................67
Signatures
....................................................................................................................................................................................................................................................................................................................69
Certifications
....................................................................................................................................................................................................................................................................................................................70
2 • SRCE
2012 Form 10-K
PART I
ITEM 1. BUSINESS.
1ST SOURCE CORPORATION
1st Source Corporation, an Indiana corporation incorporated in 1971, is a bank holding company headquartered in South Bend, Indiana that provides, through
its subsidiaries (collectively referred to as “1st Source,” “we,” and “our”), a broad array of financial products and services. 1st Source Bank (“Bank”), its banking
subsidiary, offers commercial and consumer banking services, trust and investment management services, and insurance to individual and business clients
through most of our 76 banking center locations in 17 counties in Indiana and Michigan. 1st Source Bank’s Specialty Finance Group, with 22 locations
nationwide, offers specialized financing services for new and used private and cargo aircraft, automobiles and light trucks for leasing and rental agencies,
medium and heavy duty trucks, construction equipment, and environmental equipment. While concentrated in certain equipment types, we serve a diverse
client base. We are not dependent upon any single industry or client. At December 31, 2012, we had consolidated total assets of $4.55 billion, loans and leases
of $3.33 billion, deposits of $3.62 billion, and total shareholders’ equity of $558.66 million.
Our principal executive office is located at 100 North Michigan Street, South Bend, Indiana 46601 and our telephone number is 574-235-2000. Access
to our 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, free of
charge, at www.1stsource.com soon after the material is electronically filed with the Securities and Exchange Commission (SEC).
1ST SOURCE BANK
1st Source Bank is a wholly owned subsidiary of 1st Source Corporation that 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 Bank provides commercial, small business, agricultural, and real estate loans to primarily
privately owned business clients mainly located within our regional market area. Loans are made for a wide variety of general corporate purposes, including
financing for industrial and commercial properties, financing for equipment, inventories and accounts receivable, and acquisition financing. Other services
include commercial leasing and cash management services.
Consumer Services — 1st Source Bank provides a full range of consumer banking services, including checking accounts, online banking including bill payment,
telephone banking, mobile banking, savings programs, installment and real estate loans, home equity loans and lines of credit, drive-through and night deposit
services, safe deposit facilities, automated teller machines, debit and credit card services, financial literacy seminars and brokerage services.
Trust Services — 1st Source Bank provides a wide range of trust, investment, agency, and custodial services for individual, corporate, and not-for-profit clients.
These services include the administration of estates and personal trusts, as well as the management of investment accounts for individuals, employee benefit
plans, and charitable foundations.
Specialty Finance Group Services — 1st Source Bank, through its Specialty Finance Group, provides a broad range of comprehensive equipment loan and
lease finance products addressing the financing needs of a broad array of companies. This group can be broken down into five areas: auto and light trucks;
environmental equipment; medium and heavy duty trucks; new and used aircraft; and construction equipment.
The auto and light truck division consists of financings to automobile rental and leasing companies, light truck rental and leasing companies, and special
purpose vehicles. The auto and light truck finance receivables generally range from $100,000 to $20 million with fixed or variable interest rates and terms
of one to five years.
Environmental equipment financing handles trash and recycling equipment for municipalities and private businesses as well as equipment for landfills.
Receivables generally range from $50,000 to $5 million with fixed or variable interest rates and terms of one to five years.
The medium and heavy duty truck division provides financing for highway tractors and trailers and delivery trucks to the commercial trucking industry.
Medium and heavy duty truck finance receivables generally range from $500,000 to $15 million with fixed or variable interest rates and terms of three
to seven years.
Aircraft financing consists of financings for new and used general aviation aircraft (including helicopters) for private and corporate aircraft users, aircraft
distributors and dealers, air charter operators, air cargo carriers, and other aircraft operators. We have selectively entered the international aircraft
markets, primarily Brazil and Mexico, on a limited basis where desirable aircraft financing opportunities exist for private and corporate aircraft users. Aircraft
finance receivables generally range from $500,000 to $15 million with fixed or variable interest rates and terms of one to ten years.
Construction equipment financing includes financing of equipment (i.e., asphalt and concrete plants, bulldozers, excavators, cranes, and loaders, etc.) to
the construction industry. Construction equipment finance receivables generally range from $100,000 to $15 million with fixed or variable interest rates
and terms of three to five years.
We also generate equipment rental income through the leasing of construction equipment, medium and heavy duty trucks, automobiles, and other equipment
to clients through operating leases.
SPECIALTY FINANCE GROUP SUBSIDIARIES
The Specialty Finance Group also consists of separate wholly owned subsidiaries of 1st Source Bank which include: Michigan Transportation Finance Corporation;
1st Source Specialty Finance, Inc.; SFG Aircraft, Inc.; 1st Source Intermediate Holding, LLC; SFG Commercial Aircraft Leasing, Inc.; and SFG Equipment Leasing
Corporation I.
1ST SOURCE INSURANCE, INC.
1st Source Insurance, Inc. is a wholly owned subsidiary of 1st Source Bank that provides insurance products and services to individuals and businesses covering
corporate and personal property, casualty insurance, and individual and group health and life insurance. 1st Source Insurance, Inc. has eight offices.
3 • SRCE
2012 Form 10-K
1ST SOURCE CORPORATION INVESTMENT ADVISORS, INC.
1st Source Corporation Investment Advisors, Inc. (Investment Advisors) is a wholly owned subsidiary of 1st Source Bank that provides investment advisory
services to trust and investment clients of 1st Source Bank and to Wasatch Advisors, Inc., the investment advisor of the Wasatch Mutual Fund family. Investment
Advisors is registered as an investment advisor with the Securities and Exchange Commission under the Investment Advisors Act of 1940. Investment Advisors
serves strictly in an advisory capacity and, as such, does not hold any client securities.
OTHER CONSOLIDATED SUBSIDIARIES
We have other subsidiaries that are not significant to the consolidated entity.
1ST SOURCE MASTER TRUST
Our unconsolidated subsidiary includes 1st Source Master Trust. This subsidiary was created for the purpose of issuing $57.00 million of trust preferred
securities and lending the proceeds to 1st Source. We guarantee, on a limited basis, payments of distributions on the trust preferred securities and payments on
redemption of the trust preferred securities.
COMPETITION
The activities in which we and the Bank engage in are highly competitive. Our businesses and the geographic markets we serve require us to compete with other
banks, some of which are affiliated with large bank holding companies headquartered outside of our principal market. We generally compete on the basis of
client service and responsiveness to client needs, available loan and deposit products, the rates of interest charged on loans and leases, the rates of interest paid
for funds, other credit and service charges, the quality of services rendered, the convenience of banking facilities, and in the case of loans and leases to large
commercial borrowers, relative lending limits.
In addition to competing with other banks within our primary service areas, the Bank also competes with other financial service companies, such as credit unions,
industrial loan associations, securities firms, insurance companies, small loan companies, finance companies, mortgage companies, real estate investment trusts,
certain governmental agencies, credit organizations, and other enterprises.
Additional competition for depositors’ funds comes from United States Government securities, private issuers of debt obligations, and suppliers of other
investment alternatives for depositors. Many of our non-bank competitors are not subject to the same extensive Federal and State regulations that govern bank
holding companies and banks. Such non-bank competitors may, as a result, have certain advantages over us in providing some services.
We compete against these financial institutions by being convenient to do business with, and by taking the time to listen and understand our clients’ needs.
We deliver personalized, one-on-one banking through knowledgeable local members of the community always keeping the clients best interest in mind while
offering a full array of products and highly personalized services. We rely on our history and our reputation in northern Indiana dating back to 1863.
EMPLOYEES
At December 31, 2012, we had approximately 1,180 employees on a full-time equivalent basis. We provide a wide range of employee benefits and consider
employee relations to be good.
REGULATION AND SUPERVISION
General — 1st Source and the Bank are extensively regulated under Federal and State law. To the extent that the following information describes statutory or
regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations
may have a material effect on our business and our prospective business. Our operations may be affected by legislative changes and by the policies of various
regulatory authorities. We are unable to predict the nature or the extent of the effects on our business and earnings that fiscal or monetary policies, economic
controls, or new Federal or State legislation may have in the future.
We are a registered bank holding company under the Bank Holding Company Act of 1956 (BHCA) and, as such, we are subject to regulation, supervision, and
examination by the Board of Governors of the Federal Reserve System (Federal Reserve). We are required to file annual reports with the Federal Reserve and
to provide the Federal Reserve such additional information as it may require.
1st Source Bank, as an Indiana state bank and member of the Federal Reserve System, is supervised by the Indiana Department of Financial Institutions (DFI)
and the Federal Reserve. As such, 1st Source Bank is regularly examined by and subject to regulations promulgated by the DFI and the Federal Reserve.
Because the Federal Deposit Insurance Corporation (FDIC) provides deposit insurance to 1st Source Bank, we are also subject to supervision and regulation by
the FDIC (even though the FDIC is not our primary Federal regulator).
Bank Holding Company Act — Under the BHCA, as amended, our activities are limited to business so closely related to banking, managing, or controlling banks
as to be a proper incident thereto. We are also subject to capital requirements applied on a consolidated basis in a form substantially similar to those required
of the Bank. The BHCA also requires a bank holding company to obtain approval from the Federal Reserve before (i) acquiring, or holding more than 5% voting
interest in any bank or bank holding company, (ii) acquiring all or substantially all of the assets of another bank or bank holding company, or (iii) merging or
consolidating with another bank holding company.
The BHCA also restricts non-bank activities to those which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related
to the business of banking or of managing or controlling banks. As discussed below, the Gramm-Leach-Bliley Act (GLBA), 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.
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 provided for the recapitalization of the former Bank Insurance
Fund, deposit insurance reform, including the implementation of risk-based deposit insurance premiums, the establishment of five capital levels for financial
institutions (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”) that would impose
more scrutiny and restrictions on less capitalized institutions, along with a number of other supervisory and regulatory issues. At December 31, 2012, the Bank
was categorized as “well capitalized,” meaning that our total risk-based capital ratio exceeded 10.00%, our Tier 1 risk-based capital ratio exceeded 6.00%,
our leverage ratio exceeded 5.00%, and we are not subject to a regulatory order, agreement, or directive to meet and maintain a specific capital level for any
capital measure.
4 • SRCE
2012 Form 10-K
Federal Deposit Insurance Reform Act — On February 1, 2006, Congress approved the Federal Deposit Insurance Reform Act of 2005 (FDIRA). Among other
things, the FDIRA provides for the merger of the Bank Insurance Fund with the Savings Association Insurance Fund and for an immediate increase in Federal
deposit insurance for certain retirement accounts up to $250,000. The statute further provides for the indexing of the maximum deposit insurance coverage for
all types of deposit accounts in the future to account for inflation. The FDIRA also requires the FDIC to provide certain banks and thrifts that were in existence
prior to December 31, 1996 with one-time credits against future premiums based on the amount of their payments to the Bank Insurance Fund or Savings
Association Insurance Fund prior to that date.
FDIC Deposit Insurance Assessments — On October 16, 2008, in response to the problems facing the financial markets and the economy, the Federal Deposit
Insurance Corporation (FDIC) published a restoration plan (Restoration Plan) designed to replenish the Deposit Insurance Fund (DIF) such that the reserve ratio
would return to 1.15 percent within five years. On December 16, 2008, the FDIC adopted a final rule increasing risk-based assessment rates uniformly by seven
basis points, on an annual basis, for the first quarter 2009.
On February 27, 2009, the FDIC concluded that the problems facing the financial services sector and the economy at large constituted extraordinary
circumstances and amended the Restoration Plan and extended the time within which the reserve ratio would return to 1.15 percent from five to seven years
(Amended Restoration Plan). In May 2009, Congress amended the statutory provision governing establishment and implementation of a Restoration Plan to
allow the FDIC eight years to bring the reserve ratio back to 1.15 percent, absent extraordinary circumstances.
On May 22, 2009, the FDIC adopted a final rule imposing a five basis point special assessment on each insured depository institution’s assets minus Tier 1
capital as of June 30, 2009. The special assessment was collected on September 30, 2009.
In a final rule issued on September 29, 2009, the FDIC amended the Amended Restoration Plan as follows:
• The period of the Amended Restoration Plan was extended from seven to eight years.
• The FDIC announced that it will not impose any further special assessments under the final rule it adopted in May 2009.
• The FDIC announced plans to maintain assessment rates at their current levels through the end of 2010. The FDIC also immediately adopted a uniform
three basis point increase in assessment rates effective January 1, 2011 to ensure that the DIF returns to 1.15 percent within the Amended Restoration
Plan period of eight years. The FDIC subsequently rescinded this three basis point increase in assessment rates before it became effective.
• The FDIC announced that, at least semi-annually following the adoption of the Amended Restoration Plan, it will update its loss and income projections for
the DIF. The FDIC also announced that it may, if necessary, adopt a new rule prior to the end of the eight-year period to increase assessment rates in order
to return the reserve ratio to 1.15 percent.
On November 12, 2009, the FDIC adopted a final rule to require insured institutions to prepay their quarterly risk-based deposit insurance assessments for the
fourth quarter of 2009, and for all of 2010, 2011 and 2012, on December 30, 2009. Our payment was $20.26 million.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which was signed into law on July 21, 2010, changes how the FDIC
will calculate future deposit insurance premiums payable by insured depository institutions. The Dodd-Frank Act directs the FDIC to amend its assessment
regulations so that future assessments will generally be based upon a depository institution’s average total consolidated assets minus the average tangible
equity of the insured depository institution during the assessment period, whereas assessments were previously based on the amount of an institution’s insured
deposits. The minimum deposit insurance fund rate will increase from 1.15% to 1.35% by September 30, 2020, and the cost of the increase will be borne by
depository institutions with assets of $10 billion or more.
The Dodd-Frank Act also provides the FDIC with discretion to determine whether to pay rebates to insured depository institutions when its deposit insurance
reserves exceed certain thresholds. Previously, the FDIC was required to give rebates to depository institutions equal to the excess once the reserve ratio
exceeded 1.50%, and was required to rebate 50% of the excess over 1.35% but not more than 1.5% of insured deposits. The FDIC adopted a final rule on
February 7, 2011 that implements these provisions of the Dodd-Frank Act.
Temporary Liquidity Guarantee Program — On November 21, 2008, the FDIC Board of Directors adopted a final rule implementing the Temporary Liquidity
Guarantee Program (TLGP). The TLGP consists of two basic components: a guarantee of newly issued senior unsecured debt of banks, thrifts, and certain
holding companies (the debt guarantee program) and full guarantee of non-interest bearing deposit transaction accounts, such as business payroll accounts,
regardless of dollar amount (the transaction account guarantee program). The purpose of the guarantee of transaction accounts and the debt guarantee was to
reduce funding costs and allow banks and thrifts to increase lending to consumers and businesses. All insured depository institutions were automatically enrolled
in both programs unless they elected to opt out by a specified date. 1st Source did not elect to opt out and thus participated in both programs.
As originally adopted, the transaction account guarantee program was to terminate on December 31, 2009, although the FDIC subsequently extended the
program through December 31, 2010. The Dodd-Frank Act, which was adopted on July 21, 2010, included a provision that effectively replaced the transaction
account guarantee program and extended the unlimited FDIC guarantee of noninterest bearing transaction accounts through December 31, 2012 for all
insured depository institutions, not just those that elect to participate. Also, the Dodd-Frank Act provision, unlike the transaction account guarantee program,
does not include low-interest NOW accounts within the definition of noninterest-bearing transaction accounts, and such accounts are therefore not covered
by unlimited deposit insurance coverage. A subsequent amendment to the Dodd-Frank Act that became effective on December 31, 2010 extended unlimited
deposit insurance coverage for “Interest on Lawyers Trust Accounts” through December 31, 2012.
The debt guarantee program under the TLGP initially permitted participating entities to issue FDIC-guaranteed senior unsecured debt until June 30, 2009, with
the FDIC’s guarantee for such debt to expire on the earlier of the maturity of the debt (or the conversion date, for mandatory convertible debt) or June 30, 2012.
On March 17, 2009, the FDIC extended the debt guarantee portion of the TLGP from June 30, 2009 to October 31, 2009 and imposed a surcharge on debt
issued with a maturity of one year or more beginning in the second quarter to gradually phase out the program. There were no further extensions of the debt
guarantee program, and the program concluded on October 31, 2009. The FDIC’s guarantee of debt issued before that date expired on December 31, 2012.
Emergency Economic Stabilization Act of 2008 — On October 3, 2008, President George W. Bush signed the Emergency Economic Stabilization Act of
2008 (EESA). This Act temporarily increased the standard maximum deposit insurance amount from $100,000 to $250,000 effective immediately. This
temporary increase in the scope of deposit insurance coverage was originally set to expire on December 31, 2013, but the Dodd-Frank Act made this temporary
increase permanent.
5 • SRCE
2012 Form 10-K
Under the Troubled Asset Relief Program established by EESA, the U.S. Treasury Department (Treasury) announced a Capital Purchase Program (CPP). CPP
was designed to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and support the U.S.
economy. Under the program, Treasury could purchase up to $250 billion of senior preferred shares on standardized terms as described in the program’s term
sheet. The program was available to qualifying U.S. controlled banks, savings associations, and certain bank and savings and loan holding companies engaged
only in financial activities that submitted applications to Treasury by November 14, 2008. EESA provided for Treasury to determine an applicant’s eligibility to
participate in the CPP after consulting with the appropriate federal banking agency.
1st Source submitted an application to participate in the CPP and obtained Treasury approval on December 11, 2008. On January 23, 2009, 1st Source issued
preferred stock valued at $111.00 million and a warrant to acquire 837,947 shares of its common stock to Treasury pursuant to the CPP. The warrant was
exercisable at any time during the ten-year period following issuance at an exercise price of $19.87 per share. On December 29, 2010, 1st Source redeemed
all of the preferred stock issued to the Treasury under CPP for $111.68 million, which included accrued and unpaid dividends payable to Treasury on the
preferred stock. On March 8, 2011, 1st Source repurchased the common stock warrant for $3.75 million.
Securities and Exchange Commission (SEC) and The Nasdaq Stock Market (Nasdaq) — We are under the jurisdiction of the SEC and certain state securities
commissions for matters relating to the offering and sale of our securities and our investment advisory services. We are subject to the disclosure and regulatory
requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. We are listed on
the Nasdaq Global Select Market under the trading symbol “SRCE,” and we are subject to the rules of Nasdaq for listed companies.
Interstate Branching — Congress enacted the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Interstate Act) to allow bank holding
companies to expand, by acquiring existing banks, into all states, even those which had theretofore restricted entry. The legislation also authorized a bank to
open de novo branches in other states, but only to the extent that the law of the bank’s home state, as well as the law of the state where the branch was to be
located, permitted an out-of-state bank to open a de novo branch. The Interstate Act also authorized, subject to future action by individual states, a bank holding
company to convert its subsidiary banks located in different states under a single charter.
The Dodd-Frank Act amended the Interstate Act by expanding the authority of a state or national bank to open offices in other states. A state or national bank
may now open a de novo branch in another state if the law of the state where the branch is to be located would permit a state bank chartered by that state to
open the branch. This amendment repealed the restriction under the Interstate Act that permitted an out-of-state bank to open a de novo branch in another
state only if the bank’s home state and the state where the branch was to be located had each enacted reciprocal de novo interstate branching laws.
Gramm-Leach-Bliley Act of 1999 — The GLBA is intended to modernize the banking industry by removing barriers to affiliation among banks, insurance
companies, the securities industry, and other financial service providers. It provides financial organizations with the flexibility of structuring such affiliations
through a holding company structure or through a financial subsidiary of a bank, subject to certain limitations. The GLBA establishes a new type of bank holding
company, known as a financial holding company, which may engage in an expanded list of activities that are “financial in nature,” which include securities and
insurance brokerage, securities underwriting, insurance underwriting, and merchant banking. The GLBA also sets forth a system of functional regulation that
makes the Federal Reserve the “umbrella supervisor” for holding companies, while providing for the supervision of the holding company’s subsidiaries by other
Federal and state agencies. A bank holding company may not become a financial holding company if any of its subsidiary financial institutions are not well-
capitalized or well-managed. Further, each bank subsidiary of the holding company must have received at least a satisfactory Community Reinvestment Act
(CRA) rating. The GLBA also expands the types of financial activities a national bank may conduct through a financial subsidiary, addresses state regulation
of insurance, generally prohibits unitary thrift holding companies organized after May 4, 1999 from participating in new activities that are not financial in
nature, provides privacy protection for nonpublic customer information of financial institutions, modernizes the Federal Home Loan Bank system, and makes
miscellaneous regulatory improvements. The Federal Reserve and the Secretary of the Treasury must coordinate their supervision regarding approval of new
financial activities to be conducted through a financial holding company or through a financial subsidiary of a bank. While the provisions of the GLBA regarding
activities that may be conducted through a financial subsidiary directly apply only to national banks, those provisions indirectly apply to state-chartered banks. In
addition, the Bank is subject to other provisions of the GLBA, including those relating to CRA and privacy, regardless of whether we elect to become a financial
holding company or to conduct activities through a financial subsidiary. We do not currently intend to file notice with the Board to become a financial holding
company or to engage in expanded financial activities through a financial subsidiary.
Financial Privacy — In accordance with the GLBA, Federal banking regulators adopted rules that limit the ability of banks and other financial institutions to
disclose non-public information about customers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some
circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. The privacy provisions of the GLBA affect
how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. We are also subject to various state laws that
generally require us to notify any customer whose personal financial information may have been released to an unauthorized person as the result of a breach
of our data security policies and procedures.
USA Patriot Act of 2001 — The USA Patriot Act of 2001 (USA Patriot Act) was signed into law following the terrorist attacks of September 11, 2001. The
USA Patriot Act is comprehensive anti-terrorism legislation that, among other things, substantially broadened the scope of anti–money laundering laws and
regulations by imposing significant new compliance and due diligence obligations on financial institutions.
The regulations adopted by the Treasury under the USA Patriot Act require financial institutions to maintain appropriate policies, procedures and controls to
detect, prevent and report money laundering, and terrorist financing. Additionally, the regulations require that we, upon request from the appropriate Federal
regulatory agency, provide records related to anti–money laundering, perform due diligence of private banking and correspondent accounts, establish standards
for verifying customer identity, and perform other related duties.
Failure of a financial institution to comply with the USA Patriot Act’s requirements could have serious legal and reputational consequences for the institution.
Regulations Governing Capital Adequacy — The Federal bank regulatory agencies use capital adequacy guidelines in their examination and regulation of
bank holding companies and banks. If capital falls below the minimum levels established by these guidelines, a bank holding company or bank will be required
to submit an acceptable plan for achieving compliance with the capital guidelines and will be subject to denial of applications and appropriate supervisory
enforcement actions. The various regulatory capital requirements that we are subject to are disclosed in Part II, Item 8, Financial Statements and Supplementary
Data — Note 19 of the Notes to Consolidated Financial Statements.
6 • SRCE
2012 Form 10-K
Community Reinvestment Act — The Community Reinvestment Act of 1977 requires that, in connection with examinations of financial institutions within their
jurisdiction, the Federal banking regulators must evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low
and moderate income neighborhoods, consistent with the safe and sound operation of those banks. Federal banking regulators are required to consider a financial
institution’s performance in these areas as they review applications filed by the institution to engage in mergers or acquisitions or to open a branch or facility.
Regulations Governing Extensions of Credit — 1st Source Bank is subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit
to 1st Source or our subsidiaries, or investments in our securities and on the use of our securities as collateral for loans to any borrowers. These regulations and
restrictions may limit our ability to obtain funds from the Bank for our cash needs, including funds for acquisitions and for payment of dividends, interest and
operating expenses. Further, the BHCA, certain regulations of the Federal Reserve, state laws and many other Federal laws govern the extensions of credit and
generally prohibit a bank from extending credit, engaging in a lease or sale of property, or furnishing services to a customer on the condition that the customer
obtain additional services from the bank’s holding company or from one of its subsidiaries.
1st Source Bank is also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal
shareholders, or any related interest of such persons. Extensions of credit (i) must be made on substantially the same terms, including interest rates and
collateral, and subject to credit underwriting procedures that are at least as stringent as those prevailing at the time for comparable transactions with non
affiliates, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. The Bank is also subject to certain lending
limits and restrictions on overdrafts to such persons.
Reserve Requirements — The Federal Reserve requires all depository institutions to maintain reserves against their transaction account deposits. The Bank
must maintain reserves of 3.00% against net transaction accounts greater than $12.40 million and up to $79.50 million (subject to adjustment by the Federal
Reserve) and reserves of 10.00% must be maintained against that portion of net transaction accounts in excess of $79.50 million. These amounts are indexed
to inflation and adjusted annually by the Federal Reserve.
Dividends — The ability of the Bank to pay dividends is limited by state and Federal laws and regulations that require 1st Source Bank to obtain the prior approval
of the DFI and the Federal Reserve Bank of Chicago before paying a dividend that, together with other dividends it has paid during a calendar year, would exceed
the sum of its net income for the year to date combined with its retained net income for the previous two years. The amount of dividends the Bank may pay may
also be limited by certain covenant agreements and by the principles of prudent bank management. See Part II, Item 5, Market for Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities for further discussion of dividend limitations.
Monetary Policy and Economic Control — The commercial banking business in which we engage is affected not only by general economic conditions, but also
by the monetary policies of the Federal Reserve. Changes in the discount rate on member bank borrowing, availability of borrowing at the “discount window,”
open market operations, the imposition of changes in reserve requirements against member banks’ deposits and assets of foreign branches, and the imposition
of, and changes in, reserve requirements against certain borrowings by banks and their affiliates are some of the instruments of monetary policy available to
the Federal Reserve. These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments, and
deposits, and such use may affect interest rates charged on loans and leases or paid on deposits. The monetary policies of the Federal Reserve have had a
significant effect on the operating results of commercial banks and are expected to do so in the future. The monetary policies of the Federal Reserve are
influenced by various factors, including economic growth, inflation, unemployment, short-term and long-term changes in the international trade balance, and
in the fiscal policies of the U.S. Government. Future monetary policies and the effect of such policies on our future business and earnings, and the effect on the
future business and earnings of the Bank cannot be predicted.
Sarbanes-Oxley Act of 2002 — The Sarbanes-Oxley Act of 2002 (SOA) includes provisions intended to enhance corporate responsibility and protect
investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws, and which increase penalties for accounting and
auditing improprieties at public traded companies. The SOA generally applies to all companies that file or are required to file periodic reports with the SEC under
the Exchange Act.
Among other things, the SOA creates the Public Company Accounting Oversight Board as an independent body subject to SEC supervision with responsibility for
setting auditing, quality control, and ethical standards for auditors of public companies. The SOA also requires public companies to make faster and more-extensive
financial disclosures, requires the chief executive officer and the chief financial officer of public companies to provide signed certifications as to the accuracy and
completeness of financial information filed with the SEC, and provides enhanced criminal and civil penalties for violations of the Federal securities laws.
The SOA also addresses functions and responsibilities of audit committees of public companies. The statute, by mandating certain stock exchange listing rules,
makes the audit committee directly responsible for the appointment, compensation, and oversight of the work of the company’s outside auditor, and requires
the auditor to report directly to the audit committee. The SOA authorizes each audit committee to engage independent counsel and other advisors, and requires
a public company to provide the appropriate funding, as determined by its audit committee, to pay the company’s auditors and any advisors that its audit
committee retains. The SOA also requires public companies to prepare an internal control report and assessment by management, along with an attestation to
this report prepared by the company’s independent registered public accounting firm, in their annual reports to stockholders.
Secure and Fair Enforcement for Mortgage Licensing Act — The Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (S.A.F.E. Act) establishes a
nationwide licensing and registration system for mortgage loan originators. The S.A.F.E. Act requires an employee of a bank, savings association or credit union
and certain of their subsidiaries that are regulated by a federal banking agency (agency-regulated institutions) who acts as a residential mortgage loan originator
to register with the Nationwide Mortgage Licensing System and Registry (NMLS), obtain a unique identifier, and maintain this registration.
The federal banking agencies adopted a final rule that was published on August 23, 2010 to implement these provisions. The final rule requires, among other things,
that a loan originator submit to the NMLS certain information concerning his or her personal history and experience, undergo an FBI criminal background check,
and authorize the NMLS to obtain information related to any administrative, civil, or criminal findings by any governmental agency regarding the loan originator.
Dodd-Frank Wall Street Reform and Consumer Protection Act — On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which significantly
changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial
institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and small bank and thrift holding companies will be regulated
in the future. Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax
rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, and impose new capital requirements on bank
7 • SRCE
2012 Form 10-K
and thrift holding companies. The Dodd-Frank Act also includes several corporate governance provisions that apply to all public companies, not just financial
institutions. These include provisions mandating certain disclosures regarding executive compensation and provisions addressing proxy access by shareholders.
The Dodd-Frank Act also makes permanent the temporary increase in deposit insurance coverage from $100,000 to $250,000 that was included in the
EESA, and extended until December 31, 2012 the period during which the FDIC provided unlimited deposit insurance for “noninterest-bearing transaction
accounts.” After that date, deposit insurance coverage of non-interest bearing transaction accounts at an insured depository institution is subject to the same
restrictions that apply to other deposit accounts at the institution.
The Dodd-Frank Act also establishes the Consumer Financial Protection Bureau (CFPB) as an independent entity within the Federal Reserve. Effective
July 10, 2011, the CFPB assumed primary responsibility for administering substantially all of the consumer compliance regulations, including Regulation Z issued
under the Truth in Lending Act and Regulation X issued under the Real Estate Settlement Procedures Act, formerly administered by other federal agencies.
The CFPB also has the authority to promulgate consumer protection regulations that will apply to all entities, including banks, that offer consumer financial
services or products. Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other
things, originator compensation, minimum repayment standards, and pre-payment penalties. The Dodd-Frank Act contains numerous other provisions affecting
financial institutions of all types, many of which may have an impact on our operating environment in substantial and unpredictable ways.
Because many of the regulations required to implement the Dodd-Frank Act have not yet been issued, the statute’s effect on the financial services industry
in general, and on us in particular, is uncertain at this time. The Dodd-Frank Act is likely to affect our cost of doing business, however, and may limit or expand
the scope of our permissible activities and affect the competitive balance within our industry and market areas. Our management continues to monitor the
implementation of the Dodd-Frank Act and as new regulations are issued, will assess their effect on our business, financial condition, and results of operations.
Basel III — In June 2012, the Federal Reserve and the other federal banking agencies issued a proposed rule that would revise each agency’s risk-based and
leverage capital requirements consistent with agreements reached by the Basel Committee on Banking Supervision (Basel III). As proposed, the rule would
require banks and bank holding companies to maintain a minimum amount of capital in the form of tangible common equity, and would generally increase the
required capital ratios and change the risk weightings of assets used to determine those ratios. The proposed rule would also require new deductions from
capital for certain intangible assets, including mortgage servicing assets and deferred tax assets exceeding specified thresholds. The proposed rule would also
require institutions seeking the freedom to make capital distributions and to pay discretionary bonuses to executive officers without restriction to maintain a
2.5% common equity “capital conservation buffer,” which would be phased in from January 1, 2016 through January 1, 2019. This capital conservation buffer
is in addition to the other minimum risk-based capital standards in the rule.
The proposed rule would also eliminate or reduce the ability of certain types of capital instruments to count as regulatory capital, and would eliminate the Tier 1
treatment of trust preferred securities (as required by the Dodd-Frank Act) following a phase-in period beginning in 2013. The Company has outstanding two
series of trust preferred securities, representing an aggregate principal amount of $58.76 million, which would no longer qualify as Tier 1 capital if the proposed
rule were to be adopted as proposed and after it is fully implemented.
As originally proposed, these capital standards were to become effective on January 1, 2013. On November 9, 2012, however, the banking agencies announced
that they do not expect that the proposed rule would become effective on that date. The agencies did not indicate the likely new effective date.
Pending Legislation — Because of concerns relating to competitiveness and the safety and soundness of the banking industry, Congress often considers a
number of wide-ranging proposals for altering the structure, regulation, and competitive relationships of the nation’s financial institutions. We cannot predict
whether or in what form any proposals will be adopted or the extent to which our business may be affected.
ITEM 1A. RISK FACTORS.
An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that we believe affect us are described below.
See “Forward-Looking Statements” under Item 7 of this report for a discussion of other important factors that can affect our business.
CREDIT RISKS
We are subject to credit risks relating to our loan and lease portfolios — We have certain lending policies and procedures in place that are designed to optimize
loan and lease income within an acceptable level of risk. Our management reviews and approves these policies and procedures on a regular basis. A reporting
system supplements the review process by providing our management with frequent reports related to loan and lease production, loan quality, concentrations
of credit, loan and lease delinquencies, and nonperforming and potential problem loans and leases. Diversification in the loan and lease portfolios is a means of
managing risk associated with fluctuations and economic conditions.
We maintain an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are
presented to our management. The loan and lease review process complements and reinforces the risk identification and assessment decisions made by lenders
and credit personnel, as well as our policies and procedures.
Commercial and commercial real estate loans generally involve higher credit risks than residential real estate and consumer loans. Because payments on loans
secured by commercial real estate or equipment are often dependent upon the successful operation and management of the underlying assets, repayment of
such loans may be influenced to a great extent by conditions in the market or the economy. We seek to minimize these risks through our underwriting standards.
We obtain financial information and perform credit risk analysis on our customers. Credit criteria may include, but are not limited to, assessments of income, cash
flows, collateral, and net worth; asset ownership; bank and trade credit references; credit bureau reports; and operational history.
Commercial real estate or equipment loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and generate
positive cash flows. Our management examines current and projected cash flows of the borrower to determine the ability of the borrower to repay their
obligations as agreed. Underwriting standards are designed to promote relationship banking rather than transactional banking. Most commercial and industrial
loans are secured by the assets being financed or other business assets; however, some loans may be made on an unsecured basis. Our credit policy sets
different maximum exposure limits both by business sector and our current and historical relationship and previous experience with each customer.
We offer both fixed-rate and adjustable-rate consumer mortgage loans secured by properties, substantially all of which are located in our primary market area.
Adjustable-rate mortgage loans help reduce our exposure to changes in interest rates; however, during periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans may increase as a result of repricing and the increased payments required from the borrower. Additionally, some residential
mortgages are sold into the secondary market and serviced by our principal banking subsidiary, 1st Source Bank.
8 • SRCE
2012 Form 10-K
Consumer loans are primarily all other non–real estate loans to individuals in our regional market area. Consumer loans can entail risk, particularly in the case of
loans that are unsecured or secured by rapidly depreciating assets. In these cases, any repossessed collateral may not provide an adequate source of repayment
of the outstanding loan balance. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining
a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness, or personal bankruptcy.
The 1st Source Specialty Finance Group loan and lease portfolio consists of commercial loans and leases secured by construction and transportation equipment,
including aircraft, autos, trucks, and vans. Finance receivables for this Group generally provide for monthly payments and may include prepayment penalty
provisions.
Our construction and transportation related businesses could be adversely affected by slowdowns in the economy. Clients who rely on the use of assets financed
through the Specialty Finance Group to produce income could be negatively affected, and we could experience substantial loan and lease losses. By the nature
of the businesses these clients operate in, we could be adversely affected by rapid increases of fuel costs. Since some of the relationships in these industries are
large (up to $25 million), a slowdown could have a significant adverse impact on our performance.
Our construction and transportation related businesses could be adversely impacted by the negative effects caused by high fuel costs, terrorist and other
potential attacks, and other destabilizing events. These factors could contribute to the deterioration of the quality of our loan and lease portfolio, as they could
have a negative impact on the travel and transportation sensitive businesses for which our specialty finance businesses provide financing.
In addition, our leasing and equipment financing activity is subject to the risk of cyclical downturns, industry concentration and clumping, and other adverse
economic developments affecting these industries and markets. This area of lending, with transportation in particular, is dependent upon general economic
conditions and the strength of the travel, construction, and transportation industries.
Our reserve for loan and lease losses may prove to be insufficient to absorb probable losses in our loan and lease portfolio — In the financial services
industry, there is always a risk that certain borrowers may not repay borrowings. The determination of the appropriate level of the reserve for loan and lease
losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may
undergo material changes. Our reserve for loan and lease losses may not be sufficient to cover the loan and lease losses that we may actually incur. If we
experience defaults by borrowers in any of our businesses, our earnings could be negatively affected. Changes in local economic conditions could adversely
affect credit quality, particularly in our local business loan and lease portfolio. Changes in national or international economic conditions could also adversely
affect the quality of our loan and lease portfolio and negate, to some extent, the benefits of national or international diversification through our Specialty Finance
Group’s portfolio. In addition, bank regulatory agencies periodically review our reserve for loan and lease losses and may require an increase in the provision for
loan and lease losses or the recognition of further loan or lease charge-offs based upon their judgments, which may be different from ours.
The soundness of other financial institutions could adversely affect us — Financial services institutions are interrelated as a result of trading, clearing,
counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties
in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions
expose us to credit risk in the event of a default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot
be realized or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due us. Any such losses could have a material
adverse effect on our financial condition and results of operations.
Certain investments could have a negative impact — As a result of recent economic conditions, some municipalities are struggling to meet financial obligations.
We have investment securities which are subject to credit risk if the issuers are unable to meet their obligations to us. Although we believe the issuers will be able
to meet their obligations, there can be no certainty regarding future results. In addition, we face further credit analysis requirements as a result of the Dodd-
Frank Act and rules promulgated by the Federal Reserve.
Our liability for residential mortgage loan repurchases could be insufficient — The agreements under which we sell residential mortgage loans in the
secondary market contain various representations and warranties regarding the acceptability of loans for purchase. On occasion, we may be asked to indemnify
the loan purchaser for credit losses on loans that were later deemed ineligible for purchase or we may be asked to repurchase the loan. We have established a
mortgage loan repurchase liability which represents our best estimate of the losses we may incur. This estimate is based on specific loan repurchase requests
and a historical loss ratio with respect to origination dollar volume. Because the level of mortgage loan repurchase losses are dependent on economic factors,
investor demand strategies and other external conditions that may change over the life of the underlying loans, the level of liability for mortgage loan repurchase
losses is difficult to estimate and requires considerable management judgment. Within the industry, repurchase demands in recent years have increased and
while we believe the loans we have underwritten and sold have met or exceeded applicable transaction parameters, we must acknowledge the current trend
of mortgage insurance rescissions and speculative repurchase requests. If significant additions to our existing repurchase liability are required, it could have a
material adverse impact on our financial condition and results of operations.
MARKET RISKS
Fluctuations or stagnation in interest rates could reduce our profitability and affect the value of our assets — Like other financial institutions, we are subject to
interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and leases and investments, and
interest paid on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities
and the relationships of various interest rates to each other. Over any defined period of time, our interest-earning assets may be more sensitive to changes in
market interest rates than our interest-bearing liabilities, or vice-versa. In addition, the individual market interest rates underlying our loan and lease and deposit
products may not change to the same degree over a given time period. In any event, if market interest rates should move contrary to our position, earnings may
be negatively affected. In addition, loan and lease volume and quality and deposit volume and mix can be affected by market interest rates as can the businesses
of our clients. Changes in levels of market interest rates could have a material adverse effect on our net interest spread, asset quality, origination volume, and
overall profitability.
Market interest rates are beyond our control, and they fluctuate in response to general economic conditions and the policies of various governmental and
regulatory agencies, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, may negatively affect our ability
to originate loans and leases, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately could affect our earnings.
9 • SRCE
2012 Form 10-K
Adverse changes in economic conditions could impair our financial condition and results of operations — We are impacted by general business and economic
conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative
and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, unemployment, and the strength of the U.S.
economy and the local economies in which we operate, all of which are beyond our control. A deterioration in economic conditions could result in an increase in
loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services. Economic turmoil
in the European Union represents significant risk to the global economy. Economic collapse of any EU member or similar severe crisis in Europe could adversely
impact us and our clients.
LIQUIDITY RISKS
We could have liquidity risks associated with our Indiana public fund deposits — Under Indiana law governing the collateralization of public fund deposits,
the Indiana Board for Depositories determines which financial institutions are required to pledge collateral based on the strength of their financial ratings. We
have been informed that no collateral is required for our public fund deposits. However, the Board of Depositories could alter this requirement in the future and
adversely impact our liquidity.
We rely on dividends from our subsidiaries — Our parent company, 1st Source Corporation, receives substantially all of its revenue from dividends from our
subsidiaries. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt. Various federal and/
or state laws and regulations limit the amount of dividends that our subsidiaries may pay to our parent company. In the event our subsidiaries are unable to pay
dividends to our parent company, we may not be able to service debt, pay obligations or pay dividends on our common stock. The inability to receive dividends
from our subsidiaries could have a material adverse effect on our business, financial condition and results of operations.
OPERATIONAL RISKS
We are dependent upon the services of our management team — Our future success and profitability is substantially dependent upon our management and
the banking abilities of our senior executives. We believe that our future results will also depend in part upon our ability to attract and retain highly skilled and
qualified management. We are especially dependent on a limited number of key management personnel, many of whom do not have employment agreements
with us. The loss of the chief executive officer and other senior management and key personnel could have a material adverse impact on our operations because
other officers may not have the experience and expertise to readily replace these individuals. Many of these senior officers have primary contact with our clients
and are important in maintaining personalized relationships with our client base. The unexpected loss of services of one or more of these key employees could
have a material adverse effect on our operations and possibly result in reduced revenues if we were unable to find suitable replacements promptly. Competition
for senior personnel is intense, and we may not be successful in attracting and retaining such personnel. Changes in key personnel and their responsibilities may
be disruptive to our businesses and could have a material adverse effect on our businesses, financial condition, and results of operations.
Technology security breaches and constant technological change — Information security risks have increased significantly due to the use of online, telephone,
and mobile banking channels by clients and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. Any
compromise of our security could deter our clients from using our banking services. We depend on the services of a variety of third party vendors to meet data
processing and communication needs. We rely on security systems to provide the security and authentication necessary to effect secure transmission of data
against damage by theft, fire, power loss, telecommunications failure or similar catastrophic event, as well as from security breaches, denial of service attacks,
viruses, worms, and other disruptive problems caused by hackers. Computer break-ins, phishing and other disruptions of customer or vendor systems could also
jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure. We also maintain a cyber insurance
policy that is designed to cover loss resulting from cyber security breaches. These precautions may not protect our systems from compromises or breaches of
our security measures that could result in damage to our reputation and business.
The financial services industry is constantly undergoing rapid technological change with frequent introductions of new technology-driven products and services.
The effective use of technology increases efficiency and enables financial institutions to better service clients and reduce costs. Our future success depends, in
part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands, as well as create
additional efficiencies within our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not
be able to effectively implement new technology-driven products and services quickly or be successful in marketing these products and services to our clients.
Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and,
in turn, our financial condition and results of operations.
LEGAL/COMPLIANCE RISKS
We are subject to extensive government regulation and supervision — Our operations are subject to extensive federal and state regulation and supervision.
Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not security holders.
These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal
regulatory agencies continually review banking laws, regulations and policies for possible change. Changes to statutes, regulations or regulatory policies, including
changes in interpretation or implementation of statutes, regulation or policies, could affect us in substantial and unpredictable ways. Such changes could subject
us to additional costs and limit the types of financial services and products we may offer. Failure to comply with laws, regulations or policies could result in
sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition
and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will
not occur.
Changes in accounting standards could impact reported earnings — Current accounting and tax rules, standards, policies and interpretations influence the
methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These
laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time. Events that may not have a direct
impact on us, such as bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting
Standards Board, the Securities and Exchange Commission, the Public Company Accounting Oversight Board and various taxing authorities, responding by
adopting and/or proposing substantive revision to laws, regulations, rules, standards, policies and interpretations. New accounting pronouncements and varying
interpretations of accounting pronouncements have occurred and may occur in the future. A change in accounting standards may adversely affect our reported
financial condition and results of operations.
10 • SRCE
2012 Form 10-K
Substantial ownership concentration — Our directors, executive officers and 1st Source Bank, as trustee, collectively hold a significant ownership concentration
of our common shares. Due to this significant level of ownership among our affiliates, our directors, executive officers, and 1st Source Bank, as trustee, may be
able to influence the outcome of director elections or impact significant transactions, such as mergers or acquisitions, or any other matter that might otherwise
be favored by other stockholders.
REPUTATIONAL RISKS
Competition from other financial services providers could adversely impact our results of operations — The banking and financial services business is
highly competitive. We face competition in making loans and leases, attracting deposits and providing insurance, investment, trust, and other financial services.
Increased competition in the banking and financial services businesses may reduce our market share, impair our growth or cause the prices we charge for our
services to decline. Our results of operations may be adversely impacted in future periods depending upon the level and nature of competition we encounter
in our various market areas.
Managing reputational risk is important to attracting and maintaining customers, investors, and employees — Threats to our reputation can come from many
sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of
service or quality, compliance deficiencies, and questionable or fraudulent activities of our customers. We have policies and procedures in place that seek to
protect our reputation and promote ethical conduct. Nonetheless, negative publicity may arise regarding our business, employees, or customers, with or without
merit, and could result in the loss of customers, investors, and employees; costly litigation; a decline in revenues; and increased government regulation.
None
ITEM 1B. UNRESOLVED STAFF COMMENTS.
ITEM 2. PROPERTIES.
Our headquarters building is located in downtown South Bend, Indiana. The building is part of a larger complex, including a 300-room hotel and a 500-car
parking garage. In December 2010, we entered into a new 10.5 year lease on our headquarters building which became effective January 1, 2011. As of
December 31, 2012, 1st Source leases approximately 69% of the office space in this complex.
At December 31, 2012, we also owned property and/or buildings on which 54 of 1st Source Bank’s 76 banking centers were located, including the facilities in
Allen, Elkhart, Fulton, Huntington, Kosciusko, LaPorte, Marshall, Porter, St. Joseph, Starke, Whitley, and Wells Counties in the State of Indiana and Berrien and
Cass Counties in the State of Michigan, as well as an operations center, warehouse, and our former headquarters building, which is utilized for additional business
operations. The Bank leases additional property and/or buildings to and from third parties under lease agreements negotiated at arm’s-length.
ITEM 3. LEGAL PROCEEDINGS.
As previously reported, 1st Source Bank, as the trustee (the “Trustee”) of the Morris Family Trusts for Ernestine M. Raclin, Chairman Emeritus of the Company,
and other beneficiaries, requested approval of the Probate Court of St. Joseph County Indiana to divide the Morris Family Trusts into four separate family trust
lines. The Trustee also sought other relief regarding the trusts including approving its accounts. The action was taken in light of possible changes in tax laws and
for financial and estate planning purposes, including the possible divesture of some 1st Source Corporation common stock owned by the Trusts. Shares at issue
in the probate action held by the Morris Family Trusts represent approximately 22% of the outstanding common stock of the Company.
The four family trust lines correspond to the four children of Mrs. Raclin. In a response filed on September 28, 2012, two of the siblings and their respective
children filed a joint answer to the Trustee’s petition and a counter-petition setting forth their objection to the Trustee’s proposed division of the Morris Family
Trusts into four family trust lines. They also sought affirmative relief, alleging that the Trustee has breached its duties by, among other things, acquiring an
inappropriate and unreasonably high concentration in common stock of the Company in 1971 and, for decades thereafter, failing to prudently, impartially and
timely diversify the assets of the Morris Family Trusts uninfluenced by the impact on the Company or its executives.
The relief sought includes removal of the Trustee, unspecified damages and payment by 1st Source Bank of all fees, costs and expenses incurred by the Trustee
for, among other things, all matters related to the preparation and prosecution of the probate action. Mrs. Raclin, the two remaining siblings and their children,
respectively, filed their joint answer to the petition indicating their previous and ongoing support for the Trustee’s acquisition of and continuing investment in the
common stock of the Company. The Company believes there is no basis for the relief requested in the objection and counter-petition. The Trustee intends to
defend the matter vigorously.
1st Source and our subsidiaries are involved in various other legal proceedings incidental to the conduct of our businesses. Our management does not expect
that the outcome of any such proceedings will have a material adverse effect on our consolidated financial position or results of operations.
None
ITEM 4. MINE SAFETY DISCLOSURES.
11 • SRCE
2012 Form 10-K
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is traded on the Nasdaq Global Select Market under the symbol “SRCE.” The following table sets forth for each quarter the high and low
sales prices for our common stock, as reported by Nasdaq, and the cash dividends paid per share for each quarter.
Common Stock Prices (quarter ended)
High
Low
2012 Sales Price
March 31
June 30
September 30
December 31
$26.79
$23.54
24.86
23.97
23.15
20.51
21.40
19.70
Cash Dividends
Paid
$0.16
0.16
0.17
0.17
2011 Sales Price
High
Low
$20.90
$17.86
21.33
24.00
26.06
19.10
19.36
19.91
Cash Dividends
Paid
$0.16
0.16
0.16
0.16
As of February 8, 2013, there were 948 holders of record of 1st Source common stock
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN*
Among 1st Source, Morningstar Market Weighted NASDAQ Index** and Peer Group Index***
100
100
100
140
66
60
99
87
57
167
129
103
102
71
61
150
120
73
1st Source
NASDAQ Index
Peer Group
175
150
125
100
75
50
25
0
2007
2008
2009
2010
2011
2012
*
**
Assumes $100 invested on December 31, 2007, in 1st Source Corporation common stock, NASDAQ market index, and peer group index.
The Morningstar Weighted NASDAQ Index Return is calculated using all companies which trade as NASD Capital Markets, NASD Global Markets or NASD
Global Select. It includes both domestic and foreign companies. The index is weighted by the then current shares outstanding and assumes dividends
reinvested. The return is calculated on a monthly basis.
***
The peer group is a market-capitalization-weighted stock index of 151 banking companies in Illinois, Indiana, Michigan, Ohio, and Wisconsin.
NOTE: Total return assumes reinvestment of dividends.
12 • SRCE
2012 Form 10-K
The following table summarizes our share repurchase activity during the three months ended December 31, 2012.
Period
October 01 - 31, 2012
November 01 - 30, 2012
December 01 - 31, 2012
Total Number of
Shares Purchased
Average Price
Paid Per Share
-
3,500
46,666
$ -
19.91
21.74
Total Number of
Shares Purchased as
Part of Publicly Announced
Plans or Programs*
Maximum Number
(or Approximate Dollar Value)
of Shares that may yet be
Purchased Under
the Plans or Programs
-
3,500
46,666
1,020,192
1,016,692
970,026
*1st Source maintains a stock repurchase plan that was authorized by the Board of Directors on April 26, 2007. Under the terms of the plan, 1st Source may
repurchase up to 2,000,000 shares of its common stock when favorable conditions exist on the open market or through private transactions at various prices
from time to time. Since the inception of the plan, 1st Source has repurchased a total of 1,029,974 shares.
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 19 of the Notes
to Consolidated Financial Statements.
The following selected financial data should be read in conjunction with our Consolidated Financial Statements and the accompanying notes presented elsewhere
herein.
(Dollars in thousands, except per share amounts)
2012
2011
2010
2009
2008
ITEM 6. SELECTED FINANCIAL DATA.
$ 182,085
$ 187,523
$ 200,626
$ 200,412
$ 235,308
30,309
39,123
53,129
72,200
103,148
Interest income
Interest expense
Net interest income
Provision for loan and lease losses
151,776
5,752
Net interest income after provision for loan and lease losses
146,024
Noninterest income
Noninterest expense
Income before income taxes
Income taxes
Net income
81,192
151,536
75,680
26,047
49,633
148,400
3,129
145,271
80,872
152,354
73,789
25,594
48,195
147,497
19,207
128,290
86,691
154,505
60,476
19,232
41,244
128,212
31,101
97,111
85,530
151,123
31,518
6,028
132,160
16,648
115,512
84,003
153,114
46,401
13,015
25,490
33,386
Net income available to common shareholders
$
49,633
$
48,195
$
29,655
$
19,074
$
33,386
Assets at year-end
$ 4,550,693
$ 4,374,071
$ 4,445,281
$ 4,542,100
$ 4,464,174
Long-term debt and mandatorily redeemable
securities at year-end
Shareholders’ equity at year-end (1)
Basic net income per common share
Diluted net income per common share
Cash dividends per common share
Dividend payout ratio
Return on average assets
Return on average common equity
Average common equity to average assets
71,021
558,655
37,156
523,918
24,816
486,383
19,761
570,320
29,832
453,664
2.02
2.02
0.66
32.67 %
1.11 %
9.10 %
12.20 %
1.96
1.96
0.64
32.65 %
1.09 %
9.51 %
11.51 %
1.21
1.21
0.61
50.41 %
0.91 %
6.10 %
10.69 %
0.79
0.79
0.59
74.68 %
0.57 %
4.07 %
10.40 %
1.38
1.37
0.58
42.34 %
0.76 %
7.52 %
10.09 %
(1) Results for 2009 include the issuance of Preferred Stock under TARP which was redeemed in the fourth quarter of 2010.
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 our results of operations for each of the past three
years and financial condition for each of the past two years. In order to fully appreciate this analysis the reader is encouraged to review the consolidated financial
statements and statistical data presented in this document.
FORWARD-LOOKING STATEMENTS
This report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements. Forward-
looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and
future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause actual results,
performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.
13 • SRCE
2012 Form 10-K
All statements other than statements of historical fact are statements that could be forward-looking statements. Words such as “believe,” “contemplate,” “seek,”
“estimate,” “plan,” “project,” “anticipate,” “possible,” “assume,” “expect,” “intend,” “targeted,” “continue,” “remain,” “will,” “should,” “indicate,” “would,” “may” and
other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking
statements provide current expectations or forecasts of future events and are not guarantees of future performance, nor should they be relied upon as
representing management’s views as of any subsequent date.
All written or oral forward-looking statements that are made by or attributable to us are expressly qualified in their entirety by this cautionary notice. We have no
obligation and do not undertake to update, revise, or correct any of the forward-looking statements after the date of this report, or after the respective dates on
which such statements otherwise are made. We have expressed our expectations, beliefs, and projections in good faith and we believe they have a reasonable
basis. However, we make no assurances that our expectations, beliefs, or projections will be achieved or accomplished. The results or outcomes indicated by our
forward-looking statements may not be realized due to a variety of factors, including, without limitation, the following:
• Local, regional, national, and international economic conditions and the impact they may have on us and our clients and our assessment of that impact.
• Changes in the level of nonperforming assets and charge-offs.
• Changes in estimates of future cash reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.
• The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.
• Inflation, interest rate, securities market, and monetary fluctuations.
• Political instability.
• Acts of war or terrorism.
• Substantial increases in the cost of fuel.
• The timely development and acceptance of new products and services and perceived overall value of these products and services by others.
• Changes in consumer spending, borrowings, and savings habits.
• Changes in the financial performance and/or condition of our borrowers.
• Technological changes.
• Acquisitions and integration of acquired businesses.
• The ability to increase market share and control expenses.
• Changes in the competitive environment among bank holding companies.
• The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, and insurance) with which we and our
subsidiaries must comply.
• The effect of changes in accounting policies and practices and auditing requirements, as may be adopted by the regulatory agencies, as well as the Public
Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standard setters.
• Changes in our organization, compensation, and benefit plans.
• The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquires and
the results of regulatory examinations or reviews.
• Greater than expected costs or difficulties related to the integration of new products and lines of business.
• Our success at managing the risks described in Item 1A. Risk Factors.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP) and follow general practices within
the industries in which we operate. Application of these principles requires management to make estimates or judgments that affect the amounts reported in
the financial statements and accompanying notes. These estimates or judgments reflect management’s view of the most appropriate manner in which to record
and report our overall financial performance. Because these estimates or judgments are based on current circumstances, they may change over time or prove
to be inaccurate based on actual experience. As such, changes in these estimates, judgments, and/or assumptions may have a significant impact on our financial
statements. All accounting policies are important, and all policies described in Part II, Item 8, Financial Statements and Supplementary Data, Note 1 (Note 1),
should be reviewed for a greater understanding of how our financial performance is recorded and reported.
We have identified the following three policies as being critical because they require management to make particularly difficult, subjective, and/or complex
estimates or judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under
different conditions or using different assumptions. These policies relate to the determination of the reserve for loan and lease losses, fair value measurements,
and the valuation of mortgage servicing rights. Management believes it has used the best information available to make the estimations or judgments necessary
to value the related assets and liabilities. Actual performance that differs from estimates or judgments and future changes in the key variables could change
future valuations and impact net income. Management has reviewed the application of these policies with the Audit Committee of the Board of Directors.
Following is a discussion of the areas we view as our most critical accounting policies.
Reserve for Loan and Lease Losses — The reserve for loan and lease losses represents management’s estimate of probable losses inherent in the loan and
lease portfolio and the establishment of a reserve that is sufficient to absorb those losses. In determining an appropriate reserve, management makes numerous
judgments, assumptions, and estimates based on continuous review of the loan and lease portfolio, estimates of client performance, collateral values, and disposition,
as well as historical loss rates and expected cash flows. In assessing these factors, management benefits from a lengthy organizational history and experience with
credit decisions and related outcomes. Nonetheless, if management’s underlying assumptions prove to be inaccurate, the reserve for loan and lease losses would
have to be adjusted. Our accounting policy related to the reserve is disclosed in Note 1 under the heading “Reserve for Loan and Lease Losses.”
14 • SRCE
2012 Form 10-K
Fair Value Measurements — We use fair value measurements to record certain financial instruments and to determine fair value disclosures. Available-for-
sale securities, trading account securities, mortgage loans held for sale, and interest rate swap agreements are financial instruments recorded at fair value on
a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis. These nonrecurring
fair value adjustments typically involve write-downs of, or specific reserves against, individual assets. GAAP establishes a three-level hierarchy for disclosure
of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation
methodology used in the measurement are observable or unobservable. Observable inputs reflect market-driven or market-based information obtained from
independent sources, while unobservable inputs reflect our estimates about market data.
The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices
or observable market data. For financial instruments that trade actively and have quoted market prices or observable market data, there is minimal subjectivity
involved in measuring fair value. When observable market prices and data are not fully available, management judgment is necessary to estimate fair value. In
addition, changes in the market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets
or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, we use
valuation techniques that require more management judgment to estimate the appropriate fair value measurement. Fair value is discussed further in Note 1
under the heading “Fair Value Measurements” and in Note 20, “Fair Value Measurements.”
Mortgage Servicing Rights Valuation — We recognize as assets the rights to service mortgage loans for others, known as mortgage servicing rights, whether
the servicing rights are acquired through purchases or through originated loans. Mortgage servicing rights do not trade in an active open market with readily
observable market prices. Although sales of mortgage servicing rights do occur, the precise terms and conditions may not be readily available. As such, the value
of mortgage servicing assets is established and valued using discounted cash flow modeling techniques which require management to make estimates regarding
future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other
economic factors. The estimated rates of mortgage loan prepayments are the most significant factors driving the value of mortgage servicing assets. Increases in
mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced. In determining the fair value of
the mortgage servicing assets, mortgage interest rates (which are used to determine prepayment rates), and discount rates are held constant over the estimated
life of the portfolio. Estimated mortgage loan prepayment rates are derived from a third-party model and adjusted to reflect our actual prepayment experience.
Mortgage servicing assets are carried at the lower of amortized cost or fair value. The values of these assets are sensitive to changes in the assumptions used
and readily available market pricing does not exist. The valuation of mortgage servicing assets is discussed further in Note 20 “Fair Value Measurements.”
EARNINGS SUMMARY
Net income in 2012 was $49.63 million, up from $48.20 million in 2011 and up from $41.24 million in 2010. Diluted net income per common share was
$2.02 in 2012, $1.96 in 2011, and $1.21 in 2010. Return on average total assets was 1.11% in 2012 compared to 1.09% in 2011, and 0.91% in 2010. Return
on average common shareholders’ equity was 9.10% in 2012 versus 9.51% in 2011, and 6.10% in 2010.
Net income in 2012 was positively impacted by a $3.38 million or 2.27% increase in net interest income from 2011, which was offset by an increase of $2.62
million or 83.83% in provision for loan and lease losses. Net income in 2011, as compared to 2010, was positively impacted by a $16.08 million or 83.71%
decrease in provision for loan and lease losses, which was offset by a decrease of $5.82 million or 6.71% in noninterest income and an increase of $6.36 million
or 33.08% in income tax expense.
Dividends paid on common stock in 2012 amounted to $0.66 per share, compared to $0.64 per share in 2011, and $0.61 per share in 2010. The level of
earnings reinvested and dividend payouts are determined by the Board of Directors based on management’s assessment of future growth opportunities and the
level of capital necessary to support them.
Net Interest Income — Our primary source of earnings is net interest income, the difference between income on earning assets and the cost of funds supporting
those assets. Significant categories of earning assets are loans and securities while deposits and borrowings represent the major portion of interest-bearing
liabilities. For purposes of the following discussion, comparison of net interest income is done on a tax equivalent basis, which provides a common basis for
comparing yields on earning assets exempt from federal income taxes to those which are fully taxable.
Net interest margin (the ratio of net interest income to average earning assets) is significantly 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 3.69% in 2012 and 2011, compared to
3.59% in 2010. The stable margin in 2012 reflects the decline in funding costs offset by lower yields on earnings assets. The higher margin in 2011 compared
to 2010 was due to a decline in funding costs. Net interest income was $151.78 million for 2012, compared to $148.40 million for 2011 and $147.50 for
2010. Tax-equivalent net interest income totaled $153.84 million for 2012, up $2.93 million from the $150.91 million reported for 2011. Tax-equivalent net
interest income for 2011 was relatively flat from the $150.87 million reported in 2010.
During 2012, average earning assets increased $84.15 million while average interest-bearing liabilities decreased $46.72 million over the comparable period
in 2011. The yield on average earning assets decreased 24 basis points to 4.41% for 2012 from 4.65% for 2011 due to reduced market interest rates. Total
cost of average interest-bearing liabilities decreased 25 basis points to 0.94% during 2012 from 1.19% in 2011 as liabilities were impacted by decreases in
market rates and rate re-pricing on maturing certificates of deposit. The result was an increase of 1 basis point to net interest spread, or the difference between
interest income on earning assets and expense on interest-bearing liabilities.
The largest contributor to the decrease in the yield on average earning assets in 2012 was the 31 basis point decrease in the loan and lease portfolio yield.
Average net loans and leases increased $130.91 million or 4.25% in 2012 from 2011 while the yield decreased to 5.02%.
During 2012, the tax-equivalent yield on securities available for sale decreased 30 basis points to 2.42% while the average balance decreased $17.50 million.
Average mortgages held for sale increased $5.74 million during 2012 and the yield decreased 73 basis points. Average other investments, which include federal
funds sold, time deposits with other banks, Federal Reserve Bank excess balances, Federal Reserve Bank and Federal Home Loan Bank stock and commercial
paper decreased $35.00 million during 2012 while the yield increased 45 basis points. The increase in yield was primarily a result of higher dividends on Federal
Home Loan Bank stock.
Average interest-bearing deposits decreased $56.25 million during 2012 while the effective rate paid on those deposits decreased 28 basis points. Average
noninterest-bearing demand deposits increased $75.01 million during 2012.
15 • SRCE
2012 Form 10-K
Average short-term borrowings decreased $11.49 million during 2012 while the effective rate paid decreased 8 basis points. Average long-term debt increased
$22.29 million during 2012 as the effective rate decreased 124 basis points.
The following table provides an analysis of net interest income and illustrates interest income earned and interest expense charged for each major component
of interest earning assets and the interest bearing liabilities. Yields/rates are computed on a tax-equivalent basis, using a 35% rate. Nonaccrual loans and leases
are included in the average loan and lease balance outstanding.
2012
Interest
Income/
Expense
Average
Balance
Yield/
Rate
Average
Balance
2011
Interest
Income/
Expense
Yield/
Rate
Average
Balance
2010
Interest
Income/
Expense
Yield/
Rate
$ 775,103 $ 16,426
2.12%
$ 780,215 $ 18,533
2.38%
$ 743,838 $ 20,466
2.75%
107,289
4,939
4.60
119,680
5,921
4.95
170,415
8,201
4.81
(Dollars in thousands)
ASSETS
Investment securities:
Taxable
Tax-exempt
Mortgages held for sale
16,700
592
3.54
10,959
468
4.27
52,097
2,430
4.66
Net loans and leases
3,209,490
161,253
5.02
3,078,581
164,117
5.33
3,109,508
171,843
5.53
Other investments
65,861
943
1.43
100,862
991
0.98
131,627
1,061
0.81
Total earning assets
4,174,443
184,153
4.41
4,090,297
190,030
4.65
4,207,485
204,001
4.85
Cash and due from banks
60,099
Reserve for loan and
lease losses
Other assets
(83,430)
321,767
59,698
(86,617)
339,176
60,977
(89,656)
364,896
Total assets
$ 4,472,879
$ 4,402,554
$ 4,543,702
LIABILITIES AND
SHAREHOLDERS’ EQUITY
Interest bearing deposits
$ 2,957,785 $ 21,877
0.74%
$ 3,014,033 $ 30,762
1.02%
$ 3,121,167 $ 44,605
1.43%
Short-term borrowings
137,937
169
0.12
149,428
300
0.20
164,191
800
0.49
Subordinated notes
Long-term debt and
mandatorily redeemable
88,425
6,484
7.33
89,692
6,589
7.35
89,692
6,589
7.35
securities
55,383
1,779
3.21
33,093
1,472
4.45
27,149
1,135
4.18
Total interest bearing liabilities
3,239,530
30,309
0.94
3,286,246
39,123
1.19
3,402,199
53,129
1.56
Noninterest bearing deposits
616,426
Other liabilities
Shareholders' equity
Total liabilities and
71,292
545,631
541,421
67,948
506,939
484,028
67,011
590,464
shareholders’ equity
$ 4,472,879
$ 4,402,554
$ 4,543,702
Net interest income
$ 153,844
$ 150,907
$ 150,872
Net interest margin on a tax
equivalent basis
3.69%
3.69%
3.59%
16 • SRCE
2012 Form 10-K
The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar
amounts of the change in each. The following table shows changes in tax equivalent interest earned and interest paid, resulting from changes in volume and
changes in rates:
(Dollars in thousands)
2012 compared to 2011
Interest earned on:
Investment securities:
Taxable
Tax-exempt
Mortgages held for sale
Net loans and leases
Other investments
Total earning assets
Interest paid on:
Interest bearing deposits
Short-term borrowings
Subordinated notes
Long-term debt and mandatorily redeemable securities
Total interest bearing liabilities
Net interest income
2011 compared to 2010
Interest earned on:
Investment securities:
Taxable
Tax-exempt
Mortgages held for sale
Net loans and leases
Other investments
Total interest earning assets
Interest paid on:
Interest bearing deposits
Short-term borrowings
Subordinated notes
Long-term debt and mandatorily redeemable securities
Total interest bearing liabilities
Net interest income
Increase (Decrease) due to
Volume
Rate
Net
$
(90)
$ (2,017)
$ (2,107)
(581)
184
8,256
150
$ 7,919
(401)
(60)
(11,120)
(198)
(982)
124
(2,864)
(48)
$ (13,796)
$ (5,877)
$
(593)
$ (8,292)
$ (8,885)
(19)
(87)
523
$
(176)
$ 8,095
$ 1,026
(2,527)
(1,774)
(1,557)
(941)
(112)
(18)
(216)
$ (8,638)
$ (5,158)
(131)
(105)
307
$ (8,814)
$ 2,937
$ (2,959)
$
(1,933)
247
(188)
(6,169)
871
(2,280)
(1,962)
(7,726)
(70)
$ (5,773)
$
(8,198)
$ (13,971)
$ (1,439)
$ (12,404)
$ (13,843)
(62)
-
260
$ (1,241)
$ (4,532)
(438)
-
77
$ (12,765)
$ 4,567
(500)
-
337
$ (14,006)
$
35
17 • SRCE
2012 Form 10-K
Noninterest Income — Noninterest income increased $0.32 million or 0.40% in 2012 from 2011 following a $5.82 million or 6.71% decrease in 2011 over
2010. Noninterest income for the most recent three years ended December 31 was as follows:
(Dollars in thousands)
Noninterest income:
Trust fees
Service charges on deposit accounts
Mortgage banking income
Insurance commissions
Equipment rental income
Other income
Investment securities and other investment gains
Total noninterest income
2012
2011
2010
$ 16,498
18,807
8,357
5,494
18,796
12,660
580
$ 81,192
$ 16,327
18,488
3,839
4,793
23,361
12,665
1,399
$ 80,872
$ 15,838
19,323
6,218
5,074
26,036
11,909
2,293
$ 86,691
Trust fees (which include investment management fees, estate administration fees, mutual fund fees, annuity fees, and fiduciary fees) increased by $0.17
million or 1.05% in 2012 from 2011 compared to an increase of $0.49 million or 3.09% in 2011 over 2010. Trust fees are largely based on the size of client
relationships and the market value of assets under management. The market value of trust assets under management at December 31, 2012 and 2011 was
$3.40 billion and $3.30 billion, respectively. At December 31, 2012, these trust assets were comprised of $2.01 billion of personal and agency trusts, $966.54
million of employee benefit plan assets, $309.63 million of estate administration assets and individual retirement accounts, and $113.29 million of custody
assets. The increase in trust fees in 2012 and 2011 was primarily a result of an increase in the market values of investment accounts.
Service charges on deposit accounts increased $0.32 million or 1.73% in 2012 from 2011 compared to a decrease of $0.84 million or 4.32% in 2011 from
2010. The improvement in service charges on deposit accounts in 2012 was primarily due to higher usage of debit cards offset by lower volume of nonsufficient
fund transactions. The decline in service charges on deposit accounts in 2011 from 2010 largely reflects a lower volume of nonsufficient fund transactions.
Mortgage banking income increased $4.52 million or 117.69% in 2012 over 2011, compared to a decrease of $2.38 million or 38.26% in 2011 over 2010.
In 2012, we had $0.24 million in valuation recovery adjustments of mortgage servicing rights compared to $0.24 million in valuation impairment adjustments
of mortgage servicing rights in 2011 and no mortgage servicing rights impairment in 2010. During 2012, 2011 and 2010, we determined that no permanent
write-down was necessary for previously recorded impairment on mortgage servicing assets. During 2012, mortgage banking income was also positively
impacted by higher loan production volumes and higher margins on loan sales. Mortgage banking income was impacted by reduced loan production volumes in
2011 as a result of exiting wholesale broker lending in late 2010.
Insurance commissions increased $0.70 million or 14.63% in 2012 from 2011 compared to a decrease of $0.28 million or 5.54% in 2011 from 2010.
The increase in 2012 was due to the acquisition of a benefits agency’s book of business in January 2012. The lower commission income in 2011 was mainly
due to reduced contingent commissions, primarily as a result of a higher level of claims activity in our books of business and intense competition which drove
premiums lower.
Equipment rental income generated from operating leases declined by $4.57 million or 19.54% during 2012 from 2011 compared to a decrease of $2.68
million or 10.27% during 2011 from 2010. The average equipment rental portfolio decreased 19.10% in 2012 over 2011 and 8.79% in 2011 over 2010
resulting in lower rental income. In addition, new leases are at lower rates due to current market conditions including lower rates and increased competition.
Investment securities and other investment gains totaled $0.58 million for the year ended 2012 compared to gains of $1.40 million for the year ended 2011
and gains of $2.29 million for the year ended 2010. During 2012, we recorded investment portfolio gains on the sale of corporate equity and agency securities
and recognized partnership valuation net gains. In 2011, we recorded gains on the sale of agency securities. In 2010, we recognized a gain on sale of a venture
capital investment of $1.62 million and had other partnership gains of $0.64 million.
Other income was flat in 2012 from 2011 and increased $0.76 million or 6.35% in 2011 from 2010. The increase in 2011 was mainly due to higher earnout
fees on the sale of assets of Investment Advisors related to the management of the 1st Source Monogram Funds.
18 • SRCE
2012 Form 10-K
Noninterest Expense — Noninterest expense decreased $0.82 million or 0.54% in 2012 over 2011 following a $2.15 million or 1.39% decrease in 2011 from
2010. Noninterest expense for the recent three years ended December 31 was as follows:
(Dollars in thousands)
Noninterest expense:
Salaries and employee benefits
Net occupancy expense
Furniture and equipment expense
Depreciation — leased equipment
Professional fees
Supplies and communications
FDIC and other insurance
Business development and marketing expense
Loan and lease collection and repossession expense
Intangible asset amortization
Other expense
Total noninterest expense
2012
2011
2010
$ 82,599
$ 77,261
$ 75,815
7,819
15,406
15,202
6,083
5,701
3,602
4,232
5,772
1,325
3,795
8,714
14,130
18,650
5,508
5,453
4,421
4,032
6,724
1,300
6,161
8,788
12,543
20,715
6,353
5,499
6,256
3,774
6,227
1,324
7,211
$ 151,536
$ 152,354
$ 154,505
Total salaries and employee benefits increased $5.34 million or 6.91% in 2012 from 2011, following a $1.45 million or 1.91% increase in 2011 from 2010.
Employee salaries increased $3.72 million or 5.94% in 2012 from 2011 compared to being flat in 2011 from 2010. The increase in 2012 was primarily due
to higher base salaries, executive incentive expense and loan producer commissions. Larger base salary expense was primarily due to more full time equivalent
employees and annual performance raises. Loan producer commissions were higher due to increased residential mortgage loan production volumes.
Employee benefits grew by $1.62 million or 11.04% in 2012 from 2011, compared to an increase of $1.48 million or 11.21% in 2011 from 2010. The increase
in 2012 and 2011 was primarily due to higher group insurance costs.
Occupancy expense decreased $0.90 million or 10.27% in 2012 from 2011, compared to remaining stable in 2011 from 2010. The lower expense in 2012
was mainly due to reduced real estate taxes as a result of the successful appeals of assessed values.
Furniture and equipment expense, including depreciation, increased $1.28 million or 9.03% in 2012 from 2011 compared to an increase of $1.59 million
or 12.65% in 2011 from 2010. The higher expense during 2012 was in the areas of equipment depreciation, computer processing charges and software
maintenance. The increase in 2011 was primarily due to higher computer processing charges, Mastercard operating expense and aircraft maintenance.
Depreciation on equipment owned under operating leases decreased $3.45 million or 18.49% in 2012 from 2011, following a $2.07 million or 9.97%
decrease in 2011 from 2010. In 2012 and 2011, depreciation on equipment owned under operating leases decreased in conjunction with the decrease in
equipment rental income.
Professional fees grew by $0.58 million or 10.44% in 2012 from 2011, compared to a $0.85 million or 13.30% decrease in 2011 from 2010. The increase
in 2012 was primarily due to higher consulting fees offset by lower legal fees. During 2011, reduced legal and consulting fees resulted in lower professional
fees than 2010.
Supplies and communications expense increased $0.25 million or 4.55% in 2012 from 2011 after being flat in 2011 as compared to 2010. During 2012, data
communication costs were higher than prior year.
FDIC and other insurance expense declined $0.82 million or 18.53% in 2012 over 2011 versus a $1.84 million or 29.33% decrease in 2011 over 2010. The
decrease in 2012 and 2011 was due to a change in FDIC premium calculations in the second quarter 2011 based on average total consolidated assets minus
the average tangible equity of the insured depository institution during the assessment period, whereas assessments were previously based on the amount of
an institution’s insured deposits.
Business development and marketing expense increased $0.20 million or 4.96% in 2012 from 2011 compared to a $0.26 million or 6.84% increase in 2011
from 2010. Increased promotions and marketing activity resulted in higher costs in 2012. The increase in 2011 from 2010 was primarily related to business
development costs.
Loan and lease collection and repossession expenses decreased $0.95 million or 14.16% in 2012 from 2011 compared to an increase of $0.50 million or
7.98% in 2011 from 2010. Loan and lease collection and repossession expense was lower in 2012 mainly due to reduced ORE operating costs, collection and
repossession expense, and valuation adjustments as credit quality slowly improves. These reductions were offset by higher mortgage loan repurchase losses. The
increase in 2011 was primarily a result of higher ORE operating costs and valuation adjustments and mortgage loan repurchase losses offset by lower valuation
adjustments on repossessed aircraft in 2011 as compared to 2010.
Intangible asset amortization increased $0.03 million or 1.92% in 2012 from 2011 compared to a $0.02 million or 1.81% decrease in 2011 from 2010.
Due to the acquisition of a benefits agency’s book of business in January 2012, intangible asset amortization increased over 2011. During early 2011, deposit
intangibles from a prior acquisition fully amortized causing 2011 expense to be lower than 2010.
Other expenses decreased $2.37 million or 38.40% in 2012 as compared to 2011 and decreased $1.05 million or 14.56% in 2011 from 2010. The decline
in 2012 was mainly due to a lower provision on unfunded loan commitments and the gain on sale of the corporate headquarters’ parking garage. Other expense
decreased in 2011 primarily due to a gain on sale of the corporate aircraft offset by a charge for provision on unfunded loan commitments.
19 • SRCE
2012 Form 10-K
Income Taxes — 1st Source recognized income tax expense in 2012 of $26.05 million, compared to $25.59 million in 2011, and $19.23 million in 2010. The
effective tax rate in 2012 was 34.42% compared to 34.69% in 2011, and 31.80% in 2010. The effective tax rate was higher in 2012 and 2011 compared
to 2010 due to a decrease in tax-exempt interest in relation to income before taxes. Additionally, during the first quarter of 2011 we reached a state tax
settlement for the 2008 year and as a result recorded a reduction of unrecognized tax benefit in the amount of $0.84 million that affected the effective tax
rate and increased earnings in the amount of $0.47 million. For a detailed analysis of 1st Source’s income taxes see Part II, Item 8, Financial Statements and
Supplementary Data — Note 16 of the Notes to Consolidated Financial Statements.
FINANCIAL CONDITION
Loan and Lease Portfolio — The following table shows 1st Source’s loan and lease distribution at the end of each of the last five years as of December 31:
(Dollars in thousands)
2012
2011
2010
2009
2008
Commercial and agricultural loans
$ 639,069
$ 545,570
$ 530,228
$ 546,222
$ 643,440
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer loans
Total loans and leases
438,147
172,002
696,479
278,974
554,968
438,641
109,273
435,965
159,796
620,782
261,204
545,457
423,606
98,163
396,500
162,824
614,357
285,634
594,729
390,951
95,400
349,741
204,545
617,384
313,300
580,709
371,514
109,735
353,838
243,375
632,121
375,983
574,394
344,355
130,706
$ 3,327,553
$ 3,090,543
$ 3,070,623
$ 3,093,150
$ 3,298,212
At December 31, 2012, 13.2% of total loans and leases were concentrated with auto rental and leasing.
Loans and leases, net of unearned discount, at December 31, 2012, were $3.33 billion and were 73.12% of total assets, compared to $3.09 billion and
70.66% of total assets at December 31, 2011. Average loans and leases, net of unearned discount, increased $130.91 million or 4.25% and decreased
$30.93 million or 0.99% in 2012 and 2011, respectively.
Commercial and agricultural lending, excluding those loans secured by real estate, increased $93.50 million or 17.14% in 2012 over 2011. Commercial and
agricultural lending outstandings were $639.07 million and $545.57 million at December 31, 2012 and December 31, 2011, respectively. This increase was
mainly attributed to an improved economy in our target markets, resulting in greater line of credit usage and the financing of increased capital expenditures by
our clients. In 2012, we also grew our business client base.
Auto, light truck, and environmental equipment financing increased very slightly in 2012 over 2011. At December 31, 2012, auto, light truck, and environmental
equipment financing had outstandings of $438.15 million and $435.97 million at December 31, 2011.
Medium and heavy duty truck loans and leases grew by $12.21 million or 7.64% in 2012. Medium and heavy duty truck financing at December 31, 2012 and
2011 had outstandings of $172.00 million and $159.80 million, respectively. Most of the increase at December 31, 2012 from December 31, 2011 can be
attributed to clients reacting to their aging equipment by normalizing their replacement policies. Consequently, demand has increased as the trucking industry
acquired new equipment.
Aircraft financing at year-end 2012 increased $75.70 million or 12.19% from year-end 2011. Aircraft financing at December 31, 2012 and 2011 had
outstandings of $696.48 million and $620.78 million, respectively. The increase was mainly due to a recovering business climate, a perception in the markets
that business aircraft values had bottomed and reduced aircraft lending competition.
Construction equipment financing increased $17.77 million or 6.80% in 2012 compared to 2011. Construction equipment financing at December 31, 2012
had outstandings of $278.97 million, compared to outstandings of $261.20 million at December 31, 2011. The increase in this category was primarily due to
a gradual improvement in the construction industry and the need to replace older equipment.
Commercial loans secured by real estate, the majority of which is owner occupied, increased slightly during 2012 over 2011. Commercial loans secured by real
estate outstanding at December 31, 2012 were $554.97 million and $545.46 million at December 31, 2011.
Residential real estate loans were $438.64 million at December 31, 2012 and $423.61 million at December 31, 2011. Residential real estate loans increased
$15.04 million or 3.55% in 2012 from 2011. The increase in residential mortgage lending was primarily due to a higher volume of refinance activity as a result
of lower market interest rates and our decision to retain more loans in our portfolio.
20 • SRCE
2012 Form 10-K
Consumer loans increased $11.11 million or 11.32% in 2012 over 2011. Consumer loans outstanding at December 31, 2012, were $109.27 million and
$98.16 million at December 31, 2011. The increase during 2012 was due to higher demand in auto and personal loans as a result of lower interest rates.
The following table shows the maturities of loans and leases in the categories of commercial and agriculture, auto, light truck and environmental equipment,
medium and heavy duty truck, aircraft and construction equipment outstanding as of December 31, 2012.
(Dollars in thousands)
0-1 Year
1-5 Years
Over 5 Years
Total
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
$ 338,635
189,849
52,425
197,777
77,662
$ 250,694
$ 49,740
$ 639,069
247,378
116,697
397,635
184,310
920
2,880
101,067
17,002
438,147
172,002
696,479
278,974
Total
$ 856,348
$ 1,196,714
$ 171,609
$ 2,224,671
The amounts due after one year are also classified according to the sensitivity to changes in interest rates.
Rate Sensitivity (Dollars in thousands)
Fixed Rate
Variable Rate
Total
1 – 5 Years
Over 5 Years
Total
$684,682
33,763
$512,032
137,846
$1,196,714
171,609
$718,445
$649,878
$1,368,323
During 2012, approximately 70% of the Bank’s residential mortgage originations were sold into the secondary market. Mortgage loans held for sale were
$10.88 million at December 31, 2012 and were $12.64 million at December 31, 2011. Although 1st Source Bank is participating in the U.S. Treasury Making
Home Affordable programs, we do not feel it has a material effect on our financial condition or results of operations.
1st Source Bank sells residential mortgage loans to Fannie Mae and Freddie Mac, as well as FHA-insured and VA-guaranteed loans in Ginnie Mae mortgage-
backed securities. Additionally, we have sold loans on a service released basis to various other financial institutions in recent years. The agreements under
which we sell these mortgage loans contain various representations and warranties regarding the acceptability of loans for purchase. On occasion, we may be
asked to indemnify the loan purchaser for credit losses on loans that were later deemed ineligible for purchase or we may be asked to repurchase a loan. Both
circumstances are collectively referred to as “repurchases.” Within the industry, repurchase demands have increased during recent years. While we believe the
loans we have underwritten and sold to these entities have met or exceeded applicable transaction parameters, we must acknowledge the trend of mortgage
insurance rescissions and speculative repurchase requests.
Our liability for repurchases, included in accrued expenses and other liabilities on the Statements of Financial Condition, was $1.59 million and $1.14 million
as of December 31, 2012 and 2011, respectively. Our expense for repurchase losses, included in loan and lease collection and repossession expense on the
Statements of Income, was $2.05 million in 2012 compared to $1.47 million in 2011 and $1.09 million in 2010. The mortgage repurchase liability represents
our best estimate of the loss that we may incur. The estimate is based on specific loan repurchase requests and a historical loss ratio with respect to origination
dollar volume. Because the level of mortgage loan repurchase losses are dependent on economic factors, investor demand strategies and other external
conditions that may change over the life of the underlying loans, the level of liability for mortgage loan repurchase losses is difficult to estimate and requires
considerable management judgment.
CREDIT EXPERIENCE
Reserve for Loan and Lease Losses — Our reserve for loan and lease losses is provided for by direct charges to operations. Losses on loans and leases are
charged against the reserve and likewise, recoveries during the period for prior losses are credited to the reserve. Our management evaluates the reserve
quarterly, reviewing all loans and leases over a fixed-dollar amount ($100,000) where the internal credit quality grade is at or below a predetermined
classification, actual and anticipated loss experience, current economic events in specific industries, and other pertinent factors including general economic
conditions. Determination of the reserve is inherently subjective as it requires significant estimates, including the amounts and timing of expected future
cash flows or fair value of collateral on collateral-dependent impaired loans and leases, estimated losses on pools of homogeneous loans and leases based
on historical loss experience, and consideration of environmental factors, principally economic risk and concentration risk, all of which may be susceptible to
significant and unforeseen changes. We review the status of the loan and lease portfolio to identify borrowers that might develop financial problems in order to
aid borrowers in the handling of their accounts and to mitigate losses. See Part II, Item 8, Financial Statements and Supplementary Data — Note 1 of the Notes
to Consolidated Financial Statements for additional information on management’s evaluation of the reserve for loan and lease losses.
The reserve for loan and lease loss methodology has been consistently applied for several years, with enhancements instituted periodically. Reserve ratios are
reviewed quarterly and revised periodically to reflect recent loss history and to incorporate current risks and trends which may not be recognized in historical
data. As we update our historical charge-off analysis, we review the look-back periods for each business loan portfolio.
During 2012, the medium-term portion of the look-back period was four years given that 2009 through 2012 losses were considerably impacted by the severe
recession. Although the recession began in December 2007, its financial consequences were not recognized in the loan portfolios until 2009. We gave the
greatest weight to this recent four year period in our calculation, as we feel it is most consistent with our current expectations for 2013. Furthermore, we perform
a thorough analysis of charge-offs, non-performing asset levels, special attention outstandings and delinquency in order to review portfolio trends and other
factors, including specific industry risks and economic conditions, which may have an impact on the reserves and reserve ratios applied to various portfolios. We
adjust the calculated historical based ratio as a result of our analysis of environmental factors, principally economic risk and concentration risk. Key economic
factors affecting our portfolios are growth in gross domestic product, unemployment rates, housing market trends, commodity prices, inflation and global
economic and political issues, particularly the European debt crisis. Concentration risk is impacted primarily by geographic concentration in Northern Indiana and
Southwestern Lower Michigan in our business banking and commercial real estate portfolios and by collateral concentration in our specialty finance portfolios.
21 • SRCE
2012 Form 10-K
The European debt crisis continues to be a large shadow hanging over the global economy. Problems in Europe eroded confidence and deepened fears of
businesses and consumers in the U.S. and around the world. While we are unable to determine with any precision the impact of global economic and political
issues on 1st Source Bank’s loan portfolios, we feel the risks are real and significant. We believe there is a risk of negative consequences for our borrowers that
would affect their ability to repay their financial obligations. Therefore, we increased our loss ratios across all portfolios as of year-end 2011 and continued to
include this risk factor in our analysis throughout 2012.
Another area of concern continues to be our aircraft portfolio. Several aircraft borrowers who are experiencing financial difficulty have significant commercial
real estate exposure. The severe recession and the protracted recovery have had a negative effect on our borrowers and global economic concerns have
resulted in steeply declining aircraft values. As a result of current economic conditions and the depressed private jet market as evidenced by declines in new
jet deliveries and softening of used jet prices, we continue to experience relatively high loss ratios in this portfolio. We reduced the ratios slightly in 2012 as the
velocity of deterioration in collateral values has slowed, although we have not seen any significant sustained up-tick in values.
We experienced ongoing improvement in the medium and heavy duty truck portfolio during 2012. We recognized sizable losses during 2009 and the first half
of 2010; however, there were no charge-offs during the most recent thirty months. Current industry concerns are focused on new regulation for driver hours
of service, higher equipment costs, long-term rising fuel costs and ongoing concerns with driver turnover and driver shortages. Nevertheless, the underlying
industry fundamentals are improving. As a result, we reduced some of the risk factors in our calculated reserve ratio slightly again in 2012.
Our construction equipment portfolio is characterized by stable outstanding loan balances and improved credit quality in 2012. The construction industry, which
was hard hit during the recession, is positioned to benefit from an improved housing market and increased demand in the energy sector. Historically, 1st Source
Bank has experienced less volatility in this portfolio than the industry as losses have been mitigated by appropriate underwriting and the advantage of strong
collateral values due to the global market for used construction equipment. The underlying risk has not changed significantly for this portfolio; our reserve factors
are similar to last year.
The auto, light truck and environmental equipment portfolio has been a source of loan growth during this time of economic turmoil. Industry dynamics changed
favorably for auto rental operations with stable to increasing rental rates, strong used car prices and improved efficiencies in the business model with downsized fleets
and fewer repurchase vehicles. We sustained a significant loss on one auto rental account in 2012 as a result of fraudulent activity by the borrower. Recognizing the
higher potential for fraud related losses and our recent experience, we made an upward adjustment in the reserve ratio for the auto portfolio. As a result of realizing
a full recovery on our largest environmental equipment charge-off, we reduced slightly the reserve ratio for the environmental equipment portfolio.
There are several industries represented in the commercial and agricultural portfolio. The outlook for the business banking portfolio is somewhat mixed. While
recent economic news indicates improvement, the economy remains weak and small business owners remained concerned. With the struggling job market,
unemployment remains high nationally and is somewhat higher in our local region, which also bodes poorly for our consumer portfolios. The outlook for the
agriculture portfolio is strong, with high and increasing crop prices and land values. Agricultural input costs are higher, but the strong commodity prices are more
than offsetting the increased input costs. We have reviewed the calculated loss ratios and the environmental factors and concentration issues affecting these
portfolios and incorporated minor adjustments to the reserve ratios as deemed appropriate.
The reserve for loan and lease losses at December 31, 2012, totaled $83.31 million and was 2.50% of loans and leases, compared to $81.64 million or 2.64%
of loans and leases at December 31, 2011 and $86.87 million or 2.83% of loans and leases at December 31, 2010. It is our opinion that the reserve for loan
and lease losses was appropriate to absorb losses inherent in the loan and lease portfolio as of December 31, 2012.
Charge-offs for loan and lease losses were $7.64 million for 2012, compared to $12.59 million for 2011 and $24.11 million for 2010. Charge-offs decreased
in 2012 and 2011 due to a decrease in nonperforming loans and leases reflecting a slowly improving economy. In 2012, the large auto rental account loss
accounted for almost fifty percent of gross losses and in excess of ninety percent of net charge-offs. The provision for loan and lease losses was $5.75 million
for 2012, compared to the provision for loan and lease losses of $3.13 million for 2011 and the provision for loan and lease losses of $19.21 million for 2010.
The higher provision for loan and lease losses in 2010 was due to the deterioration in the loan portfolio mainly due to the deterioration in the economy which
led to a decline in underlying collateral values.
22 • SRCE
2012 Form 10-K
The following table summarizes our loan and lease loss experience for each of the last five years ended December 31:
(Dollars in thousands)
2012
2011
2010
2009
2008
Amounts of loans and leases outstanding
at end of period
$ 3,327,553
$ 3,090,543
$ 3,070,623
$ 3,093,150
$ 3,298,212
Average amount of net loans and leases outstanding
during period
$ 3,209,490
$ 3,078,581
$ 3,109,508
$ 3,154,820
$ 3,263,276
Balance of reserve for loan and lease losses
at beginning of period
$
81,644
$
86,874
$
88,236
$
79,776
$
66,602
Charge-offs:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer loans
Total charge-offs
Recoveries:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer loans
Total recoveries
Net charge-offs
Provision for loan and lease losses
Balance at end of period
Ratio of net charge-offs to average net
524
3,795
-
600
120
471
594
1,532
7,636
484
1,223
192
711
268
223
43
407
3,551
4,085
5,752
1,667
346
-
4,681
853
3,120
282
1,640
4,000
1,014
1,879
6,507
2,372
6,219
486
1,629
8,809
2,750
2,071
7,812
1,476
2,654
99
2,544
12,589
24,106
28,215
1,923
1,612
3,193
175
2
964
308
346
56
456
4,230
8,359
3,129
80
50
636
345
105
47
662
3,537
20,569
19,207
310
5
983
444
28
8
603
5,574
22,641
31,101
1,580
234
924
462
1,695
761
118
2,619
8,393
1,177
330
248
2,230
139
-
171
624
4,919
3,474
16,648
$
83,311
$
81,644
$
86,874
$
88,236
$
79,776
loans and leases outstanding
0.13 %
0.27 %
0.66 %
0.72 %
0.11 %
Ratio of reserve for loan and lease losses to net loans
and leases outstanding end of period
2.50 %
2.64 %
2.83 %
2.85 %
2.42 %
Coverage ratio of reserve for loan and lease losses to
nonperforming loans and leases
226.03 %
143.49 %
115.50 %
104.84 %
212.30 %
23 • SRCE
2012 Form 10-K
Net charge-offs (recoveries) as a percentage of average loans and leases by portfolio type follow:
Commercial and agricultural loans
0.01 %
(0.05)%
2012
2011
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer loans
0.56
(0.11)
(0.02)
(0.05)
0.05
0.13
1.08
0.04
-
0.61
0.20
0.49
0.06
1.24
2010
0.44 %
0.24
0.99
0.96
0.67
1.05
0.11
0.95
2009
0.95 %
0.73
0.93
1.09
0.30
0.45
0.03
1.63
2008
0.06 %
(0.03)
0.25
(0.30)
0.41
0.14
(0.02)
1.44
Total net charge-offs to average portfolio loans and leases
0.13 %
0.27 %
0.66 %
0.72 %
0.11 %
The reserve for loan and lease losses has been allocated according to the amount deemed necessary to provide for the estimated probable losses that have
been incurred within the categories of loans and leases set forth in the table below. The amount of such components of the reserve at December 31 and the
ratio of such loan and lease categories to total outstanding loan and lease balances, are as follows:
2012
2011
2010
2009
2008
Percent of
Loans and
Leases
in Each
Category
to Total
Loans and
Leases
Percent of
Loans and
Leases
in Each
Category
to Total
Loans and
Leases
Reserve
Amount
Percent of
Loans and
Leases
in Each
Category
to Total
Loans and
Leases
Reserve
Amount
Percent of
Loans and
Leases
in Each
Category
to Total
Loans and
Leases
Percent of
Loans and
Leases
in Each
Category
to Total
Loans and
Leases
Reserve
Amount
Reserve
Amount
19.21 % $13,091
17.65 % $20,544
17.27 % $24,017
17.66 % $22,694
19.51 %
(Dollars in thousands)
Reserve
Amount
Commercial and agricultural loans $12,326
Auto, light truck, and
environmental equipment
9,584
13.17
8,469
14.11
7,542
12.91
9,630
11.31
9,709
10.73
Medium and heavy duty truck
3,001
5.17
3,742
5.17
5,768
5.30
6,186
6.61
8,785
7.38
Aircraft financing
34,205
20.93
28,626
20.09
29,811
20.01
24,807
19.96
18,883
19.17
Construction equipment financing
5,390
8.38
6,295
8.45
8,439
9.30
8,875
10.13
10,516
11.40
Commercial real estate
13,778
16.68
16,772
17.65
11,177
19.37
10,453
18.76
4,939
17.41
Residential real estate
3,652
13.18
3,362
13.70
2,518
12.73
880
12.02
755
10.44
Consumer loans
1,375
3.28
1,287
3.18
1,075
3.11
3,388
3.55
3,495
3.96
Total
$83,311 100.00 % $81,644
100.00 % $86,874
100.00 % $88,236
100.00 % $79,776
100.00 %
Nonperforming Assets — Nonperforming assets include loans past due over 90 days, nonaccrual loans, other real estate, former bank premises held for
sale, repossessions and other nonperforming assets we own. Our policy is to discontinue the accrual of interest on loans and leases where principal or interest
is past due and remains unpaid for 90 days or more, or when an individual analysis of a borrower’s credit worthiness indicates a credit should be placed on
nonperforming status, except for residential mortgage loans, which are placed on nonaccrual at the time the loan is placed in foreclosure and consumer loans
that are both well secured and in the process of collection.
Nonperforming assets amounted to $42.27 million at December 31, 2012, compared to $72.48 million at December 31, 2011, and $88.71 million at
December 31, 2010. During 2012, interest income on nonaccrual loans and leases would have increased by approximately $3.58 million compared to $3.90
million in 2011 if these loans and leases had earned interest at their full contractual rate.
Nonperforming assets at December 31, 2012 decreased from December 31, 2011, mainly due to decreases in nonaccrual loans and leases and repossessed
aircraft. The decrease in nonaccrual loans and leases was spread among the various loan portfolios except for an increase in consumer and construction
equipment financing. The largest dollar decreases during the most recent year occurred in the aircraft and commercial real estate portfolios.
As of December 31, 2012, the industry with the largest dollar exposure was with borrowers whose primary source of income was derived from commercial real
estate. These impaired loans totaled approximately $15.70 million which were comprised of $12.89 million secured by commercial real estate and included
in commercial real estate loans, $1.52 million secured by aircraft and included in aircraft financing and $1.29 million secured by construction equipment
and included in construction equipment financing. We have limited exposure to commercial real estate. However, our borrowers with commercial real estate
exposure have suffered as a result of declining real estate values and minimal sales activity. Furthermore, aircraft values for some models have been declining
since 2010, increasing the risk in aircraft secured transactions.
24 • SRCE
2012 Form 10-K
Nonperforming assets at December 31 (Dollars in thousands)
2012
2011
2010
2009
2008
Loans past due over 90 days
Nonaccrual loans and leases
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer loans
$
442
$
460
$
361
$
628
$ 1,022
9,179
858
52
5,292
5,285
13,055
2,323
373
10,966
2,002
1,599
12,526
4,137
20,569
4,380
261
8,083
3,330
5,068
17,897
8,568
26,621
4,958
328
9,507
9,200
11,624
6,024
7,218
32,395
6,605
964
5,399
709
7,801
9,975
1,934
6,524
2,623
1,590
Total nonaccrual loans and leases
36,417
56,440
74,853
83,537
36,555
Total nonperforming loans and leases
36,859
56,900
75,214
84,165
37,577
Other real estate
Former bank premises held for sale
Repossessions:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Consumer loans
Total repossessions
Operating leases
4,311
1,034
7,621
1,134
6,392
1,200
33
222
-
24
475
170
6,490
4,795
-
47
201
5
-
52
-
-
-
11
63
-
4,039
2,490
164
336
-
9,391
238
36
1,381
3,356
53
226
1,248
16
67
59
6,792
5,670
10,165
1,669
29
236
154
185
Total nonperforming assets
$ 42,267
$ 72,476
$ 88,712
$ 101,013
$ 44,168
Nonperforming loans and leases to loans and leases,
net of unearned discount
1.11 %
1.84 %
2.45 %
2.72 %
1.14 %
Nonperforming assets to loans and leases and operating leases,
net of unearned discount
1.25 %
2.28 %
2.81 %
3.15 %
1.30 %
Potential Problem Loans — Potential problem loans consist of loans that are performing but for which management has concerns about the ability of a
borrower to continue to comply with repayment terms because of the borrower’s potential operating or financial difficulties. Management monitors these loans
closely and reviews their performance on a regular basis. As of December 31, 2012 and 2011, we had $11.41 million and $4.10 million, respectively, in loans
of this type which are not included in either of the non-accrual or 90 days past due loan categories. At December 31, 2012, potential problem loans consisted
of 5 credit relationships. Weakness in these companies’ operating performance has caused us to heighten attention given to these credits.
Foreign Outstandings — Our foreign loan and lease outstandings, all denominated in U.S. dollars were $271.41 million and $216.93 million as of December 31,
2012 and 2011, respectively. Foreign loans and leases are in aircraft financing. Loan and lease outstandings to borrowers in Brazil and Mexico were $169.42
million and $55.12 million as of December 31, 2012, respectively, compared to $149.21 million and $41.27 million as of December 31, 2011, respectively.
Outstanding balances to borrowers in other countries were insignificant.
25 • SRCE
2012 Form 10-K
INVESTMENT PORTFOLIO
The amortized cost of securities at year-end 2012 decreased slightly from 2011, following a 10.39% decrease from year-end 2010 to year-end 2011. The
amortized cost of securities at December 31, 2012 was $849.14 million or 18.66% of total assets, compared to $853.20 million or 19.51% of total assets at
December 31, 2011. The decrease in the investment portfolio in 2011 from 2010 was primarily related to a reduction in deposits as a funding source.
The amortized cost of securities available-for-sale as of December 31 is summarized as follows:
(Dollars in thousands)
U.S. Treasury and Federal agencies securities
U.S. States and political subdivisions securities
Mortgage-backed securities – Federal agencies
Corporate debt securities
Foreign government and other securities
Marketable equity securities
2012
$ 410,983
100,055
301,136
30,897
3,700
2,368
2011
$ 390,819
101,587
317,392
36,349
4,690
2,367
2010
$ 442,612
147,679
309,046
45,778
5,732
1,254
Total investment securities available-for-sale
$ 849,139
$ 853,204
$ 952,101
Yields on tax-exempt obligations are calculated on a fully tax equivalent basis assuming a 35% tax rate. The following table shows the maturities of securities
available-for-sale at December 31, 2012, at the amortized costs and weighted average yields of such securities:
(Dollars in thousands)
U.S. Treasury and Federal agencies securities
Under 1 year
1 – 5 years
5 – 10 years
Over 10 years
Total U.S. Treasury and Federal agencies securities
U.S. States and political subdivisions securities
Under 1 year
1 – 5 years
5 – 10 years
Over 10 years
Total U.S. States and political subdivisions securities
Corporate debt securities
Under 1 year
1 – 5 years
5 – 10 years
Over 10 years
Total Corporate debt securities
Foreign government and other securities
Under 1 year
1 – 5 years
5 – 10 years
Over 10 years
Total Foreign government and other securities
Mortgage-backed securities – Federal agencies
Marketable equity securities
Amount
Yield
$ 10,091
304,256
96,636
-
410,983
9,822
45,228
38,895
6,110
100,055
12,224
18,673
-
-
30,897
3,100
600
-
-
3,700
301,136
2,368
1.91 %
1.69
1.48
-
1.65
5.57
4.94
4.65
2.20
4.72
1.03
1.52
-
-
1.32
1.32
1.95
-
-
1.42
2.55
4.28
Total investment securities available-for-sale
$ 849,139
2.32 %
At December 31, 2012, the residential mortgage-backed securities we held consisted primarily of GNMA, FNMA and FHLMC pass-through certificates
(Government Sponsored Enterprise, GSEs). The type of loans underlying the securities were all conforming loans at the time of issuance. The underlying
GSE backing these mortgage-backed securities are rated Aaa or AA+ from the rating agencies. At December 31, 2012, the vintage of the underlying loans
comprising our securities are: 42% in the years 2011 and 2012; 41% in the years 2009 and 2010; 8% in the years 2007 and 2008; and 9% in years 2006
and prior.
26 • SRCE
2012 Form 10-K
DEPOSITS
The average daily amounts of deposits and rates paid on such deposits are summarized as follows:
2012
2011
2010
(Dollars in thousands)
Amount
Rate
Amount
Rate
Amount
Rate
Noninterest bearing demand deposits
$ 616,426
- %
$ 541,421
- %
$ 484,028
- %
Interest bearing demand deposits
Savings deposits
Other time deposits
Total deposits
1,151,617
656,245
1,149,923
$ 3,574,211
0.16
0.14
1.66
1,350,193
364,453
1,299,387
$ 3,555,454
0.22
0.11
2.11
1,377,549
321,030
1,422,588
$ 3,605,195
0.32
0.13
2.79
See Part II, Item 8, Financial Statements and Supplementary Data — Note 10 of the Notes to Consolidated Financial Statements for additional information on
deposits.
SHORT-TERM BORROWINGS
The following table shows the distribution of our short-term borrowings and the weighted average interest rates thereon at the end of each of the last three
years. Also provided are the maximum amount of borrowings and the average amount of borrowings, as well as weighted average interest rates for the last
three years.
(Dollars in thousands)
2012
Balance at December 31, 2012
Maximum amount outstanding at any month-end
Average amount outstanding
Federal Funds
Purchased and
Securities
Repurchase
Agreements
$ 158,680
189,150
121,495
Commercial
Paper
$ 3,469
10,114
6,739
Weighted average interest rate during the year
0.13 %
0.21 %
Weighted average interest rate for outstanding amounts at
Other
Short-Term
Borrowings
$ 7,039
11,531
9,703
- %
December 31, 2012
2011
Balance at December 31, 2011
Maximum amount outstanding at any month-end
Average amount outstanding
Weighted average interest rate during the year
Weighted average interest rate for outstanding amounts at
December 31, 2011
2010
Balance at December 31, 2010
Maximum amount outstanding at any month-end
Average amount outstanding
Weighted average interest rate during the year
Weighted average interest rate for outstanding amounts at
December 31, 2010
0.20 %
0.22 %
- %
$ 106,991
144,062
129,233
0.16 %
0.14 %
$ 136,028
169,831
137,368
0.27 %
0.20 %
$ 7,579
8,058
5,506
0.30 %
0.21 %
$ 3,598
8,533
6,866
0.43 %
0.28 %
$ 10,664
16,548
14,689
0.53 %
- %
$ 16,363
21,542
19,957
1.97 %
0.68 %
Total
Borrowings
$ 169,188
210,795
137,937
0.12 %
0.19 %
$ 125,234
168,668
149,428
0.20 %
0.13 %
$ 155,989
199,906
164,191
0.49 %
0.25 %
27 • SRCE
2012 Form 10-K
LIQUIDITY
Core Deposits — Our major source of investable funds is provided by stable core deposits consisting of all interest bearing and noninterest bearing deposits,
excluding brokered certificates of deposit and certain certificates of deposit over $250,000 in 2012 and $100,000 in 2011 and 2010 based on established
FDIC insured deposits. In 2012, average core deposits equaled 77.32% of average total assets, compared to 71.46% in 2011 and 70.53% in 2010. The
effective rate of core deposits in 2012 was 0.58%, compared to 0.72% in 2011 and 1.05% in 2010.
Average demand deposits (noninterest bearing core deposits) increased 13.85% in 2012 compared to an increase of 11.86% in 2011. These represented
17.82% of total core deposits in 2012, compared to 17.21% in 2011, and 15.10% in 2010.
Purchased Funds — We use purchased funds to supplement core deposits, which include certain certificates of deposit over $250,000, brokered certificates
of deposit, over-night borrowings, 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 2012, our reliance on purchased
funds decreased to 5.67% of average total assets from 12.70% in 2011.
Shareholders’ Equity — Average shareholders’ equity equated to 12.20% of average total assets in 2012 compared to 11.51% in 2011. Shareholders’ equity
was 12.28% of total assets at year-end 2012, compared to 11.98% at year-end 2011. We include unrealized gains (losses) on available-for-sale securities,
net of income taxes, in accumulated other comprehensive income (loss) which is a component of shareholders’ equity. While regulatory capital adequacy ratios
exclude unrealized gains (losses), it does impact our equity as reported in the audited financial statements. The unrealized gains (losses) on available-for-sale
securities, net of income taxes, were $19.54 million and $18.51 million at December 31, 2012 and 2011, respectively.
Other Liquidity — Under Indiana law, the Indiana Board of Depositories determines what financial institutions are required to pledge collateral on a quarterly
basis. We have been informed that no collateral is necessary for our Indiana public fund deposits. However, the Board of Depositories could alter this requirement
in the future. Our potential liquidity exposure if we must pledge collateral is approximately $569 million.
Liquidity Risk Management — The Bank’s liquidity is monitored and closely managed by the Asset/Liability Management Committee (ALCO), whose members
are comprised of the Bank’s senior management. Asset and liability management includes the management of interest rate sensitivity and the maintenance of
an adequate liquidity position. The purpose of interest rate sensitivity management is to stabilize net interest income during periods of changing interest rates.
Liquidity management is the process by which the Bank ensures that adequate liquid funds are available to meet financial commitments on a timely basis.
Financial institutions must maintain liquidity to meet day-to-day requirements of depositors and borrowers, take advantage of market opportunities and provide
a cushion against unforeseen needs.
Liquidity of the Bank is derived primarily from core deposits, principal payments received on loans, the sale and maturity of investment securities, net cash
provided by operating activities, and access to other funding sources. The most stable source of liability-funded liquidity is deposit growth and retention of the
core deposit base. The principal source of asset-funded liquidity is available-for-sale investment securities, cash and due from banks, overnight investments,
securities purchased under agreements to resell, and loans and interest bearing deposits with other banks maturing within one year. Additionally, liquidity is
provided by repurchase agreements, and the ability to borrow from the Federal Reserve Bank (FRB) and the Federal Home Loan Bank (FHLB).
The Bank’s liquidity strategy is guided by internal policies and the Interagency Policy Statement on Funding and Liquidity Risk Management. Internal guidelines
consist of:
(i) Available Liquidity (sum of short term borrowing capacity) greater than $500 million;
(ii)
Liquidity Ratio (total of net cash, short term investments and unpledged marketable assets divided by the sum of net deposits and short term liabilities)
greater than 15%;
(iii) Dependency Ratio (net potentially volatile liabilities minus short term investments divided by total earning assets minus short term investments) less
than 15%; and
(iv) Loans to Deposits Ratio less than 100%
At December 31, 2012, we were in compliance with the foregoing internal policies and regulatory guidelines.
The Bank also maintains a contingency funding plan that assesses the liquidity needs under various scenarios of market conditions, asset growth and credit
rating downgrades. The plan includes liquidity stress testing which measures various sources and uses of funds under the different scenarios. The contingency
plan provides for ongoing monitoring of unused borrowing capacity and available sources of contingent liquidity to prepare for unexpected liquidity needs and
to cover unanticipated events that could affect liquidity.
We have borrowing sources available to supplement deposits and meet our funding needs. 1st Source Bank has established relationships with several banks to
provide short term borrowings in the form of federal funds purchased. While at December 31, 2012 there was $58.50 million outstanding, we could borrow
approximately $176.50 million in additional funds for a short time from these banks on a collective basis. As of December 31, 2012, we had $56.71 million
outstanding in FHLB advances and could borrow an additional $138.98 million. We also had $338.34 million available to borrow from the FRB with no amounts
outstanding as of December 31, 2012.
Interest Rate Risk Management — ALCO monitors and manages the relationship of earning assets to interest bearing liabilities and the responsiveness of
asset yields, interest expense, and interest margins to changes in market interest rates. In the normal course of business, we face ongoing interest rate risks
and uncertainties. We occasionally utilize interest rate swaps to partially manage the primary market exposures associated with the interest rate risk related to
underlying assets, liabilities, and anticipated transactions.
28 • SRCE
2012 Form 10-K
A hypothetical change in net interest income was modeled by calculating an immediate 100 basis point (1.00%) change in interest rates across all maturities.
At December 31, 2012 and 2011, the aggregate hypothetical impact to pre-tax net interest income was as follows:
Aggregate Hypothetical Change in Net Interest Income
December 31, 2012
December 31, 2011
Change in Interest Rates (dollars in thousands)
Estimated
Net Interest Income
Dollar
Change
Percent
Change
Estimated
Net Interest Income
Dollar
Change
Percent
Change
+1.00%
Base
-1.00%
$152,241
$1,066
0.71 %
$151,003
$4,733
3.24 %
151,175
148,660
-
-
(2,515)
(1.66)
146,270
138,435
-
-
(7,835)
(5.36)
The earnings simulation model excludes the earnings dynamics related to how fee income and noninterest expense may be affected by changes 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.
At December 31, 2012 and 2011, the impact of these hypothetical fluctuations in interest rates on our derivative holdings was not significant, and, as such,
separate disclosure is not presented. We manage the interest rate risk related to mortgage loan commitments by entering into contracts for future delivery of
loans with outside parties. See Part II, Item 8, Financial Statements and Supplementary Data — Note 17 of the Notes to Consolidated Financial Statements.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
In the ordinary course of operations, we enter into certain contractual obligations. Such obligations include the funding of operations through debt issuances as
well as leases for premises and equipment. The following table summarizes our significant fixed, determinable, and estimated contractual obligations, by payment
date, at December 31, 2012, except for obligations associated with short-term borrowing arrangements. Payments for borrowings do not include interest.
Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.
Contractual obligation payments by period follows:
(Dollars in thousands)
Note
0 – 1 Year
1 – 3 Years
3 – 5 Years
Over 5
Years
Indeterminate
maturity
Total
Deposits without stated maturity
Certificates of deposit
Long-term debt
Subordinated notes
Operating leases
Purchase obligations
-
10
11
12
17
-
$ 2,556,122
$
-
$
-
$
-
$
511,848
522,153
15,646
-
3,188
25,305
6,377
-
4,937
2,451
27,473
31,704
6,751
4,544
-
58,764
4,249
575
7,122
-
-
-
$ 2,556,122
1,068,225
12,750
-
-
-
71,021
58,764
19,496
28,331
Total contractual obligations
$ 3,112,109
$ 535,918
$ 64,001
$ 77,181
$ 12,750
$ 3,801,959
We routinely enter into contracts for services. These contracts may require payment for services to be provided in the future and may also contain penalty
clauses for early termination of the contract. We have made a diligent effort to estimate such payments and penalties, where applicable. Additionally, where
necessary, we have made reasonable estimates as to certain purchase obligations as of December 31, 2012. Our management has used the best information
available to make the estimations necessary to value the related purchase obligations. Our management is not aware of any additional commitments or
contingent liabilities which may have a material adverse impact on our liquidity or capital resources at year-end 2012.
We also enter into derivative contracts under which we are required to either receive cash from, or pay cash to, counterparties depending on changes in interest
rates. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future
cash receipts or payments based on market interest rates as of the balance sheet date. The fair value of the contracts changes daily as market interest rates
change. Because the derivative assets and liabilities recorded on the balance sheet at December 31, 2012 do not necessarily represent the amounts that may
ultimately be paid under these contracts, these assets and liabilities are not included in the table of contractual obligations presented above.
In addition, due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at December 31, 2012, we are
unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $2.57 million of unrecognized
tax benefits have been excluded from the contractual obligations table above. See Note 16 of the Notes to Consolidated Financial Statements for a discussion
on income taxes.
Assets under management and assets under custody are held in fiduciary or custodial capacity for our clients. In accordance with U.S. generally accepted
accounting principles, these assets are not included on our balance sheet.
We are also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our clients. These financial
instruments include commitments to extend credit and standby letters of credit. Further discussion of these commitments is included in Part II, Item 8, Financial
Statements and Supplementary Data — Note 17 of the Notes to Consolidated Financial Statements.
29 • SRCE
2012 Form 10-K
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited consolidated selected quarterly statement of operations data for the years ended December 31, 2012 and 2011.
Three Months Ended (Dollars in thousands, except per share amounts)
March 31
June 30
September 30
December 31
2012
Interest income
Interest expense
Net interest income
Provision for loan and lease losses
Investment securities and other investment gains
Income before income taxes
Net income
Diluted net income per common share
2011
Interest income
Interest expense
Net interest income
Provision for (recovery of) loan and lease losses
Investment securities and other investment gains (losses)
Income before income taxes
Net income
Diluted net income per common share
$ 45,301
7,916
37,385
2,254
395
17,606
11,715
0.48
$ 47,210
10,350
36,860
2,198
130
15,139
10,608
0.43
$ 45,731
7,756
37,975
2,055
8
19,132
12,567
0.51
$ 47,873
10,289
37,584
67
1,142
22,998
14,865
0.61
$ 45,580
7,673
37,907
650
89
20,369
13,005
0.53
$ 46,586
9,960
36,626
1,260
414
18,448
11,540
0.47
$ 45,473
6,964
38,509
793
88
18,573
12,346
0.50
$ 45,854
8,524
37,330
(396)
(287)
17,204
11,182
0.45
Net income was $12.35 million for the fourth quarter of 2012, compared to the $11.18 million of net income reported for the fourth quarter of 2011. Diluted net
income per common share for the fourth quarter of 2012 amounted to $0.50, compared to $0.45 per common share reported in the fourth quarter of 2011.
The net interest margin was 3.64% for the fourth quarter of 2012 versus 3.66% for the same period in 2011. Tax-equivalent net interest income was $39.00
million for the fourth quarter of 2012, up 2.93% from 2011’s fourth quarter.
Our provision for loan and lease losses was $0.79 million in the fourth quarter of 2012 compared to recovery of provision for loan and lease losses of $(0.40)
million in the fourth quarter of 2011. Net charge-offs were $0.98 million for the fourth quarter 2012, compared to net charge-offs of $2.17 million a year ago.
Noninterest income for the fourth quarter of 2012 was $20.57 million, compared to $20.27 million for the fourth quarter of 2011. Noninterest expense for
the fourth quarter of 2012 was $39.72 million and was $40.79 million in the fourth quarter 2011.
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.
30 • SRCE
2012 Form 10-K
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of 1st Source Corporation
We have audited 1st Source Corporation (the “Company”) internal control over financial reporting as of December 31, 2012, based on criteria established in
Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). 1st Source
Corporation management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express
an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, 1st Source Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012 based
on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements
of financial condition of 1st Source Corporation as of December 31, 2012 and 2011, and the consolidated statements of income, comprehensive income,
shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2012 and our report dated February 22, 2013 expressed
an unqualified opinion thereon.
/s/ Ernst & Young LLP
Chicago, Illinois
February 22, 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of 1st Source Corporation and Subsidiaries
We have audited the accompanying consolidated statements of financial condition of 1st Source Corporation and subsidiaries (“the Company”) as of December 31,
2012 and 2011, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years
in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of 1st Source Corporation
and subsidiaries at December 31, 2012 and 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period
ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), 1st Source Corporation’s internal
control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2013 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Chicago, Illinois
February 22, 2013
31 • SRCE
2012 Form 10-K
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31 (Dollars in thousands)
ASSETS
Cash and due from banks
Federal funds sold and interest bearing deposits with other banks
Investment securities available-for-sale
(amortized cost of $849,139 and $853,204 at December 31, 2012, and December 31, 2011, respectively)
Other investments
Trading account securities
Mortgages held for sale
Loans and leases, net of unearned discount:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer loans
Total loans and leases
Reserve for loan and lease losses
Net loans and leases
Equipment owned under operating leases, net
Net premises and equipment
Goodwill and intangible assets
Accrued income and other assets
Total assets
LIABILITIES
Deposits:
Noninterest bearing
Interest bearing
Total deposits
Short-term borrowings:
Federal funds purchased and securities sold under agreements to repurchase
Other short-term borrowings
Total short-term borrowings
Long-term debt and mandatorily redeemable securities
Subordinated notes
Accrued expenses and other liabilities
Total liabilities
SHAREHOLDERS’ EQUITY
Preferred stock; no par value
2012
2011
$
83,232
$
61,406
702
52,921
880,764
22,609
146
10,879
639,069
438,147
172,002
696,479
278,974
554,968
438,641
109,273
883,000
18,974
132
12,644
545,570
435,965
159,796
620,782
261,204
545,457
423,606
98,163
3,327,553
3,090,543
(83,311)
(81,644)
3,244,242
3,008,899
52,173
45,016
87,502
123,428
69,551
39,857
87,675
139,012
$ 4,550,693
$ 4,374,071
$ 646,380
2,977,967
$ 580,101
2,940,040
3,624,347
3,520,141
158,680
10,508
169,188
71,021
58,764
68,718
106,991
18,243
125,234
37,156
89,692
77,930
3,992,038
3,850,153
Authorized 10,000,000 shares; none issued or outstanding
-
-
Common stock; no par value
Authorized 40,000,000 shares; issued 25,641,887 shares in 2012 and 25,643,506 shares in 2011
Retained earnings
Cost of common stock in treasury (1,399,261 shares in 2012 and 1,429,484 shares in 2011)
Accumulated other comprehensive income
Total shareholders’ equity
Total liabilities and shareholders’ equity
The accompanying notes are a part of the consolidated financial statements.
346,535
223,715
(31,134)
19,539
558,655
346,535
190,261
(31,389)
18,511
523,918
$ 4,550,693
$ 4,374,071
32 • SRCE
2012 Form 10-K
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31 (Dollars in thousands, except per share data)
2012
2011
2010
Interest income:
Loans and leases
Investment securities, taxable
Investment securities, tax-exempt
Other
Total interest income
Interest expense:
Deposits
Short-term borrowings
Subordinated notes
Long-term debt and mandatorily redeemable securities
Total interest expense
Net interest income
Provision for loan and lease losses
$ 161,376
16,426
3,340
943
$ 163,986
18,533
4,013
991
$ 173,526
20,466
5,573
1,061
182,085
187,523
200,626
21,877
30,762
44,605
169
6,484
1,779
300
6,589
1,472
800
6,589
1,135
30,309
39,123
53,129
151,776
148,400
5,752
3,129
147,497
19,207
Net interest income after provision for loan and lease losses
146,024
145,271
128,290
Noninterest income:
Trust fees
Service charges on deposit accounts
Mortgage banking income
Insurance commissions
Equipment rental income
Other income
Investment securities and other investment gains
Total noninterest income
Noninterest expense:
Salaries and employee benefits
Net occupancy expense
Furniture and equipment expense
Depreciation – leased equipment
Professional fees
Supplies and communications
FDIC and other insurance
Business development and marketing expense
Loan and lease collection and repossession expense
Other expense
Total noninterest expense
Income before income taxes
Income taxes
Net income
Preferred stock dividends and discount accretion
16,498
18,807
8,357
5,494
18,796
12,660
580
16,327
18,488
3,839
4,793
23,361
12,665
1,399
15,838
19,323
6,218
5,074
26,036
11,909
2,293
81,192
80,872
86,691
82,599
77,261
75,815
7,819
15,406
15,202
8,714
14,130
18,650
8,788
12,543
20,715
6,083
5,701
3,602
4,232
5,772
5,120
5,508
5,453
4,421
4,032
6,724
7,461
6,353
5,499
6,256
3,774
6,227
8,535
151,536
152,354
154,505
75,680
26,047
73,789
25,594
49,633
48,195
-
-
60,476
19,232
41,244
(11,589)
Net income available to common shareholders
$ 49,633
$ 48,195
$ 29,655
Basic net income per common share
Diluted net income per common share
$
$
2.02
2.02
$
$
1.96
1.96
$
$
1.21
1.21
The accompanying notes are a part of the consolidated financial statements.
33 • SRCE
2012 Form 10-K
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year Ended December 31 (Dollars in thousands, except per share data)
2012
2011
2010
Net income
Other comprehensive income, net of tax:
Change in unrealized appreciation of available-for-sale securities, net of tax
Reclassification adjustment for gains included in net income, net of tax
Other comprehensive income
Comprehensive income
The accompanying notes are a part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
$ 49,633
$ 48,195
$ 41,244
1,202
(174)
1,028
$ 50,661
8,857
(856)
8,001
$ 56,196
5,578
(162)
5,416
$ 46,660
(Dollars in thousands, except per share data)
Total
Preferred
Stock
Common
Stock
Retained
Earnings
Cost of
Common
Stock in
Treasury
Accumulated
Other
Comprehensive
Income (Loss), Net
Balance at January 1, 2010
$ 570,320
$ 104,930
$ 350,269
$ 142,407
$ (32,380)
$ 5,094
Net income
Other comprehensive income
Issuance of 187,554 common shares per
stock based compensation awards, including
related tax effects
Cost of 125,767 shares of common
stock acquired for treasury
41,244
5,416
2,873
(2,142)
-
-
-
-
Preferred stock discount accretion
-
6,070
Redemption of preferred stock
(111,000)
(111,000)
Preferred stock dividend (paid and/or accrued)
Stock based compensation
Common stock dividend ($0.61 per share)
(5,519)
13
(14,822)
Balance at December 31, 2010
$ 486,383
$
Net income
Other comprehensive income
Issuance of 154,921 common shares per
stock based compensation awards, including
related tax effects
Cost of 113,709 shares of common
stock acquired for treasury
Repurchase of common stock warrant
Stock based compensation
48,195
8,001
2,953
(2,241)
(3,750)
3
Common stock dividend ($0.64 per share)
(15,626)
Balance at December 31, 2011
$ 523,918
$
Net income
Other comprehensive income
49,633
1,028
Issuance of 184,220 common shares per
stock based compensation awards, including
related tax effects
Cost of 154,637 shares of common
stock acquired for treasury
Common stock dividend ($0.66 per share)
3,935
(3,701)
(16,158)
Balance at December 31, 2012
$ 558,655
$
The accompanying notes are a part of the consolidated financial statements.
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
13
-
41,244
-
-
-
-
5,416
635
2,238
-
(6,070)
-
(5,519)
-
(14,822)
(2,142)
-
-
-
-
-
-
-
-
-
-
-
-
$ 350,282
$ 157,875
$ (32,284)
$ 10,510
-
-
-
-
(3,750)
3
-
48,195
-
-
-
-
8,001
(183)
3,136
-
-
-
(15,626)
(2,241)
-
-
-
-
-
-
-
-
$ 346,535
$ 190,261
$ (31,389)
$ 18,511
-
-
-
-
-
49,633
-
-
-
-
1,028
(21)
3,956
-
(16,158)
(3,701)
-
-
-
-
$ 346,535
$ 223,715
$ (31,134)
$ 19,539
34 • SRCE
2012 Form 10-K
CONSOLIDATED STATEMENTS OF CASH FLOW
Year Ended December 31 (Dollars in thousands)
2012
2011
2010
Operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses
Depreciation of premises and equipment
Depreciation of equipment owned and leased to others
Amortization of investment security premiums and accretion of discounts, net
Amortization of mortgage servicing rights
Mortgage servicing asset (recoveries)/impairment
Deferred income taxes
Investment securities and other investment gains
Originations of loans held for sale, net of principal collected
Proceeds from the sales of loans held for sale
Net gain on sale of loans held for sale
Change in trading account securities
Change in interest receivable
Change in interest payable
Change in other assets
Change in other liabilities
Other
Net change in operating activities
Investing activities:
Proceeds from sales of investment securities
Proceeds from maturities of investment securities
Purchases of investment securities
Net change in other investments
Loans sold or participated to others
Net change in loans and leases
Net change in equipment owned under operating leases
Purchases of premises and equipment
Net change in investing activities
Financing activities:
Net change in demand deposits, NOW accounts and savings accounts
Net change in certificates of deposit
Net change in short-term borrowings
Proceeds from issuance of long-term debt
Payments on subordinated notes
Payments on long-term debt
Net proceeds from issuance of treasury stock
Acquisition of treasury stock
Redemption of preferred stock
Repurchase of common stock warrant
Cash dividends paid on preferred stock
Cash dividends paid on common stock
Net change in financing activities
Net change in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
Supplemental Information:
Non-cash transactions:
$ 49,633
$ 48,195
$ 41,244
5,752
4,241
15,202
4,214
2,921
(238)
(7,641)
(580)
(210,276)
219,269
(7,228)
(14)
928
(1,001)
15,571
1,254
1,186
3,129
3,733
18,650
2,260
2,907
238
3,634
(1,399)
(107,974)
130,400
(2,471)
6
592
(2,514)
15,950
6,274
2,798
19,207
4,132
20,715
1,576
3,277
(1)
(1,055)
(2,293)
(411,541)
412,019
(6,427)
(13)
1,969
(4,728)
22,100
8,387
2,700
93,193
124,408
111,268
61,001
295,241
(355,811)
(3,635)
28,919
(273,439)
2,176
(9,478)
133,241
353,170
(388,376)
2,369
20,254
(64,167)
(10,063)
(11,417)
83,089
431,137
(572,172)
3,605
19,311
(35,428)
(1,850)
(2,515)
(255,026)
35,011
(74,823)
223,037
(118,831)
43,954
36,169
(30,928)
(5,673)
3,935
(3,701)
-
-
-
(16,522)
39,919
(142,523)
(30,755)
11,427
-
(1,073)
2,953
(2,241)
-
(3,750)
-
(15,921)
126,079
(155,798)
5,879
16,163
-
(11,134)
2,873
(2,142)
(111,000)
-
(5,519)
(15,076)
131,440
(141,964)
(149,675)
(30,393)
17,455
(113,230)
114,327
96,872
210,102
$ 83,934
$ 114,327
$ 96,872
Loans transferred to other real estate and repossessed assets
Common stock matching contribution to Employee Stock Ownership and Profit Sharing Plan
$
3,425
2,643
$ 15,633
2,420
$ 18,075
2,545
Cash paid for:
Interest
Income taxes
The accompanying notes are a part of the consolidated financial statements.
$ 31,309
33,833
$ 41,637
19,867
$ 57,857
17,404
35 • SRCE
2012 Form 10-K
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 — Accounting Policies
1st Source Corporation is a bank holding company headquartered in South Bend, Indiana that provides, through its subsidiaries (collectively referred to as
“1st Source” or “the Company”), a broad array of financial products and services. 1st Source Bank (“Bank”), its banking subsidiary, offers commercial and
consumer banking services, trust and investment management services, and insurance to individual and business clients in Indiana and Michigan. The following
is a summary of significant accounting policies followed in the preparation of the consolidated financial statements.
Basis of Presentation — The financial statements consolidate 1st Source and its subsidiaries (principally the Bank). All significant intercompany balances and
transactions have been eliminated. For purposes of the parent company only financial information presented in Note 21, investments in subsidiaries are carried
at equity in the underlying net assets.
Use of Estimates in the Preparation of Financial Statements — Financial statements prepared in accordance with U.S. generally accepted accounting principles
require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from
those estimates.
Business Combinations — Business combinations are accounted for under the purchase method of accounting. Under the purchase method, assets and
liabilities of the business acquired are recorded at their estimated fair values as of the date of acquisition with any excess of the cost of the acquisition over the
fair value of the net tangible and intangible assets acquired recorded as goodwill. Results of operations of the acquired business are included in the income
statement from the date of acquisition.
Cash Flow — For purposes of the consolidated and parent company only statements of cash flows, the Company considers cash and due from banks, federal
funds sold and interest bearing deposits with other banks with original maturities of three months or less as cash and cash equivalents.
Securities — Securities that the Company has the ability and positive intent to hold to maturity are classified as investment securities held-to-maturity. Held-to-
maturity investment securities, when present, are carried at amortized cost. As of December 31, 2012 and 2011, the Company held no securities classified as
held-to-maturity. Securities that may be sold in response to, or in anticipation of, changes in interest rates and resulting prepayment risk, or for other factors, are
classified as available-for-sale and are carried at fair value. Unrealized gains and losses on these securities are reported, net of applicable taxes, as a separate
component of accumulated other comprehensive income (loss) in shareholders’ equity.
The initial indication of other-than-temporary impairment (OTTI) for both debt and equity securities is a decline in fair value below amortized cost. Quarterly,
any impaired securities are analyzed on a qualitative and quantitative basis in determining OTTI. Declines in the fair value of available-for-sale debt securities
below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses.
The amount of impairment related to other factors is recognized in other comprehensive income. In estimating OTTI impairment losses, the Company considers
among other things, (i) the length of time and the extent to which fair value has been less than cost, (ii) the financial condition and near-term prospects of the
issuer, and (iii) whether it is more likely than not that the Company will not have to sell any such securities before an anticipated recovery of cost.
Debt and equity securities that are purchased and held principally for the purpose of selling them in the near term are classified as trading account securities
and are carried at fair value with unrealized gains and losses reported in earnings. Realized gains and losses on the sales of all securities are reported in earnings
and computed using the specific identification cost basis.
Other investments consist of shares of Federal Home Loan Bank of Indianapolis (FHLBI) and Federal Reserve Bank stock. As restricted member stocks, these
investments are carried at cost. Both cash and stock dividends received on the stocks are reported as income. Quarterly, the Company reviews its investment
in FHLBI for impairment. Factors considered in determining impairment are: history of dividend payments; determination of cause for any net loss; adequacy of
capital; and review of the most recent financial statements. As of December 31, 2012 and 2011, it was determined that the Company’s investment in FHLBI
stock is appropriately valued at cost, which equates to par value. In addition, other investments include interest bearing deposits with other banks with original
maturities of greater than three months. These investments are in denominations, including accrued interest, that are fully insured by the FDIC.
Loans and Leases — Loans are stated at the principal amount outstanding, net of unamortized deferred loan origination fees and costs and net of unearned
income. Interest income is accrued as earned based on unpaid principal balances. Origination fees and direct loan and lease origination costs are deferred and
the net amount amortized to interest income over the estimated life of the related loan or lease. Loan commitment fees are deferred and amortized into other
income over the commitment period.
Direct financing leases are carried at the aggregate of lease payments plus estimated residual value of the leased property, net of unamortized deferred lease
origination fees and costs and unearned income. Interest income on direct financing leases is recognized over the term of the lease to achieve a constant
periodic rate of return on the outstanding investment.
The accrual of interest on loans and leases is discontinued when a loan or lease becomes contractually delinquent for 90 days, or when an individual analysis of
a borrower’s credit worthiness indicates a credit should be placed on nonperforming status, except for residential mortgage loans and consumer loans that are
well secured and in the process of collection. Residential mortgage loans are placed 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
and lease losses. However, in some cases, the Company may elect to continue the accrual of interest when the net realizable value of collateral is sufficient to
cover the principal and accrued interest. When a loan or lease is classified as nonaccrual and the future collectibility of the recorded loan or lease balance is
doubtful, collections on interest and principal are applied as a reduction to principal outstanding. Loans are returned to accrual status when all principal and
interest amounts contractually due are brought current and future payments are reasonably assured, which is typically evidenced by a sustained repayment
performance of at least six months.
A loan or lease is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Interest on impaired loans and leases, which are
not classified as nonaccrual, is recognized on the accrual basis. The Company evaluates loans and leases exceeding $100,000 for impairment and establishes
an allowance as a component of the reserve for loan and lease losses when it is probable all amounts due will not be collected pursuant to the contractual terms
of the loan or lease and the recorded investment in the loan or lease exceeds its fair value.
36 • SRCE
2012 Form 10-K
Loans and leases that have been modified and economic concessions have been granted to borrowers who have experienced financial difficulties are considered
a troubled debt restructuring (TDR). These concessions typically result from the Company’s loss mitigation activities and may include reductions in the interest
rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructuring and
typically are returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period of at least six months.
When the Company modifies loans and leases in a TDR, it evaluates any possible impairment similar to other impaired loans based on the present value of
expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or use the current fair value of the collateral,
less selling costs for collateral dependent loans. If the Company determines that the value of the modified loan is less than the recorded investment in the loan
(net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a
charge-off to the allowance. In periods subsequent to modification, the Company evaluates all TDRs, including those that have payment defaults, for possible
impairment and recognizes impairment through the allowance.
The Company sells mortgage loans to the Government National Mortgage Association (GNMA) in the normal course of business and retains the servicing rights.
The GNMA programs under which the loans are sold allow the Company to repurchase individual delinquent loans that meet certain criteria from the securitized
loan pool. At its option, and without GNMA’s prior authorization, the Company may repurchase a delinquent loan for an amount equal to 100% of the remaining
principal balance on the loan. Once the Company has the unconditional ability to repurchase a delinquent loan, the Company is deemed to have regained
effective control over the loan and the Company is required to recognize the loan on its balance sheet and record an offsetting liability, regardless of its intent to
repurchase the loan. At December 31, 2012 and 2011, residential real estate portfolio loans included $7.04 million and $10.66 million, respectively, of loans
available for repurchase under the GNMA optional repurchase programs with the offsetting liability recorded within other short-term borrowings.
Mortgage Banking Activities — Loans held for sale are composed of performing one-to-four family residential mortgage loans originated for resale. Mortgage
loans originated with the intent to sell are carried at fair value.
The Company recognizes the rights to service mortgage loans for others as separate assets, whether the servicing rights are acquired through a separate
purchase or through the sale of originated loans with servicing rights retained. The Company allocates a portion of the total proceeds of a mortgage loan to
servicing rights based on the fair value. These assets are amortized as reductions of mortgage servicing fee income over the estimated servicing period in
proportion to the estimated servicing income to be received. Gains and losses on the sale of mortgage servicing rights are recognized as noninterest income in
the period in which such rights are sold.
Mortgage servicing assets are evaluated for impairment at each reporting date. For purposes of impairment measurement, mortgage servicing assets are
stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. If temporary impairment exists within a tranche, a
valuation allowance is established through a charge to income equal to the amount by which the carrying value exceeds the fair value. If it is later determined all
or a portion of the temporary impairment no longer exists for a particular tranche, the valuation allowance is reduced through a recovery of income.
Mortgage servicing assets are also reviewed for other-than-temporary impairment. Other-than-temporary impairment exists when recoverability of a recorded
valuation allowance is determined to be remote considering historical and projected interest rates, prepayments, and loan pay-off activity. When this situation
occurs, the unrecoverable portion of the valuation allowance is applied as a direct write-down to the carrying value of the mortgage servicing asset. Unlike
a valuation allowance, a direct write-down permanently reduces the carrying value of the mortgage servicing asset and the valuation allowance, precluding
subsequent recoveries.
As part of mortgage banking operations, the Company enters into commitments to originate loans whereby the interest rate on these loans is determined prior
to funding (“rate lock commitments”). Similar to loans held for sale, the fair value of rate lock commitments is subject to change primarily due to changes in
interest rates. Under the Company’s risk management policy, these fair values are hedged primarily by selling forward contracts on agency securities. The rate
lock commitments on mortgage loans intended to be sold and the related hedging instruments are recorded at fair value with changes in fair value recorded in
current earnings.
Reserve for Loan and Lease Losses — The reserve for loan and lease losses is maintained at a level believed to be appropriate by the Company to absorb
probable losses inherent in the loan and lease portfolio. The determination of the reserve requires significant judgment reflecting the Company’s best estimate
of probable loan and lease losses related to specifically identified impaired loans and leases as well as probable losses in the remainder of the various loan and
lease portfolios. For purposes of determining the reserve, the Company has segmented loans and leases into classes based on the associated risk within these
segments. The Company has determined that eight classes exist within the loan and lease portfolio. The methodology for assessing the appropriateness of the
reserve consists of several key elements, which include: specific reserves for impaired loans, formula reserves for each business lending division portfolio including
percentage allocations for special attention loans and leases not deemed impaired, and reserves for pooled homogenous loans and leases. The Company’s
evaluation is based upon a continuing review of these portfolios, estimates of customer performance, collateral values and dispositions, and assessments of
economic and geopolitical events, all of which are subject to judgment and will change.
Specific reserves are established for certain business and specialty finance credits based on a regular analysis of special attention loans and leases. This analysis
is performed by the Credit Policy Committee, the Loan Review Department, Credit Administration, and the Loan Workout Departments. The specific reserves
are based on an analysis of underlying collateral values, cash flow considerations and, if applicable, guarantor capacity. Sources for determining collateral values
include appraisals, evaluations, auction values and industry guides. Generally, for loans secured by commercial real estate and dependent on cash flows from the
underlying collateral to service the debt, a new appraisal is obtained at the time the credit is deemed to be impaired. For non-income producing commercial real
estate, an appraisal or evaluation is ordered depending on an analysis of the underlying factors, including an assessment of the overall credit worthiness of the
borrower, the value of non-real estate collateral supporting the transaction and the date of the most recent existing appraisal or evaluation. An evaluation may
be performed in lieu of obtaining a new appraisal for less complex transactions secured by local market properties. Values based on evaluations are discounted
more heavily than those determined by appraisals when calculating loan impairment. Appraisals, evaluations and industry guides are used to determine aircraft
values. Appraisals, industry guides and auction values are used to determine construction equipment, truck and auto values.
The formula reserves determined for each business lending division portfolio are calculated quarterly by applying loss factors to outstanding loans and leases
based upon a review of historical loss experience and qualitative factors, which include but are not limited to, economic trends, current market risk assessment
by industry, recent loss experience in particular segments of the portfolios, movement in equipment values collateralizing specialized industry portfolios,
concentrations of credit, delinquencies, trends in volume, experience and depth of relationship managers and division management, and the effects of changes
in lending policies and practices, including changes in quality of the loan and lease origination, servicing and risk management processes. Special attention loans
and leases without specific reserves receive a higher percentage allocation ratio than credits not considered special attention.
37 • SRCE
2012 Form 10-K
Pooled loans and leases are smaller credits and are homogenous in nature, such as consumer credits and residential mortgages. Pooled loan and lease loss
reserves are based on historical net charge-offs, adjusted for delinquencies, the effects of lending practices and programs and current economic conditions,
and current trends in the geographic markets which the Company serves.
A comprehensive analysis of the reserve is performed on a quarterly basis by reviewing all loans and leases over a fixed dollar amount ($100,000) where
the internal credit quality grade is at or below a predetermined classification. Although the Company determines the amount of each element of the reserve
separately and relies on this process as an important credit management tool, the entire reserve is available for the entire loan and lease portfolio. The actual
amount of losses incurred can vary significantly from the estimated amounts both positively and negatively. The Company’s methodology includes several factors
intended to minimize the difference between estimated and actual losses. These factors allow the Company to adjust its estimate of losses based on the most
recent information available.
Impaired loans with impairment are reviewed quarterly to assess the probability of being able to collect the portion considered impaired. When a review and
analysis of the underlying credit and collateral indicates ultimate collection is improbable, the impairment is charged-off and deducted from the reserve.
Additional loans and leases, which are deemed uncollectible or have a low likelihood of collection, are charged off and deducted from the reserve, while
recoveries of amounts previously charged off are credited to the reserve. A (recovery of) provision for loan and lease losses is credited or charged to operations
based on the Company’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.
Equipment Owned Under Operating Leases — The Company finances various types of construction equipment, medium and heavy duty trucks, automobiles
and other equipment under leases classified as operating leases. Revenue consists of the contractual lease payments and is recognized on a straight-line basis
over the lease term. Generally, lease terms range from three to seven years. Leased assets are being depreciated on a straight-line method over the lease term
to the estimate of the equipment’s fair market value at lease termination, also referred to as “residual” value. For automobile leases, fair value was based upon
published industry market guides. For other equipment leases, fair value may be based upon observable market prices, third-party valuations, or prices received
on sales of similar assets at the end of the lease term. These residual values are reviewed periodically to ensure the recorded amount does not exceed the fair
market value at the lease termination.
Other Real Estate — Other real estate acquired through partial or total satisfaction of nonperforming loans is included in other assets and recorded at the lower
of cost or fair value less anticipated selling costs based upon the property’s appraised value at the date of transfer, with any difference between the fair value of
the property less cost to sell, and the carrying value of the loan charged to the reserve for loan losses. Other real estate also includes bank premises qualifying
as held for sale. Bank premises are transferred at the lower of carrying value or estimated fair value less anticipated selling costs. Subsequent fair value write-
downs, property maintenance costs, and gains or losses recognized upon the sale of other real estate are recognized in Noninterest Expense on the Statements
of Income. Gains or losses resulting from the sale of other real estate are recognized on the date of sale. As of December 31, 2012 and 2011, other real estate
had carrying values of $5.35 million and $8.76 million, respectively, and is included in Other Assets in the Statements of Financial Condition.
Repossessed Assets — Repossessed assets may include fixtures and equipment, inventory and receivables, aircraft, construction equipment, and vehicles
acquired from business banking activities and specialty finance activities. Repossessed assets are included in other assets at the lower of cost or fair value of the
equipment or vehicle less estimated selling costs. At the time of repossession, the recorded amount of the loan or lease is written down, if necessary, to the fair
value of the equipment or vehicle by a charge to the reserve for loan and lease losses. Subsequent fair value write-downs, equipment maintenance costs, and
gains or losses recognized upon the sale of repossessions are recognized in Noninterest Expense on the Statements of Income. Gains or losses resulting from
the sale of repossessed assets are recognized on the date of sale. Repossessed assets totaled $0.06 million and $6.79 million, as of December 31, 2012 and
2011, respectively, and are included in Other Assets in the Statements of Financial Condition.
Premises and Equipment — Premises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation is
computed by the straight-line method, primarily with useful lives ranging from three to 31.5 years. Maintenance and repairs are charged to expense as incurred,
while improvements, which extend the useful life, are capitalized and depreciated over the estimated remaining life.
Goodwill and Intangibles — Goodwill represents the excess of the cost of businesses acquired over the fair value of the net assets acquired. Other intangible
assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or
because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. Goodwill is reviewed for
impairment at least annually or on an interim basis if an event occurs or circumstances change that would more likely than not reduce the carrying amount.
Goodwill is allocated into two reporting units. Fair value for each reporting unit is estimated using stock price multiples or revenue multiples. Intangible assets
that have finite lives are amortized over their estimated useful lives and are subject to impairment testing. All of the Company’s other intangible assets have finite
lives and are amortized on a straight-line basis over varying periods not exceeding eleven years. The Company performed the required annual impairment test
of goodwill during the fourth quarter of 2012 and determined that no impairment exists.
Partnership Investment — The Company accounts for its investments in partnerships for which it owns three percent or more of the partnership on the equity
method. The partnerships which the Company has investments in account for their investments at fair value. As a result, the Company’s investments in these
partnerships reflect the underlying fair value of the partnerships’ investments. The Company accounts for its investments in partnerships of which it owns less
than three percent at the lower of cost or fair value. Investments in partnerships are included in Other Assets in the Statements of Financial Condition. The
balances as of December 31, 2012 and 2011 were $3.21 million and $2.80 million, respectively.
Short-Term Borrowings — Short-term borrowings consist of Federal funds purchased, securities sold under agreements to repurchase, commercial paper,
Federal Home Loan Bank notes, and borrowings from non-affiliated banks. Federal funds purchased, securities sold under agreements to repurchase, and
other short-term borrowings mature within one to 365 days of the transaction date. Commercial paper matures within seven to 270 days. Other short-term
borrowings in the Statements of Financial Condition include the Company’s liability related to mortgage loans available for repurchase under GNMA optional
repurchase programs.
Securities purchased under agreements to resell and securities sold under agreements to repurchase are treated as collateralized financing transactions and
are recorded at the amounts at which the securities were acquired or sold plus accrued interest. The fair value of collateral either received from or provided to
a third party is continually monitored and additional collateral obtained or requested to be returned to the Company as deemed appropriate.
Trust Fees — Trust fees are recognized on the accrual basis.
38 • SRCE
2012 Form 10-K
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
consolidated financial statements, rather than amounts reported on the income tax return. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period
that includes the enactment date. A valuation allowance, if needed, reduces deferred tax assets to the expected amount most likely to be realized. Realization of
deferred tax assets is dependent upon the generation of a sufficient level of future taxable income and recoverable taxes paid in prior years. Although realization
is not assured, the Company believes it is more likely than not that all of the deferred tax assets will be realized.
Positions taken in the tax returns may be subject to challenge by the taxing authorities upon examination. Uncertain tax positions are initially recognized in the
financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and
subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming
full knowledge of the position and all relevant facts. The Company provides for interest and, in some cases, penalties on tax positions that may be challenged
by the taxing authorities. Interest expense is recognized beginning in the first period that such interest would begin accruing. Penalties are recognized in the
period that the Company claims the position in the tax return. Interest and penalties on income tax uncertainties are classified within income tax expense in the
Statements of Income.
Net Income Per Common Share — Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-
average number of shares of common stock outstanding. Diluted earnings per common share is computed by dividing net income available to common
shareholders by the weighted-average number of shares of common stock outstanding, plus the dilutive effect of outstanding stock options, stock warrants and
nonvested stock-based compensation awards.
Stock-Based Employee Compensation — The Company recognizes stock-based compensation as compensation cost in the Statements of Income based on
their fair values on the measurement date, which, for its purposes, is the date of grant. The Company accounts for stock-based compensation using the modified
prospective transition method.
Segment Information — 1st Source has one principal business segment, commercial banking. While our chief decision makers monitor the revenue streams of
various products and services, the identifiable segments’ operations are managed and financial performance is evaluated on a company-wide basis. Accordingly,
all of the Company’s financial service operations are considered to be aggregated in one reportable operating segment.
Derivative Financial Instruments — The Company 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. All derivative instruments are recorded on the Statements of Financial Condition,
as either an asset or liability, at their fair value. The accounting for the gain or loss resulting from the change in fair value depends on the intended use of the
derivative. For a derivative used to hedge changes in fair value of a recognized asset or liability, or an unrecognized firm commitment, the gain or loss on the
derivative will be recognized in earnings together with the offsetting loss or gain on the hedged item. This results in an earnings impact only to the extent that
the hedge is ineffective in achieving offsetting changes in fair value. If it is determined that the derivative instrument is not highly effective as a hedge, hedge
accounting is discontinued and the adjustment to fair value of the derivative instrument is recorded in earnings. For a derivative used to hedge changes in cash
flows associated with forecasted transactions, the gain or loss on the effective portion of the derivative will be deferred, and reported as accumulated other
comprehensive income, a component of shareholders’ equity, until such time the hedged transaction affects earnings. For derivative instruments not accounted
for as hedges, changes in fair value are recognized in noninterest income/expense. Deferred gains and losses from derivatives that are terminated and were in a
cash flow hedge are amortized over the shorter of the original remaining term of the derivative or the remaining life of the underlying asset or liability.
Fair Value Measurements — The Company records certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Securities available for sale, trading securities,
mortgage loans held for sale, and derivative instruments are carried at fair value on a recurring basis. Fair value measurements are also utilized to determine
the initial value of certain assets and liabilities, to perform impairment assessments, and for disclosure purposes. The Company uses quoted market prices and
observable inputs to the maximum extent possible when measuring fair value. In the absence of quoted market prices, various valuation techniques are utilized
to measure fair value. When possible, observable market data for identical or similar financial instruments are used in the valuation. When market data is not
available, fair value is determined using valuation models that incorporate management’s estimates of the assumptions a market participant would use in pricing
the asset or liability.
Fair value measurements are classified within one of three levels based on the observability of the inputs used to determine fair value, as follows:
Level 1 — The valuation is based on quoted prices in active markets for identical instruments.
Level 2 — The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar
instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3 — The valuation is based on unobservable inputs that are supported by minimal or no market activity and that are significant to the fair value of
the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques that incorporate
management’s own estimates of assumptions that market participants would use in pricing the instrument, or valuations that require significant management
judgment or estimation.
Reclassifications — Certain amounts in the prior period consolidated financial statements have been reclassified to conform with the current year presentation.
These reclassifications had no effect on total assets, shareholders’ equity or net income as previously reported.
Note 2 — Recent Accounting Pronouncements
Offsetting Assets and Liabilities: In December 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-11
“Balance Sheet (Topic 210) - Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 requires an entity to disclose both gross information and net
information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an
agreement similar to a master netting arrangement. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013, and interim
39 • SRCE
2012 Form 10-K
periods within those annual periods. Retrospective disclosure is required for all comparative periods presented. The Company is assessing the impact of ASU
2011-11 on its disclosures.
Goodwill: In September 2011, the FASB issued ASU No. 2011-08 “Intangibles – Goodwill and Other (Topic 350) - Testing Goodwill for Impairment.”
ASU 2011-08 allows an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate
the fair value of the reporting unit. ASU 2011-08 was effective for annual and interim goodwill impairment tests performed for fiscal years beginning after
December 15, 2011. Early adoption was permitted. The Company did not adopt ASU 2011-08.
Comprehensive Income: In June 2011, the FASB issued ASU No. 2011-05 “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.”
ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or
in two separate but consecutive statements. In both cases, an entity is required to present each component of net income along with total net income, each
component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. In December
2011, FASB issued ASU No. 2011-12 which defers the effective date of the requirement in ASU 2011-05 to present items that are reclassified from
accumulated other comprehensive income to net income alongside their respective components of net income and other comprehensive income. ASU 2011-05
was effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2011. The effect of applying this standard is
reflected in the Consolidated Statements of Comprehensive Income and Consolidated Statements of Shareholders’ Equity.
Fair Value Measurements: In May 2011, the FASB issued ASU No. 2011-04 “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair
Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 changed the wording used to describe many of the requirements
in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. Consequently, the amendments in this update result in
common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs (International Financial Reporting Standards). ASU 2011-04 was
effective prospectively during interim and annual periods beginning on or after December 15, 2011. Early application by public entities was not permitted. The
effect of applying this standard is reflected in Note 20 - Fair Value Measurements.
Transfers and Servicing: In April 2011, the FASB issued ASU No. 2011-03 “Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for
Repurchase Agreement.” ASU 2011-03 removed from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or
redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. ASU 2011-03 was effective for the first interim or
annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions
that occur on or after the effective date. Early adoption was not permitted. ASU 2011-03 did not have an impact on the Company’s financial condition, results
of operations, or disclosures.
Note 3 — Investment Securities
Investment securities available-for-sale were as follows:
(Dollars in thousands)
December 31, 2012
U.S. Treasury and Federal agencies securities
U.S. States and political subdivisions securities
Mortgage-backed securities - Federal agencies
Corporate debt securities
Foreign government and other securities
Total debt securities
Marketable equity securities
Amortized
Cost
Gross
Unrealized Gains
Gross
Unrealized Losses
Fair Value
$ 410,983
100,055
301,136
30,897
3,700
846,771
2,368
$ 11,353
5,864
11,296
445
26
28,984
3,329
$
(83)
(482)
(25)
(94)
-
(684)
(4)
$ 422,253
105,437
312,407
31,248
3,726
875,071
5,693
Total investment securities available-for-sale
$ 849,139
$ 32,313
$
(688)
$ 880,764
December 31, 2011
U.S. Treasury and Federal agencies securities
U.S. States and political subdivisions securities
Mortgage-backed securities - Federal agencies
Corporate debt securities
Foreign government and other securities
Total debt securities
Marketable equity securities
$ 390,819
101,587
317,392
36,349
4,690
850,837
2,367
$ 10,356
6,433
11,565
325
24
28,703
2,673
$
(50)
(660)
(9)
(364)
(1)
$ 401,125
107,360
328,948
36,310
4,713
(1,084)
878,456
(496)
4,544
Total investment securities available-for-sale
$ 853,204
$ 31,376
$ (1,580)
$ 883,000
At December 31, 2012, the residential mortgage-backed securities held by the Company consisted primarily of GNMA, FNMA and FHLMC pass-through
certificates which are guaranteed by those respective agencies of the United States government (Government Sponsored Enterprise, GSEs).
40 • SRCE
2012 Form 10-K
The contractual maturities of investments in securities available-for-sale at December 31, 2012, 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.
(Dollars in thousands)
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage-backed securities
Total debt securities available-for-sale
Amortized
Cost
$ 111,582
343,408
90,336
309
301,136
$ 846,771
Fair Value
$ 111,603
356,027
94,725
309
312,407
$ 875,071
The following table shows the gross realized gains and losses on sale of securities from the securities available-for-sale portfolio, including marketable equity
securities.
(Dollars in thousands)
Gross realized gains
Gross realized losses
Net realized gains
2012
$ 282
-
$ 282
2011
$ 1,662
(284)
$ 1,378
2010
$ 297
(36)
$ 261
The following table summarizes gross unrealized losses and fair value by investment category and age. There were no other-than-temporary-impairment (OTTI)
write-downs in 2012 or 2011.
(Dollars in thousands)
December 31, 2012
Less than 12 Months
12 months or Longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
U.S. Treasury and Federal agencies securities
$ 37,316
$
(83)
$
-
$
-
$ 37,316
$
(83)
U.S. States and political subdivisions securities
Mortgage-backed securities - Federal agencies
Corporate debt securities
Foreign government and other securities
7,730
6,264
-
100
(46)
(24)
-
-
Total debt securities
Marketable equity securities
51,410
(153)
7,855
-
-
5
3,364
(436)
60
4,431
-
(1)
(94)
-
(531)
(4)
11,094
6,324
4,431
100
59,265
5
(482)
(25)
(94)
-
(684)
(4)
Total temporarily impaired available-for-sale securities
$ 51,410
$ (153)
$ 7,860
$ (535)
$ 59,270
$
(688)
December 31, 2011
U.S. Treasury and Federal agencies securities
$ 42,536
$
(50)
$
-
$
-
$ 42,536
$
(50)
U.S. States and political subdivisions securities
Mortgage-backed securities - Federal agencies
Corporate debt securities
Foreign government and other securities
Total debt securities
Marketable equity securities
423
5,071
4,858
1,011
53,899
622
(9)
(1)
(142)
(1)
(203)
(492)
5,149
13,099
8,579
-
26,827
4
(651)
(8)
(222)
-
(881)
(4)
5,572
18,170
13,437
1,011
(660)
(9)
(364)
(1)
80,726
(1,084)
626
(496)
Total temporarily impaired available-for-sale securities
$ 54,521
$ (695)
$ 26,831
$ (885)
$ 81,352
$ (1,580)
At December 31, 2012, the Company does not have the intent to sell any of the available-for-sale securities in the table above and believes that it is more
likely than not that it will not have to sell any such securities before an anticipated recovery of cost. The unrealized losses on debt securities are due to market
volatility and market illiquidity on auction rate securities which are reflected in U.S. States and Political subdivisions. The fair value is expected to recover on all
debt securities as they approach their maturity date or repricing date or if market yields for such investments decline. The Company does not believe any of the
securities are impaired due to reasons of credit quality.
At December 31, 2012 and 2011, investment securities with carrying values of $216.34 million and $250.36 million, respectively, were pledged as collateral
to secure government deposits, security repurchase agreements, and for other purposes.
41 • SRCE
2012 Form 10-K
Note 4 — Loan and Lease Financings
Total loans and leases outstanding were recorded net of unearned income and deferred loan fees and costs at December 31, 2012 and 2011, and totaled $3.33
billion and $3.09 billion, respectively. At December 31, 2012 and 2011, net deferred loan and lease costs were $3.68 million and $3.51 million, respectively.
The loan and lease portfolio includes direct financing leases, which are included in auto, light truck and environmental equipment, medium and heavy duty truck,
aircraft financing, and construction equipment financing on the consolidated Statements of Financial Condition.
A summary of the gross investment in lease financing and the components of the investment in lease financing at December 31, 2012 and 2011, follows:
(Dollars in thousands)
Direct finance leases:
Rentals receivable
Estimated residual value of leased assets
Gross investment in lease financing
Unearned income
Net investment in lease financing
2012
2011
$ 256,851
13,131
269,982
(43,209)
$ 226,773
$ 216,322
23,115
239,437
(35,118)
$ 204,319
At December 31, 2012, the minimum future lease payments receivable for each of the years 2013 through 2017 were $48.26 million, $42.83 million, $37.45
million, $30.73 million, and $26.27 million, respectively.
In the ordinary course of business, the Company has extended loans to certain directors, executive officers, and principal shareholders of equity securities of
1st Source and to their affiliates. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with persons not related to the Company and did not involve more than the normal risk of collectability,
or present other unfavorable features. The loans are consistent with sound banking practices and within applicable regulatory and lending limitations. The
aggregate dollar amounts of these loans were $14.94 million and $14.21 million at December 31, 2012 and 2011, respectively. During 2012, $1.58 million
of new loans and other additions were made and repayments and other reductions totaled $0.85 million.
The Company evaluates loans and leases for credit quality at least annually but more frequently if certain circumstances occur (such as material new information
which becomes available and indicates a potential change in credit risk). The Company uses two methods to assess credit risk: loan or lease credit quality
grades and credit risk classifications. The purpose of the loan or lease credit quality grade is to document the degree of risk associated with individual credits
as well as inform management of the degree of risk in the portfolio taken as a whole. Credit risk classifications are used to categorize loans by degree of risk
and to designate individual or committee approval authorities for higher risk credits at the time of origination. Credit risk classifications include categories for:
Acceptable, Marginal, Special Attention, Special Risk, Restricted by Policy, Regulated and Prohibited by Law.
All loans and leases, except residential real estate loans and consumer loans, are assigned credit quality grades on a scale from 1 to 12 with grade 1 representing
superior credit quality. The criteria used to assign grades to extensions of credit that exhibit potential problems or well-defined weaknesses are primarily
based upon the degree of risk and the likelihood of orderly repayment, and their effect on our safety and soundness. Loans or leases graded 7 or weaker are
considered “special attention” credits and, as such, relationships in excess of $100,000 are reviewed quarterly as part of management’s evaluation of the
appropriateness of the reserve for loan and lease losses. Grade 7 credits are defined as “watch” and contain greater than average credit risk and are monitored
to limit our exposure to increased risk; grade 8 credits are “special mention” and, following regulatory guidelines, are defined as having potential weaknesses that
deserve management’s close attention. Credits that exhibit well-defined weaknesses and a distinct possibility of loss are considered “classified” and are graded
9 through 12 corresponding to the regulatory definitions of “substandard” (grades 9 and 10) and the more severe “doubtful” (grade 11) and “loss” (grade 12).
The table below presents the credit quality grades of the recorded investment in loans and leases, segregated by class, as of December 31.
(Dollars in thousands)
December 31, 2012
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Total
December 31, 2011
Commercial and agricultural loans
Auto, light truck, and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Total
42 • SRCE
Credit Quality Grades
1-6
7-12
Total
$ 612,567
$ 26,502
$ 639,069
428,582
170,116
648,316
262,980
507,219
9,565
1,886
48,163
15,994
47,749
438,147
172,002
696,479
278,974
554,968
$ 2,629,780
$ 149,859
$ 2,779,639
$ 513,011
$ 32,559
$ 545,570
432,288
154,261
580,004
239,643
487,576
3,677
5,535
40,778
21,561
57,881
435,965
159,796
620,782
261,204
545,457
$ 2,406,783
$ 161,991
$ 2,568,774
2012 Form 10-K
For residential real estate and consumer loans, credit quality is based on the aging status of the loan and by payment activity. The table below presents the
recorded investment in residential real estate and consumer loans by performing or nonperforming status as of December 31. Nonperforming loans are those
loans which are on nonaccrual status or are 90 days or more past due.
(Dollars in thousands)
December 31, 2012
Residential real estate
Consumer
Total
December 31, 2011
Residential real estate
Consumer
Total
Performing
Nonperforming
Total
$ 435,962
108,814
$ 544,776
$ 418,810
97,857
$ 516,667
$ 2,679
459
$ 3,138
$ 4,796
306
$ 5,102
$ 438,641
109,273
$ 547,914
$ 423,606
98,163
$ 521,769
The table below presents the recorded investment of loans and leases, segregated by class, with delinquency aging and nonaccrual status as of December 31.
(Dollars in thousands)
Current
December 31, 2012
30-59
Days
Past Due
60-89
Days
Past Due
90 Days or
More Past Due
and Accruing
Total
Accruing
Loans
Nonaccrual
Total Financing
Receivables
Commercial and agricultural loans
$ 629,035
$ 807
$
48
$
Auto, light truck and
environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total
December 31, 2011
Auto, light truck and
environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total
437,087
171,950
691,187
272,817
541,811
202
-
-
598
102
434,434
1,019
107,630
816
-
-
-
274
-
509
368
356
86
$ 629,890
$ 9,179
$ 639,069
437,289
171,950
858
52
691,187
5,292
273,689
5,285
541,913
13,055
436,318
2,323
108,900
373
438,147
172,002
696,479
278,974
554,968
438,641
109,273
$ 3,285,951
$ 3,544
$ 1,199
$ 442
$ 3,291,136
$ 36,417
$ 3,327,553
433,048
158,192
608,032
256,691
674
5
224
376
522,883
2,005
415,177
2,894
96,824
762
241
-
-
-
-
739
271
416
45
$ 534,604
$ 10,966
$ 545,570
433,963
158,197
2,002
1,599
608,256
12,526
257,067
4,137
524,888
20,569
419,226
97,902
4,380
261
435,965
159,796
620,782
261,204
545,457
423,606
98,163
$ 3,024,900
$ 7,490
$ 1,252
$ 461
$ 3,034,103
$ 56,440
$ 3,090,543
-
-
-
-
-
-
-
-
-
-
-
-
Commercial and agricultural loans
$ 534,053
$ 550
$
1
$
Interest income for the years ended December 31, 2012, 2011, and 2010, would have increased by approximately $3.58 million, $3.90 million, and $5.81
million, respectively, if the nonaccrual loans and leases had earned interest at their full contract rate.
43 • SRCE
2012 Form 10-K
The table below presents impaired loans and leases, segregated by class, and the corresponding reserve for impaired loan and lease losses as of December 31.
(Dollars in thousands)
December 31, 2012
With no related allowance recorded:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total with no related allowance recorded
With an allowance recorded:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total with an allowance recorded
Total impaired loans
December 31, 2011
With no related allowance recorded:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Recorded
Investment
Unpaid Principal
Balance
Related
Allowance
$ 2,572
$ 2,572
$
474
-
3,115
5,109
474
-
3,115
5,107
19,597
19,597
101
-
101
-
30,968
30,966
6,075
6,074
-
-
2,086
-
1,588
-
-
-
-
2,086
-
1,588
-
-
-
-
-
-
-
-
-
-
-
729
-
-
852
-
42
-
-
9,749
9,748
$ 40,717
$ 40,714
1,623
$ 1,623
$ 2,002
$ 2,002
$
770
959
11,206
3,949
17,088
-
211
770
959
11,206
3,949
17,091
-
210
-
-
-
-
-
-
-
-
-
Total with no related allowance recorded
36,185
36,187
With an allowance recorded:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total with an allowance recorded
Total impaired loans
8,406
113
645
1,118
-
6,029
-
-
8,406
113
645
1,118
-
6,029
-
-
1,461
35
165
534
-
294
-
-
16,311
$ 52,496
16,311
$ 52,498
2,489
$ 2,489
44 • SRCE
2012 Form 10-K
Average recorded investment and interest income recognized on impaired loans and leases, segregated by class, is shown in the table below for years ending
December 31, 2012, 2011 and 2010.
2012
2011
2010
(Dollars in thousands)
Average
Recorded
Investment
Interest
Income
Commercial and agricultural loans
$ 9,322
$ 16
Auto, light truck and environmental equipment
2,113
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer loans
Total
696
7,976
4,409
22,126
87
-
7
2
-
6
441
6
-
Average
Recorded
Investment
$ 11,256
1,581
3,786
14,971
5,634
27,172
-
88
Interest
Income
$ 340
2
5
16
36
186
-
5
Average
Recorded
Investment
Interest
Income
$ 16,058
$ 563
3,346
8,514
11,941
10,591
29,791
-
-
4
7
85
222
170
-
-
$ 46,729
$ 478
$ 64,488
$ 590
$ 80,241
$ 1,051
The number of loans and leases classified as troubled debt restructuring (TDR) during 2012 and 2011, segregated by class, is shown in the table below as well as
the recorded investment as of December 31. The classification between nonperforming and performing is shown at the time of modification. During 2012 and
2011, modification programs focused on extending maturity dates or modifying payment patterns with most TDRs experiencing a combination of concessions.
The modifications did not result in the contractual forgiveness of principal or interest, or interest rate reductions below market rates. Consequently, the financial
impact of the modifications was immaterial.
(Dollars in thousands)
Performing TDRs:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total performing TDR modifications
Nonperforming TDRs:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total nonperforming TDR modifications
Total TDR modifications
2012
2011
Number of
Modifications
Recorded
Investment
Number of
Modifications
Recorded
Investment
1
-
-
-
-
1
1
-
3
-
-
-
-
3
1
-
-
4
7
$ 127
-
-
-
-
7,014
101
-
7,242
-
-
-
-
1,316
1,141
-
-
2,457
$ 9,699
9
-
-
1
1
5
-
2
$ 831
-
-
-
218
421
-
211
18
1,681
3
-
-
-
4
6
-
-
13
31
155
-
-
-
886
944
-
-
1,985
$ 3,666
45 • SRCE
2012 Form 10-K
The number of troubled debt restructured loans and leases which had payment defaults within twelve months following modification during the years ended
December 31, 2012 and 2011, segregated by class, are shown in the table below as well as the recorded investment as of December 31. The classification
between nonperforming and performing is shown at the time of modification. Default occurs when a loan or lease is 90 days or more past due under the
modified terms or transferred to nonaccrual.
(Dollars in thousands)
Performing TDRs:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total performing TDR defaults
Nonperforming TDRs:
Commercial and agricultural loans
Auto, light truck and environmental equipment
Medium and heavy duty truck
Aircraft financing
Construction equipment financing
Commercial real estate
Residential real estate
Consumer
Total nonperforming TDR defaults
Total TDR defaults
2012
2011
Number of
Defaults
Recorded
Investment
Number of
Defaults
Recorded
Investment
-
-
-
-
-
-
-
-
-
3
-
-
-
1
2
-
-
6
6
$
-
-
-
-
-
-
-
-
-
113
-
-
-
-
171
-
-
284
$ 284
4
-
-
2
-
2
-
-
8
-
-
-
-
-
-
-
-
-
8
$6,625
-
-
519
-
84
-
-
7,228
-
-
-
-
-
-
-
-
-
$7,228
The table below presents the recorded investment of loans and leases classified as troubled debt restructurings as of December 31.
Year Ended December 31 (Dollars in thousands)
Performing TDRs
Nonperforming TDRs
Total TDRs
2012
2011
$ 8,839
12,869
$ 3,294
12,125
$ 21,708
$ 15,419
46 • SRCE
2012 Form 10-K
Note 5 — Reserve for Loan and Lease Losses
Changes in the reserve for loan and lease losses, segregated by class, for each of the three years ended December 31 are shown below.
(Dollars in thousands)
December 31, 2012
Reserve for loan and lease losses
Balance, beginning of year
Charge-offs
Recoveries
Net charge-offs (recoveries)
Provision (recovery of provision)
Commercial and
agricultural loans
Auto, light truck
and environmental
equipment
Medium and
heavy duty
truck
Aircraft
financing
Construction
equipment
financing
Commercial
real estate
Residential
real estate
Consumer
loans
Total
$ 13,091
524
484
40
(725)
$ 8,469
3,795
1,223
$ 3,742
-
192
$ 28,626 $ 6,295
120
268
600
711
$ 16,772
471
223
2,572
3,687
(192)
(933)
(111)
5,468
(148)
(1,053)
248
(2,746)
$ 3,362 $ 1,287 $
594
43
551
841
1,532
407
1,125
1,213
81,644
7,636
3,551
4,085
5,752
Balance, end of year
$ 12,326
$ 9,584
$ 3,001
$ 34,205 $ 5,390
$ 13,778
$ 3,652 $ 1,375 $
83,311
Ending balance, individually
evaluated for impairment
Ending balance, collectively
evaluated for impairment
$
729
$
-
$
-
$
852 $
-
$
42
$
- $
- $
1,623
11,597
9,584
3,001
33,353
5,390
13,736
3,652
1,375
81,688
Total reserve for loan and lease losses $ 12,326
$ 9,584
$ 3,001
$ 34,205 $ 5,390
$ 13,778
$ 3,652 $ 1,375 $
83,311
Recorded investment in loans
Ending balance, individually
evaluated for impairment
Ending balance, collectively
evaluated for impairment
$ 8,647
$
474
$
-
$ 5,201 $ 5,109
$ 21,185
$
101 $
- $
40,717
630,422
437,673
172,002
691,278
273,865
533,783
438,540
109,273
3,286,836
Total recorded investment in loans
$ 639,069
$ 438,147
$ 172,002
$ 696,479 $ 278,974
$ 554,968
$ 438,641 $ 109,273 $ 3,327,553
December 31, 2011
Reserve for loan and lease losses
Balance, beginning of year
Charge-offs
Recoveries
Net charge-offs (recoveries)
Provision (recovery of provision)
$ 20,544
1,667
1,923
(256)
(7,709)
$
7,542
346
175
171
1,098
$
5,768
-
2
(2)
(2,028)
$ 29,811 $
4,681
964
3,717
2,532
8,439
853
308
545
(1,599)
$ 11,177
3,120
346
$
2,518 $
282
56
1,075 $
1,640
456
2,774
8,369
226
1,070
1,184
1,396
86,874
12,589
4,230
8,359
3,129
Balance, end of year
$ 13,091
$
8,469
$
3,742
$ 28,626 $
6,295
$ 16,772
$
3,362 $
1,287 $
81,644
Ending balance, individually
evaluated for impairment
Ending balance, collectively
evaluated for impairment
$
1,461
$
35
$
165
$
534 $
-
$
294
$
- $
- $
2,489
11,630
8,434
3,577
28,092
6,295
16,478
3,362
1,287
79,155
Total reserve for loan and lease losses
$ 13,091
$
8,469
$
3,742
$ 28,626 $
6,295
$ 16,772
$
3,362 $
1,287 $
81,644
Recorded investment in loans
Ending balance, individually
evaluated for impairment
Ending balance, collectively
evaluated for impairment
Total recorded investment in loans
December 31, 2010
Reserve for loan and lease losses
Balance, beginning of year
Charge-offs
Recoveries
Net charge-offs (recoveries)
Provision (recovery of provision)
$ 10,408
$
883
$
1,604
$ 12,324 $
3,949
$ 23,117
$
- $
211 $
52,496
535,162
$ 545,570
$ 24,017
4,000
1,612
2,388
(1,085)
435,082
158,192
608,458
257,255
522,340
423,606
97,952
3,038,047
$ 435,965
$ 159,796
$ 620,782 $ 261,204
$ 545,457
$ 423,606 $ 98,163 $ 3,090,543
$
9,630
1,014
80
934
(1,154)
$
6,186
1,879
50
1,829
1,411
$ 24,807 $
6,507
636
5,871
10,875
8,875
2,372
345
2,027
1,591
$
$ 10,453
6,219
105
880 $
486
47
3,388 $
1,629
662
6,114
6,838
439
2,077
967
(1,346)
88,236
24,106
3,537
20,569
19,207
Balance, end of year
$ 20,544
$
7,542
$
5,768
$ 29,811 $
8,439
$ 11,177
$
2,518 $
1,075 $
86,874
Ending balance, individually
evaluated for impairment
Ending balance, collectively
evaluated for impairment
$
4,190
$
377
$
1,049
$
2,050 $
648
$
893
$
- $
- $
9,207
16,354
7,165
4,719
27,761
7,791
10,284
2,518
1,075
77,667
Total reserve for loan and lease losses
$ 20,544
$
7,542
$
5,768
$ 29,811 $
8,439
$ 11,177
$
2,518 $
1,075 $
86,874
Recorded investment in loans
Ending balance, individually
evaluated for impairment
Ending balance, collectively
evaluated for impairment
Total recorded investment in loans
47 • SRCE
$ 13,212
$
2,732
$
5,095
$ 18,422 $
8,908
$ 29,696
$
- $
- $
78,065
517,016
$ 530,228
393,768
157,729
595,935
276,726
565,033
390,951
95,400
2,992,558
$ 396,500
$ 162,824
$ 614,357 $ 285,634
$ 594,729
$ 390,951 $ 95,400 $ 3,070,623
2012 Form 10-K
Note 6 — Operating Leases
The Company finances various types of construction equipment, medium and heavy duty trucks, automobiles, and miscellaneous production equipment under
leases classified as operating leases. The equipment underlying the operating leases is reported at cost, net of accumulated depreciation, in the Statements of
Financial Condition. These operating lease arrangements require the lessee to make a fixed monthly rental payment over a specified lease term, typically from
three to seven years. Rental income is earned on the operating lease assets and reported as noninterest income. These operating lease assets are depreciated
over the term of the lease to the estimated fair value of the asset at the end of the lease. The depreciation of these operating lease assets is reported as a
component of noninterest expense. At the end of the lease, the operating lease asset is either purchased by the lessee or returned to the Company.
Operating lease equipment at December 31, 2012 and 2011 was $52.17 million and $69.55 million, respectively, net of accumulated depreciation of $33.51
million and $47.88 million, respectively. Depreciable lives for operating lease equipment generally range from three to seven years.
The minimum future lease rental payments due from clients on operating lease equipment at December 31, 2012, totaled $32.90 million, of which $12.89
million is due in 2013, $9.29 million in 2014, $5.81 million in 2015, $3.55 million in 2016, $1.25 million in 2017, and $0.11 million thereafter. Depreciation
expense related to operating lease equipment for the years ended December 31, 2012, 2011 and 2010 was $15.20 million, $18.65 million and $20.72
million, respectively.
Note 7 — Premises and Equipment
Premises and equipment as of December 31 consisted of the following:
(Dollars in thousands)
Land
Buildings and improvements
Furniture and equipment
Total premises and equipment
Accumulated depreciation and amortization
Net premises and equipment
2012
$ 13,944
44,601
36,667
95,212
(50,196)
$ 45,016
2011
$ 10,869
42,330
36,574
89,773
(49,916)
$ 39,857
On December 28, 2010, the Company entered into an agreement with the City of South Bend for the sale of the South Bend headquarters building parking
garage for $1.95 million. Although the City of South Bend took possession of the parking garage on that date, the proceeds were placed in an escrow account.
Under the terms of the agreement, receipt of the proceeds from the escrow was contingent upon the Company investing $5.40 million into its properties within
the City of South Bend by December 31, 2013. As of December 31, 2011, the parking garage asset was classified as held for sale and included in Accrued
Income and Other Assets on the Statements of Financial Condition. In the third quarter 2012, the proceeds for the parking garage were received from escrow
and a gain on sale of $1.61 million (or $1.00 million net of tax) was recognized in Other Expense on the Statements of Income.
Depreciation and amortization of properties and equipment totaled $4.24 million in 2012, $3.73 million in 2011, and $4.13 million in 2010.
Note 8 — Mortgage Servicing Assets
The unpaid principal balance of residential mortgage loans serviced for third parties was $921.20 million at December 31, 2012, compared to $995.09 million
at December 31, 2011, and $1.08 billion at December 31, 2010.
Amortization expense on mortgage servicing rights is expected to total $1.00 million, $0.84 million, $0.65 million, $0.50 million, and $0.39 million in 2013,
2014, 2015, 2016, and 2017, respectively. Projected amortization excludes the impact of future asset additions or disposals.
Changes in the carrying value of mortgage servicing assets and the associated valuation allowance follow:
(Dollars in thousands)
Mortgage servicing assets:
Balance at beginning of year
Additions
Amortization
Sales
Carrying value before valuation allowance at end of year
Valuation allowance:
Balance at beginning of year
Impairment (charges) recoveries
Balance at end of year
Net carrying value of mortgage servicing assets at end of year
Fair value of mortgage servicing assets at end of year
2012
2011
$ 5,610
1,956
(2,921)
-
4,645
(238)
238
$
-
$ 4,645
$ 5,760
$ 7,556
961
(2,907)
-
5,610
-
(238)
$
(238)
$ 5,372
$ 6,725
48 • SRCE
2012 Form 10-K
During 2012 and 2011, the Company determined that it was not necessary to permanently write-down any previously established valuation allowance. At
December 31, 2012, the fair value of mortgage servicing assets exceeded the carrying value reported in the consolidated Statements of Financial Condition by
$1.12 million. This difference represents increases in the fair value of certain mortgage servicing assets that could not be recorded above cost basis.
Funds held in trust at 1st Source for the payment of principal, interest, taxes and insurance premiums applicable to mortgage loans being serviced for others,
were approximately $23.54 million and $24.84 million at December 31, 2012 and December 31, 2011, respectively. Mortgage loan contractual servicing
fees, including late fees and ancillary income, were $3.63 million, $4.08 million, and $4.04 million for 2012, 2011, and 2010, respectively. Mortgage loan
contractual servicing fees are included in Mortgage Banking Income on the consolidated Statements of Income.
Note 9 — Intangible Assets and Goodwill
At December 31, 2012, intangible assets consisted of goodwill of $83.68 million and other intangible assets of $3.82 million, which is net of accumulated
amortization of $6.00 million. At December 31, 2011, intangible assets consisted of goodwill of $83.33 million and other intangible assets of $4.35 million,
which is net of accumulated amortization of $6.13 million. Intangible asset amortization was $1.32 million, $1.30 million, and $1.32 million for 2012, 2011, and
2010, respectively. Amortization on other intangible assets is expected to total $1.16 million, $0.97 million, $0.69 million, $0.57 million, and $0.36 million in
2013, 2014, 2015, 2016, and 2017, respectively.
A summary of core deposit intangible and other intangible assets as of December 31 follows:
(Dollars in thousands)
Core deposit intangibles:
Gross carrying amount
Less: accumulated amortization
Net carrying amount
Other intangibles:
Gross carrying amount
Less: accumulated amortization
Net carrying amount
Note 10 — Deposits
2012
2011
$ 9,566
(5,821)
$ 3,745
$ 254
(177)
$
77
$ 10,224
(5,985)
$ 4,239
$
254
(146 )
$
108
The amount of certificates of deposit of $100,000 or more and other time deposits of $100,000 or more outstanding at December 31, 2012, by time
remaining until maturity is as follows:
(Dollars in thousands)
Under 3 months
4 – 6 months
7 – 12 months
Over 12 months
Total
Scheduled maturities of time deposits, including both private and public funds, at December 31, 2012 were as follows:
(Dollars in thousands)
2013
2014
2015
2016
2017
Thereafter
Total
$ 61,765
31,760
96,960
218,732
$ 409,217
$ 511,848
397,895
124,258
16,329
11,144
6,751
$ 1,068,225
49 • SRCE
2012 Form 10-K
Note 11 — Borrowed Funds and Mandatorily Redeemable Securities
Details of long-term debt and mandatorily redeemable securities as of December 31, 2012 and 2011 are as follows:
(Dollars in thousands)
Federal Home Loan Bank borrowings (0.78% – 6.54%)
Mandatorily redeemable securities
Other long-term debt
Total long-term debt and mandatorily redeemable securities
2012
$ 56,711
12,750
1,560
$ 71,021
2011
$ 25,897
10,213
1,046
$ 37,156
Annual maturities of long-term debt outstanding at December 31, 2012, for the next five years and thereafter beginning in 2013, are as follows (in thousands):
$15,646; $5,686; $691; $5,844; $25,860; and $17,294.
At December 31, 2012, the Federal Home Loan Bank borrowings represented a source of funding for certain residential mortgage activities and consisted of
17 fixed rate notes with maturities ranging from 2013 to 2023. These notes were collateralized by $71.46 million of certain real estate loans.
Short-term borrowings include Federal funds purchased, security repurchase agreements, commercial paper and other short-term borrowings. Federal funds
purchased were $58.50 million as of December 31, 2012. There were no Federal funds purchased outstanding as of December 31, 2011. Securities sold
under agreement to repurchase were $100.18 million and $106.99 million as of December 31, 2012 and 2011. Commercial paper was $3.47 million and
$7.58 million as of December 31, 2012 and 2011. Other short-term borrowings were $7.04 million and $10.66 million as of December 31, 2012 and 2011.
Weighted average interest rates on short term borrowings as of December 31, 2012 and 2011 were 0.20% and 0.14% for Federal funds purchased and
security repurchase agreements, 0.22% and 0.21% for commercial paper and 0.00% and 0.00% for other short-term borrowings, respectively.
Mandatorily redeemable securities as of December 31, 2012 and 2011, of $12.75 million and $10.21 million, respectively reflected the “book value” shares
under the 1st Source Executive Incentive Plan. See Note 15 - Employee Stock Benefit Plans for additional information. Dividends paid on these shares and
changes in book value per share are recorded as other interest expense. Total interest expense recorded for 2012, 2011, and 2010 was $1.11 million, $1.04
million, and $0.55 million, respectively.
Note 12 — Subordinated Notes
The Company sponsors one trust, 1st Source Master Trust (Capital Trust) of which 100% of the common equity is owned by the Company. The Capital Trust
was formed in 2007 for the purpose of issuing corporation-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors
and investing the proceeds from the sale of the capital securities solely in junior subordinated debenture securities of the Company (the subordinated notes).
The subordinated notes held by the Capital Trust are the sole assets of the Capital Trust. The Capital Trust qualifies as a variable interest entity for which the
Company is not the primary beneficiary and therefore reported in the financial statements as an unconsolidated subsidiary. The junior subordinated debentures
are reflected as subordinated notes in the Statements of Financial Condition with the corresponding interest distributions reflected as interest expense in the
Statements of Income. The common shares issued by the Capital Trust are included in other assets in the Statements of Financial Condition.
Distributions on the capital securities issued by the Capital Trust are payable quarterly at a rate per annum equal to the interest rate being earned by the Capital
Trust on the subordinated notes held by the Capital Trust. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the
subordinated notes. The Company has entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the
terms of each of the guarantees. The capital securities held by the Capital Trust qualify as Tier 1 capital under Federal Reserve Board guidelines.
On December 17, 2012, the capital securities of 1st Source Capital Trust IV, the September 2004 issuance, were redeemed in whole for $30.93 million.
The subordinated notes are summarized as follows, at December 31, 2012:
(Dollars in thousands)
June 2007 issuance-fixed rate
August 2007 issuance-fixed rate
Total
Note 13 — Earnings Per Share
Amount of
Subordinated Notes
$ 41,238
17,526
$ 58,764
Interest
Rate
7.22 %
7.10 %
Maturity
Date
06/15/37
09/15/37
Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to
common shareholders by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating
securities. Participating securities include non-vested restricted stock awards. Non-vested restricted stock awards are considered participating securities to
the extent the holders of these securities receive non-forfeitable dividends at the same rate as holders of common stock. Diluted earnings per common share
is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock
compensation using the treasury stock method.
Stock options and warrants, where the exercise price was greater than the average market price of the common shares, were excluded from the computation
of diluted earnings per common share because the result would have been antidilutive. No stock options were considered antidilutive as of December 31, 2012
and 2011. Stock options of 33,000 were considered antidilutive as of December 31, 2010. A stock warrant for 837,947 shares was considered antidilutive as
of December 31, 2010. No warrants were outstanding as of December 31, 2012 and 2011.
50 • SRCE
2012 Form 10-K
The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share for the three years
ending December 31.
(Dollars in thousands - except per share amounts)
2012
2011
2010
Distributed earnings allocated to common stock
Undistributed earnings allocated to common stock
Net earnings allocated to common stock
Net earnings allocated to participating securities
$
16,027
$
15,524
$
14,771
32,923
48,950
683
32,025
47,549
646
14,594
29,365
290
Net income allocated to common stock and participating securities
$
49,633
$
48,195
$
29,655
Weighted average shares outstanding for basic earnings per common share
24,267,471
24,237,924
24,232,092
Dilutive effect of stock compensation
9,857
9,532
7,102
Weighted average shares outstanding for diluted earnings per common share
24,277,328
24,247,456
24,239,194
Basic earnings per common share
Diluted earnings per common share
Note 14 — Employee Benefit Plans
$
$
2.02
2.02
$
$
1.96
1.96
$
$
1.21
1.21
The 1st Source Corporation Employee Stock Ownership and Profit Sharing Plan (as amended, the “Plan”) includes an employee stock ownership component,
which is designed to invest in and hold 1st Source common stock, and a 401(k) plan component, which holds all Plan assets not invested in 1st Source common
stock. The Plan encourages diversification of investments with opportunities to change investment elections and contribution levels.
Employees are eligible to participate in the Plan the first of the month following 90 days of employment. The Company matches dollar for dollar on the first 4% of
deferred compensation, plus 50 cents on the dollar of the next 2% deferrals. The Company will also contribute to the Plan an amount designated as a fixed 2%
employer contribution. The amount of fixed contribution is equal to two percent of the participant’s eligible compensation. Additionally, each year the Company
may, in its sole discretion, make a discretionary profit sharing contribution. As of December 31, 2012 and 2011, there were 1,472,043 and 1,510,309 shares,
respectively, of 1st Source Corporation common stock held in relation to employee benefit plans.
The Company contributions are allocated among the participants on the basis of compensation. Each participant’s account is credited with cash and/or shares
of 1st Source common stock based on that participant’s compensation earned during the year. After completing five years of service in which they worked at
least 1,000 hours per year, a participant will be completely vested in their employer’s contribution. An employee is always 100% vested in their deferral. Plan
participants are entitled to receive distributions from their Plan accounts upon termination of service, retirement, or death.
Contribution expense for the years ended December 31, 2012, 2011, and 2010, amounted to $4.52 million, $4.30 million, and $4.01 million, respectively.
In addition to the 1st Source Corporation Employee Stock Ownership and Profit Sharing Plan, the Company provides a limited health care and life insurance
benefit for some of its retired employees. Effective March 31, 2009, the Company amended the plan so that no new retirees would be covered by the plan.
The amendment will have no effect on the coverage for retirees covered at the time of the amendment. Prior to amendment, all full-time employees became
eligible for these retiree benefits upon reaching age 55 with 20 years of credited service. The retiree medical plan pays a stated percentage of eligible medical
expenses reduced by any deductibles and payments made by government programs and other group coverage. The lifetime maximum benefit payable under
the medical plan is $15,000 and for life insurance is $3,000.
The Company’s net periodic post retirement benefit cost (recovery) recognized in the consolidated Statements of Income for the year ended December 31,
2012 was insignificant and for the years ended December 31, 2011, and 2010 amounted to $(0.03) million, and $(0.02) million, respectively. The accrued
post retirement benefit cost was not material at December 31, 2012, 2011, and 2010.
Note 15 — Employee Stock Benefit Plans
As of December 31, 2012, the Company had five active stock-based employee compensation plans. These plans include one stock option plan, namely,
the 2001 Stock Option Plan; three executive stock award plans, namely, the Executive Incentive Plan (EIP), the Restricted Stock Award Plan, and the 1998
Performance Compensation Plan; and the Employee Stock Purchase Plan. The 2011 Stock Option Plan was approved by the shareholders on April 21, 2011
but the Company had not made any grants through December 31, 2012. These stock-based employee compensation plans were established to help retain
and motivate key employees. All of the plans have been approved by the shareholders of 1st Source Corporation. The Executive Compensation and Human
Resources Committee (the “Committee”) of the 1st Source Corporation Board of Directors has sole authority to select the employees, establish the awards to
be issued, and approve the terms and conditions of each award under the stock-based compensation plans.
Stock-based compensation to employees is recognized as compensation cost in the Statements of Income based on their fair values on the measurement date,
which, for 1st Source, is the date of grant. Stock-based compensation expense is recognized ratably over the requisite service period for all awards. The total
fair value of share awards vested was $4.30 million during 2012, $2.45 million in 2011, and $0.38 million in 2010.
51 • SRCE
2012 Form 10-K
A combined summary of activity regarding active stock option and stock award plans is presented in the following table.
Non-Vested Stock
Awards Outstanding
Stock Options
Outstanding
Shares
Available
for Grant
Number of
Shares
Weighted-
Average
Grant-Date
Fair Value
Number of
Shares
Weighted-
Average
Exercise
Price
Balance, January 1, 2010
2,348,117
421,907
$ 16.40
71,763
$ 18.19
Shares authorized - 2010 EIP
Granted
Stock options exercised
Stock awards vested
Forfeited
Canceled
55,351
(93,350)
-
-
9,530
-
-
-
93,350
17.31
-
(21,666)
(54,981)
-
-
19.21
12.68
-
-
-
-
-
-
-
-
-
(9,255)
25.03
-
-
Balance, December 31, 2010
2,319,648
438,610
16.92
62,508
17.18
Shares authorized - 2011 EIP
190,515
Shares authorized -
2011 Stock Option Plan
2,000,000
Shares authorized -
1982 Restricted Stock Plan
100,000
Shares authorized -
1998 Performance Compensation Plan
Granted
Stock options exercised
Stock awards vested
Forfeited
Canceled
100,000
(261,523)
-
-
1,029
(2,129,177)
-
-
-
-
-
-
-
-
261,523
20.15
-
(121,744)
(47,541)
-
-
17.08
13.71
-
-
-
-
-
-
-
-
-
-
-
(5,090)
19.15
-
-
(35,418)
20.09
-
-
Balance, December 31, 2011
2,320,492
530,848
18.76
22,000
12.04
Shares authorized - 2012 EIP
76,815
Shares authorized -
1998 Performance Compensation Plan
Granted
Stock options exercised
Stock awards vested
Forfeited
Canceled
2,302
(98,617)
-
-
4,124
-
-
-
-
-
98,617
21.95
-
(190,674)
(5,587)
-
-
17.24
19.71
-
-
-
-
-
-
-
(14,500)
12.04
-
-
-
-
-
-
Balance, December 31, 2012
2,305,116
433,204
$ 20.15
7,500
$ 12.04
Stock Option Plans — Incentive stock option plans include the 2001 Stock Option Plan (the “2001 Plan”) and the 2011 Stock Option Plan (the “2011 Plan”).
The 2001 Plan was terminated, except for outstanding options, after the 2011 Plan was approved by the shareholders. Options under the 2001 Plan vest in
one to eight years from date of grant. As of December 31, 2012, there were 7,500 shares available for issuance upon exercise from previous grants under the
2001 Plan. No additional grants will be made under the 2001 Plan. There were 2,000,000 shares available for issuance under the 2011 Plan.
Each award from all plans is evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the
option pertains, and such other provisions as the Committee determines. The option price is equal to the fair market value of a share of 1st Source Corporation’s
common stock on the date of grant. Options granted expire at such time as the Committee determines at the date of grant and in no event does the exercise
period exceed a maximum of ten years. Upon merger, consolidation, or other corporate consolidation in which 1st Source Corporation is not the surviving
corporation, as defined in the plans, all outstanding options immediately vest.
There were 14,500 and 5,090 stock options exercised during 2012 and 2011, respectively. There were no stock option exercises during 2010. All shares
issued in connection with stock option exercises and non-vested stock awards are issued from available treasury stock.
The total intrinsic value of outstanding stock options (all of which were exercisable) was $0.08 million at December 31, 2012. Only one stock option grant of
7,500 shares was outstanding and exercisable as of December 31, 2012. It had a contractual life of 0.30 years and an exercise price of $12.04. The Company
recognized an insignificant amount of additional stock-based compensation expense related to stock options for 2011 and for 2010 (not subject to tax). No
stock-based compensation expense related to stock options was recognized in 2012.
52 • SRCE
2012 Form 10-K
The fair value of each option on the date of grant was estimated using the Black-Scholes option pricing model. Expected volatility is based on the historical
volatility estimated over a period equal to the expected life of the options. In estimating the fair value of stock options under the Black-Scholes valuation model,
separate groups of employees that have similar historical exercise behavior are considered separately. The expected life of the options granted is derived based
on past experience and represents the period of time that options granted are expected to be outstanding.
Stock Award Plans — Incentive stock award plans include the Executive Incentive Plan (EIP), the 1998 Performance Compensation Plan (PCP) and the
Restricted Stock Award Plan (RSAP). The EIP is also administered by the Committee. Awards under the EIP and PCP include “book value” shares and “market
value” shares of common stock. These shares are awarded annually based on weighted performance criteria and generally vest over a period of five years. The
EIP book value shares may only be sold to 1st Source and such sale is mandatory in the event of death, retirement, disability, or termination of employment.
The RSAP is designed for key employees. Awards under the RSAP are made to employees recommended by the Chief Executive Officer and approved by the
Committee. Shares granted under the RSAP vest over a two to ten year period and vesting is based upon meeting certain various criteria, including continued
employment with 1st Source.
Stock-based compensation expense relating to the EIP, PCP and RSAP totaled $2.07 million in 2012, $2.09 million in 2011, and $1.84 million in 2010. The
total income tax benefit recognized in the accompanying consolidated Statements of Income related to stock-based compensation was $0.78 million in 2012,
$0.79 million in 2011, and $0.70 million in 2010. No unrecognized stock-based compensation expense related to stock options existed at December 31, 2012.
Unrecognized stock-based compensation expense related to non-vested stock awards (EIP/PCP/RSAP) was $7.98 million at December 31, 2012. At such date,
the weighted-average period over which this unrecognized expense was expected to be recognized was 3.31 years.
The fair value of non-vested stock awards for the purposes of recognizing stock-based compensation expense is market price of the stock on the measurement
date, which, for the Company’s purposes is the date of the award.
Employee Stock Purchase Plan — The Company offers an Employee Stock Purchase Plan (ESPP) for substantially all employees with at least two years of
service on the effective date of an offering under the plan. Eligible employees may elect to purchase any dollar amount of stock, so long as such amount does not
exceed 25% of their base rate of pay and the aggregate stock accrual rate for all offerings does not exceed $25,000 in any calendar year. The purchase price for
shares offered is the lower of the closing market bid price for the offering date or the average market bid price for the five business days preceding the offering
date. The purchase price and discount to the actual market closing price on the offering date for the 2012, 2011, and 2010 offerings were $20.54 (0.15%),
$20.29 (0.00%), and $17.80 (0.00%), respectively. Payment for the stock is made through payroll deductions over the offering period, and employees may
discontinue the deductions at any time and exercise the option or take the funds out of the program. The most recent offering began June 1, 2012 and runs
through May 31, 2014, with $240,813 in stock value to be purchased at $20.54 per share.
Note 16 — Income Taxes
Income tax expense was comprised of the following:
Year Ended December 31 (Dollars in thousands)
2012
2011
2010
Current:
Federal
State
Total current
Deferred:
Federal
State
Total deferred
Total provision
$ 30,041
3,647
33,688
(7,087)
(554)
(7,641)
$ 26,047
$ 18,985
2,975
21,960
3,596
38
3,634
$ 25,594
$ 17,446
2,841
20,287
(731)
(324)
(1,055)
$ 19,232
53 • SRCE
2012 Form 10-K
The reasons for the difference between income tax expense and the amount computed by applying the statutory federal income tax rate (35%) to income
before income taxes are as follows:
Year Ended December 31 (Dollars in thousands)
Amount
2012
2011
2010
Percent of
Pretax
Income
Percent of
Pretax
Income
Amount
Percent of
Pretax
Income
Amount
Statutory federal income tax
$26,488
35.0 %
$25,826
35.0 %
$21,167
35.0 %
(Decrease) increase in income taxes resulting from:
Tax-exempt interest income
State taxes, net of federal income tax benefit
Other
Total
(1,370)
2,010
(1,081)
(1.8)
2.7
(1.5)
(1,668)
1,958
(522)
(2.3)
2.7
(0.7)
(2,240)
1,636
(1,331)
(3.7)
2.7
(2.2)
$26,047
34.4 %
$25,594
34.7 %
$19,232
31.8 %
The tax expense applicable to securities gains for the years 2012, 2011, and 2010 was $222,000, $530,000, and $868,000, respectively.
Deferred tax assets and liabilities as of December 31, 2012 and 2011 consisted of the following:
(Dollars in thousands)
Deferred tax assets:
Reserve for loan and lease losses
Accruals for employee benefits
Other
Total deferred tax assets
Deferred tax liabilities:
Differing depreciable bases in premises and leased equipment
Net unrealized gains on securities available-for-sale
Differing bases in assets related to acquisitions
Mortgage servicing
Capitalized loan costs
Prepaid expenses
Other
Total deferred tax liabilities
Net deferred tax liability
2012
2011
$ 32,979
3,590
1,831
38,400
23,795
12,087
4,376
1,493
1,440
826
781
44,798
$ (6,398)
$ 32,547
3,683
992
37,222
30,812
11,284
4,003
1,598
1,382
1,873
762
51,714
$ (14,492)
No valuation allowance for deferred tax assets was recorded at December 31, 2012 and 2011 as the Company believes it is more likely than not that all of the
deferred tax assets will be realized.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:
(Dollars in thousands)
Balance, beginning of year
Additions based on tax positions related to the current year
Additions for tax positions of prior years
Reductions for tax positions of prior years
Reductions due to lapse in statute of limitations
Settlements
Balance, end of year
2012
$ 3,387
704
1,471
(49)
(1,445)
-
$ 4,068
2011
$ 3,424
419
1,632
(79)
(1,165)
(844)
$ 3,387
2010
$ 3,043
431
1,105
(2)
(1,153)
-
$ 3,424
54 • SRCE
2012 Form 10-K
The total amount of unrecognized tax benefits that would affect the effective tax rate if recognized was $2.02 million at December 31, 2012, $1.67 million at
December 31, 2011 and $1.52 million at December 31, 2010. Interest and penalties are recognized through the income tax provision. For the years 2012, 2011
and 2010, the Company recognized approximately $(0.02) million, $(0.03) million and $0.05 million in interest, net of tax effect, and penalties, respectively.
Interest and penalties of approximately $0.55 million, $0.57 million and $0.60 million were accrued at December 31, 2012, 2011 and 2010, respectively.
Tax years that remain open and subject to audit include the federal 2009–2012 years and the Indiana 2009–2012 years. Additionally, during 2011 the
Company reached a state tax settlement for the 2008 year and as a result recorded a reduction of unrecognized tax benefits in the amount of $0.84 million
that affected the effective tax rate and increased earnings in the amount of $0.47 million. The Company does not anticipate a significant change in the amount
of uncertain tax positions within the next 12 months.
Note 17 — Contingent Liabilities, Commitments, and Financial Instruments with Off-Balance-Sheet Risk
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 the Company’s consolidated financial position or results of operations.
1st Source Bank sells residential mortgage loans to Fannie Mae and Freddie Mac, as well as FHA-insured and VA-guaranteed loans in Ginnie Mae mortgage-
backed securities. Additionally, the Bank has sold loans on a service released basis to various other financial institutions in recent years. The agreements under
which the Bank sells these mortgage loans contain various representations and warranties regarding the acceptability of loans for purchase. On occasion, the
Bank may be required to indemnify the loan purchaser for credit losses on loans that were later deemed ineligible for purchase or may be required to repurchase
a loan. Both circumstances are collectively referred to as “repurchases.”
The Company’s liability for repurchases, included in accrued expenses and other liabilities on the Statements of Financial Condition, was $1.59 million and $1.14
million as of December 31, 2012 and 2011, respectively. The mortgage repurchase liability represents the Company’s best estimate of the loss that it may incur.
The estimate is based on specific loan repurchase requests and a historical loss ratio with respect to origination dollar volume. Because the level of mortgage
loan repurchase losses are dependent on economic factors, investor demand strategies and other external conditions that may change over the life of the
underlying loans, the level of liability for mortgage loan repurchase losses is difficult to estimate and requires considerable management judgment.
Commitments — 1st Source and its subsidiaries are obligated under operating leases for certain office premises and equipment. Future minimum rental
commitments for all noncancellable operating leases total approximately, $3.19 million in 2013, $2.68 million in 2014, $2.26 million in 2015, $2.17 million in
2016, $2.08 million in 2017, and $7.12 million, thereafter. As of December 31, 2012, future minimum rentals to be received under noncancellable subleases
totaled $2.99 million.
Rental expense of office premises and equipment and related sublease income were as follows:
Year Ended December 31 (Dollars in thousands)
Gross rental expense
Sublease rental income
Net rental expense
2012
$ 3,787
(878)
$ 2,909
2011
$ 3,714
(878)
$ 2,836
2010
$ 3,173
(1,562)
$ 1,611
Financial Instruments with Off-Balance-Sheet Risk — To meet the financing needs of our clients, 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 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.
The Company’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. The Company 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. The Company grants
mortgage loan commitments to borrowers, subject to normal loan underwriting standards. The interest rate risk associated with these loan commitments is
managed by entering into contracts for future deliveries of loans.
Standby letters of credit are conditional commitments issued to guarantee the performance of a client to a third party. The credit risk involved in and collateral
obtained when issuing standby letters of credit are essentially the same as those involved in extending loan commitments to clients. Standby letters of credit
totaled $17.29 million and $14.66 million at December 31, 2012 and 2011, respectively. Standby letters of credit generally have terms ranging from six months
to one year.
55 • SRCE
2012 Form 10-K
Note 18 — Derivative Financial Instruments
Commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans are considered derivative
instruments. See Note 17 for further information.
The Company has certain interest rate derivative positions that are not designated as hedging instruments. These derivative positions relate to transactions in
which the Company enters into an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial
institution. In connection with each transaction, the Company agrees to pay interest to the client on a notional amount at a variable interest rate and receive
interest from the client on the same notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same
fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the client to
effectively convert a variable rate loan to a fixed rate. Because the terms of the swaps with the customers and the other financial institution offset each other,
with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not
significantly impact the Company’s results of operations.
At December 31, 2012 and 2011, the amounts of non-hedging derivative financial instruments are shown in the chart below:
Asset derivatives
Liability derivatives
(Dollars in thousands)
Notional or
contractual
amount
Statement of
Financial Condition
classification
Fair
value
Statement of
Financial Condition
classification
Fair
value
Interest rate swap contracts
$ 446,024
Other assets
$ 16,126
Other liabilities
$ 16,444
Loan commitments
Forward contracts
33,961
Mortgages held for sale
21,500
N/A
Total - December 31, 2012
$ 501,485
220
-
$ 16,346
N/A
Mortgages held for sale
Interest rate swap contracts
$ 453,428
Other assets
$ 17,496
Other liabilities
Loan commitments
Forward contracts
38,209
21,247
Mortgages held for sale
N/A
Total - December 31, 2011
$ 512,884
189
-
$ 17,685
N/A
Mortgages held for sale
-
33
$ 16,477
$ 17,945
-
218
$ 18,163
At December 31, 2012, 2011 and 2010, the amounts included in the consolidated statements of income for non-hedging derivative financial instruments are
shown in the chart below:
(Dollars in thousands)
Statement of Income classification
2012
2011
Gain (loss)
Interest rate swap contracts
Interest rate swap contracts
Other expense
Other income
Loan commitments
Forward contracts
Total
Note 19 — Regulatory Matters
Mortgage banking income
Mortgage banking income
$ 131
$
57
721
31
185
588
159
(669)
$ 1,068
$ 135
2010
$ 61
448
(47)
40
$ 502
The Company 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 the Company’s
financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital
guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.
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 the Company to maintain minimum amounts and ratios of total capital and Tier
I capital to risk-weighted assets and of Tier I capital to average assets. The Company believes that it meets all capital adequacy requirements to which it is subject.
The most recent notification from the Federal bank regulators categorized 1st Source Bank, the largest of its subsidiaries, as “well capitalized” under the
regulatory framework for prompt corrective action. To be categorized as “well capitalized” the Bank must maintain minimum total risk-based, Tier I risk-based,
and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that the Company believes will have changed
the institution’s category.
56 • SRCE
2012 Form 10-K
As discussed in Note 12, the capital securities held by the Capital Trusts qualify as Tier 1 capital under Federal Reserve Board guidelines. The actual and required
capital amounts and ratios for 1st Source Corporation and 1st Source Bank as of December 31, 2012, are presented in the table below:
Actual
Minimum Capital
Adequacy
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
(Dollars in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
2012
Total Capital (to Risk-Weighted Assets):
1st Source Corporation
1st Source Bank
$ 555,163
15.57 %
535,409
15.05 %
Tier I Capital (to Risk-Weighted Assets):
1st Source Corporation
1st Source Bank
508,582
14.26 %
490,077
13.78 %
Tier I Capital (to Average Assets):
1st Source Corporation
1st Source Bank
508,582
11.47 %
490,077
11.08 %
2011
Total Capital (to Risk-Weighted Assets):
1st Source Corporation
1st Source Bank
$ 547,655
536,730
16.51 %
16.24 %
Tier I Capital (to Risk-Weighted Assets):
1st Source Corporation
1st Source Bank
504,691
494,882
15.21 %
14.97 %
Tier I Capital (to Average Assets):
1st Source Corporation
1st Source Bank
504,691
494,882
11.72 %
11.52 %
$ 285,304
284,611
142,652
142,305
177,299
176,928
$ 265,368
264,479
132,684
132,240
172,246
171,812
8.00 %
8.00 %
4.00 %
4.00 %
4.00 %
4.00 %
8.00 %
8.00 %
4.00 %
4.00 %
4.00 %
4.00 %
$ 356,631
10.00 %
355,763
10.00 %
213,978
213,458
221,624
221,160
6.00 %
6.00 %
5.00 %
5.00 %
$ 331,710
330,599
10.00 %
10.00 %
199,026
198,359
215,307
214,764
6.00 %
6.00 %
5.00 %
5.00 %
The Bank was required to maintain noninterest bearing cash balances with the Federal Reserve Bank until July 11, 2012 when the Federal Reserve eliminated
the contractual clearing balance program. The average balance of these deposits for the years ended December 31, 2012 and 2011, was approximately $1.62
million and $3.00 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.
Due to the Company’s mortgage activities, 1st Source Bank is required to maintain minimum net worth capital requirements established by various governmental
agencies. 1st Source Bank’s net worth requirements are governed by the Department of Housing and Urban Development and GNMA. As of December 31,
2012, 1st Source Bank met its minimum net worth capital requirements.
Note 20 — Fair Value Measurements
The Company determines the fair values of its financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of quoted
prices and observable inputs and to minimize the use of unobservable inputs when measuring fair value. The Company elected fair value accounting for
mortgages held for sale. The Company believes the election for mortgages held for sale (which are economically hedged with free-standing derivatives) will
reduce certain timing differences and better match changes in the value of these assets with changes in the value of derivatives used as economic hedges for
these assets. At December 31, 2012 and 2011, all mortgages held for sale are carried at fair value.
57 • SRCE
2012 Form 10-K
The following table reflects the differences between fair value carrying amount of mortgages held for sale measured at fair value and the aggregate unpaid
principal amount the Company is contractually entitled to receive at maturity on December 31, 2012 and 2011:
(Dollars in thousands)
December 31, 2012
Mortgages held for sale reported at fair value:
Total Loans
Nonaccrual Loans
Loans 90 days or more past due and still accruing
December 31, 2011
Mortgages held for sale reported at fair value:
Total Loans
Nonaccrual Loans
Loans 90 days or more past due and still accruing
Fair value carrying amount
Aggregate unpaid principal
Excess of fair value
carrying amount over
(under) unpaid principal
$10,879
$10,293
$586 (1)
-
-
-
-
-
-
$12,644
$12,265
$379 (1)
-
-
-
-
-
-
(1) The excess of fair value carrying amount over unpaid principal is included in mortgage banking income and includes changes in fair value at and subsequent
to funding, gains and losses on the related loan commitment prior to funding, and premiums on acquired loans.
Financial Instruments on Recurring Basis:
The following is a description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis:
Investment securities available for sale are valued primarily by a third party pricing agent. Prices supplied by the independent pricing agent, as well as their
pricing methodologies and assumptions, are reviewed by the Company for reasonableness and to ensure such prices are aligned with market levels. In general,
the Company’s investment securities do not possess a complex structure that could introduce greater valuation risk. The portfolio mainly consists of traditional
investments including U.S. Treasury and Federal agencies securities, federal agency mortgage pass-through securities, and general obligation and revenue
municipal bonds. Pricing for such instruments is fairly generic and is easily obtained. On a quarterly basis, prices supplied by the pricing agent are validated by
comparison to prices obtained from other third party sources for a material portion of the portfolio.
The valuation policy and procedures for Level 3 fair value measurements of available for sale debt securities are decided through collaboration between
management of the Corporate Accounting and Funds Management departments. The changes in fair value measurement for Level 3 securities are analyzed
on a periodic basis under a collaborative framework with the aforementioned departments. The methodology and variables used for input are derived from the
combination of observable and unobservable inputs. The unobservable inputs are determined through internal assumptions that may vary from period to period
due to external factors, such as market movement and credit rating adjustments.
Both the market and income valuation approaches are implemented using the following types of inputs:
• U.S. treasuries are priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.
• Government-sponsored agency debt securities and corporate bonds are primarily priced using available market information through processes such as
benchmark curves, market valuations of like securities, sector groupings and matrix pricing.
• Other government-sponsored agency securities, mortgage-backed securities and some of the actively traded REMICs and CMOs, are primarily priced
using available market information including benchmark yields, prepayment speeds, spreads and volatility of similar securities.
• Other inactive government-sponsored agency securities are primarily priced using consensus pricing and dealer quotes.
• State and political subdivisions are largely grouped by characteristics, i.e., geographical data and source of revenue in trade dissemination systems.
Since some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like
securities. Local direct placement municipal securities, with very little market activity, are priced using an appropriate market yield curve.
• Marketable equity (common) securities are primarily priced using the market approach and utilizing live data feeds from active market exchanges for
identical securities.
Trading account securities are priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.
Mortgages held for sale and the related loan commitments and forward contracts (hedges) are valued using a market value approach and utilizing an appropriate
current market yield and a loan commitment closing rate based on historical analysis.
Interest rate swap positions, both assets and liabilities, are valued by a third party pricing agent using an income approach and utilizing models that use as their
basis readily observable market parameters. This valuation process considers various factors including interest rate yield curves, time value and volatility factors.
Validation of third party agent valuations is accomplished by comparing those values to the Company’s swap counterparty valuations. Management believes an
adjustment is required to “mid-market” valuations for derivatives tied to its performing loan portfolio to recognize the imprecision and related exposure inherent
in the process of estimating expected credit losses as well as velocity of deterioration evident with systemic risks imbedded in these portfolios.
58 • SRCE
2012 Form 10-K
The table below presents the balance of assets and liabilities at December 31, 2012 and 2011 measured at fair value on a recurring basis.
(Dollars in thousands)
Assets:
Level 1
Level 2
Level 3
Total
Investment securities available-for-sale:
U.S. Treasury and Federal agencies securities
$ 20,063
U.S. States and political subdivisions securities
Mortgage-backed securities - Federal agencies
Corporate debt securities
Foreign government and other securities
Total debt securities
Marketable equity securities
$ 402,190
97,736
312,407
31,248
3,726
$
-
7,701
-
-
-
$ 422,253
105,437
312,407
31,248
3,726
-
-
-
-
20,063
5,693
847,307
7,701
875,071
-
-
5,693
Total investment securities available-for-sale
25,756
847,307
7,701
880,764
Trading account securities
Mortgages held for sale
Accrued income and other assets (interest rate swap agreements)
146
-
-
-
10,879
16,126
-
-
-
146
10,879
16,126
Total - December 31, 2012
$ 25,902
$ 874,312
$ 7,701
$ 907,915
Liabilities:
Accrued expenses and other liabilities (interest rate swap agreements)
Total - December 31, 2012
$
$
-
-
$ 16,444
$ 16,444
$
$
-
-
$ 16,444
$ 16,444
Assets:
Investment securities available-for-sale:
U.S. Treasury and Federal agencies securities
U.S. States and political subdivisions securities
Mortgage-backed securities - Federal agencies
Corporate debt securities
Foreign government and other securities
Total debt securities
Marketable equity securities
$ 20,016
$ 381,109
-
-
-
-
96,867
328,948
36,310
4,038
$
-
10,493
-
-
675
$ 401,125
107,360
328,948
36,310
4,713
20,016
847,272
11,168
878,456
4,403
141
-
4,544
Total investment securities available-for-sale
24,419
847,413
11,168
883,000
Trading account securities
Mortgages held for sale
Accrued income and other assets (interest rate swap agreements)
132
-
-
-
12,644
17,496
-
-
-
132
12,644
17,496
Total - December 31, 2011
$ 24,551
$ 877,553
$ 11,168
$ 913,272
Liabilities:
Accrued expenses and other liabilities (interest rate swap agreements)
Total - December 31, 2011
$
$
-
-
$ 17,945
$ 17,945
$
$
-
-
$ 17,945
$ 17,945
59 • SRCE
2012 Form 10-K
The changes in Level 3 assets and liabilities at December 31, 2012 and 2011 measured at fair value on a recurring basis are summarized as follows:
(Dollars in thousands)
U.S. States and political
subdivisions
securities
Corporate debt
securities
Foreign government
and other securities
Investment securities
available-for-sale
Beginning balance January 1, 2012
$ 10,493
$
Total gains or losses (realized/unrealized):
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Settlements
Maturities
Transfers into Level 3
Transfers out of Level 3
-
258
-
-
-
(3,050)
-
-
Ending balance December 31, 2012
$ 7,701
$
-
-
-
-
-
-
-
-
-
-
$ 675
$ 11,168
-
-
-
-
-
-
-
-
(675)
$
-
-
258
-
-
-
(3,050)
-
(675)
$ 7,701
Beginning balance January 1, 2011
$ 16,306
$ 9,992
$ 675
$ 26,973
Total gains or losses (realized/unrealized):
Included in earnings
Included in other comprehensive income
Purchases
Issuances
Settlements
Maturities
Transfers into Level 3
Transfers out of Level 3
-
978
700
-
-
-
-
-
-
-
(7,491)
(9,992)
-
-
-
-
-
-
-
-
100
-
-
(100)
-
-
-
978
800
-
-
(17,583)
-
-
$ 675
$ 11,168
Ending balance December 31, 2011
$ 10,493
$
There were no gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held
at December 31, 2012 or 2011. A foreign government debt security was transferred from Level 3 to Level 2 during 2012 due to the Company’s periodic review
of valuation methodologies and inputs. The Company determined that the observable inputs used in determining fair value warranted a transfer to Level 2 as the
unobservable inputs were deemed to be insignificant to the overall fair value measurement. No transfers between Level 1 and 2 occurred during 2012 or 2011.
The table below presents the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a recurring basis at
December 31, 2012.
(Dollars in thousands)
Fair Value
Investment securities available-for-sale
Valuation
Methodology
Unobservable Inputs
Range of Inputs
Adjustable rate securities
$ 3,364
Discounted cash flows
Illiquidity adjustment
Term assumption (1)
4% - 8%
5 years
Coupon forecast assumption
0.50% - 0.88%
Direct placement municipal securities
4,337
Discounted cash flows
Credit spread assumption
1.22% - 1.95%
Total investment securities available-for-sale
$ 7,701
(1) Term assumption is influenced by security call history
The sensitivity to changes in the unobservable inputs and their impact on the fair value measurement can be significant. The significant unobservable inputs
for Adjustable Rate Securities are illiquidity, term and coupon forecast assumptions. The illiquidity adjustment is negatively correlated to the fair value measure.
An increase (decrease) in the determined illiquidity adjustment will lower (increase) the fair value measure. The term assumption is negatively correlated to the
fair value measure. An increase (decrease) in the determined term adjustment will decrease (increase) the fair value measure. The coupon forecast is positively
correlated to the fair value measure. An increase (decrease) in the determined coupon forecast will increase (decrease) the fair value measure. A permutation
that includes a change in the coupon forecast with a change in either or both of the two variables will mitigate the significance of the change to the fair value
measure. The significant unobservable input for direct placement municipal securities is the underlying market level used to determine the fair value measure.
An increase (decrease) in the estimated yield level of the market will decrease (increase) the fair value measure of the securities.
60 • SRCE
2012 Form 10-K
Financial Instruments on Non-recurring Basis:
The Company may be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis in accordance with GAAP.
These adjustments to fair value usually result from application of lower of cost or market accounting or impairment charges of individual assets.
The Credit Policy Committee, a management committee, is responsible for overseeing the valuation processes and procedures for Level 3 measurements of
impaired loans, other real estate and repossessions. The Committee reviews these assets on a quarterly basis to determine the accuracy of the observable
inputs, generally third party appraisals, auction values, values derived from trade publications and data submitted by the borrower, and the appropriateness of
the unobservable inputs, generally discounts due to current market conditions and collection issues. The Committee establishes discounts based on asset type
and valuation source; deviations from the standard are documented. The discounts are reviewed periodically, annually at a minimum, to determine they remain
appropriate. Consideration is given to current trends in market values for the asset categories and gain and losses on sales of similar assets. The Loan and Funds
Management Committee of the Board of Directors is responsible for overseeing the Credit Policy Committee.
Discounts range from 10% to 90% depending on the nature of the assets and the source of value. Aircraft are generally valued using quarterly trade publications
adjusted for engine time, condition, maintenance programs, discounted by 10%. Likewise, autos are valued using current auction values, discounted by 10%;
medium and heavy duty trucks are valued using trade publications and auction values, discounted by 15%. Construction equipment and environmental equipment
is generally valued using trade publications and auction values, discounted by 20%. Real estate is valued based on appraisals or evaluations, discounted by
20% at a minimum with higher discounts for property in poor condition or property with characteristics which may make it more difficult to market. Commercial
loans subject to borrowing base certificates are generally discounted by 20% for receivables and 40-75% for inventory with higher discounts when monthly
borrowing base certificates are not required or received.
Impaired loans and related write-downs are based on the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral
values are reviewed quarterly and estimated using customized discounting criteria, appraisals and dealer and trade magazine quotes which are used in a market
valuation approach.
Partnership investments and the adjustments to fair value primarily result from application of lower of cost or fair value accounting. The partnership investments
are priced using financial statements provided by the partnerships. Quantitative unobservable inputs are not reasonably available for reporting purposes.
The Company has established mortgage servicing rights (MSRs) valuation policies and procedures based on industry standards and to ensure valuation
methodologies are consistent and verifiable. MSRs and related adjustments to fair value result from application of lower of cost or fair value accounting. For
purposes of impairment, MSRs are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. The fair value
of each tranche of the servicing portfolio is estimated by calculating the present value of estimated future net servicing cash flows, taking into consideration
actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors. Prepayment rates and discount rates are
derived through a third party pricing agent. Changes in the most significant inputs, including prepayment rates and discount rates, are compared to the changes
in the fair value measurements and appropriate resolution is made. A fair value analysis is also obtained from an independent third party agent and compared
to the internal valuation for reasonableness. MSRs do not trade in an active, open market with readily observable prices and though sales of MSRs do occur,
precise terms and conditions typically are not readily available and the characteristics of the Company’s servicing portfolio may differ from those of any servicing
portfolios that do trade.
Other real estate is based on the lower of cost or fair value of the underlying collateral less expected selling costs. Collateral values are estimated primarily using
appraisals and reflect a market value approach. Fair values are reviewed quarterly and new appraisals are obtained annually. Repossessions are similarly valued.
For assets measured at fair value on a nonrecurring basis the following represents impairment charges (recoveries) recognized on these assets during the year
ended December 31, 2012 and 2011, respectively: impaired loans - $0.46 million and $3.37 million; partnership investments - $(0.28) million and $(0.20)
million; mortgage servicing rights - $(0.24) million and $0.24 million; repossessions - $0.40 million and $0.89 million, and other real estate - $0.71 million
and $0.76 million.
The table below presents the carrying value of assets at December 31, 2012 and 2011, measured at fair value on a non-recurring basis.
(Dollars in thousands)
December 31, 2012
Level 1
Level 2
Level 3
Total
Impaired loans - collateral based
$ -
$ -
Accrued income and other assets (partnership investments)
Accrued income and other assets (mortgage servicing rights)
Accrued income and other assets (repossessions)
Accrued income and other assets (other real estate)
Total
December 31, 2011
Impaired loans - collateral based
Accrued income and other assets (partnership investments)
Accrued income and other assets (mortgage servicing rights)
Accrued income and other assets (repossessions)
Accrued income and other assets (other real estate)
-
-
-
-
$ -
$ -
-
-
-
-
-
-
-
-
$ -
$ 2,027
2,032
4,645
63
5,344
$ 14,111
$ 2,027
2,032
4,645
63
5,344
$ 14,111
$ -
$ 7,419
$ 7,419
-
-
-
-
2,799
5,372
6,792
8,755
2,799
5,372
6,792
8,755
Total
$ -
$ -
$ 31,137
$ 31,137
61 • SRCE
2012 Form 10-K
The table below presents the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a non-recurring basis
at December 31, 2012.
(Dollars in thousands)
Carrying
Value
Fair Value
Valuation
Methodology
Impaired loans
$ 2,027
$ 2,027
Collateral based measurements
including appraisals, trade
publications, and auction values
Unobservable Inputs
Range of Inputs
Discount for lack of marketability
and current conditions
10% - 90%
Mortgage servicing rights
4,645
5,760
Discounted cash flows
Constant prepayment rate (CPR)
14.1% - 23.2%
Repossessions
63
59
Appraisals, trade publications
and auction values
Discount rate
8.5% - 11.5%
Discount for lack of marketability
0% - 45%
Other real estate
5,344
6,550
Appraisals
Discount for lack of marketability
0% - 68%
GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured
and reported at fair value on a recurring or non-recurring basis.
The fair values of the Company’s financial instruments as of December 31, 2012 and 2011 are summarized in the table below.
(Dollars in thousands)
December 31, 2012
Assets:
Cash and due from banks
Federal funds sold and interest bearing deposits with other banks
Investment securities, available-for-sale
Other investments and trading account securities
Mortgages held for sale
Loans and leases, net of reserve for loan and lease losses
Cash surrender value of life insurance policies
Mortgage servicing rights
Carrying or
Contract Value
Fair Value
Level 1
Level 2
Level 3
$
83,232 $
702
880,764
22,755
10,879
3,244,242
56,572
4,645
83,232 $
702
880,764
22,755
10,879
3,287,976
56,572
5,760
83,232 $
702
25,756
22,755
-
-
56,572
-
- $
-
847,307
-
10,879
-
-
-
-
-
7,701
-
-
3,287,976
-
5,760
Interest rate swaps
16,126
16,126
-
16,126
Liabilities:
Deposits
Short-term borrowings
Long-term debt and mandatorily redeemable securities
Subordinated notes
Interest rate swaps
Off-balance-sheet instruments *
December 31, 2011
Assets:
Cash and due from banks
Federal funds sold and interest bearing deposits with other banks
Investment securities, available-for-sale
Other investments and trading account securities
Mortgages held for sale
Loans and leases, net of reserve for loan and lease losses
Cash surrender value of life insurance policies
Mortgage servicing rights
$ 3,624,347 $ 3,641,280 $ 2,556,122 $ 1,085,158 $
169,188
71,021
58,764
16,444
-
169,188
71,557
72,914
16,444
188
161,138
-
-
-
-
8,050
71,557
72,914
16,444
188
$
61,406 $
52,921
883,000
19,106
12,644
3,008,899
54,729
5,372
61,406
52,921
883,000
19,106
12,644
3,125,581
54,729
6,725
-
-
-
-
-
-
-
Interest rate swaps
17,496
17,496
Liabilities:
Deposits
Short-term borrowings
Long-term debt and mandatorily redeemable securities
Subordinated notes
Interest rate swaps
Off-balance-sheet instruments *
$ 3,520,141 $ 3,546,366
125,234
37,865
87,527
17,945
131
125,141
37,156
89,692
17,945
-
* Represents estimated cash outflows required to currently settle the obligations at current market rates.
62 • SRCE
2012 Form 10-K
The methodologies for estimating fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are
discussed above. The estimated fair value approximates carrying value for cash and due from banks, federal funds sold and interest bearing deposits with other
banks, other investments, and cash surrender value of life insurance policies. The methodologies for other financial assets and financial liabilities are discussed below:
Loans and Leases — For variable rate loans and leases that reprice frequently and with no significant change in credit risk, fair values are based on carrying
values. The fair values of other loans and leases are estimated using discounted cash flow analyses which use interest rates currently being offered for loans and
leases with similar terms to borrowers of similar credit quality.
Deposits — The fair values for all deposits other than time deposits are equal to the amounts payable on demand (the carrying value). Fair values of variable rate
time deposits are equal to their carrying values. Fair values for fixed rate time deposits are estimated using discounted cash flow analyses using interest rates
currently being offered for deposits with similar remaining maturities.
Short-Term Borrowings — The carrying values of Federal funds purchased, securities sold under repurchase agreements, and other short-term borrowings,
including the liability related to mortgage loans available for repurchase under GNMA optional repurchase programs, approximate their fair values.
Long-Term Debt and Mandatorily Redeemable Securities — The fair values of long-term debt are estimated using discounted cash flow analyses, based on
our current estimated incremental borrowing rates for similar types of borrowing arrangements. The carrying values of mandatorily redeemable securities are
based on our current estimated cost of redeeming these securities which approximate their fair values.
Subordinated Notes — Fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are estimated based
on calculated market prices of comparable securities.
Off-Balance-Sheet Instruments — Contract and fair values for certain of our off-balance-sheet financial instruments (guarantees) are estimated based on
fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.
Limitations — Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments.
Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss
experience, current economic conditions, risk characteristics of various financial instruments, and other such factors.
These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial
instrument. These estimates are subjective in nature and require considerable judgment to interpret market data. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts the Company could realize in a current market exchange, nor are they intended to represent the fair value of
1st Source as a whole. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The fair value estimates presented herein are based on pertinent information available to management as of the respective balance sheet date. Although the
Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued
since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.
Other significant assets, such as premises and equipment, other assets, and liabilities not defined as financial instruments, are not included in the above
disclosures. Also, the fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities
compared to the cost of borrowing funds in the market.
Note 21 — 1st Source Corporation (Parent Company Only) Financial Information
STATEMENTS OF FINANCIAL CONDITION
December 31 (Dollars in thousands)
ASSETS
Cash and cash equivalents
Short-term investments with bank subsidiary
Investment securities, available-for-sale
(amortized cost of $1,243 and $1,744 at December 31, 2012 and 2011, respectively)
Other investments
Trading account securities
Investments in:
Bank subsidiaries
Non-bank subsidiaries
Premises and equipment, net
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Commercial paper borrowings
Other liabilities
Long-term debt and mandatorily redeemable securities
Total liabilities
Shareholders’ equity
2012
2011
$ 32,603
500
$ 24,415
500
3,779
1,470
146
594,851
2,120
30
5,693
4,275
-
132
598,507
1,858
63
8,298
$ 641,192
$ 638,048
$
4,659
4,824
73,054
82,537
558,655
$
8,001
5,198
100,931
114,130
523,918
Total liabilities and shareholders’ equity
$ 641,192
$ 638,048
63 • SRCE
2012 Form 10-K
STATEMENTS OF INCOME
Year Ended December 31 (Dollars in thousands)
2012
2011
2010
Income:
Dividends from bank subsidiary
Rental income from subsidiaries
Other
Investment securities and other investment gains
Total income
Expenses:
Interest on long-term debt and mandatorily redeemable securities
Interest on commercial paper and other short-term borrowings
Rent expense
Other
Total expenses
Income before income tax benefit and equity in undistributed
(distributed in excess of) income of subsidiaries
Income tax benefit
$ 58,739
1,873
499
273
$ 28,175
1,772
418
237
$ 106,485
2,439
584
592
61,384
30,602
110,100
7,592
7,628
17
18
1,635
1,483
354
763
7,497
30
1,109
3,693
9,598
9,892
12,329
51,786
2,274
20,710
2,607
97,771
3,365
Income before equity in undistributed (distributed in excess of) income of subsidiaries
54,060
23,317
101,136
Equity in (distributed in excess of) undistributed income of subsidiaries:
Bank subsidiaries
Non-bank subsidiaries
Net income
(4,690)
263
24,511
367
(59,987)
95
$ 49,633
$ 48,195
$ 41,244
64 • SRCE
2012 Form 10-K
STATEMENTS OF CASH FLOW
Year Ended December 31 (Dollars in thousands)
2012
2011
2010
Operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Equity distributed (undistributed) in excess of income of subsidiaries
Depreciation of premises and equipment
Realized/unrealized investment securities and other investment gains
Change in trading account securities
Other
Net change in operating activities
Investing activities:
Proceeds from sales and maturities of investment securities
Purchases of other investments
Net change in premises and equipment
Return of capital from subsidiaries
Net change in investing activities
Financing activities:
Net change in commercial paper
Proceeds from issuance of long-term debt and mandatorily redeemable securities
Payments on subordinated notes
Payments on long-term debt and mandatorily redeemable securities
Net proceeds from issuance of treasury stock
Repurchase of common stock warrant
Redemption of preferred stock
Acquisition of treasury stock
Cash dividends paid on preferred stock
Cash dividends paid on common stock
Net change in financing activities
Net change in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
$ 49,633
$ 48,195
$ 41,244
4,427
39
(273)
(14)
3,600
(24,878)
59,892
76
(237)
6
2,246
541
(592)
(13)
1,431
57,412
25,408
102,503
500
(1,470)
(6)
-
(976)
(3,342)
2,627
(30,928)
(317)
3,935
-
-
(3,701)
-
(16,522)
(48,248)
8,188
24,415
$ 32,603
657
-
142
1,000
1,799
3,760
1,936
-
(328)
2,953
(3,750)
-
(2,241)
-
(15,921)
(13,591)
13,616
10,799
$ 24,415
3,613
-
1,418
-
5,031
(872)
142
-
(10,337)
2,873
-
(111,000)
(2,142)
(5,519)
(15,076)
(141,931)
(34,397)
45,196
$ 10,799
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
ITEM 9A. CONTROLS AND PROCEDURES.
1st Source carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934) pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that, at December 31, 2012, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by 1st Source in reports
that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms and are designed to ensure that information required to be disclosed in those reports is accumulated and communicated to
management as appropriate to allow timely decisions regarding required disclosure.
In addition, there were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the fourth fiscal quarter of
2012 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
65 • SRCE
2012 Form 10-K
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of 1st Source Corporation (“1st Source”) is responsible for establishing and maintaining adequate internal control over financial reporting.
1st Source’s internal control over financial reporting includes policies and procedures pertaining to 1st Source’s ability to record, process, and report reliable
information. Actions are taken to correct any deficiencies as they are identified through internal and external audits, regular examinations by bank regulatory
agencies, 1st Source’s formal risk management process, and other means. 1st Source’s internal control system is designed to provide reasonable assurance to
1st Source’s management and Board of Directors regarding the preparation and fair presentation of 1st Source’s published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal
control may vary over time.
1st Source’s management assessed the effectiveness of internal control over financial reporting as of December 31, 2012. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated
Framework. Based on management’s assessment, 1st Source believes that, as of December 31, 2012, 1st Source’s internal control over financial reporting is
effective based on those criteria.
Ernst & Young LLP, independent registered public accounting firm, has issued an attestation report on management’s assessment of 1st Source’s internal
control over financial reporting. This report appears on page 31.
By
/s/ CHRISTOPHER J. MURPHY III
Christopher J. Murphy III, Chief Executive Officer
By
/s/ ANDREA G. SHORT
Andrea G. Short, Treasurer and Chief Financial Officer
South Bend, Indiana
None
ITEM 9B. OTHER INFORMATION.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information under the caption “Proposal Number 1: Election of Directors,” “Board Committees and Other Corporate Governance Matters,” and “Section
16(a) Beneficial Ownership Reporting Compliance” of the 2013 Proxy Statement is incorporated herein by reference.
The information under the caption “Compensation Discussion & Analysis” of the 2013 Proxy Statement is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
66 • SRCE
2012 Form 10-K
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 2013 Proxy
Statement is incorporated herein by reference.
Equity Compensation Plan Information as of December 31, 2012:
Number of Securities to
be Issued upon Exercise
of Outstanding Options,
Warrants and Rights
Weighted-average
Exercise Price of
Outstanding Options,
Warrants and Rights
Equity Compensation plans approved by shareholders
2001 stock option plan
2011 stock option plan
1997 employee stock purchase plan
1982 executive incentive plan
1982 restricted stock award plan
1998 performance compensation plan
Total plans approved by shareholders
7,500
-
20,519
-
-
-
28,019
Equity compensation plans not approved by shareholders
-
Total equity compensation plans
28,019
$12.04
-
20.42
-
-
-
$18.18
-
$18.18
Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans [excluding securities
reflected in column (a)]
-
2,000,000
131,677
148,253 (1) (2)
67,186 (1)
89,677 (1) (2)
2,436,793
-
2,463,793
(1) Amount is to be awarded by grants administered by the Executive Compensation Committee of the 1st Source Board of Directors.
(2) Amount includes market value stock only. Book value shares used for annual awards may only be sold to 1st Source
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information under the caption “Proposal Number 1: Election of Directors,” “Board Committees and Other Corporate Governance Matters,” and “Transactions
with Related Persons” of the 2013 Proxy Statement is incorporated herein by reference.
The information under the caption “Relationship with Independent Registered Public Accounting Firm” of the 2013 Proxy Statement is incorporated herein
by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Financial Statements and Schedules:
The following Financial Statements and Supplementary Data are filed as part of this annual report:
Reports of Independent Registered Public Accounting Firm
Consolidated statements of financial condition — December 31, 2012 and 2011
Consolidated statements of income — Years ended December 31, 2012, 2011, and 2010
Consolidated statements of comprehensive income — Years ended December 31, 2012, 2011, and 2010
Consolidated statements of shareholders’ equity — Years ended December 31, 2012, 2011, and 2010
Consolidated statements of cash flows — Years ended December 31, 2011, 2011, and 2010
Notes to consolidated financial statements — December 31, 2012, 2011, and 2010
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.
67 • SRCE
2012 Form 10-K
(b) Exhibits (numbered in accordance with Item 601 of Regulation S-K):
3(a)
3(b)
3(c)
4(a)
4(b)
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.
By-Laws of Registrant, as amended July 30, 2009, filed as exhibit to Form 8-K, dated July 30, 2009, and incorporated herein by reference.
Certificate of Designations for Series A Preferred Stock, dated January 23, 2009, filed as exhibit to Form 8-K, dated January 23, 2009, and
incorporated herein by reference.
Form of Common Stock Certificates of Registrant filed as exhibit to Registration Statement 2-40481 and incorporated herein by reference.
1st Source agrees to furnish to the Commission, upon request, a copy of each instrument defining the rights of holders of Senior and Subordinated
debt of 1st Source.
10(a)(1) Employment Agreement of Christopher J. Murphy III, dated January 1, 2008, filed as exhibit to Form 8-K, dated March 17, 2008, and
incorporated herein by reference.
10(a)(2) Employment Agreement of Andrea G. Short dated January 1, 2013, filed as exhibit to Form 10-K, dated December 31, 2012.
10(a)(3) Employment Agreement of John B. Griffith, dated January 1, 2008, filed as exhibit to Form 8-K, dated March 17, 2008, and incorporated
herein by reference.
10(a)(4) Employment Agreement of Steven J. Wessell, dated June 1, 2011, filed as exhibit to Form 10-Q, dated March 31, 2012, and incorporated
herein by reference.
10(b)
10(c)
10(d)
10(e)
10(f)
10(g)
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.
1st Source Corporation 1982 Executive Incentive Plan, amended February 3, 2011, filed as exhibit to Form 10-K, dated December 31, 2010,
and incorporated herein by reference.
1st Source Corporation 1982 Restricted Stock Award Plan, amended January 17, 2003, and filed as exhibit to Form 10-K, dated December 31,
2003, and incorporated herein by reference.
1st Source Corporation 2001 Stock Option Plan, amended July 27, 2006, and filed as an exhibit to 1st Source Corporation Proxy Statement
dated March 7, 2001, and incorporated herein by reference.
1st Source Corporation 1998 Performance Compensation Plan, amended January 20, 2011, filed as exhibit to Form 10-K, dated December 31,
2010, and incorporated herein by reference.
Contract with Fiserv Solutions, Inc. dated November 23, 2005, filed as exhibit to Form 10-K, dated, December 31, 2005, and incorporated
herein by reference.
10 (h)
1st Source Corporation 2011 Stock Option Plan, dated January 20, 2011, filed as exhibit to Form 10-K, dated December 31, 2010, and
incorporated herein by reference.
21
Subsidiaries of Registrant (unless otherwise indicated, each subsidiary does business under its own name):
Name
1st Source Bank
SFG Aircraft, Inc. * (formerly known as SFG Equipment Leasing, Inc.)
1st Source Insurance, Inc. *
1st Source Specialty Finance, Inc. *
FBT Capital Corporation (Inactive)
1st Source Leasing, Inc.
1st Source Capital Corporation *
Trustcorp Mortgage Company (Inactive)
1st Source Capital Trust IV
1st Source Master Trust
Michigan Transportation Finance Corporation *
1st Source Intermediate Holding, LLC
1st Source Funding, LLC (Inactive)
1st Source Corporation Investment Advisors, Inc. *
SFG Commercial Aircraft Leasing, Inc. *
SFG Equipment Leasing Corporation I *
Washington and Michigan Insurance, Inc. *
*Wholly-owned subsidiaries of 1st Source Bank
Jurisdiction
Indiana
Indiana
Indiana
Indiana
Indiana
Indiana
Indiana
Indiana
Delaware
Delaware
Michigan
Delaware
Delaware
Indiana
Indiana
Indiana
Arizona
23
31.1
31.2
32.1
Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.
Certification of Christopher J. Murphy III, Chief Executive Officer (Rule 13a-14(a)).
Certification of Andrea G. Short, Chief Financial Officer (Rule 13a-14(a)).
Certification of Christopher J. Murphy III, Chief Executive Officer.
32.2
Certification of Andrea G. Short, Chief Financial Officer.
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
68 • SRCE
2012 Form 10-K
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB XBRL Taxonomy Extension Labels Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
(c) Financial Statement Schedules — None.
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.
SIGNATURES
1ST SOURCE CORPORATION
By /s/ CHRISTOPHER J. MURPHY III
Christopher J. Murphy III, Chairman of the Board,
President and Chief Executive Officer
Date: February 22, 2013
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
/s/ CHRISTOPHER J. MURPHY III
Christopher J. Murphy III
/s/ WELLINGTON D. JONES III
Wellington D. Jones III
/s/ ANDREA G. SHORT
Andrea G. Short
/s/ JOHN B. GRIFFITH
John B. Griffith
/s/ ALLISON N. EGIDI
Allison N. Egidi
/s/ DANIEL B. FITZPATRICK
Daniel B. Fitzpatrick
/s/ TRACY D. GRAHAM
Tracy D. Graham
/s/ CRAIG A. KAPSON
Craig A. Kapson
/s/ NAJEEB A. KHAN
Najeeb A. Khan
/s/ REX MARTIN
Rex Martin
/s/ CHRISTOPHER J. MURPHY IV
Christopher J. Murphy IV
/s/ TIMOTHY K. OZARK
Timothy K. Ozark
/s/ JOHN T. PHAIR
John T. Phair
/s/ MARK D. SCHWABERO
Mark D. Schwabero
Chairman of the Board,
President and Chief Executive Officer
Vice Chairman of the Board
and Director
Treasurer, Chief Financial Officer
and Principal Accounting Officer
Secretary
and General Counsel
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Date
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
February 22, 2013
69 • SRCE
2012 Form 10-K
EXHIBIT 31.1
I, Christopher J. Murphy III, Chief Executive Officer, certify that:
1.
I have reviewed this annual report on Form 10-K of 1st Source Corporation;
CERTIFICATIONS
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c)
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal
quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of the registrant’s Board of Directors:
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely
to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over
financial reporting.
Date: February 22, 2013
By
/s/ CHRISTOPHER J. MURPHY III
Christopher J. Murphy III, Chief Executive Officer
EXHIBIT 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of 1st Source Corporation (1st Source) on Form 10-K for the fiscal year ended December 31, 2012, as filed with the
Securities and Exchange Commission on the date hereof (the “Report”), I, Christopher J. Murphy III, Chief Executive Officer of 1st Source, certify, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities and Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of 1st Source.
Date: February 22, 2013
By
/s/ CHRISTOPHER J. MURPHY III
Christopher J. Murphy III, Chief Executive Officer
70 • SRCE
2012 Form 10-K
EXHIBIT 31.2
I, Andrea G. Short, Chief Financial Officer, certify that:
1.
I have reviewed this annual report on Form 10-K of 1st Source Corporation;
CERTIFICATIONS
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant
and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c)
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal
quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of the registrant’s Board of Directors:
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely
to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over
financial reporting.
Date: February 22, 2013
By
/s/ ANDREA G. SHORT
Andrea G. Short, Chief Financial Officer
EXHIBIT 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of 1st Source Corporation (1st Source) on Form 10-K for the fiscal year ended December 31, 2012, as filed with the
Securities and Exchange Commission on the date hereof (the “Report”), I, Andrea G. Short, Chief Financial Officer of 1st Source, certify, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities and Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of 1st Source.
Date: February 22, 2013
By
/s/ ANDREA G. SHORT
Andrea G. Short, Chief Financial Officer
71 • SRCE
2012 Form 10-K
OFFICERS
Christopher J. Murphy III _____________________________________ Chairman of the Board, President and Chief Executive Officer
Andrea G. Short ____________________________________________ Treasurer and Chief Financial Officer
John B. Griffith _____________________________________________ Secretary and General Counsel
DIRECTORS
Allison N. Egidi _____________________________________________ Major Gifts Officer, University of Virginia
Daniel B. Fitzpatrick _________________________________________ Chairman and Chief Executive Officer, Quality Dining, Inc.
Tracy D. Graham ____________________________________________ Managing Principal, Graham Allen Partners
Wellington D. Jones III _______________________________________ Vice Chairman of the Board
Craig A. Kapson ____________________________________________ President, Jordan Automotive Group
Najeeb A. Khan ____________________________________________ Chairman and Chief Executive Officer, Interlogic Outsourcing, Inc
Rex Martin ________________________________________________ Chairman, President and Chief Executive Officer, NIBCO Inc.
Christopher J. Murphy III _____________________________________ Chairman, President and Chief Executive Officer
Christopher J. Murphy IV _____________________________________ Chief Operating Officer, Owner and Artistic Director, Catharsis Productions, LLC
Timothy K. Ozark ___________________________________________ Chairman and Chief Executive Officer, Aim Financial Corporation
John T. Phair _______________________________________________ President, Holladay Properties
Mark D. Schwabero _________________________________________ President, Mercury Marine
OFFICERS
Christopher J. Murphy III _____________________________________ Chairman of the Board, President and Chief Executive Officer
James R. Seitz _____________________________________________ President, 1st Source Bank
Andrea G. Short ____________________________________________ Senior Vice President, Treasurer and Chief Financial Officer
John B. Griffith _____________________________________________ Executive Vice President, Secretary and General Counsel
Allen R. Qualey _____________________________________________ Executive Vice President, Specialty Finance Group
Steven J. Wessell ___________________________________________ Executive Vice President, Private Banking, Wealth Management, Insurance,
Jeffrey L. Buhr _____________________________________________ Senior Vice President, Chief Credit Officer
Information Technology
72 • SRCE
2012 Form 10-K
P.O. Box 1602, South Bend, Indiana 46634
© 2013 1st Source Corporation all rights reserved.