Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934          

 

For the quarterly period ended June 30, 2013

 

OR

 

o         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

 

GRAPHIC

(Exact name of registrant as specified in its charter)

 

INDIANA

 

35-1068133

(State or other jurisdiction of

 

(I.R.S. Employer Identification

incorporation or organization)

 

No.)

 

 

 

100 North Michigan Street

 

 

South Bend, IN

 

46601

(Address of principal executive

 

(Zip Code)

offices)

 

 

 

(574) 235-2000

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o  Yes   x   No

 

Number of shares of common stock outstanding as of July 12, 2013 — 24,375,595 shares

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

Consolidated Statements of Financial Condition — June 30, 2013 and December 31, 2012

3

 

Consolidated Statements of Income — three and six months ended June 30, 2013 and 2012

4

 

Consolidated Statements of Comprehensive Income — three and six months ended June 30, 2013 and 2012

5

 

Consolidated Statements of Shareholders’ Equity — six months ended June 30, 2013 and 2012

5

 

Consolidated Statements of Cash Flows — six months ended June 30, 2013 and 2012

6

 

Notes to the Consolidated Financial Statements

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

32

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

41

Item 4.

Controls and Procedures

41

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

41

Item 1A.

Risk Factors

41

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

Item 3.

Defaults Upon Senior Securities

42

Item 4.

Mine Safety Disclosures

42

Item 5.

Other Information

42

Item 6.

Exhibits

42

 

 

 

SIGNATURES

 

43

 

 

 

CERTIFICATIONS

 

 

 

Exhibit 31.1

 

 

Exhibit 31.2

 

 

Exhibit 32.1

 

 

Exhibit 32.2

 

 

2



Table of Contents

 

1st SOURCE CORPORATION

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited - Dollars in thousands)

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

ASSETS

 

 

 

 

 

Cash and due from banks

 

$

64,850

 

$

83,232

 

Federal funds sold and interest bearing deposits with other banks

 

3,171

 

702

 

Investment securities available-for-sale (amortized cost of $815,626 and $849,139 at June 30, 2013 and December 31, 2012, respectively)

 

828,312

 

880,764

 

Other investments

 

22,409

 

22,609

 

Trading account securities

 

166

 

146

 

Mortgages held for sale

 

10,849

 

10,879

 

Loans and leases - net of unearned discount

 

 

 

 

 

Commercial and agricultural loans

 

660,380

 

639,069

 

Auto, light truck and environmental equipment

 

510,562

 

438,147

 

Medium and heavy duty truck

 

178,594

 

172,002

 

Aircraft financing

 

677,510

 

696,479

 

Construction equipment financing

 

311,135

 

278,974

 

Commercial real estate

 

576,810

 

554,968

 

Residential real estate

 

454,983

 

438,641

 

Consumer loans

 

123,411

 

109,273

 

Total loans and leases

 

3,493,385

 

3,327,553

 

Reserve for loan and lease losses

 

(85,690

)

(83,311

)

Net loans and leases

 

3,407,695

 

3,244,242

 

Equipment owned under operating leases, net

 

52,856

 

52,173

 

Net premises and equipment

 

46,027

 

45,016

 

Goodwill and intangible assets

 

86,915

 

87,502

 

Accrued income and other assets

 

115,561

 

123,428

 

Total assets

 

$

4,638,811

 

$

4,550,693

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest bearing

 

$

698,389

 

$

646,380

 

Interest bearing

 

3,002,410

 

2,977,967

 

Total deposits

 

3,700,799

 

3,624,347

 

Short-term borrowings:

 

 

 

 

 

Federal funds purchased and securities sold under agreements to repurchase

 

162,778

 

158,680

 

Other short-term borrowings

 

39,126

 

10,508

 

Total short-term borrowings

 

201,904

 

169,188

 

Long-term debt and mandatorily redeemable securities

 

58,216

 

71,021

 

Subordinated notes

 

58,764

 

58,764

 

Accrued expenses and other liabilities

 

51,375

 

68,718

 

Total liabilities

 

4,071,058

 

3,992,038

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

Preferred stock; no par value

 

 

 

 

 

Authorized 10,000,000 shares; none issued or outstanding

 

 

 

Common stock; no par value

 

 

 

 

 

Authorized 40,000,000 shares; issued 25,641,887 at June 30, 2013 and December 31, 2012

 

346,535

 

346,535

 

Retained earnings

 

241,401

 

223,715

 

Cost of common stock in treasury (1,269,292 shares at June 30, 2013 and 1,399,261 shares at December 31, 2012)

 

(28,021

)

(31,134

)

Accumulated other comprehensive income

 

7,838

 

19,539

 

Total shareholders’ equity

 

567,753

 

558,655

 

Total liabilities and shareholders’ equity

 

$

4,638,811

 

$

4,550,693

 

 

The accompanying notes are a part of the consolidated financial statements.

 

3



Table of Contents

 

1st SOURCE CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited - Dollars in thousands, except per share amounts)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Interest income:

 

 

 

 

 

 

 

 

 

Loans and leases

 

$

40,112

 

$

40,318

 

$

79,282

 

$

80,214

 

Investment securities, taxable

 

3,498

 

4,334

 

7,193

 

8,661

 

Investment securities, tax-exempt

 

760

 

848

 

1,531

 

1,700

 

Other

 

241

 

231

 

483

 

457

 

Total interest income

 

44,611

 

45,731

 

88,489

 

91,032

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

4,412

 

5,704

 

8,954

 

11,449

 

Short-term borrowings

 

45

 

47

 

77

 

100

 

Subordinated notes

 

1,055

 

1,648

 

2,110

 

3,295

 

Long-term debt and mandatorily redeemable securities

 

228

 

357

 

723

 

828

 

Total interest expense

 

5,740

 

7,756

 

11,864

 

15,672

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

38,871

 

37,975

 

76,625

 

75,360

 

Provision for loan and lease losses

 

1,293

 

2,055

 

2,050

 

4,309

 

Net interest income after provision for loan and lease losses

 

37,578

 

35,920

 

74,575

 

71,051

 

 

 

 

 

 

 

 

 

 

 

Noninterest income:

 

 

 

 

 

 

 

 

 

Trust fees

 

4,439

 

4,379

 

8,540

 

8,352

 

Service charges on deposit accounts

 

2,325

 

2,621

 

4,564

 

5,059

 

Debit card income

 

2,344

 

2,194

 

4,409

 

4,261

 

Mortgage banking income

 

1,936

 

1,502

 

3,564

 

3,444

 

Insurance commissions

 

1,393

 

1,211

 

2,839

 

2,568

 

Equipment rental income

 

4,086

 

4,666

 

8,098

 

10,016

 

Investment securities and other investment gains

 

38

 

8

 

211

 

403

 

Other income

 

3,560

 

3,209

 

6,844

 

6,210

 

Total noninterest income

 

20,121

 

19,790

 

39,069

 

40,313

 

 

 

 

 

 

 

 

 

 

 

Noninterest expense:

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

19,176

 

20,370

 

39,112

 

40,686

 

Net occupancy expense

 

2,147

 

1,848

 

4,354

 

4,008

 

Furniture and equipment expense

 

3,909

 

3,831

 

7,808

 

7,338

 

Depreciation - leased equipment

 

3,274

 

3,803

 

6,499

 

8,114

 

Professional fees

 

1,310

 

1,449

 

2,665

 

2,847

 

Supplies and communication

 

1,499

 

1,385

 

3,035

 

2,778

 

FDIC and other insurance

 

927

 

854

 

1,805

 

1,803

 

Business development and marketing expense

 

932

 

1,050

 

1,705

 

1,917

 

Loan and lease collection and repossession expense

 

1,095

 

979

 

1,852

 

2,480

 

Other expense

 

1,475

 

1,009

 

3,459

 

2,655

 

Total noninterest expense

 

35,744

 

36,578

 

72,294

 

74,626

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

21,955

 

19,132

 

41,350

 

36,738

 

Income tax expense

 

8,013

 

6,565

 

15,004

 

12,456

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

13,942

 

$

12,567

 

$

26,346

 

$

24,282

 

 

 

 

 

 

 

 

 

 

 

Per common share:

 

 

 

 

 

 

 

 

 

Basic net income per common share

 

$

0.56

 

$

0.51

 

$

1.07

 

$

0.99

 

Diluted net income per common share

 

$

0.56

 

$

0.51

 

$

1.07

 

$

0.99

 

Dividends

 

$

0.17

 

$

0.16

 

$

0.34

 

$

0.32

 

Basic weighted average common shares outstanding

 

24,367,529

 

24,263,881

 

24,344,882

 

24,261,649

 

Diluted weighted average common shares outstanding

 

24,368,973

 

24,273,898

 

24,346,053

 

24,272,423

 

 

The accompanying notes are a part of the consolidated financial statements.

 

4



Table of Contents

 

1st SOURCE CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME      

(Unaudited - Dollars in thousands)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

13,942

 

$

12,567

 

$

26,346

 

$

24,282

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

Change in unrealized (depreciation) appreciation of available-for-sale securities, net of tax

 

(10,495

)

1,449

 

(11,701

)

1,047

 

Reclassification adjustment for gains included in net income, net of tax

 

 

 

 

(171

)

Other comprehensive (loss) income

 

(10,495

)

1,449

 

(11,701

)

876

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

3,447

 

$

14,016

 

$

14,645

 

$

25,158

 

 

The accompanying notes are a part of the consolidated financial statements.

 

1st SOURCE CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited - Dollars in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Cost of

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Common

 

Other

 

 

 

 

 

Preferred

 

Common

 

Retained

 

Stock

 

Comprehensive

 

 

 

Total

 

Stock

 

Stock

 

Earnings

 

in Treasury

 

Income (Loss), Net

 

Balance at January 1, 2012

 

$

523,918

 

$

 

$

346,535

 

$

190,261

 

$

(31,389

)

$

18,511

 

Net income

 

24,282

 

 

 

24,282

 

 

 

Other comprehensive income

 

876

 

 

 

 

 

876

 

Issuance of 165,460 common shares under stock based compensation awards, including related tax effects

 

3,644

 

 

 

85

 

3,559

 

 

Cost of 104,471 shares of common stock acquired for treasury

 

(2,617

)

 

 

 

(2,617

)

 

Common stock dividend ($0.32 per share)

 

(7,839

)

 

 

(7,839

)

 

 

Balance at June 30, 2012

 

$

542,264

 

$

 

$

346,535

 

$

206,789

 

$

(30,447

)

$

19,387

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2013

 

$

558,655

 

$

 

$

346,535

 

$

223,715

 

$

(31,134

)

$

19,539

 

Net income

 

26,346

 

 

 

26,346

 

 

 

Other comprehensive loss

 

(11,701

)

 

 

 

 

(11,701

)

Issuance of 157,032 common shares under stock based compensation awards, including related tax effects

 

3,419

 

 

 

(313

)

3,732

 

 

Cost of 27,063 shares of common stock acquired for treasury

 

(619

)

 

 

 

(619

)

 

Common stock dividend ($0.34 per share)

 

(8,347

)

 

 

(8,347

)

 

 

Balance at June 30, 2013

 

$

567,753

 

$

 

$

346,535

 

$

241,401

 

$

(28,021

)

$

7,838

 

 

The accompanying notes are a part of the consolidated financial statements.

 

5



Table of Contents

 

1st SOURCE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited - Dollars in thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

Operating activities:

 

 

 

 

 

Net income

 

$

26,346

 

$

24,282

 

Adjustments to reconcile net income to net cash provided (used) by operating activities:

 

 

 

 

 

Provision for loan and lease losses

 

2,050

 

4,309

 

Depreciation of premises and equipment

 

2,331

 

2,094

 

Depreciation of equipment owned and leased to others

 

6,499

 

8,114

 

Amortization of investment security premiums and accretion of discounts, net

 

1,929

 

1,999

 

Amortization of mortgage servicing rights

 

937

 

1,528

 

Mortgage servicing asset recoveries

 

 

(147

)

Deferred income taxes

 

(2,020

)

(3,996

)

Investment securities and other investment gains

 

(211

)

(403

)

Originations of loans held for sale, net of principal collected

 

(59,773

)

(96,948

)

Proceeds from the sales of loans held for sale

 

62,295

 

94,491

 

Net gain on sale of loans held for sale

 

(2,492

)

(2,736

)

Change in trading account securities

 

(20

)

(6

)

Change in interest receivable

 

(912

)

(312

)

Change in interest payable

 

1,041

 

1,702

 

Change in other assets

 

10,939

 

7,894

 

Change in other liabilities

 

(7,795

)

(4,542

)

Other

 

341

 

586

 

Net change in operating activities

 

41,485

 

37,909

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

Proceeds from sales of investment securities

 

 

40,236

 

Proceeds from maturities of investment securities

 

112,836

 

159,553

 

Purchases of investment securities

 

(81,041

)

(169,504

)

Net change in other investments

 

200

 

(960

)

Loans sold or participated to others

 

19,819

 

15,494

 

Net change in loans and leases

 

(187,832

)

(199,988

)

Net change in equipment owned under operating leases

 

(7,182

)

3,173

 

Purchases of premises and equipment

 

(3,361

)

(3,082

)

Net change in investing activities

 

(146,561

)

(155,078

)

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

Net change in demand deposits, NOW accounts and savings accounts

 

61,457

 

92,814

 

Net change in certificates of deposit

 

14,995

 

(26,938

)

Net change in short-term borrowings

 

32,716

 

8,694

 

Proceeds from issuance of long-term debt

 

12,035

 

25,600

 

Payments on long-term debt

 

(26,296

)

(268

)

Net proceeds from issuance of treasury stock

 

3,419

 

3,644

 

Acquisition of treasury stock

 

(619

)

(2,617

)

Cash dividends paid on common stock

 

(8,544

)

(8,007

)

Net change in financing activities

 

89,163

 

92,922

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

(15,913

)

(24,247

)

 

 

 

 

 

 

Cash and cash equivalents, beginning of year

 

83,934

 

114,327

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

68,021

 

$

90,080

 

 

 

 

 

 

 

Supplemental Information:

 

 

 

 

 

Non-cash transactions:

 

 

 

 

 

Loans transferred to other real estate and repossessed assets

 

$

2,510

 

$

1,791

 

Common stock matching contribution to Employee Stock Ownership and Profit Sharing Plan

 

2,801

 

2,643

 

 

The accompanying notes are a part of the consolidated financial statements.

 

6



Table of Contents

 

1ST SOURCE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1.                     Basis of Presentation

 

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.  The accompanying unaudited consolidated financial statements reflect all adjustments (all of which are normal and recurring in nature) which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, the results of operations, changes in comprehensive income, changes in shareholders’ equity, and cash flows for the periods presented.  These unaudited consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been omitted.

 

The Notes to the Consolidated Financial Statements appearing in 1st Source Corporation’s Annual Report on Form 10-K (2012 Annual Report), which include descriptions of significant accounting policies, should be read in conjunction with these interim financial statements.  The Consolidated Statement of Financial Condition at December 31, 2012 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  Certain amounts in the prior period consolidated financial statements have been reclassified to conform to the current year presentation.

 

Note 2.                     Recent Accounting Pronouncements

 

Comprehensive Income:  In February 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-02 “Comprehensive Income (Topic 220) — Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU 2013-02 requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component.  ASU 2013-02 is effective prospectively during interim and annual periods beginning after December 15, 2012.  The Company has adopted the standard as required, however the effect of applying this standard is not reflected in the June 30, 2013 Form 10Q as the Company did not have amounts reclassified out of Accumulated Other Comprehensive Income during the three or six months ended June 30, 2013.  Amounts in future periods, when they occur, will be reflected in the investment securities and other investment gains and the income tax expense line items in the Consolidated Statements of Income.

 

Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities:  In January 2013, the FASB issued ASU No. 2013-01 “Balance Sheet (Topic 210) — Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.”  ASU 2013-01 clarifies that ordinary trade receivables and receivables are not in the scope of ASU 2011-11.  ASU 2011-11 applies only to derivatives, repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria in the Accounting Standards Codification or subject to a master netting arrangement or similar agreement.  ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods.  Retrospective disclosure is required for all comparative periods presented.  The effect of applying this standard is reflected in Note 8 — Derivative Financial Instruments.

 

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Table of Contents

 

Offsetting Assets and Liabilities:  In December 2011, the FASB issued 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 periods within those annual periods.  Retrospective disclosure is required for all comparative periods presented.  The effect of applying this standard is reflected in Note 8 — Derivative Financial Instruments.

 

Note 3.                     Investment Securities

 

Investment securities available-for-sale were as follows:

 

 

 

Amortized

 

Gross

 

Gross

 

 

 

(Dollars in thousands)

 

Cost

 

Unrealized Gains

 

Unrealized Losses

 

Fair Value

 

June 30, 2013

 

 

 

 

 

 

 

 

 

U.S. Treasury and Federal agencies securities

 

$

391,452

 

$

6,545

 

$

(5,357

)

$

392,640

 

U.S. States and political subdivisions securities

 

103,875

 

3,949

 

(1,186

)

106,638

 

Mortgage-backed securities — Federal agencies

 

287,099

 

6,749

 

(2,626

)

291,222

 

Corporate debt securities

 

28,133

 

216

 

(18

)

28,331

 

Foreign government and other securities

 

2,700

 

9

 

(1

)

2,708

 

Total debt securities

 

813,259

 

17,468

 

(9,188

)

821,539

 

Marketable equity securities

 

2,367

 

4,409

 

(3

)

6,773

 

Total investment securities available-for-sale

 

$

815,626

 

$

21,877

 

$

(9,191

)

$

828,312

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

U.S. Treasury and Federal agencies securities

 

$

410,983

 

$

11,353

 

$

(83

)

$

422,253

 

U.S. States and political subdivisions securities

 

100,055

 

5,864

 

(482

)

105,437

 

Mortgage-backed securities — Federal agencies

 

301,136

 

11,296

 

(25

)

312,407

 

Corporate debt securities

 

30,897

 

445

 

(94

)

31,248

 

Foreign government and other securities

 

3,700

 

26

 

 

3,726

 

Total debt securities

 

846,771

 

28,984

 

(684

)

875,071

 

Marketable equity securities

 

2,368

 

3,329

 

(4

)

5,693

 

Total investment securities available-for-sale

 

$

849,139

 

$

32,313

 

$

(688

)

$

880,764

 

 

At June 30, 2013 and 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).

 

The contractual maturities of investments in debt securities available-for-sale at June 30, 2013 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)

 

Amortized Cost

 

Fair Value

 

Due in one year or less

 

$

123,887

 

$

123,155

 

Due after one year through five years

 

330,448

 

336,000

 

Due after five years through ten years

 

70,565

 

69,983

 

Due after ten years

 

1,260

 

1,179

 

Mortgage-backed securities

 

287,099

 

291,222

 

Total debt securities available-for-sale

 

$

813,259

 

$

821,539

 

 

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Table of Contents

 

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.  Realized gains and losses on the sales of all securities are computed using the specific identification cost basis.  There were no other-than-temporary-impairment (OTTI) write-downs in 2013 or 2012.

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(Dollars in thousands)

 

2013

 

2012

 

2013

 

2012

 

Gross realized gains

 

$

 

$

 

$

 

$

275

 

Gross realized losses

 

 

 

 

 

Net realized gains

 

$

 

$

 

$

 

$

275

 

 

The following table summarizes gross unrealized losses and fair value by investment category and age.

 

 

 

Less than 12 Months

 

12 months or Longer

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

(Dollars in thousands) 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and Federal agencies securities

 

$

186,172

 

$

(5,185

)

$

15,069

 

$

(172

)

$

201,241

 

$

(5,357

)

U.S. States and political subdivisions securities

 

29,755

 

(875

)

2,343

 

(311

)

32,098

 

(1,186

)

Mortgage-backed securities - Federal agencies

 

70,652

 

(2,625

)

52

 

(1

)

70,704

 

(2,626

)

Corporate debt securities

 

 

 

4,507

 

(18

)

4,507

 

(18

)

Foreign government and other securities

 

199

 

(1

)

 

 

199

 

(1

)

Total debt securities

 

286,778

 

(8,686

)

21,971

 

(502

)

308,749

 

(9,188

)

Marketable equity securities

 

 

 

5

 

(3

)

5

 

(3

)

Total investment securities available-for-sale

 

$

286,778

 

$

(8,686

)

$

21,976

 

$

(505

)

$

308,754

 

$

(9,191

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and Federal agencies securities

 

$

37,316

 

$

(83

)

$

 

$

 

$

37,316

 

$

(83

)

U.S. States and political subdivisions securities

 

7,730

 

(46

)

3,364

 

(436

)

11,094

 

(482

)

Mortgage-backed securities - Federal agencies

 

6,264

 

(24

)

60

 

(1

)

6,324

 

(25

)

Corporate debt securities

 

 

 

4,431

 

(94

)

4,431

 

(94

)

Foreign government and other securities

 

100

 

 

 

 

100

 

 

Total debt securities

 

51,410

 

(153

)

7,855

 

(531

)

59,265

 

(684

)

Marketable equity securities

 

 

 

5

 

(4

)

5

 

(4

)

Total investment securities available-for-sale

 

$

51,410

 

$

(153

)

$

7,860

 

$

(535

)

$

59,270

 

$

(688

)

 

The initial indication of OTTI for both debt and equity securities is a decline in fair value below amortized cost.  Quarterly, the 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 a recovery of cost.

 

At June 30, 2013, 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.  Primarily 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 re-pricing 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.

 

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Table of Contents

 

At June 30, 2013 and December 31, 2012, investment securities with carrying values of $234.05 million and $216.34 million, respectively, were pledged as collateral to secure government deposits, security repurchase agreements, and for other purposes.

 

Note 4.                     Loan and Lease Financings

 

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 the Company’s 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 the 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.

 

 

 

Credit Quality Grades

 

(Dollars in thousands) 

 

1-6

 

7-12

 

Total

 

June 30, 2013

 

 

 

 

 

 

 

Commercial and agricultural loans

 

$

632,373

 

$

28,007

 

$

660,380

 

Auto, light truck and environmental equipment

 

498,023

 

12,539

 

510,562

 

Medium and heavy duty truck

 

176,267

 

2,327

 

178,594

 

Aircraft financing

 

634,459

 

43,051

 

677,510

 

Construction equipment financing

 

296,960

 

14,175

 

311,135

 

Commercial real estate

 

542,186

 

34,624

 

576,810

 

Total

 

$

2,780,268

 

$

134,723

 

$

2,914,991

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

Commercial and agricultural loans

 

$

612,567

 

$

26,502

 

$

639,069

 

Auto, light truck and environmental equipment

 

428,582

 

9,565

 

438,147

 

Medium and heavy duty truck

 

170,116

 

1,886

 

172,002

 

Aircraft financing

 

648,316

 

48,163

 

696,479

 

Construction equipment financing

 

262,980

 

15,994

 

278,974

 

Commercial real estate

 

507,219

 

47,749

 

554,968

 

Total

 

$

2,629,780

 

$

149,859

 

$

2,779,639

 

 

10



Table of Contents

 

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.  Nonperforming loans are those loans which are on nonaccrual status or are 90 days or more past due.

 

(Dollars in thousands) 

 

Performing

 

Nonperforming

 

Total

 

Juune 30, 2013

 

 

 

 

 

 

 

Residential real estate

 

$

452,262

 

$

2,721

 

$

454,983

 

Consumer

 

122,986

 

425

 

123,411

 

Total

 

$

575,248

 

$

3,146

 

$

578,394

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

Residential real estate

 

$

435,962

 

$

2,679

 

$

438,641

 

Consumer

 

108,814

 

459

 

109,273

 

Total

 

$

544,776

 

$

3,138

 

$

547,914

 

 

The table below presents the recorded investment of loans and leases, segregated by class, with delinquency aging and nonaccrual status.

 

 

 

 

 

 

 

 

 

90 Days

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

or More

 

 

 

 

 

 

 

 

 

 

 

30-59 Days

 

60-89 Days

 

Past Due

 

Total

 

 

 

Total Financing

 

(Dollars in thousands) 

 

Current

 

Past Due

 

Past Due

 

and Accruing

 

Accruing Loans

 

Nonaccrual

 

Receivables

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and agricultural loans

 

$

652,550

 

$

164

 

$

149

 

$

 

$

652,863

 

$

7,517

 

$

660,380

 

Auto, light truck and environmental equipment

 

509,899

 

264

 

53

 

 

510,216

 

346

 

510,562

 

Medium and heavy duty truck

 

177,878

 

 

 

 

177,878

 

716

 

178,594

 

Aircraft financing

 

667,269

 

5,746

 

 

 

673,015

 

4,495

 

677,510

 

Construction equipment financing

 

306,999

 

174

 

 

 

307,173

 

3,962

 

311,135

 

Commercial real estate

 

567,490

 

 

 

 

567,490

 

9,320

 

576,810

 

Residential real estate

 

450,728

 

878

 

656

 

145

 

452,407

 

2,576

 

454,983

 

Consumer

 

121,887

 

912

 

187

 

39

 

123,025

 

386

 

123,411

 

Total

 

$

3,454,700

 

$

8,138

 

$

1,045

 

$

184

 

$

3,464,067

 

$

29,318

 

$

3,493,385

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and agricultural loans

 

$

629,035

 

$

807

 

$

48

 

$

 

$

629,890

 

$

9,179

 

$

639,069

 

Auto, light truck and environmental equipment

 

437,087

 

202

 

 

 

437,289

 

858

 

438,147

 

Medium and heavy duty truck

 

171,950

 

 

 

 

171,950

 

52

 

172,002

 

Aircraft financing

 

691,187

 

 

 

 

691,187

 

5,292

 

696,479

 

Construction equipment financing

 

272,817

 

598

 

274

 

 

273,689

 

5,285

 

278,974

 

Commercial real estate

 

541,811

 

102

 

 

 

541,913

 

13,055

 

554,968

 

Residential real estate

 

434,434

 

1,019

 

509

 

356

 

436,318

 

2,323

 

438,641

 

Consumer

 

107,630

 

816

 

368

 

86

 

108,900

 

373

 

109,273

 

Total

 

$

3,285,951

 

$

3,544

 

$

1,199

 

$

442

 

$

3,291,136

 

$

36,417

 

$

3,327,553

 

 

11



Table of Contents

 

The table below presents impaired loans and leases, segregated by class, and the corresponding reserve for impaired loan and lease losses.

 

 

 

 

 

Unpaid

 

 

 

 

 

Recorded

 

Principal

 

Related

 

(Dollars in thousands) 

 

Investment

 

Balance

 

Allowance

 

June 30, 2013

 

 

 

 

 

 

 

With no related allowance recorded:

 

 

 

 

 

 

 

Commercial and agricultural loans

 

$

6,973

 

$

6,972

 

$

 

Auto, light truck and environmental equipment

 

142

 

142

 

 

Medium and heavy duty truck

 

711

 

711

 

 

Aircraft financing

 

292

 

292

 

 

Construction equipment financing

 

3,895

 

3,893

 

 

Commercial real estate

 

17,293

 

17,293

 

 

Residential real estate

 

 

 

 

Consumer loans

 

 

 

 

Total with no related allowance recorded

 

29,306

 

29,303

 

 

With an allowance recorded:

 

 

 

 

 

 

 

Commercial and agricultural loans

 

5,235

 

5,235

 

222

 

Auto, light truck and environmental equipment

 

 

 

 

Medium and heavy duty truck

 

 

 

 

Aircraft financing

 

4,132

 

4,132

 

537

 

Construction equipment financing

 

 

 

 

Commercial real estate

 

 

 

 

Residential real estate

 

 

 

 

Consumer loans

 

 

 

 

Total with an allowance recorded

 

9,367

 

9,367

 

759

 

Total impaired loans

 

$

38,673

 

$

38,670

 

$

759

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

With no related allowance recorded:

 

 

 

 

 

 

 

Commercial and agricultural loans

 

$

2,572

 

$

2,572

 

$

 

Auto, light truck and environmental equipment

 

474

 

474

 

 

Medium and heavy duty truck

 

 

 

 

Aircraft financing

 

3,115

 

3,115

 

 

Construction equipment financing

 

5,109

 

5,107

 

 

Commercial real estate

 

19,597

 

19,597

 

 

Residential real estate

 

101

 

101

 

 

Consumer loans

 

 

 

 

Total with no related allowance recorded

 

30,968

 

30,966

 

 

With an allowance recorded:

 

 

 

 

 

 

 

Commercial and agricultural loans

 

6,075

 

6,074

 

729

 

Auto, light truck and environmental equipment

 

 

 

 

Medium and heavy duty truck

 

 

 

 

Aircraft financing

 

2,086

 

2,086

 

852

 

Construction equipment financing

 

 

 

 

Commercial real estate

 

1,588

 

1,588

 

42

 

Residential real estate

 

 

 

 

Consumer loans

 

 

 

 

Total with an allowance recorded

 

9,749

 

9,748

 

1,623

 

Total impaired loans

 

$

40,717

 

$

40,714

 

$

1,623

 

 

12



Table of Contents

 

Average recorded investment and interest income recognized on impaired loans and leases, segregated by class, is shown in the table below.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

(Dollars in thousands) 

 

Average
Recorded
Investment

 

Interest
Income

 

Average
Recorded
Investment

 

Interest
Income

 

Average

Recorded
Investment

 

Interest
Income

 

Average
Recorded
Investment

 

Interest
Income

 

Commercial and agricultural loans

 

$

8,850

 

$

32

 

$

9,219

 

$

2

 

$

8,585

 

$

35

 

$

9,606

 

$

10

 

Auto, light truck and environmental equipment

 

159

 

 

3,251

 

 

313

 

 

2,421

 

7

 

Medium and heavy duty truck

 

237

 

 

940

 

1

 

118

 

 

1,158

 

1

 

Aircraft financing

 

7,868

 

 

8,126

 

 

8,068

 

 

10,197

 

 

Construction equipment financing

 

3,975

 

1

 

5,019

 

1

 

4,340

 

3

 

4,342

 

5

 

Commercial real estate

 

18,446

 

152

 

23,006

 

115

 

19,495

 

304

 

22,116

 

164

 

Residential real estate

 

 

 

106

 

2

 

 

 

71

 

2

 

Consumer

 

 

 

 

 

 

 

 

 

Total

 

$

39,535

 

$

185

 

$

49,667

 

$

121

 

$

40,919

 

$

342

 

$

49,911

 

$

189

 

 

The number of loans and leases classified as troubled debt restructuring (TDR) during the three and six months ended June 30, 2013 and 2012, segregated by class, are shown in the table below as well as the recorded investment as of June 30. The classification between nonperforming and performing is shown at the time of modification.  During 2013 and 2012, 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 is immaterial.

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

(Dollars in thousands)

 

Number of
Modifications

 

Recorded
Investment

 

Number of
Modifications

 

Recorded
Investment

 

Number of
Modifications

 

Recorded
Investment

 

Number of
Modifications

 

Recorded Investment

 

Performing TDRs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and agricultural loans

 

1

 

$

750

 

 

$

 

1

 

$

750

 

 

$

 

Auto, light truck and environmental equipment

 

 

 

 

 

 

 

 

 

Medium and heavy duty truck

 

 

 

 

 

 

 

 

 

Aircraft financing

 

 

 

 

 

 

 

 

 

Construction equipment financing

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

 

1

 

7,014

 

 

 

1

 

7,014

 

Residential real estate

 

 

 

 

 

 

 

1

 

106

 

Consumer

 

 

 

 

 

 

 

 

 

Total performing TDR modifications

 

1

 

$

750

 

1

 

$

7,014

 

1

 

$

750

 

2

 

$

7,120

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonperforming TDRs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and agricultural loans

 

 

$

 

 

$

 

1

 

$

280

 

 

$

 

Auto, light truck and environmental equipment

 

 

 

 

 

 

 

 

 

Medium and heavy duty truck

 

 

 

 

 

 

 

 

 

Aircraft financing

 

 

 

 

 

 

 

 

 

Construction equipment financing

 

 

 

3

 

1,618

 

 

 

3

 

1,618

 

Commercial real estate

 

 

 

 

 

 

 

 

 

Residential real estate

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

Total nonperforming TDR modifications

 

 

$

 

3

 

$

1,618

 

1

 

$

280

 

3

 

$

1,618

 

Total TDR modifications

 

1

 

$

750

 

4

 

$

8,632

 

2

 

$

1,030

 

5

 

$

8,738

 

 

There was one commercial and agricultural TDR which had payment defaults within the twelve months following modification during the three and six months ended June 30, 2013.  This loan was transferred into Other Real Estate during the three months ended June 30, 2013.  There were no TDRs which had payment

 

13



Table of Contents

 

defaults within twelve months following modification during the three and six months ended June 30, 2012.  Default occurs when a loan or lease is 90 days or more past due under the modified terms or transferred to nonaccrual.

 

The table below presents the recorded investment of loans and leases classified as troubled debt restructurings as of June 30, 2013 and December 31, 2012.

 

 

 

June 30,

 

December 31,

 

(Dollars in thousands)

 

2013

 

2012

 

Performing TDRs

 

$

9,277

 

$

8,839

 

Nonperforming TDRs

 

9,213

 

12,869

 

Total TDRs

 

$

18,490

 

$

21,708

 

 

Note 5.       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 the historical charge-off analysis is updated, the Company reviews the look-back periods for each business loan portfolio.  Furthermore, a thorough analysis of charge-offs, non-performing asset levels, special attention outstandings and delinquency is performed 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.  The Company adjusts the calculated historical based ratio as a result of the analysis of environmental factors, principally economic risk and concentration risk.  Key economic factors affecting the portfolios are growth in gross domestic product, unemployment rates, housing market trends, commodity prices, inflation and global economic and political issues.  Concentration risk is impacted primarily by geographic concentration in Northern Indiana and Southwestern Lower Michigan in the business banking and commercial real estate portfolios and by collateral concentration in the specialty finance portfolios and exposure to foreign markets by geographic risk.

 

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 homogeneous 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.

 

14



Table of Contents

 

Changes in the reserve for loan and lease losses, segregated by class, for the three months ended June 30, 2013 and 2012 are shown below.

 

(Dollars in thousands) 

 

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

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reserve for loan and lease losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

13,227

 

$

9,330

 

$

2,839

 

$

33,832

 

$

5,725

 

$

13,921

 

$

3,706

 

$

1,431

 

$

84,011

 

Charge-offs

 

129

 

 

 

 

5

 

102

 

77

 

178

 

491

 

Recoveries

 

132

 

15

 

15

 

506

 

39

 

81

 

5

 

84

 

877

 

Net charge-offs (recoveries)

 

(3

)

(15

)

(15

)

(506

)

(34

)

21

 

72

 

94

 

(386

)

Provision (recovery of provision)

 

(1,028

)

2,544

 

324

 

(1,015

)

306

 

(371

)

261

 

272

 

1,293

 

Balance, end of period

 

$

12,202

 

$

11,889

 

$

3,178

 

$

33,323

 

$

6,065

 

$

13,529

 

$

3,895

 

$

1,609

 

$

85,690

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment

 

$

222

 

$

 

$

 

$

537

 

$

 

$

 

$

 

$

 

$

759

 

Ending balance, collectively evaluated for impairment

 

11,980

 

11,889

 

3,178

 

32,786

 

6,065

 

13,529

 

3,895

 

1,609

 

84,931

 

Total reserve for loan and lease losses

 

$

12,202

 

$

11,889

 

$

3,178

 

$

33,323

 

$

6,065

 

$

13,529

 

$

3,895

 

$

1,609

 

$

85,690

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recorded investment in loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment

 

$

12,208

 

$

142

 

$

711

 

$

4,424

 

$

3,895

 

$

17,293

 

$

 

$

 

$

38,673

 

Ending balance, collectively evaluated for impairment

 

648,172

 

510,420

 

177,883

 

673,086

 

307,240

 

559,517

 

454,983

 

123,411

 

3,454,712

 

Total recorded investement in loans

 

$

660,380

 

$

510,562

 

$

178,594

 

$

677,510

 

$

311,135

 

$

576,810

 

$

454,983

 

$

123,411

 

$

3,493,385

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reserve for loan and lease losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

12,525

 

$

9,769

 

$

3,667

 

$

28,598

 

$

6,851

 

$

16,326

 

$

3,378

 

$

1,280

 

$

82,394

 

Charge-offs

 

126

 

867

 

 

 

 

109

 

32

 

539

 

1,673

 

Recoveries

 

68

 

75

 

1

 

196

 

50

 

45

 

2

 

86

 

523

 

Net charge-offs (recoveries)

 

58

 

792

 

(1

)

(196

)

(50

)

64

 

30

 

453

 

1,150

 

Provision (recovery of provision)

 

610

 

1,323

 

(50

)

1,077

 

(571

)

(1,090

)

173

 

583

 

2,055

 

Balance, end of period

 

$

13,077

 

$

10,300

 

$

3,618

 

$

29,871

 

$

6,330

 

$

15,172

 

$

3,521

 

$

1,410

 

$

83,299

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment

 

$

1,073

 

$

500

 

$

 

$

688

 

$

 

$

19

 

$

 

$

 

$

2,280

 

Ending balance, collectively evaluated for impairment

 

12,004

 

9,800

 

3,618

 

29,183

 

6,330

 

15,153

 

3,521

 

1,410

 

81,019

 

Total reserve for loan and lease losses

 

$

13,077

 

$

10,300

 

$

3,618

 

$

29,871

 

$

6,330

 

$

15,172

 

$

3,521

 

$

1,410

 

$

83,299

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recorded investment in loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment

 

$

8,946

 

$

2,643

 

$

787

 

$

6,308

 

$

5,022

 

$

23,535

 

$

106

 

$

 

$

47,347

 

Ending balance, collectively evaluated for impairment

 

547,040

 

505,850

 

171,518

 

655,876

 

275,693

 

520,157

 

441,481

 

105,630

 

3,223,245

 

Total recorded investement in loans

 

$

555,986

 

$

508,493

 

$

172,305

 

$

662,184

 

$

280,715

 

$

543,692

 

$

441,587

 

$

105,630

 

$

3,270,592

 

 

15



Table of Contents

 

Changes in the reserve for loan and lease losses, segregated by class, for the six months ended June 30, 2013 and 2012 are shown below.

 

(Dollars in thousands) 

 

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

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reserve for loan and lease losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

12,326

 

$

9,584

 

$

3,001

 

$

34,205

 

$

5,390

 

$

13,778

 

$

3,652

 

$

1,375

 

$

83,311

 

Charge-offs

 

414

 

1

 

 

31

 

88

 

164

 

154

 

601

 

1,453

 

Recoveries

 

241

 

138

 

29

 

684

 

74

 

410

 

11

 

195

 

1,782

 

Net charge-offs (recoveries)

 

173

 

(137

)

(29

)

(653

)

14

 

(246

)

143

 

406

 

(329

)

Provision (recovery of provision)

 

49

 

2,168

 

148

 

(1,535

)

689

 

(495

)

386

 

640

 

2,050

 

Balance, end of period

 

$

12,202

 

$

11,889

 

$

3,178

 

$

33,323

 

$

6,065

 

$

13,529

 

$

3,895

 

$

1,609

 

$

85,690

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment

 

$

222

 

$

 

$

 

$

537

 

$

 

$

 

$

 

$

 

$

759

 

Ending balance, collectively evaluated for impairment

 

11,980

 

11,889

 

3,178

 

32,786

 

6,065

 

13,529

 

3,895

 

1,609

 

84,931

 

Total reserve for loan and lease losses

 

$

12,202

 

$

11,889

 

$

3,178

 

$

33,323

 

$

6,065

 

$

13,529

 

$

3,895

 

$

1,609

 

$

85,690

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recorded investment in loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment

 

$

12,208

 

$

142

 

$

711

 

$

4,424

 

$

3,895

 

$

17,293

 

$

 

$

 

$

38,673

 

Ending balance, collectively evaluated for impairment

 

648,172

 

510,420

 

177,883

 

673,086

 

307,240

 

559,517

 

454,983

 

123,411

 

3,454,712

 

Total recorded investement in loans

 

$

660,380

 

$

510,562

 

$

178,594

 

$

677,510

 

$

311,135

 

$

576,810

 

$

454,983

 

$

123,411

 

$

3,493,385

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reserve for loan and lease losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

13,091

 

$

8,469

 

$

3,742

 

$

28,626

 

$

6,295

 

$

16,772

 

$

3,362

 

$

1,287

 

$

81,644

 

Charge-offs

 

272

 

2,900

 

 

139

 

119

 

142

 

73

 

795

 

4,440

 

Recoveries

 

164

 

858

 

22

 

321

 

84

 

79

 

34

 

224

 

1,786

 

Net charge-offs (recoveries)

 

108

 

2,042

 

(22

)

(182

)

35

 

63

 

39

 

571

 

2,654

 

Provision (recovery of provision)

 

94

 

3,873

 

(146

)

1,063

 

70

 

(1,537

)

198

 

694

 

4,309

 

Balance, end of period

 

$

13,077

 

$

10,300

 

$

3,618

 

$

29,871

 

$

6,330

 

$

15,172

 

$

3,521

 

$

1,410

 

$

83,299

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment

 

$

1,073

 

$

500

 

$

 

$

688

 

$

 

$

19

 

$

 

$

 

$

2,280

 

Ending balance, collectively evaluated for impairment

 

12,004

 

9,800

 

3,618

 

29,183

 

6,330

 

15,153

 

3,521

 

1,410

 

81,019

 

Total reserve for loan and lease losses

 

$

13,077

 

$

10,300

 

$

3,618

 

$

29,871

 

$

6,330

 

$

15,172

 

$

3,521

 

$

1,410

 

$

83,299

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recorded investment in loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment

 

$

8,946

 

$

2,643

 

$

787

 

$

6,308

 

$

5,022

 

$

23,535

 

$

106

 

$

 

$

47,347

 

Ending balance, collectively evaluated for impairment

 

547,040

 

505,850

 

171,518

 

655,876

 

275,693

 

520,157

 

441,481

 

105,630

 

3,223,245

 

Total recorded investement in loans

 

$

555,986

 

$

508,493

 

$

172,305

 

$

662,184

 

$

280,715

 

$

543,692

 

$

441,587

 

$

105,630

 

$

3,270,592

 

 

Note 6.       Mortgage Servicing Assets

 

The Company recognizes the rights to service residential 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 relative fair value.  The unpaid principal balance of residential mortgage loans serviced for third parties was $864.41 million and $921.20 million at June 30, 2013 and December 31, 2012, respectively.

 

16



Table of Contents

 

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.

 

Changes in the carrying value of mortgage servicing assets and the associated valuation allowance follow:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

(Dollars in thousands)

 

2013

 

2012

 

2013

 

2012

 

Mortgage servicing assets:

 

 

 

 

 

 

 

 

 

Balance at beginning of period

 

$

4,528

 

$

5,248

 

$

4,645

 

$

5,610

 

Additions

 

563

 

572

 

926

 

902

 

Amortization

 

(457

)

(836

)

(937

)

(1,528

)

Sales

 

 

 

 

 

Carrying value before valuation allowance at end of period

 

4,634

 

4,984

 

4,634

 

4,984

 

 

 

 

 

 

 

 

 

 

 

Valuation allowance:

 

 

 

 

 

 

 

 

 

Balance at beginning of period

 

 

(4

)

 

(238

)

Impairment (charges) recoveries

 

 

(87

)

 

147

 

Balance at end of period

 

$

 

$

(91

)

$

 

$

(91

)

Net carrying value of mortgage servicing assets at end of period

 

$

4,634

 

$

4,893

 

$

4,634

 

$

4,893

 

Fair value of mortgage servicing assets at end of period

 

$

7,240

 

$

5,622

 

$

7,240

 

$

5,622

 

 

During the six months ended June 30, 2013, the Company determined that it was not necessary to permanently write-down any previously established valuation allowance.  At June 30, 2013 and 2012, the fair value of mortgage servicing assets exceeded the carrying value reported in the consolidated statement of financial condition by $2.61 million and $0.73 million, respectively.  This difference represents increases in the fair value of certain mortgage servicing assets that could not be recorded above cost basis.

 

Mortgage loan contractual servicing fees, including late fees and ancillary income, were $0.82 million and $0.88 million for the three months ended June 30, 2013 and 2012, respectively.  Mortgage loan contractual servicing fees, including late fees and ancillary income, were $1.64 million and $1.82 million for the six months ended June 30, 2013 and 2012, respectively.  Mortgage loan contractual servicing fees are included in mortgage banking income in the consolidated statements of income.

 

Note 7.       Commitments and Financial Instruments with Off-Balance-Sheet Risk

 

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 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.

 

1st Source Bank (Bank), a subsidiary of 1st Source Corporation, 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.  Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the

 

17



Table of Contents

 

commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

The Bank issues letters of credit which are conditional commitments that guarantee the performance of a client to a third party.  The credit risk involved and collateral obtained in issuing letters of credit is essentially the same as that involved in extending loan commitments to clients.  Standby letters of credit totaled $15.20 million and $17.29 million at June 30, 2013 and December 31, 2012, respectively.  Standby letters of credit generally have terms ranging from six months to one year.

 

Note 8.       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 7 for further information.

 

The Company has certain interest rate derivative positions that are not designated as hedging instruments.  Derivative assets and liabilities are recorded at fair value on the balance sheet and do take into account the effects of master netting agreements.  Master netting agreements allow the Company to settle all derivative contracts held with a single counterparty on a net basis, and to offset net derivative positions with related collateral, where applicable. 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 institutions 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 June 30, 2013 and December 31, 2012, 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

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts

 

$

423,397

 

Other assets

 

$

10,740

 

Other liabilities

 

$

10,945

 

Loan commitments

 

14,438

 

Mortgages held for sale

 

153

 

N/A

 

 

Forward contracts

 

19,600

 

Mortgages held for sale

 

764

 

N/A

 

 

Total

 

$

457,435

 

 

 

$

11,657

 

 

 

$

10,945

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap contracts

 

$

446,024

 

Other assets

 

$

16,126

 

Other liabilities

 

$

16,444

 

Loan commitments

 

33,961

 

Mortgages held for sale

 

220

 

N/A

 

 

Forward contracts

 

21,500

 

N/A

 

 

Mortgages held for sale

 

33

 

Total

 

$

501,485

 

 

 

$

16,346

 

 

 

$

16,477

 

 

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For the three and six months ended June 30, 2013 and 2012, the amounts included in the consolidated statements of income for non-hedging derivative financial instruments are shown in the chart below:

 

 

 

 

 

Gain (loss)

 

 

 

Statement of

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

(Dollars in thousands)

 

Income classification

 

2013

 

2012

 

2013

 

2012

 

Interest rate swap contracts

 

Other expense

 

$

83

 

$

4

 

$

113

 

$

79

 

Interest rate swap contracts

 

Other income

 

204

 

214

 

398

 

253

 

Loan commitments

 

Mortgage banking income

 

(111

)

(72

)

(67

)

141

 

Forward contracts

 

Mortgage banking income

 

780

 

(374

)

797

 

(98

)

Total

 

 

 

$

956

 

$

(228

)

$

1,241

 

$

375

 

 

At June 30, 2013 and December 31, 2012 the offsetting of financial assets and derivative assets are shown in the chart below:

 

 

 

Gross
Amounts of

 

Gross Amounts
Offset in the

 

Net Amounts of
Assets Presented in

 

Gross Amounts Not Offset in the
Statement of Financial Position

 

 

 

(Dollars in thousands)

 

Recognized
Assets

 

Statement of
Financial Position

 

the Statement of
Financial Position

 

Financial
Instruments

 

Cash Collateral
Received

 

Net Amount

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

$

11,523

 

$

783

 

$

10,740

 

$

 

$

 

$

10,740

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

$

17,422

 

$

1,296

 

$

16,126

 

$

 

$

 

$

16,126

 

 

At June 30, 2013 and December 31, 2012 the offsetting of financial liabilities and derivative liabilities are shown in the chart below:

 

 

 

Gross
Amounts of

 

Gross Amounts
Offset in the

 

Net Amounts of
Liabilities Presented in

 

Gross Amounts Not Offset in the
Statement of Financial Position

 

 

 

(Dollars in thousands)

 

Recognized
Liabilities

 

Statement of
Financial Position

 

the Statement of
Financial Position

 

Financial
Instruments

 

Cash Collateral
Pledged

 

Net Amount

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

$

11,728

 

$

783

 

$

10,945

 

$

 

$

9,984

 

$

961

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Swaps

 

$

17,740

 

$

1,296

 

$

16,444

 

$

 

$

15,811

 

$

633

 

 

Note 9.       Earnings Per Share

 

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, 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.  There were no stock options outstanding as of June 30, 2013.  No stock options were considered antidilutive as of June 30, 2012.

 

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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 and six months ended June 30, 2013 and 2012.

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

(Dollars in thousands - except per share amounts)

 

2013

 

2012

 

2013

 

2012

 

Distributed earnings allocated to common stock

 

$

4,140

 

$

3,881

 

$

8,283

 

$

7,772

 

Undistributed earnings allocated to common stock

 

9,618

 

8,515

 

17,719

 

16,166

 

Net earnings allocated to common stock

 

13,758

 

12,396

 

26,002

 

23,938

 

Net earnings allocated to participating securities

 

184

 

171

 

344

 

344

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income allocated to common stock and participating securities

 

$

13,942

 

$

12,567

 

$

26,346

 

$

24,282

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding for basic earnings per common share

 

24,367,529

 

24,263,881

 

24,344,882

 

24,261,649

 

Dilutive effect of stock compensation

 

1,444

 

10,017

 

1,171

 

10,774

 

Weighted average shares outstanding for diluted earnings per common share

 

24,368,973

 

24,273,898

 

24,346,053

 

24,272,423

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.56

 

$

0.51

 

$

1.07

 

$

0.99

 

Diluted earnings per common share

 

$

0.56

 

$

0.51

 

$

1.07

 

$

0.99

 

 

Note 10.     Stock Based Compensation

 

As of June 30, 2013, the Company had four active stock-based employee compensation plans, which are more fully described in Note 15 of the Consolidated Financial Statements in 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2012.  These plans include 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 last outstanding grant under the 2001 Stock Option Plan was exercised in March 2013.  The 2011 Stock Option Plan was approved by the shareholders on April 21, 2011 but the Company had not made any grants through June 30, 2013.

 

Stock-based compensation expense for all stock-based compensation awards granted is based on the grant-date fair value.  For all awards except stock option awards, the grant date fair value is either the fair market value per share or book value per share (corresponding to the type of stock awarded) as of the grant date.  For stock option awards, the grant date fair value is estimated using the Black-Scholes option pricing model.  For all awards the Company recognizes these compensation costs only for those shares expected to vest on a straight-line basis over the requisite service period of the award, for which the Company uses the related vesting term.  The Company estimates forfeiture rates based on historical employee option exercise and employee termination experience.  The Company has identified separate groups of award recipients that exhibit similar option exercise behavior and employee termination experience and have considered them as separate groups in the valuation models and expense estimates.

 

The stock-based compensation expense recognized in the consolidated statements of income for the three and six months ended June 30, 2013 and 2012 was based on awards ultimately expected to vest, and accordingly has been adjusted by the amount of estimated forfeitures.  GAAP requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  Forfeitures were estimated based partially on historical experience.

 

Total fair value of options vested and expensed was zero for the six months ended June 30, 2013 and 2012.  As of June 30, 2013 there were no outstanding stock options.  There were 7,500 stock options exercised at a

 

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weighted average price of $12.04 during the six months ended June 30, 2013.  All shares issued in connection with stock option exercises are issued from available treasury stock.

 

As of June 30, 2013, there was $7.26 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements.  That cost is expected to be recognized over a weighted-average period of 3.37 years.

 

Note 11.     Income Taxes

 

The total amount of unrecognized tax benefits that would affect the effective tax rate if recognized was $2.19 million at June 30, 2013 and $2.02 million at December 31, 2012.  Interest and penalties were recognized through the income tax provision.  For the six months ended June 30, 2013 and 2012, the Company recognized approximately $0.10 million and $(0.04) million in interest, net of tax effect, and penalties, respectively.  Interest and penalties of approximately $0.65 million and $0.55 million were accrued at June 30, 2013 and December 31, 2012, respectively.

 

Effective January 1, 2014, the Indiana Financial Institutions tax rate decreases from 8.5% to 8.0% and continues to decrease by 0.5% each of the next three years.  As a result of the rate change, the Company decreased the carrying value of certain state deferred tax assets.  The impact of this change was not material and was recorded in the financial statements during the second quarter of 2013.

 

Tax years that remain open and subject to audit include the federal 2009-2012 years and the Indiana 2009-2012 years.  The Company does not anticipate a significant change in the amount of uncertain tax positions within the next 12 months.

 

Note 12.     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.  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 is 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

 

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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.

 

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

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 June 30, 2013 and December 31, 2012, all mortgages held for sale were carried at fair value.

 

The following table reflects the differences between the 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 June 30, 2013 and December 31, 2012:

 

(Dollars in thousands)

 

Fair value carrying
amount

 

Aggregate
unpaid principal

 

Excess of fair
value carrrying
amount over
(under) unpaid
principal

 

June 30, 2013

 

 

 

 

 

 

 

Mortgages held for sale reported at fair value

 

 

 

 

 

 

 

Total Loans

 

$

10,849

 

$

10,161

 

$

688

(1)

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

Mortgages held for sale reported at fair value

 

 

 

 

 

 

 

Total Loans

 

$

10,879

 

$

10,293

 

$

586

(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

 

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Table of Contents

 

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.

 

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Table of Contents

 

The table below presents the balance of assets and liabilities at June 30, 2013 and December 31, 2012 measured at fair value on a recurring basis:

 

(Dollars in thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

June 30, 2013

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale:

 

 

 

 

 

 

 

 

 

U.S. Treasury and Federal agencies securities

 

$

19,567

 

$

373,073

 

$

 

$

392,640

 

U.S. States and political subdivisions securities

 

 

101,186

 

5,452

 

106,638

 

Mortgage-backed securities — Federal agencies

 

 

291,222

 

 

291,222

 

Corporate debt securities

 

 

28,331

 

 

28,331

 

Foreign government and other securities

 

 

2,708

 

 

2,708

 

Total debt securities

 

19,567

 

796,520

 

5,452

 

821,539

 

Marketable equity securities

 

6,773

 

 

 

6,773

 

Total investment securities available-for-sale

 

26,340

 

796,520

 

5,452

 

828,312

 

Trading account securities

 

166

 

 

 

166

 

Mortgages held for sale

 

 

10,849

 

 

10,849

 

Accrued income and other assets (Interest rate swap agreements)

 

 

10,740

 

 

10,740

 

Total

 

$

26,506

 

$

818,109

 

$

5,452

 

$

850,067

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Accrued expenses and other liabilities (Interest rate swap agreements)

 

$

 

$

10,945

 

$

 

$

10,945

 

Total

 

$

 

$

10,945

 

$

 

$

10,945

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

Investment securities available-for-sale:

 

 

 

 

 

 

 

 

 

U.S. Treasury and Federal agencies securities

 

$

20,063

 

$

402,190

 

$

 

$

422,253

 

U.S. States and political subdivisions securities

 

 

97,736

 

7,701

 

105,437

 

Mortgage-backed securities — Federal agencies

 

 

312,407

 

 

312,407

 

Corporate debt securities

 

 

31,248

 

 

31,248

 

Foreign government and other securities

 

 

3,726

 

 

3,726

 

Total debt securities

 

20,063

 

847,307

 

7,701

 

875,071

 

Marketable equity securities

 

5,693

 

 

 

5,693

 

Total investment securities available-for-sale

 

25,756

 

847,307

 

7,701

 

880,764

 

Trading account securities

 

146

 

 

 

146

 

Mortgages held for sale

 

 

10,879

 

 

10,879

 

Accrued income and other assets (Interest rate swap agreements)

 

 

16,126

 

 

16,126

 

Total

 

$

25,902

 

$

874,312

 

$

7,701

 

$

907,915

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Accrued expenses and other liabilities (Interest rate swap agreements)

 

$

 

$

16,444

 

$

 

$

16,444

 

Total

 

$

 

$

16,444

 

$

 

$

16,444

 

 

24



Table of Contents

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter ended June 30, 2013 and 2012 are summarized as follows:

 

(Dollars in thousands)

 

U.S. States and
political
subdivisions
securities

 

Foreign
government
and other
securities

 

Investment
securities
available-
for-sale

 

Beginning balance April 1, 2013

 

$

7,070

 

$

 

$

7,070

 

Total gains or losses (realized/unrealized):

 

 

 

 

 

 

 

Included in earnings

 

 

 

 

Included in other comprehensive income

 

182

 

 

182

 

Purchases

 

 

 

 

Issuances

 

 

 

 

Settlements

 

 

 

 

Maturities

 

(1,800

)

 

(1,800

)

Transfers into Level 3

 

 

 

 

Transfers out of Level 3

 

 

 

 

Ending balance June 30, 2013

 

$

5,452

 

$

 

$

5,452

 

 

 

 

 

 

 

 

 

Beginning balance April 1, 2012

 

$

9,934

 

$

 

$

9,934

 

Total gains or losses (realized/unrealized):

 

 

 

 

 

 

 

Included in earnings

 

 

 

 

Included in other comprehensive income

 

209

 

 

209

 

Purchases

 

 

 

 

Issuances

 

 

 

 

Settlements

 

 

 

 

Maturities

 

(2,000

)

 

(2,000

)

Transfers into Level 3

 

 

 

 

Transfers out of Level 3

 

 

 

 

Ending balance June 30, 2012

 

$

8,143

 

$

 

$

8,143

 

 

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 June 30, 2013 or 2012.  No transfers between levels occurred during the six months ended June 30, 2013.  One transfer between levels occurred during the six months ended June 30, 2012.  No transfers between Level 1 and 2 occurred during the period ended June 30, 2013.  A foreign government debt security was transferred from Level 3 to Level 2 as of March 31, 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.

 

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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 June 30, 2013 and December 31, 2012.

 

 

 

 

 

Valuation

 

 

 

 

 

(Dollars in thousands)

 

Fair Value

 

Methodology

 

Unobservable Inputs

 

Range of Inputs

 

 

 

 

 

 

 

 

 

 

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjustable rate securities

 

$

1,690

 

Discounted cash flows

 

Illiquidity adjustment

 

4.00% - 8.00%

 

 

 

 

 

 

 

Term assumption (1)

 

5 yrs

 

 

 

 

 

 

 

Coupon forecast assumption

 

0.37%

 

 

 

 

 

 

 

 

 

 

 

Direct placement municipal securities

 

3,762

 

Discounted cash flows

 

Credit spread assumption

 

1.27% - 2.31%

 

 

 

 

 

 

 

 

 

 

 

Total investment securities available-for-sale

 

$

5,452

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities available-for sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjustable rate securities

 

$

3,364

 

Discounted cash flows

 

Illiquidity adjustment

 

4.00% - 8.00%

 

 

 

 

 

 

 

Term assumption (1)

 

5 yrs

 

 

 

 

 

 

 

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.

 

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

 

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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.  In accordance with fair value measurements, only impaired loans for which a reserve for loan loss has been established based on the fair value collateral require classification in the fair value hierarchy.  As a result, only a portion of the Company’s impaired loans are classified in the fair value hierarchy.

 

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.

 

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Table of Contents

 

For assets measured at fair value on a nonrecurring basis the following represents impairment charges (recoveries) recognized on these assets during the quarter ended June 30, 2013:  impaired loans - $0.00 million; partnership investments - $(0.05) million; mortgage servicing rights - $0.00 million; repossessions - $0.00 million, and other real estate - $0.17 million.

 

The table below presents the carrying value of assets at June 30, 2013 and December 31, 2012 measured at fair value on a non-recurring basis:

 

(Dollars in thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

June 30, 2013

 

 

 

 

 

 

 

 

 

Impaired loans - collateral based

 

$

 

$

 

$

3,550

 

$

3,550

 

Accrued income and other assets (partnership investments)

 

 

 

2,252

 

2,252

 

Accrued income and other assets (mortgage servicing rights)

 

 

 

4,634

 

4,634

 

Accrued income and other assets (repossessions)

 

 

 

137

 

137

 

Accrued income and other assets (other real estate)

 

 

 

6,406

 

6,406

 

Total

 

$

 

$

 

$

16,979

 

$

16,979

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

Impaired loans - collateral based

 

$

 

$

 

$

2,027

 

$

2,027

 

Accrued income and other assets (partnership investments)

 

 

 

2,032

 

2,032

 

Accrued income and other assets (mortgage servicing rights)

 

 

 

4,645

 

4,645

 

Accrued income and other assets (repossessions)

 

 

 

63

 

63

 

Accrued income and other assets (other real estate)

 

 

 

5,344

 

5,344

 

Total

 

$

 

$

 

$

14,111

 

$

14,111

 

 

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Table of Contents

 

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 June 30, 2013 and December 31, 2012.

 

(Dollars in thousands)

 

Carrying Value

 

Fair Value

 

Valuation Methodology

 

Unobservable Inputs

 

Range of Inputs

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

3,550

 

$

3,550

 

Collateral based measurements including appraisals, trade publications, auction values

 

Discount for lack of marketability and current conditions

 

10% - 90%

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage servicing rights

 

4,634

 

7,240

 

Discounted cash flows

 

Constant prepayment rate (CPR)

 

10.9% - 15.2%

 

 

 

 

 

 

 

 

 

Discount rate

 

9.75% - 12.75%

 

 

 

 

 

 

 

 

 

 

 

 

 

Repossessions

 

137

 

167

 

Appraisals, trade publications and auction values

 

Discount for lack of marketability

 

0% - 9%

 

 

 

 

 

 

 

 

 

 

 

 

 

Other real estate

 

6,406

 

7,282

 

Appraisals

 

Discount for lack of marketability

 

0% - 74%

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

2,027

 

$

2,027

 

Collateral based measurements including appraisals, trade publications, auction values

 

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%

 

 

 

 

 

 

 

 

 

Discount rate

 

8.5% - 11.5%

 

 

 

 

 

 

 

 

 

 

 

 

 

Repossessions

 

63

 

59

 

Appraisals, trade publications and auction values

 

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.

 

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Table of Contents

 

The fair values of the Company’s financial instruments as of June 30, 2013 and December 31, 2012 are summarized in the table below.

 

 

 

Carrying or

 

 

 

 

 

 

 

 

 

(Dollars in thousands)

 

Contract Value

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

64,850

 

$

64,850

 

$

64,850

 

$

 

$

 

Federal funds sold and interest bearing deposits with other banks

 

3,171

 

3,171

 

3,171

 

 

 

Investment securities, available-for-sale

 

828,312

 

828,312

 

26,340

 

796,520

 

5,452

 

Other investments and trading account securities

 

22,575

 

22,575

 

22,575

 

 

 

Mortgages held for sale

 

10,849

 

10,849

 

 

10,849

 

 

Loans and leases, net of reserve for loan and lease losses

 

3,407,695

 

3,424,533

 

 

 

3,424,533

 

Cash surrender value of life insurance policies

 

57,552

 

57,552

 

57,552

 

 

 

Mortgage servicing rights

 

4,634

 

7,240

 

 

 

7,240

 

Interest rate swaps

 

10,740

 

10,740

 

 

10,740

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

3,700,799

 

$

3,710,100

 

$

2,617,578

 

$

1,092,522

 

$

 

Short-term borrowings

 

201,904

 

201,904

 

167,017

 

34,887

 

 

Long-term debt and mandatorily redeemable securities

 

58,216

 

57,448

 

 

57,448

 

 

Subordinated notes

 

58,764

 

70,774

 

 

70,774

 

 

Interest rate swaps

 

10,945

 

10,945

 

 

10,945

 

 

Off-balance-sheet instruments *

 

 

165

 

 

165

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

83,232

 

$

83,232

 

$

83,232

 

$

 

$

 

Federal funds sold and interest bearing deposits with other banks

 

702

 

702

 

702

 

 

 

Investment securities, available-for-sale

 

880,764

 

880,764

 

25,756

 

847,307

 

7,701

 

Other investments and trading account securities

 

22,755

 

22,755

 

22,755

 

 

 

Mortgages held for sale

 

10,879

 

10,879

 

 

10,879

 

 

Loans and leases, net of reserve for loan and lease losses

 

3,244,242

 

3,287,976

 

 

 

3,287,976

 

Cash surrender value of life insurance policies

 

56,572

 

56,572

 

56,572

 

 

 

Mortgage servicing rights

 

4,645

 

5,760

 

 

 

5,760

 

Interest rate swaps

 

16,126

 

16,126

 

 

16,126

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

3,624,347

 

$

3,641,280

 

$

2,556,122

 

$

1,085,158

 

$

 

Short-term borrowings

 

169,188

 

169,188

 

161,138

 

8,050

 

 

Long-term debt and mandatorily redeemable securities

 

71,021

 

71,557

 

 

71,557

 

 

Subordinated notes

 

58,764

 

72,914

 

 

72,914

 

 

Interest rate swaps

 

16,444

 

16,444

 

 

16,444

 

 

Off-balance-sheet instruments *

 

 

188

 

 

188

 

 

 


* Represents estimated cash outflows required to currently settle the obligations at current market rates.

 

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Table of Contents

 

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 the current estimated incremental borrowing rates for similar types of borrowing arrangements.  The carrying values of mandatorily redeemable securities are based on the 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 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 the 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.

 

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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.

 

ITEM 2.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following management’s discussion and analysis is presented to provide information concerning 1st Source Corporation and its subsidiaries’ (collectively referred to as “the Company”, “we”, and “our”) financial condition as of June 30, 2013, as compared to December 31, 2012, and the results of operations for the three and six months ended June 30, 2013 and 2012.  This discussion and analysis should be read in conjunction with our consolidated financial statements and the financial and statistical data appearing elsewhere in this report and our 2012 Annual Report.

 

Except for historical information contained herein, the matters discussed in this document express “forward-looking statements.”  Generally, the words “believe,” “contemplate,” “seek,” “plan,” “possible,” “assume,” “expect,” “intend,” “targeted,” “continue,” “remain,” “estimate,” “anticipate,” “project,” “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.  Those statements, including statements, projections, estimates or assumptions concerning future events or performance, and other statements that are other than statements of historical fact, are subject to material risks and uncertainties.  We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made.  We may make other written or oral forward-looking statements from time to time.  Readers are advised that various important factors could cause our actual results or circumstances for future periods to differ materially from those anticipated or projected in such forward-looking statements.  Such factors include, but are not limited to, changes in law, regulations or U.S. generally accepted accounting principles; our competitive position within the markets we serve; increasing consolidation within the banking industry; unforeseen changes in interest rates; unforeseen changes in loan prepayment assumptions; unforeseen downturns in or major events affecting the local, regional or national economies or the industries in which we have credit concentrations; and other matters discussed in our filings with the SEC, including our Annual Report on Form 10-K  for 2012, which filings are available from the SEC.  We undertake no obligation to publicly update or revise any forward-looking statements.

 

FINANCIAL CONDITION

 

Our total assets at June 30, 2013 were $4.64 billion, an increase of $88.12 million or 1.94% from December 31, 2012.  Total loans and leases were $3.49 billion, an increase of $165.83 million or 4.98% from December 31, 2012.  Total investment securities, available for sale were $828.31 million which represented a decrease of $52.45 million or 5.96% and total deposits were $3.70 billion, an increase of $76.45 million or 2.11% over the comparable figures at the end of 2012.  Short-term borrowings were $201.90 million, an increase of $32.72 million or 19.34% from December 31, 2012.

 

Nonperforming assets at June 30, 2013 were $36.05 million, which was a decrease of $6.22 million or 14.72% from the $42.27 million reported at December 31, 2012.  At June 30, 2013 and December 31, 2012, nonperforming assets were 1.01% and 1.25%, respectively of net loans and leases.

 

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Accrued income and other assets were as follows:

 

 

 

June 30,

 

December 31,

 

(Dollars in thousands)

 

2013

 

2012

 

Accrued income and other assets:

 

 

 

 

 

Bank owned life insurance cash surrender value

 

$

57,552

 

$

56,572

 

Accrued interest receivable

 

13,610

 

12,698

 

Mortgage servicing assets

 

4,634

 

4,645

 

Other real estate

 

5,455

 

4,311

 

Former bank premises held for sale

 

951

 

1,034

 

Repossessions

 

137

 

63

 

All other assets

 

33,222

 

44,105

 

Total accrued income and other assets

 

$

115,561

 

$

123,428

 

 

CAPITAL

 

As of June 30, 2013, total shareholders’ equity was $567.75 million, up $9.10 million or 1.63% from the $558.66 million at December 31, 2012.  In addition to net income of $26.35 million, other significant changes in shareholders’ equity during the first six months of 2013 included $8.35 million of dividends paid.  The accumulated other comprehensive income/(loss) component of shareholders’ equity totaled $7.84 million at June 30, 2013, compared to $19.54 million at December 31, 2012.  The decrease in accumulated other comprehensive income/(loss) during 2013 was the result of changes in unrealized gain/(loss) on securities in the available-for-sale portfolio.  Our equity-to-assets ratio was 12.24% as of June 30, 2013, compared to 12.28% at December 31, 2012.  Book value per common share rose to $23.29 at June 30, 2013, from $23.04 at December 31, 2012.

 

We declared and paid dividends per common share of $0.17 during the second quarter of 2013.  The trailing four quarters dividend payout ratio, representing dividends per common share divided by diluted earnings per common share, was 32.54%.  The dividend payout is continually reviewed by management and the Board of Directors subject to the Company’s capital and dividend policy.

 

The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1 or core capital as a percentage of average assets, to measure the soundness of a financial institution.  In addition, banking regulators have established risk-based capital guidelines for U.S. banking organizations.  The actual capital amounts and ratios of 1st Source Corporation and 1st Source Bank as of June 30, 2013, are presented in the table below:

 

 

 

Actual

 

Minimum Capital
Adequacy

 

Capitalized Under
Prompt Corrective
Action Provisions

 

(Dollars in thousands)

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Total Capital (to Risk-Weighted Assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

1st Source Corporation

 

$

578,991

 

15.55

%

$

297,840

 

8.00

%

$

372,300

 

10.00

%

1st Source Bank

 

551,122

 

14.84

 

297,143

 

8.00

 

371,429

 

10.00

 

Tier 1 Capital (to Risk-Weighted Assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

1st Source Corporation

 

529,963

 

14.23

 

148,920

 

4.00

 

223,380

 

6.00

 

1st Source Bank

 

503,496

 

13.56

 

148,572

 

4.00

 

222,858

 

6.00

 

Tier 1 Capital (to Average Assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

1st Source Corporation

 

529,963

 

11.76

 

180,244

 

4.00

 

225,305

 

5.00

 

1st Source Bank

 

503,496

 

11.20

 

179,895

 

4.00

 

224,869

 

5.00

 

 

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In July of 2013, the Federal Reserve and other federal banking agencies issued the final Basel III rule to help ensure that banks maintain strong capital positions.  Under the final rule, minimum requirements increase for both the quantity and quality of capital held by banking organizations.  The rule includes a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets that apply to all supervised financial institutions.  The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4.0% to 6.0% and includes a minimum leverage ratio of 4.0% for all banking organizations.  These new standards will become effective for the us on January 1, 2015.

 

LIQUIDITY AND INTEREST RATE SENSITIVITY

 

Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as our operating cash needs are met.  Funds are available from a number of sources, including the securities portfolio, the core deposit base, Federal Home Loan Bank (FHLB) borrowings, Federal Reserve Bank (FRB) borrowings, and the capability to package loans for sale.

 

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.  At June 30, 2013 we had $52.00 million outstanding and could borrow approximately $213.00 million for a short time from these banks on a collective basis.  As of June 30, 2013, we had $62.72 million outstanding in FHLB advances and could borrow an additional $132.97 million.  We also had $343.22 million available to borrow from the FRB with no amounts outstanding as of June, 2013.

 

Our loan to asset ratio was 75.31% at June 30, 2013 compared to 73.12% at December 31, 2012 and 72.90% at June 30, 2012.  Cash and cash equivalents totaled $68.02 million at June 30, 2013 compared to $83.93 million at December 31, 2012 and $90.08 million at June 30, 2012.  At June 30, 2013, the consolidated statement of financial condition was rate sensitive by $318.11 million more assets than liabilities scheduled to reprice within one year, or approximately 1.16%.  Management believes that the present funding sources provide adequate liquidity to meet our cash flow needs.

 

Under Indiana law governing the collateralization of public fund deposits, the Indiana Board of 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.  Our potential liquidity exposure if we must pledge collateral is approximately $631 million.

 

RESULTS OF OPERATIONS

 

Net income for the three and six month periods ended June 30, 2013 was $13.94 million and $26.35 million, compared to $12.57 million and $24.28 million for the same periods in 2012.  Diluted net income per common share was $0.56 and $1.07 for the three and six month periods ended June 30, 2013, compared to $0.51 and $0.99 for the same periods in 2012.  Return on average common shareholders’ equity was 9.32% for the six months ended June 30, 2013, compared to 9.10% in 2012.  The return on total average assets was 1.16% for the six months ended June 30, 2013, compared to 1.10% in 2012.

 

The increase in net income for the six months ended June 30, 2013, over the first six months of 2012, was primarily the result of decreases in provision for loan and lease losses and noninterest expense. Details of the changes in the various components of net income are discussed further below.

 

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NET INTEREST INCOME

 

The taxable equivalent net interest income for the three months ended June 30, 2013 was $39.32 million, an increase of 2.15% over the same period in 2012.  The net interest margin on a fully taxable equivalent basis was 3.65% for the three months ended June 30, 2013, compared to 3.70% for the three months ended June 30, 2012.  The taxable equivalent net interest income for the six months ended June 30, 2013 was $77.54 million, an increase of 1.47% over 2012, resulting in a net yield of 3.64% compared to a net yield of 3.74% for the same period in 2012.

 

During the three and six month periods ended June 30, 2013, average earning assets increased $146.25 million or 3.50% and $180.09 million or 4.38% respectively, over the comparable periods in 2012.  Average interest-bearing liabilities increased $33.95 million or 1.04% and $60.35 million or 1.87% respectively, for the three and six month periods ended June 30, 2013 over the comparable periods one year ago.  The yield on average earning assets decreased 27 basis points to 4.18% for the second quarter of 2013 from 4.45% for the second quarter of 2012.  The yield on average earning assets for the six month period ended June 30, 2013 decreased 30 basis points to 4.20% from 4.50% for the six month period ended June 30, 2012.  The rate earned on assets decreased due to the reduction in loan and investment yields in the current interest rate environment.  Total cost of average interest-bearing liabilities decreased 25 basis points to 0.70% for the second quarter 2013 from 0.95% for the second quarter 2012.  Total cost of average interest-bearing liabilities decreased 25 basis points to 0.73% for the six months ended June 30, 2013, from 0.98% for the six months ended June 30, 2012.  The result to the net interest margin, or the ratio of net interest income to average earning assets, was a decrease of 5 basis points and 10 basis points, respectively for the three and six month periods ended June 30, 2013 from June 30, 2012.

 

The largest contributor to the decrease in the yield on average earning assets for the six months ended June 30, 2013, compared to the six months ended June 30, 2012, was a reduction in yields on net loans and leases of 39 basis points.  Average net loans and leases increased $210.18 million or 6.55% for the second quarter of 2013 from the second quarter of 2012 and $231.39 million or 7.35% for the six months ended June 30, 2013 compared to the same period in 2012.  Total average investment securities decreased $40.19 million or 4.55% for the second quarter and decreased $36.47 million or 4.11% for the six month period over one year ago.  Tax equivalent yield on investment securities decreased 34 basis points for the second quarter 2013.  Average mortgages held for sale decreased $10.12 million or 54.70% and $5.76 million or 40.38% respectively, for the three and six month periods ended June 30, 2013, over the comparable periods a year ago.  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 $13.62 million or 20.06% and $9.07 million or 14.27% respectively,  for the three and six month periods ended June 30, 2013, over the comparable periods a year ago.

 

Average interest-bearing deposits increased $57.22 million or 1.92% and $78.43 million or 2.66% respectively, for the second quarter of 2013 and the first six months of 2013 over the same periods in 2012.  The effective rate paid on average interest-bearing deposits decreased 19 basis points to 0.58% for the second quarter 2013 compared to 0.77% for the second quarter 2012.  The effective rate paid on average interest-bearing deposits decreased 18 basis points to 0.60% for the first six months of 2013 compared to 0.78% for the first six months of 2012.  The decline in the average cost of interest-bearing deposits during the second quarter of 2013 and the first six months of 2013 as compared to the second quarter and first six months of 2012 was primarily the result of interest rate re-pricing on maturing certificates of deposit and a change in deposit mix.

 

Average short-term borrowings decreased $6.31 million or 4.32% and decreased $10.87 million or 7.74%, respectively for the second quarter of 2013 and the first six months of 2013 compared to the same periods in 2012.  Interest paid on short-term borrowings was flat for the second quarter and decreased 2 basis points for

 

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the first six months of 2013.  Average subordinated notes decreased $30.93 million for the second quarter of 2013 and the first six months of 2013 while the effective rate paid decreased 19 basis points and 15 basis points, respectively due to the redemption of trust preferred securities in December 2012.  Average long-term debt increased $13.96 million or 28.52% during the second quarter of 2013 as compared to the second quarter of 2012 and increased $23.72 million or 54.33% during the first six months of 2013 as compared to the first six months of 2012.  The increase in long-term borrowings was mainly the result of higher borrowings with the Federal Home Loan Bank.  Interest paid on long-term borrowings decreased 148 basis points for the second quarter and 165 basis points for the first six months of 2013 due to lower effective rates on Federal Home Loan Bank borrowings.

 

The following table provides an analysis of net interest income and illustrates the interest earned and interest expense charged for each major component of interest-earning assets and 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.

 

DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY

INTEREST RATES AND INTEREST DIFFERENTIAL

(Dollars in thousands)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

Interest

 

 

 

 

 

Interest

 

 

 

 

 

Interest

 

 

 

 

 

Interest

 

 

 

 

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

 

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

ASSETS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

$

737,872

 

$

3,498

 

1.90

%

$

775,205

 

$

4,334

 

2.25

%

$

745,906

 

$

7,193

 

1.94

%

$

778,594

 

$

8,661

 

2.24

%

Tax exempt

 

105,998

 

1,122

 

4.25

%

108,857

 

1,254

 

4.63

%

104,519

 

2,259

 

4.36

%

108,301

 

2,514

 

4.67

%

Mortgages - held for sale

 

8,378

 

77

 

3.69

%

18,495

 

160

 

3.48

%

8,507

 

148

 

3.51

%

14,268

 

258

 

3.64

%

Net loans and leases

 

3,419,723

 

40,126

 

4.71

%

3,209,539

 

40,274

 

5.05

%

3,381,093

 

79,325

 

4.73

%

3,149,704

 

80,202

 

5.12

%

Other investments

 

54,293

 

241

 

1.78

%

67,916

 

231

 

1.37

%

54,484

 

483

 

1.79

%

63,554

 

457

 

1.45

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Earning Assets

 

4,326,264

 

45,064

 

4.18

%

4,180,012

 

46,253

 

4.45

%

4,294,509

 

89,408

 

4.20

%

4,114,421

 

92,092

 

4.50

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

61,107

 

 

 

 

 

62,382

 

 

 

 

 

58,915

 

 

 

 

 

60,970

 

 

 

 

 

Reserve for loan and lease losses

 

(84,882

)

 

 

 

 

(83,071

)

 

 

 

 

(84,510

)

 

 

 

 

(82,766

)

 

 

 

 

Other assets

 

309,464

 

 

 

 

 

322,380

 

 

 

 

 

308,892

 

 

 

 

 

328,557

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

4,611,953

 

 

 

 

 

$

4,481,703

 

 

 

 

 

$

4,577,806

 

 

 

 

 

$

4,421,182

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

$

3,043,806

 

$

4,412

 

0.58

%

$

2,986,588

 

$

5,704

 

0.77

%

$

3,029,013

 

$

8,954

 

0.60

%

$

2,950,588

 

$

11,449

 

0.78

%

Short-term borrowings

 

139,708

 

45

 

0.13

%

146,016

 

47

 

0.13

%

129,597

 

77

 

0.12

%

140,468

 

100

 

0.14

%

Subordinated notes

 

58,764

 

1,055

 

7.20

%

89,692

 

1,648

 

7.39

%

58,764

 

2,110

 

7.24

%

89,692

 

3,295

 

7.39

%

Long-term debt and mandatorily redeemable securities

 

62,918

 

228

 

1.45

%

48,954

 

357

 

2.93

%

67,388

 

723

 

2.16

%

43,664

 

828

 

3.81

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Interest-Bearing Liabilities

 

3,305,196

 

5,740

 

0.70

%

3,271,250

 

7,756

 

0.95

%

3,284,762

 

11,864

 

0.73

%

3,224,412

 

15,672

 

0.98

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

675,201

 

 

 

 

 

601,613

 

 

 

 

 

662,778

 

 

 

 

 

587,959

 

 

 

 

 

Other liabilities

 

56,688

 

 

 

 

 

68,510

 

 

 

 

 

60,046

 

 

 

 

 

72,282

 

 

 

 

 

Shareholders’ equity

 

574,867

 

 

 

 

 

540,330

 

 

 

 

 

570,220

 

 

 

 

 

536,529

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

4,611,952

 

 

 

 

 

$

4,481,703

 

 

 

 

 

$

4,577,806

 

 

 

 

 

$

4,421,182

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

 

 

$

39,324

 

 

 

 

 

$

38,497

 

 

 

 

 

$

77,544

 

 

 

 

 

$

76,420

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Yield on Earning Assets on a Taxable Equivalent Basis

 

 

 

 

 

3.65

%

 

 

 

 

3.70

%

 

 

 

 

3.64

%

 

 

 

 

3.74

%

 

PROVISION AND RESERVE FOR LOAN AND LEASE LOSSES

 

The provision for loan and lease losses for the three and six month period ended June 30, 2013 was $1.29 million and $2.05 million respectively, compared to a provision for loan and lease losses in the three and six month periods ended June 30, 2012 of $2.06 million and $4.31 million respectively.  Net recoveries of $0.39 million were recorded for the second quarter 2013, compared to net charge-offs of $1.15 million for the same quarter a year ago.  Year-to-date net recoveries of $0.33 million have been recorded in 2013, compared to net charge-offs $2.65 million through June 30, 2012.

 

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On June 30, 2013, 30 day and over loan and lease delinquencies were 0.27% compared to 0.31% on June 30, 2012.  The reserve for loan and lease losses as a percentage of loans and leases outstanding at the end of the period was 2.45% as compared to 2.55% one year ago.  A summary of loan and lease loss experience during the three and six months ended June 30, 2013 and 2012 is located in Note 5 of the Consolidated Financial Statements.

 

A loan or lease is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. We evaluate loans and leases exceeding $100,000 for impairment and establish 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 and lease and the recorded investment in the loan or lease exceeds its fair value.  A summary of impaired loans as of June 30, 2013 and December 31, 2012 is reflected in Note 4 of the Consolidated Financial Statements.

 

NONPERFORMING ASSETS

 

Nonperforming assets were as follows:

 

 

 

June 30,

 

December 31,

 

June 30,

 

(Dollars in thousands)

 

2013

 

2012

 

2012

 

Loans and leases past due 90 days or more

 

$

184

 

$

442

 

$

439

 

Nonaccrual loans and leases

 

29,318

 

36,417

 

45,777

 

Other real estate

 

5,455

 

4,311

 

7,257

 

Former bank premises held for sale

 

951

 

1,034

 

1,134

 

Repossessions

 

137

 

63

 

1,177

 

Equipment owned under operating leases

 

 

 

9

 

Total nonperforming assets

 

$

36,045

 

$

42,267

 

$

55,793

 

 

Nonperforming assets as a percentage of total loans and leases were 1.01% at June 30, 2013, 1.25% at December 31, 2012, and 1.67% at June 30, 2012.  Nonperforming assets totaled $36.05 million at June 30, 2013, a decrease of 14.72% from the $42.27 million reported at December 31, 2012, and a 35.40% decrease from the $55.79 million reported at June 30, 2012.  The decrease during the first six months of 2013 compared to the same period in 2012 was primarily related to decreases in nonaccrual loans and leases and the sale of repossessed assets and other real estate as the economy slowly improves.

 

The decrease in nonaccrual loans and leases at June 30, 2013 from December 31, 2012 and the decrease in nonaccrual loans and leases at June 30, 2013 from June 30, 2012 occurred across almost all loan types.  A summary of nonaccrual loans and leases and past due aging for the period ended June 30, 2013 and December 31, 2012 is located in Note 4 of the Consolidated Financial Statements.

 

As of June 30, 2013, 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 $14.60 million which were comprised of $12.33 million secured by commercial real estate and included in loans secured by real estate, $1.12 million secured by construction equipment and included in construction equipment financing and $1.15 million secured by aircraft and included in aircraft financing.  We have limited exposure to commercial real estate.  However, our borrowers with commercial real estate exposure have suffered in this economy.  Furthermore, aircraft values for some models declined from 2010 to 2012, increasing the risk in aircraft secured transactions; values appear to have stabilized in 2013.

 

Other real estate is the result of foreclosing on real estate in the local market for which we have a current appraisal and are well secured.  Other real estate decreased over the past year due to sales of existing properties outpacing current foreclosures.

 

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Repossessions consisted mainly of auto, light truck and environmental equipment at June 30, 2013.  At the time of repossession, the recorded amount of the loan or lease is written down, if necessary, to the estimated value of the equipment or vehicle by a charge to the reserve for loan and lease losses, unless the equipment is in the process of immediate sale.  Any subsequent write-downs are included in noninterest expense.

 

A summary of other real estate and repossessions is shown in the table below:

 

 

 

June 30,

 

December 31,

 

June 30,

 

(Dollars in thousands)

 

2013

 

2012

 

2012

 

Commercial and agricultural loans

 

$

 

$

 

$

 

Auto, light truck and environmental equipment

 

130

 

52

 

9

 

Medium and heavy duty truck

 

 

 

 

Aircraft financing

 

 

 

1,165

 

Construction equipment financing

 

 

 

 

Commercial real estate

 

4,438

 

3,362

 

6,253

 

Residential real estate

 

719

 

545

 

1,004

 

Consumer loans

 

305

 

415

 

3

 

Total

 

$

5,592

 

$

4,374

 

$

8,434

 

 

For financial statement purposes, nonaccrual loans and leases are included in loan and lease outstandings, whereas repossessions and other real estate are included in other assets.

 

Foreign Outstandings — Our foreign loan and lease outstandings, all denominated in U.S. dollars were $265.12 million and $271.41 million as of June 30, 2013 and December 31, 2012, respectively.  Foreign loans and leases are in aircraft financing.  Loan and lease outstandings to borrowers in Brazil and Mexico were $159.08 million and $60.91 million as of June 30, 2013, respectively, compared to $169.42 million and $55.12 million as of December 31, 2012, respectively.  Outstanding balances to borrowers in other countries were insignificant.

 

NONINTEREST INCOME

 

Noninterest income for the three month period ended June 30, 2013 and 2012 was $20.12 million and $19.79 million, respectively.  Noninterest income for the six month period ended June 30, 2013 and 2012 was $39.07 million and $40.31 million, respectively.  Details of noninterest income follow:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(Dollars in thousands)

 

2013

 

2012

 

2013

 

2012

 

Noninterest income:

 

 

 

 

 

 

 

 

 

Trust fees

 

$

4,439

 

$

4,379

 

$

8,540

 

$

8,352

 

Service charges on deposit accounts

 

2,325

 

2,621

 

4,564

 

5,059

 

Debit card income

 

2,344

 

2,194

 

4,409

 

4,261

 

Mortgage banking income

 

1,936

 

1,502

 

3,564

 

3,444

 

Insurance commissions

 

1,393

 

1,211

 

2,839

 

2,568

 

Equipment rental income

 

4,086

 

4,666

 

8,098

 

10,016

 

Investment securities and other investment gains

 

38

 

8

 

211

 

403

 

Other income

 

3,560

 

3,209

 

6,844

 

6,210

 

Total noninterest income

 

$

20,121

 

$

19,790

 

$

39,069

 

$

40,313

 

 

Noninterest income increased $0.33 million or 1.67% for the three months ended June 30, 2013 as compared to the same period in 2012.  Noninterest income decreased $1.24 million or 3.09% for the six months ended June 30, 2013 compared to the same period one year ago.  Trust fees and debit card income increased slightly in 2013 over the same periods in 2012.

 

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Service charges on deposit accounts decreased $0.30 million or 11.29% and $0.50 million or 9.78% for the three and six months ended June 30, 2013, respectively over the comparable periods one year ago.  The decrease in service charges on deposit accounts reflects a lower volume of nonsufficient fund transactions.

 

Mortgage banking income increased $0.43 million or 28.89% in the second quarter of 2013 as compared to the second quarter of 2012.  Mortgage banking income increased $0.12 million or 3.48% during the first six months of 2013 versus the first six months of 2012.  This positive variance was caused by increased gains on loan sales due to higher production volumes and improved margins in 2013.

 

Insurance commissions improved $0.18 million or 15.03% and $0.27 million or 10.55% in the three and six months ended June 30, 2013 over the same periods a year ago.  The increase related to higher premium and agency fees as well as an increase in the number of policies.

 

Equipment rental income declined $0.58 million or 12.43% in the second quarter of 2013 compared to the second quarter 2012.  Equipment rental income declined $1.92 million or 19.15% for year-to-date 2013 compared to the same period in 2012.  The average equipment rental portfolio decreased 21.24% in 2013 over the same period in 2012 resulting in lower rental income.  In addition, new leases are at lower rates due to current market conditions and increased competition.

 

Investment securities and other investment gains were relatively flat for the second quarter 2013 and decreased $0.19 million or 47.64% for year-to-date 2013 as compared to the same periods one year ago.  The decrease was due primarily to gains on sale of agency securities and corporate debt securities in 2012 which were not present in 2013.

 

Other income increased $0.35 million or 10.94% and $0.63 million or 10.21% for the three and six months ended June 30, 2013, respectively as compared to the same periods in 2012 primarily due to higher mutual fund income and fees on customer swaps.

 

NONINTEREST EXPENSE

 

Noninterest expense for the three month period ended June 30, 2013 and 2012 was $35.74 million and $36.58 million, respectively.  Noninterest expense for the six month period ended June 30, 2013 and 2012 was $72.29 million and $74.63 million, respectively.  Details of noninterest expense follow:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(Dollars in thousands)

 

2013

 

2012

 

2013

 

2012

 

Noninterest expense:

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

$

19,176

 

$

20,370

 

$

39,112

 

$

40,686

 

Net occupancy expense

 

2,147

 

1,848

 

4,354

 

4,008

 

Furniture and equipment expense

 

3,909

 

3,831

 

7,808

 

7,338

 

Depreciation - leased equipment

 

3,274

 

3,803

 

6,499

 

8,114

 

Professional fees

 

1,310

 

1,449

 

2,665

 

2,847

 

Supplies and communication

 

1,499

 

1,385

 

3,035

 

2,778

 

FDIC and other insurance

 

927

 

854

 

1,805

 

1,803

 

Business development and marketing expense

 

932

 

1,050

 

1,705

 

1,917

 

Loan and lease collection and repossession expense

 

1,095

 

979

 

1,852

 

2,480

 

Other expense

 

1,475

 

1,009

 

3,459

 

2,655

 

Total noninterest expense

 

$

35,744

 

$

36,578

 

$

72,294

 

$

74,626

 

 

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Noninterest expense decreased $0.83 million or 2.28% for the second quarter and $2.33 million or 3.12% for year-to-date 2013 as compared to the same periods in 2012.  FDIC and other insurance expense increased slightly in 2013 over the same periods in 2012.

 

Salaries and employee benefits decreased $1.19 million or 5.86% and $1.57 million or 3.87% in the three and six months ended June 30, 2013, respectively versus the three and six months ended June 30, 2012.  Salaries were lower mainly due to decreased base salaries, incentives and commissions expense.  Benefits increased primarily due to higher group insurance costs.

 

Net occupancy expense was higher by $0.30 million or 16.18% for the second quarter of 2013 and $0.35 million or 8.63% for year-to-date 2013 compared to the same periods one year ago.  The increase was primarily a result of higher rent and real estate taxes.

 

Furniture and equipment expense was flat for the second quarter of 2013 and increased $0.47 million or 6.41% for year-to-date 2013 compared to the same periods in 2012.  Furniture and equipment expense was higher mainly due to increased equipment depreciation, computer processing charges and software maintenance costs.

 

During the second quarter and first six months of 2013, depreciation on leased equipment decreased $0.53 million or 13.91% and $1.62 million or 19.90%, respectively in conjunction with the decrease in equipment rental income as compared to the same periods one year ago.

 

Professional fees decreased $0.14 million or 9.59% and $0.18 million or 6.39% for the three and six month periods ended June 30, 2013 respectively, as compared to the three and six month periods ended June 30, 2012.  The decrease in professional fees in 2013 was primarily the result of reduced utilization of consulting services.

 

Business development and marketing expense decreased $0.12 million or 11.24% for the three months ended June 30, 2013 versus the three months ended June 30, 2012 and $0.21 million or 11.06% for the six months ended June 30, 2013 versus the six months ended June 30, 2012.  The reduction was primarily due to decreased retail marketing.

 

Loan and lease collection and repossession expense increased $0.12 million or 11.85% for the three months ended June 30, 2013 compared to the same period in 2012 primarily due to repurchased mortgage loan losses in 2013 compared to 2012.  Loan and lease collection and repossession expense decreased $0.63 million or 25.32% in the six month period ended June 30, 2013 compared to the same period a year ago mainly due to a decreased amount of repossessions outstanding offset by higher repurchased mortgage loan losses in 2013 compared to 2012.

 

Other expenses increased $0.47 million or 46.18% and $0.80 million or 30.28% in the three and six month periods ended June 30, 2013, respectively as compared to the same periods in 2012 primarily related to a previously reported trustee matter.

 

INCOME TAXES

 

The provision for income taxes for the three and six month periods ended June 30, 2013 was $8.01 and $15.00 million, respectively compared to $6.57 million and $12.46 million for the same periods in 2012.  The effective tax rates were 36.49% and 34.31% for the second quarter ended June 30, 2013 and 2012, respectively and 36.28% and 33.90% for the six months ended June 30, 2013 and 2012, respectively.  The effective tax rates are higher in 2013 compared to 2012 due to the impact of state refunds for 2009 received in January of 2012.

 

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Effective January 1, 2014, the Indiana Financial Institutions tax rate decreases from 8.5% to 8.0% and continues to decrease by 0.5% each of the next three years.  As a result of the rate change, the Company decreased the carrying value of certain state deferred tax assets.  The impact of this change was not material and was recorded in the financial statements during the second quarter of 2013.

 

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There have been no material changes in market risks faced by 1st Source since December 31, 2012.  For information regarding our market risk, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

ITEM 4.

 

CONTROLS AND PROCEDURES

 

As of the end of the period covered by this report an evaluation was carried out, 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 June 30, 2013, 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 second fiscal quarter of 2013 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

PART II.  OTHER INFORMATION

 

ITEM 1.                          Legal Proceedings.

 

1st Source and its subsidiaries are involved in various legal proceedings incidental to the conduct of our businesses.  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.

 

ITEM 1A.                 Risk Factors.

 

There have been no material changes in risks faced by 1st Source since December 31, 2012.  For information regarding our risk factors, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

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ITEM 2.                          Unregistered Sales of Equity Securities and Use of Proceeds

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

 

 

 

 

 

 

Total number of

 

Maximum number (or approximate

 

 

 

Total number

 

Average

 

shares purchased

 

dollar value) of shares

 

 

 

of shares

 

price paid per

 

as part of publicly announced

 

that may yet be purchased under

 

Period

 

purchased

 

share

 

plans or programs*

 

the plans or programs

 

April 01 - 30, 2013

 

 

$

 

 

945,226

 

May 01 - 31, 2013

 

2,263

 

24.10

 

2,263

 

942,963

 

June 01 - 30, 2013

 

 

 

 

942,963

 

 


* 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 1,057,037 shares.

 

ITEM 3.                          Defaults Upon Senior Securities.

 

None

 

ITEM 4.                          Mine Safety Disclosures.

 

None

 

ITEM 5.                          Other Information.

 

None

 

ITEM 6.                          Exhibits

 

The following exhibits are filed with this report:

 

31.1

Certification of Chief Executive Officer required by Rule 13a-14(a).

 

 

31.2

Certification of Chief Financial Officer required by Rule 13a-14(a).

 

 

32.1

Certification pursuant to 18 U.S.C. Section 1350 of Chief Executive Officer.

 

 

32.2

Certification pursuant to 18 U.S.C. Section 1350 of Chief Financial Officer.

 

 

101.INS

XBRL Instance Document

 

 

101.SCH

XBRL Taxonomy Extension Schema Document

 

 

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

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

1st Source Corporation

 

 

 

 

DATE

July 25, 2013

 

/s/ CHRISTOPHER J. MURPHY III

 

Christopher J. Murphy III

 

Chairman of the Board, President and CEO

 

 

 

 

DATE

July 25, 2013

 

/s/ ANDREA G. SHORT

 

Andrea G. Short

 

Treasurer and Chief Financial Officer

Principal Accounting Officer

 

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