EX-13 5 0005.txt PORTIONS OF ANNUAL REPORT TO SECURITY HOLDERS EXHIBIT 13 2000 ANNUAL REPORT CONTENTS Corporate Description 1 2000 in Brief 1 Financial Highlights 2 Letter to Shareholders 3 Banking Center Locations 8 Financial Report 9 Officers and Directors 44 Shareholders' Information 45 [1ST SOURCE CORPORATION LOGO] The body of this annual report is printed on recycled paper. CORPORATE DESCRIPTION 1st Source Corporation is the largest locally owned financial institution headquartered in the Northern Indiana-Southwestern Michigan area. While delivering a comprehensive range of consumer and commercial banking services, 1st Source has distinguished itself with innovative products and highly personalized services. 1st Source also competes for business nationally by offering specialized financing services for private aircraft, automobiles for leasing and rental agencies, heavy duty trucks, construction and environmental equipment. The corporation's principal subsidiary, 1st Source Bank, has 49 banking centers in 12 counties in Indiana and Michigan and 23 locations nationwide supporting its Specialty Finance Group. 1st Source's wholly-owned mortgage banking subsidiary, Trustcorp Mortgage Company, has 13 offices in Indiana, Ohio, Michigan and North Carolina. With a history dating back to 1863, 1st Source is proud of its tradition of providing superior service to customers while playing a leadership role in the continued development of the communities in which it serves. 2000 IN BRIEF 2000 net income of $37.6 million was the highest in 1st Source history and 5.0% higher than the $35.8 million earned in 1999. Adjusted for a 5% stock dividend declared July 18, 2000, diluted net income per common share for 2000 was $1.88, up 6.2% from the $1.77 for 1999. Return on average total assets was 1.24% compared to 1.31% a year ago. Return on average common equity was 14.88% for 2000 compared to 15.74 % for 1999. The average common equity-to-assets ratio for 2000 was 8.31% compared to 8.29% last year. At year-end 2000, total assets were $3.18 billion, up 10.8% from a year earlier. Loans were up 11.9%, deposits were up 15.8% and shareholders' equity increased 13.3% from $238.8 million at the end of 1999 to $270.6 million at the end of 2000. The reserve for loan losses at year-end 2000 was 1.93% of total loans, while nonperforming assets amounted to 1.08% of total loans. NET INCOME (In Millions) [GRAPH]
96 97 98 99 00 (23.2) (26.5) (31.5) (35.8) (37.6)
DILUTED NET INCOME PER COMMON SHARE [GRAPH]
96 97 98 99 00 (1.14) (1.29) (1.55) (1.77) (1.88)
RETURN ON AVERAGE COMMON EQUITY (As a Percent) [GRAPH]
96 97 98 99 00 (14.38) (14.51) (15.30) (15.74) (14.88)
RETURN ON AVERAGE TOTAL ASSETS (As a Percent) [GRAPH]
96 97 98 99 00 (1.22) (1.21) (1.23) (1.31) (1.24)
(page 1) FINANCIAL HIGHLIGHTS EARNINGS AND DIVIDENDS (Dollars in thousands, except per share amounts)
2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Operating income .............. $ 309,306 $ 263,689 $ 248,404 $ 208,972 $ 174,299 Operating expense ............. 249,305 207,191 196,883 166,353 138,700 Net income .................... 37,573 35,768 31,457 26,489 23,203 Cash dividends ................ 6,956 5,922 5,296 4,723 4,123 Per common share * Diluted net income ......... $ 1.88 $ 1.77 $ 1.55 $ 1.29 $ 1.14 Cash dividends ............. .351 .298 .265 .238 .208 Book value ................. 13.72 12.03 10.93 9.75 8.68 Return on average common equity 14.88% 15.74% 15.30% 14.51% 14.38% Return on average total assets 1.24% 1.31% 1.23% 1.21% 1.22% Statement of Condition Average Balances: Assets ..................... $3,040,091 $2,740,044 $2,550,925 $2,198,300 $1,895,214 Earning assets ............. 2,767,721 2,478,182 2,344,555 2,046,637 1,767,055 Loans ...................... 2,207,382 1,949,172 1,853,537 1,610,889 1,348,089 Reserve for loan losses .... 41,441 39,105 38,050 31,966 28,482 Investment securities ...... 537,083 510,656 445,310 424,086 400,209 Deposits ................... 2,352,207 2,127,171 1,999,514 1,698,973 1,524,149 Shareholders' equity ....... 252,574 227,194 205,601 182,543 161,324
*The computation of per common share data gives retroactive recognition to a 5% stock dividend declared July 18, 2000; a 10% stock dividend declared January 14, 1999; a 10% stock dividend declared January 20, 1998; and a five-for-four stock split declared January 21, 1997. [1ST SOURCE CORPORATION LOGO] (Page 2) TO OUR SHAREHOLDERS: To say the year 2000 was challenging would be an understatement. We started with concerns about Y2K and ended with concerns about the economy. Financial results from 2000 were good, but not great. 1st Source Corporation achieved record earnings for the fifteenth consecutive year of $37.6 million; however, we grew at a rate of 5.0 percent which is slower than our earnings growth of the recent past. Financial highlights for the year were diluted net income per share of $1.88, a 6.2 percent increase over 1999, and a 13 percent compounded growth from 1995. Assets, loans, and deposits all grew to record levels of $3.18 billion, $2.31 billion, and $2.46 billion. These represent growth rates of 10.8 percent, 11.9 percent, and 15.8 percent, respectively, for the year. At the same time, delinquencies, nonperforming assets, and charge-offs increased. To prepare for a weakening economy, we aggressively charged down loans we believed would have continuing problems and added to our reserve for loan losses. Net charge-offs in 2000 were $7.40 million versus $2.39 million in 1999. In 2000, we provided $14.88 million to the loan loss reserve versus $7.44 million in 1999. At the close of the year, our nonperforming assets were $25.00 million compared to $15.36 million at the end of 1999. While the absolute dollars charged-off in 2000 were historically high, the charge-off ratio (net charge-offs to net loans and leases outstanding) was quite moderate at 0.34 percent. All of these credit issues were due to a weakening economy especially in those areas most impacting 1st Source customers. Higher gas prices and higher interest rates throughout most of the year negatively affected our aircraft operators, freight companies, truck and car rental agencies, construction equipment operators, mobile home and recreational vehicle manufacturers, home builders, steel producers and processors, and durable goods manufacturers. By the end of the year, higher home heating costs, the result of significant increases in natural gas prices and an unusually cold November and December, adversely affected consumer mortgages, loan collections and retail sales. Obviously, the Federal Reserve Board, sensing the same weakening, moved boldly in early 2001 to lower interest rates. We will continue to be vigilant on the credit side and will work with our customers to see them through this period of increasing volatility and weakness in our economy. FIVE YEARS OF GROWTH Six years ago, we created Vision 2000 to take us from 1996 through 2000. We had some very aggressive goals and achieved many of them, but not all. When we started the period, we operated 33 banking centers in 7 Indiana counties. We now operate full-service community banking centers in 49 locations spread over 12 counties throughout Northern Indiana and Southwestern Michigan. During this period, we developed a full array of on-line financial products through 1stsource.com and other direct computer links. In the area of personal banking, we offer on-line checking and savings, trust and investment management, bill paying, and loan and mortgage services. To our business customers, we offer on-line positive pay (a check fraud management system), employee benefit management services, and a full account and cash management system. 1stsource.com is another convenient way for customers to access 1st Source. It will continue to grow with many products and services planned for the future. During this same five-year period, we significantly increased our commitment to our Specialty Finance businesses. Our aircraft division continued its growth as a leader in the industry with people serving the country from our offices in South Bend, Indiana and Wichita, Kansas, and with senior sales officers in Philadelphia, Pennsylvania and Vancouver, Washington. We changed the focus of our truck and auto financing division, placing greater emphasis on auto rental agencies by adding experienced officers in Phoenix, Arizona; Warsaw, Indiana; and Atlanta, Georgia. Our construction machinery division also grew with new people added in Billings, Montana; Portland, Oregon; Plymouth, Indiana; Dallas, Texas; (Page 3) Pittsburgh, Pennsylvania; and Charlotte, North Carolina to supplement our staff in South Bend, Indiana and Milwaukee, Wisconsin. In early 2000, we started our environmental equipment finance division headquartered in Indianapolis, Indiana, with sales officers in Atlanta, Georgia; Fort Wayne, Indiana; and Macungie, Pennsylvania. We continue to look for knowledgeable, experienced people, both as sales officers and managers, to help these businesses grow and to develop new niche business opportunities. [PHOTO] 1st Source Business Takes Off Al Qualey (left) President of the Specialty Finance Group; Greg Holst, Portfolio Manager; and Chris Murphy, Corporate Chairman, survey aircraft types financed by 1st Source. In 1995, as we planned for the year 2000, one of our major concerns was the ability to fund the growth of our specialty finance businesses. To that end, during the last five years, we strengthened the capital base of 1st Source. In 1997, we issued $44.75 million in Trust Preferred Securities. This was supplemented by a series of loan securitizations starting with an initial $60 million in 1994, increasing to $350 million in 2000. We also sought other sources of funding and liquidity to support these and our other banking operations. We expanded our Internet Certificate of Deposit program and opened new borrowing facilities with The Federal Home Loan Bank. We also became more aggressive at selling off newly produced mortgage loans. Interest rate margins decreased steadily over the five-year period. We closed 1995 with a very strong operating net interest margin of 4.71 percent. It fell to 3.91 percent by the close of 2000. The reduction over this period came from increased competition from other financial institutions for deposits and (Page 4) investment dollars, and from a very strong and sustained stock market. Similarly, loan pricing came under increasing pressure as "consolidating" competitors lost market share during the turmoil of their mergers and then tried to "buy" their way back into the market. Because of this decreasing net interest margin, we worked hard to increase our fee income over the period and to reduce our operating cost as a percent of revenues. Annual fee income in 1995 was $19.32 million. By 2000, it had grown to $71.59 million. This represents a 30 percent compounded growth rate over the period. These fee income increases came from several areas. Over the past five years, mortgage origination, servicing and sales income increased from $2.16 million to $9.61 million. Over the same period, servicing fees and gains from our securitization of aircraft and auto receivables climbed from $628,000 in 1995 to $12.40 million in 2000. The greatest area of change occurred in the growth of equipment rental income which increased from $574,000 in 1995 to $21.22 million in 2000. Basic fees for deposit accounts, credit cards, credit insurance, trust and investment management, and insurance and brokerage sales rose in total from $15.96 million to $28.36 million during the same five-year period. Even while greatly expanding the presence of the bank during the five-year period, we were able to hold cost increases to reasonable levels. Compounded growth from salary and benefit costs was only 11 percent, going from $32.57 million to $54.57 million. We ended 1995 with an expense to revenue ratio of 58.59 percent for the consolidated holding company. Despite large investments in both people and brick and mortar, that ratio had improved to 54.84 percent by 2000. Our Personal Asset Management Group continued to grow over five years. As a result of focused local management and a commitment to personal service, our assets under management went from $1.2 billion at the close of 1995 to $1.9 billion at the end of 2000. We also confirmed our commitment to local service by opening trust and investment services offices in Warsaw and Elkhart, Indiana in 1999 and Goshen, Indiana at the very end of 2000. In 2000, 1st Source investment managers distinguished themselves by achieving or exceeding all of their investment performance benchmarks. The 1st Source Monogram Income Equity Fund was recognized by The Wall Street Journal for the second consecutive year as one of the highest performing funds in the country. In turbulent times, it is good to know we have an experienced and capable team of investment professionals located here in our market, serving our customers directly. In 1995, we reaffirmed that our Mission was "to build customer wealth." We recognized then that we do this in many ways, but most importantly by understanding that each customer is unique and has different needs. We committed ourselves to focusing on "the Market of One" and introduced formalized relationship management throughout the company. This is a systematic approach for determining each customer's distinctiveness to better understand and meet their individual needs. Each customer defines wealth differently -- whether it's buying a new car, purchasing a dream home, sending a child away to college, taking a once-in-a-lifetime vacation, or saving and investing for a comfortable retirement. Additionally, the definition for each customer changes over time. It is up to us to decipher these changes and to be there to work with our customers as these changes occur. Relationship management is still in its infancy at 1st Source; we will spend the next five years perfecting and formalizing the process. Our strategic intent over the past five years has been "to serve everyone in the market." We know this may sound impossible, but it has shifted the responsibility back on us to find ways to serve everyone -- not just those we think are profitable. It has caused us to rethink and reconfigure our products, to simplify service offerings, and to add new products designed to profitably meet the needs of customers who might otherwise be viewed as too costly to serve. As a result of this thinking, we purchased Trustcorp Mortgage Company in the 1990s, integrated our mortgage servicing with theirs and became more aggressive in offering government guaranteed (Page 5) mortgage products in the market. 1st Source and Trustcorp together have become the market leader in providing mortgages in the Michiana area. We also created Loan Source in 1997 to simplify and make the consumer loan process friendlier. New branches in Michigan and Indiana have enabled us to get physically closer to our customers. Free Checking and Overdraft Security have helped us meet the needs of modest income customers more effectively. And the Resource Plus debit card has given customers access to the money in their checking accounts from anywhere in the world. [PHOTO] Branch Boom Duke Jones, (left) President of 1st Source Bank; and Chris Murphy, Corporate Chairman, inspect plans for a new banking center opening in St. Joseph, Michigan, spring 2001. In 1995 we committed ourselves to a Vision for 1st Source in 2000 which included being the leading financial institution in the markets we serve; providing the highest quality service; nurturing pride of ownership and a spirit of teamwork in all our colleagues; maintaining independent ownership; upholding the highest ethical standards in our industry; embracing the economic and social ideals of the communities we serve; and delivering consistently superior financial returns. In reviewing our results, we are proud of what we have accomplished together. While we did not achieve all our financial goals and may not be as far along as we had hoped in realizing our Vision, we have accomplished much! We have increased and strengthened our market share. By growing one (Page 6) customer at a time, we have become the largest provider of financial services headquartered in our region. We end 2000 as an independent company proud of our heritage, with our ownership based solidly in the markets we serve and shared by all of our colleagues at 1st Source. Today, over 95 percent of 1st Source employees are shareholders either directly or through their 401(k) plan. Each year we recommit ourselves to the highest ethical standards. Like the people we serve, our colleagues have a strong work ethic and believe in straight talk and sound advice. We encourage conservative values regarding savings and balanced investments, and are mindful of the attitudes and approaches of our customers. Hard earned money should be carefully managed and protected. 1st Source has distinguished itself as a superior financial performer and has been recognized as such over the last four years by inclusion in the Keefe, Bruyette and Woods Honor Role of Financial Institutions, placing it among the best consistently performing banks in the country -- one of only eleven so recognized in 2000. Additionally, Stifel, Nicolaus & Company stated in February 2001 that "Over the past decade, 1st Source Corporation has compiled one of the most consistent track records in our Bank Index (comprised of 54 banks in the central part of the U.S.). More specifically, SRCE is one of only 15 companies in our Index to have increased earnings each of the last five (1995-2000) years." In 1995, we had hoped to earn $40.0 million in the year 2000. We actually earned $37.6 million, leaving us short of our goal in earnings and return on assets. However, we met our 1995 targets for 2000 in asset growth, loan growth, deposit growth, return on equity, nonperforming asset to loans ratio, and net charge-offs to loan ratio. We grade our performance over the past five years as a strong "B+" and will work hard to raise that to an "A" in the next five years. THE NEXT FIVE YEARS We are in the process of setting our goals and plans for 2005. To be sure, the world will be different and the economy variable. Nonetheless, we remain committed to our original Vision for 2000 with a larger view of our geographic markets and a greater appreciation for the challenges ahead. Our success in the future, just as in the past, is based on having colleagues who like being in service to others and who listen and learn from each other. We will have to be more efficient and more effective. We will have to be more aggressive and more careful. If we can continue to attract good people to join us, give them a good working environment where all opinions are valued, then we will continue to be successful. In planning for 2005, we invited all 1,000 or so of our colleagues to provide input to our planning teams. The response was inspiring -- over 600 sent in multiple page memos or e-mails. Their views were shared among the teams as we began to look at our longer-term challenges. Our plans are still developing. Over the next year, we will try to give feedback to all those at 1st Source who submitted ideas and suggestions for making this an even more successful company in 2005. TEAMWORK In closing, I want to thank Paul Bowles who retires this year from our board with 14 years of service. I also want to thank all of my colleagues throughout 1st Source for making this a special place. Everyone here is significant and we are all dependent on one another in serving our customers well. Our tellers, lenders, bankers, investment managers, accountants, maintenance staff, clerks, analysts, auditors, information technologists, operations and systems staff and everyone else -- all work together to make 1st Source what it is. We have a good team committed to doing great things carefully over time. Thank you for your support. /s/ Christopher J. Murphy Christopher J. Murphy III Chairman, President and Chief Executive Officer (page 7) --Full page graphic-- BANKING CENTER LOCATIONS - 2000 Visit 1st Source online at www.1stsource.com [MAP OF BANKING CENTER LOCATIONS] [1ST SOURCE BANK LOGO] (page 8) Management's Discussion and Analysis of Financial Condition and Results of Operations ABOUT OUR BUSINESS 1st Source Corporation (1st Source) is an Indiana-based bank holding company with $3.18 billion in total assets, $2.31 billion in total loans, $2.46 billion in total deposits, and $270.6 million in total shareholders' equity. 1st Source's principal subsidiary is 1stSource Bank with its main office in South Bend, Indiana. The assets of the bank account for 98% of the total consolidated assets of 1st Source. The bank offers a broad range of commercial banking, personal banking and trust services. As part of its commercial banking services, 1st Source also provides highly specialized financing services for automobile fleets in the rental and leasing industries; privately owned aircraft used by businesses and individuals; heavy duty trucks, construction and environmental equipment. This section of the Annual Report provides a narrative discussion and analysis of 1st Source's financial condition and results of operations for the last three years. All tables, graphs, financial statements and notes to the consolidated financial statements should be considered an integral part of this analysis. Except for historical information contained herein, the matters discussed in this document, and other information contained in 1st Source's SEC filings, may express "forward-looking statements." Those statements may involve risk and uncertainties, including statements concerning future events, performance and assumptions and other statements that are other than statements of historical facts. 1st Source cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. Readers are advised that various factors -- including, but not limited to, changes in laws, regulations or generally accepted accounting principles; 1st Source's competitive position within its markets served; increasing consolidation within the banking industry; unforeseen changes in interest rates; unforeseen downturns in the local, regional or national economies -- could cause 1st Source's actual results or circumstances for future periods to differ materially from those anticipated or projected. AVERAGE ASSETS (In Millions) [GRAPH]
96 97 98 99 00 (1,895) (2,198) (2,551) (2,740) (3,040)
AVERAGE LOANS (In Millions) [GRAPH]
96 97 98 99 00 (1,348) (1,611) (1,854) (1,949) (2,207)
AVERAGE DEPOSITS (In Millions) [GRAPH]
96 97 98 99 00 (1,524) (1,699) (2,000) (2,127) (2,352)
AVERAGE SHAREHOLDERS' EQUITY (In Millions) [GRAPH]
96 97 98 99 00 (161) (183) (206) (227) (253)
(page 9) SELECTED CONSOLIDATED FINANCIAL DATA (Dollars in thousands, except per share amounts)
2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Interest income ............................ $ 235,392 $ 200,429 $ 196,148 $ 173,316 $ 148,820 Interest expense ........................... 130,425 100,726 102,227 87,324 73,429 Net interest income ........................ 104,967 99,703 93,921 85,992 75,391 Provision for loan losses .................. 14,877 7,442 9,156 6,052 4,649 Net interest income after provision for loan losses ............... 90,090 92,261 84,765 79,940 70,742 Noninterest income ......................... 73,914 63,260 52,256 35,656 25,479 Noninterest expense ........................ 104,003 99,023 85,500 72,977 60,622 Income before income taxes ................. 60,001 56,498 51,521 42,619 35,599 Income taxes ............................... 20,030 18,471 17,843 14,392 12,396 Distribution on preferred securities of subsidiary trusts, net of income tax benefit 2,398 2,259 2,221 1,738 -- Net income ................................. $ 37,573 $ 35,768 $ 31,457 $ 26,489 $ 23,203 Assets ..................................... $3,182,181 $2,872,945 $2,733,592 $2,418,154 $2,079,767 Long-term debt ............................. 12,060 12,174 13,189 16,656 18,596 Shareholders' equity ....................... 270,572 238,820 216,793 194,953 171,833 Basic net income per common share* ......... 1.90 1.80 1.58 1.33 1.17 Diluted net income per common share* ....... 1.88 1.77 1.55 1.29 1.14 Cash dividends per common share* ........... .351 .298 .265 .238 .208 Return on average common equity ............ 14.88% 15.74% 15.30% 14.51% 14.38% Return on average total assets ............. 1.24% 1.31% 1.23% 1.21% 1.22%
*The computation of per common share data gives retroactive recognition to a 5% stock dividend declared July 18, 2000; a 10% stock dividend declared January 14, 1999; a 10% stock dividend declared January 20, 1998; and a five-for-four stock split declared January 21, 1997. (page 10) 1st Source Corporation and Subsidiaries RESULTS OF OPERATIONS Net income in 2000 was $37.6 million, up from $35.8 million in 1999 and $31.5 million in 1998. Diluted net income per common share was $1.88 in 2000, $1.77 in 1999 and $1.55 in 1998 after giving retroactive recognition to stock splits and stock dividends. Return on average total assets was 1.24% in 2000, compared to 1.31% in 1999 and 1.23% in 1998. Return on average common equity was 14.88% in 2000 versus 15.74% in 1999 and 15.30% in 1998. Net income in 2000 was favorably affected by strong noninterest income growth. By leveraging internal resources, 1st Source has been successful in generating additional noninterest income as a way to mitigate the competitive pressures on the interest margin. In addition, due to cost control measures, noninterest expenses increased moderately. The management of both noninterest income and expense enabled 1st Source to reduce the expense to net revenue ratio below 55% for 2000. Dividends declared on common stock in 2000 amounted to $.351 per share, compared to $.298 in 1999 and $.265 in 1998. The level of earnings reinvested and dividend payouts are based on management's assessment of future growth opportunities and the level of capital necessary to support them. The quarterly results of operations for the years ended December 31, 2000 and 1999 are summarized below. QUARTERLY RESULTS OF OPERATIONS (Dollars in thousands, except per share amounts)
Three Months Ended March 31 June 30 September 30 December 31 -------- ------- ------------ ----------- 2000 Interest income .................... $ 53,049 $ 58,065 $ 61,130 $ 63,148 Net interest income ................ 25,199 26,488 26,300 26,980 Provision for loan losses .......... 3,918 4,678 1,292 4,989 Investment securities and other investment gains (losses) .... 497 -- -- 1,831 Income before income taxes and subsidiary trust distributions 14,109 13,725 14,793 17,374 Net income ......................... 8,685 8,906 9,226 10,756 Diluted net income per common share* .43 .45 .46 .54 1999 Interest income .................... $ 47,898 $ 49,872 $ 50,598 $ 52,061 Net interest income ................ 23,579 24,783 25,626 25,715 Provision for loan losses .......... 1,293 1,443 2,232 2,474 Investment securities and other investment gains (losses) ...... (77) (400) -- 630 Income before income taxes and subsidiary trust distributions . 13,927 12,754 14,057 15,760 Net income ......................... 8,528 7,874 8,613 10,753 Diluted net income per common share* .42 .39 .43 .53
* The computation of per share data gives retroactive recognition to a 5% stock dividend declared July 18, 2000. (Page 11) BALANCE SHEET COMPOSITION AND MANAGEMENT Changes in interest income and interest expense are affected by the allocation of funds throughout the Statement of Financial Condition. The following sections discuss the sources from which 1st Source obtains funds and the manner in which management has chosen to invest these funds. SOURCES OF FUNDS CORE DEPOSITS -- 1st Source's major source of investable funds is provided by stable core deposits consisting of all interest bearing and noninterest bearing deposits, excluding brokered certificates of deposit and certain certificates of deposit of $100,000 and over. In 2000, average core deposits equaled 62.41% of average total assets, compared to 65.47% in 1999 and 62.49% in 1998. The effective cost rate of core deposits in 2000 was 4.25%, compared to 3.74% in 1999 and 3.94% in 1998. Average demand deposits (noninterest bearing core deposits) increased 0.66% in 2000, compared to an increase of 13.05% in 1999. They represented 15.04% of total core deposits in 2000, compared to 15.80% in 1999 and 15.73% in 1998. PURCHASED FUNDS -- 1st Source's purchased funds are used to supplement core deposits and include certain certificates of deposit of $100,000 and over, brokered certificates of deposit, federal funds, securities sold under agreements to repurchase, commercial paper and other short-term borrowings. Purchased funds are raised from customers seeking short-term investments and are used to balance the bank's interest rate sensitivity. During 2000, 1st Source's reliance on purchased funds increased to 25.75% of average total assets from 22.49% in 1999. LOAN SECURITIZATIONS -- 1st Source sells many of the aircraft and auto loans it originates through the issuance of securities backed by those loans in securitization transactions. In a securitization, 1st Source sells and transfers pools of loans to a special-purpose entity. The special-purpose entity simultaneously sells and transfers its total interest in the loans to a trust, which issues beneficial interests in the loans in the form of securities which are sold through private placement transactions. The special-purpose entity generally retains the right to receive any excess cash flows of the trust. 1st Source sold $248 million of loans in 2000 and $276 million of loans in 1999 in conjunction with aircraft and auto loan securitization transactions. SHAREHOLDERS' EQUITY -- Management continues to emphasize profitable asset growth and retention of equity in the business. Average shareholders' equity equated to 8.31% of average total assets in 2000 compared to 8.29% in 1999. Shareholders' equity was 8.50% of total assets at year-end 2000, compared to 8.31% at year-end 1999. INVESTMENT OF FUNDS INVESTMENT SECURITIES -- Investment securities at year-end 2000 increased 2.90% from 1999, following a 1.40% increase from year-end 1998 to year-end 1999. Investment securities at December 31, 2000 were $563 million and were 17.70% of total assets, compared to $547 million or 19.05% of total assets at December 31, 1999. LOANS -- Average loans, net of unearned discount, increased 13.25% in 2000, following a 5.16% increase in 1999. Loans, net of unearned discount, at December 31, 2000, were $2.31 billion and were 72.56% of total assets, compared to $2.06 billion or 71.81% of total assets at December 31, 1999. Commercial and agricultural lending outstandings, excluding those secured by real estate, increased 4.54% during 2000. 1st Source continues to experience growth in its market as customers seek professional personal service with local decision-making authority. Commercial loans secured by transportation and construction equipment at year-end 2000 increased 17.65% from year-end 1999. The increase in 2000 (Page 12) MATURITIES OF INVESTMENT SECURITIES AT DECEMBER 31, 2000 (Dollars in thousands)
U.S. Treasury States and Political and Agencies Subdivisions Other Securities Total --------------- --------------- ---------------- ---------------- Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- 0 - 1 Year $157,400 5.84% $ 23,877 5.47% $ 12,098 6.17% $193,375 5.82% 1 - 5 Years 158,310 6.40 101,933 6.44 12,003 6.38 272,246 6.41 5 - 10 Years 957 7.00 17,961 7.24 176 6.91 19,094 7.22 Over 10 Years 18,165 6.74 7,730 6.33 52,512 6.43 78,407 6.49 -------- ---- -------- ---- -------- ---- -------- ---- Total $334,832 6.16% $151,501 6.38% $ 76,789 6.38% $563,122 6.25%
Weighted average yields on tax-exempt obligations have been computed by adjusting tax-exempt income to a fully taxable equivalent basis, excluding the effect of the tax preference interest expense adjustment. was the result of further expansion of our customer base and increased penetration in all of our niche markets: construction equipment, auto fleet rental and leasing franchises, aircraft, heavy duty trucks and environmental equipment. Also contributing to the increase, fewer loans were sold in 2000 through loan securitizations than in 1999. In 2000, loans originated net of loans sold were $829 million compared to $781 million in 1999, equating to an increase of 6.15%. Real estate loans increased 9.07% during 2000. This increase was due to commercial real estate lending increasing 14.25% and an increase of 10.18% in portfolio residential mortgage loans offset by a decrease of 19.73% in residential mortgage loans held for sale. Consumer loans grew 10.37% in 2000. This growth is attributed to increased consumer lending at the new retail banking centers as well as an increase in home equity and second mortgage lending activity. LIQUIDITY RISK MANAGEMENT -- The Asset/Liability management process incorporates overall bank liquidity and interest rate sensitivity. The purpose of liquidity management is to match the sources and uses of funds to anticipated customer deposits, withdrawals and borrowing requirements, as well as to provide for the cash flow needs of 1st Source. The primary source of liquidity is the investment portfolio. At December 31, 2000, securities maturing in one year amounted to $193.4 million, which represented 34.34% of the investment portfolio as compared to 24.23% at year-end 1999. The increase was due to securities that were purchased in 1999 for liquidity purposes with maturity dates in 2001. Other alternative sources of funds are loan repayments and loan securitizations. The liquidity of 1st Source is further enhanced by a significant concentration of core deposits and $100,000-and-over certificates of deposit. Both provide a relatively stable funding base. INTEREST RATE RISK MANAGEMENT -- The Asset/Liability Management Committee of 1st Source monitors and manages the relationship of earning assets to interest bearing liabilities and the responsiveness of asset yields, interest expense and interest margins to changes in market interest rates. In the normal course of business, 1st Source faces ongoing interest rate risks and uncertainties. 1st Source occasionally utilizes interest rate swaps to partially manage the primary market exposures associated with the interest rate risk related to underlying assets, liabilities, and anticipated transactions. A hypothetical change in earnings was modeled by calculating an immediate 100 basis point (1.00%) (page 13) INVESTMENT OF FUNDS (concluded) change in interest rates across all maturities. This analysis presents the hypothetical change in earnings of those rate sensitive financial instruments held by 1st Source (excluding Trustcorp Mortgage) at December 31, 2000. The aggregate hypothetical decrease in pre-tax earnings is estimated to be $1.5 million on an annualized basis on all rate-sensitive financial instruments based on a hypothetical increase of a 100 basis point change in interest rates. The aggregate hypothetical increase in pre-tax earnings is estimated to be $2.9 million on an annualized basis on all rate-sensitive financial instruments based on a hypothetical decrease of a 100 basis point change in interest rates. Actual results may differ materially from those projected. The use of this methodology to quantify the market risk of the balance sheet should not be construed as an endorsement of its accuracy or the accuracy of the related assumptions. Due to the nature of the mortgage banking business, 1st Source manages the earning assets and interest-bearing liabilities of Trustcorp Mortgage Company on a separate basis. The predominant assets on Trustcorp's balance sheet are mortgage loans held for sale, which are funded by short-term borrowings (normally less than 30 days) from non-affiliated banks. These borrowings are managed on a daily basis. Trustcorp's other borrowings for working capital and purchases of servicing assets are funded by 1st Source Corporation and non-affiliated banks. Trustcorp manages the interest rate risk related to loan commitments by entering into contracts for future delivery of loans. (See Note M of Notes to Consolidated Financial Statements.) COMPOSITION OF AVERAGE ASSETS (In Millions) [GRAPH]
96 97 98 99 00 Loans (net of unearned discount and loss reserve) 1,323.6 1,578.9 1,815.5 1,910.1 2,165.9 Investments 411.9 434.1 489.3 527.3 559.4 Other earning assets 12.3 25.0 47.4 64.8 80.6 Other assets 147.4 160.3 198.7 237.8 234.2 Total 1,895.2 2,198.3 2,550.9 2,740.0 3,040.1
COMPOSITION OF AVERAGE LIABILITIES AND SHAREHOLDERS' EQUITY (In Millions) [GRAPH]
96 97 98 99 00 Noninterest bearing deposits 186.8 210.7 250.8 283.5 285.4 Interest bearing core deposits 1,108.0 1,182.2 1,343.3 1,510.5 1,611.8 Purchased funds & long-term debt 405.2 585.3 706.6 673.4 839.9 Other liabilities 33.9 37.6 44.6 45.4 50.4 Shareholders' equity 161.3 182.5 205.6 227.2 252.6 Total 1,895.2 2,198.3 2,550.9 2,740.0 3,040.1
(page 14) OPERATING RESULTS Net interest income, the difference between income from earning assets and the interest cost of funding those assets, is 1st Source's primary source of earnings. Net interest income, on a fully taxable equivalent basis, increased 4.61% in 2000, following a 5.96% increase in 1999. Net interest margin, the ratio of net interest income to average earning assets, is affected by movements in interest rates and changes in the mix of earning assets and the liabilities that fund those assets. Net interest margin on a fully taxable equivalent basis was 3.91% in 2000 compared to 4.17% in 1999 and 4.16% in 1998. The net interest margin was negatively impacted in 2000 primarily due to the cost of funds rising more than the yield on interest earning assets; in part, due to greater reliance on brokered and jumbo certificates of deposits to meet funding needs. The yield on earning assets in 2000 was 8.62%, compared to 8.23% in 1999 and 8.52% in 1998. Average earning assets in 2000 increased 11.68%, following a 5.70% increase in 1999. The effective rate on interest bearing liabilities was 5.42% in 2000, compared to 4.71% for 1999 and 5.10% for 1998. NONINTEREST INCOME -- Supplementing the growth in net interest income was an increase in noninterest income of 16.84% over 1999. The factors influencing the growth were increases in deposit service charges, mortgage servicing sales, revenues generated from operating leases and investment gains. Noninterest income increased 21.06% in 1999 over 1998 due to increased aircraft and auto loan securitization and servicing income and rental income from operating leases. Trust fees in 2000 were $9.61 million, compared to $8.95 million in 1999 and $8.26 million in 1998. Trust fees increased 7.35% in 2000, following an 8.44% increase in 1999. Service charges on deposit accounts increased by 17.05% resulting in $8.07 million of income for 2000. The $6.90 million recorded in 1999 was an increase of 18.00% from the $5.84 million of service charges on deposit accounts generated in 1998. Generally, overdraft fees and debit cards fees accounted for the increase in service charges on deposit accounts for both 2000 and 1999. Loan servicing and sale income generated from 1st Source's aircraft and auto loan securitization and mortgage banking activities increased 12.89% to $22.00 million in 2000. The $19.49 million recorded in 1999 represented a 22.95% increase over 1998. Loan securitization income was $12.40 million during 2000, compared to $12.07 million during 1999. The outstanding servicing portfolio of aircraft and auto loans grew to $350 million at year-end 2000, compared to $344 million at the end of 1999. Gains of $7.03 million were recognized on the origination and sale of mortgage loans and servicing in 2000, compared to gains of $5.08 million in 1999. In addition, net servicing fees on mortgages increased to $2.57 million for 2000, from $2.34 million for 1999. As of December 31, 2000, Trustcorp Mortgage Company's mortgage servicing portfolio aggregates $2.07 billion, as compared to $2.21 billion one year ago. In January 2001, Trustcorp executed an agreement to sell $1.0 billion of its mortgage servicing portfolio which was expected to settle in the first quarter of 2001 and generate approximately $6.0 million of net income. Equipment rental income generated from operating leases increased to $21.22 million in 2000, a 21.93% increase over 1999. The $17.41 million recorded in 1999 was a 38.62% increase over 1998. Revenues from operating leases for construction equipment, automobiles and other equipment, and the related depreciation on the equipment, have increased significantly in the past few years as 1st Source has focused on increasing this line of business. (page 15)
SELECTED STATISTICAL INFORMATION Distribution of Assets, Liabilities and Shareholders' Equity Interest Rates and Interest Differential (Dollars in Thousands) Year ended December 31, 2000 1999 1998 ---------------------------------- -------------------------------- ------------------------------ Interest Interest Interest Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate ---------------------------------- -------------------------------- ------------------------------- ASSETS: Investment securities: Taxable $ 369,401 $ 22,264 6.03% $ 348,944 $ 20,049 5.75% $ 294,632 $ 17,419 5.91% Tax exempt (1) 167,682 10,959 6.54% 161,712 11,336 7.01% 150,678 11,327 7.52% Net loans (2 & 3) 2,207,382 203,853 9.24% 1,949,172 171,770 8.81% 1,853,537 168,664 9.10% Other investments 23,256 1,455 6.26% 18,354 911 4.96% 45,708 2,348 5.14% --------- ------- ----- --------- ------- ----- --------- ------- ----- Total earning assets 2,767,721 238,531 8.62% 2,478,182 204,066 8.23% 2,344,555 199,758 8.52% Cash and due from banks 97,096 113,099 86,452 Reserve for loan losses (41,441) (39,105) (38,050) Other assets 216,715 187,868 157,968 ---------- ---------- ---------- Total $3,040,091 $2,740,044 $2,550,925 ========== ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest bearing deposits $2,066,846 $109,866 5.32% $1,843,692 $ 84,839 4.60% $1,748,759 $ 86,264 4.93% Short-term borrowings 327,941 19,664 6.00% 283,035 14,995 5.30% 243,431 15,034 6.18% Long-term debt 12,193 895 7.34% 12,492 892 7.14% 13,036 929 7.13% --------- ------- ----- --------- ------- ----- --------- ------- ----- Total interest bearing liabilities 2,406,980 130,425 5.42% 2,139,219 100,726 4.71% 2,005,226 102,227 5.10% Noninterest bearing deposits 285,361 283,479 250,755 Other liabilities 95,176 90,152 89,343 Shareholders' equity 252,574 227,194 205,601 ---------- ---------- ---------- Total $3,040,091 $2,740,044 $2,550,925 ========== ========== ========== Net interest income $108,106 $103,340 $97,531 ======== ======== ======= Net yield on earning assets on a taxable equivalent basis 3.91% 4.17% 4.16% ===== ===== =====
(1) Interest income includes the effects of taxable equivalent adjustments, using a 40.525% rate. Tax equivalent adjustments were $3,003 in 2000, $3,441 in 1999 and $3,408 in 1998. (2) Loan income includes fees on loans of $6,043 in 2000, $5,745 in 1999 and $4,889 in 1998. Loan income also includes the effects of taxable equivalent adjustments, using a 40.525% rate. Tax equivalent adjustments were $136 in 2000, $196 in 1999 and $202 in 1998. (3) For purposes of this computation, nonaccruing loans are included in the daily average loan amounts outstanding. (pages 16 & 17) OPERATING RESULTS (continued) Other income experienced a modest growth of 3.05% during 2000, compared to only a 0.02% increase in 1999. Both years were negatively impacted by lower consumer mortgage refinancings. Additionally, both years enjoyed moderate increases in insurance commissions and standby letter of credit fees. During the fourth quarter of 2000, a gain of $1.96 million was realized on the sale of foreign bonds in response to favorable market conditions. The balance of the net investment securities and other investment gains, in 2000 and 1999, were primarily the result of disposals and adjustments on venture capital investments. NONINTEREST EXPENSE -- 1st Source experienced a moderate increase in noninterest expense of 5.03% in 2000 compared to 15.82% for 1999. Depreciation on our growing operating lease portfolio and costs to attract and retain quality people were the leading contributors to expense growth for both years, offset by a 44.80% decrease in professional consulting fees for 2000. Cost control across all business units and better utilization of resources continues to be a major focus at 1st Source. Salaries and employee benefits increased 4.00% in 2000, following an 11.02% increase in 1999. Salaries and wages increased 3.86% in 2000 and 10.70% in 1999. The smaller increase in 2000 was due, in part, to lower commissions paid to mortgage originators from the prior year. The number of full-time equivalent employees stood at 1,070 at the end of 2000, compared to 1,083 and 1,036 at the end of 1999 and 1998, respectively. Employee benefits increased 4.51% in 2000, following a 12.15% increase in 1999. The lower percentage of increase in employee benefits for 2000 was primarily the result of a decrease in group insurance expense of 6.12% in 2000, following a 17.84% increase in 1999. Occupancy expense in 2000 increased 6.56% from 1999, following a 6.79% increase in 1999. The 2000 and 1999 increases were primarily due to normal annual lease and operating cost adjustments. Furniture and equipment expense, including depreciation, increased in 2000 by 8.88%, following a 12.56% increase in 1999. The increase in 2000 is attributed primarily to upgrades in computer systems and hardware, software costs and increased computer processing charges. Depreciation on operating leases increased 29.38% in 2000, following a 45.15% increase in 1999 due to the continued expansion of our operating lease portfolio. Supplies and communications expense decreased 4.37% in 2000, following an 11.83% increase in 1999. The increase in 1999 was primarily driven by Y2K preparation expenses. Business development and marketing expense decreased 15.06% in 2000, following an increase of 21.97% in 1999. The decrease in 2000 was in part due to effective targeting of advertising and marketing campaigns. A decrease of 10.70% occurred in other expenses during 2000, compared to a 19.26% increase in 1999. Professional consulting expenses decreased in 2000 due to increased costs in 1999 for Y2K readiness preparations. Finally, an increase in collection and repossession expenses in 2000 was offset by a substantial decrease in check forgery losses. INCOME TAXES -- Federal income taxes were $17.43 million and $15.26 million, prior to the tax benefit of $1.29 million and $1.22 million relating to the distribution on preferred securities of subsidiary trusts for 2000 and 1999, respectively. After this benefit, 2000 federal income taxes were $16.14 million, or 30.05% of income after state taxes, compared to $14.04 million or 28.19% in 1999 and $12.30 million or 28.11% in 1998. A settlement with the Internal Revenue Service was reached during 1997 over a (page 18) OPERATING RESULTS (concluded) dispute arising from the 1983 purchase of the First National Bank of Mishawaka relating to deduction of core deposit intangibles. Interest of $955,000 related to the settlement was paid to the IRS in 1998. State income taxes were $2.60 million and $3.21 million in 2000 and 1999, respectively, prior to the tax benefit of $174,000 and $200,000 relating to the distribution on preferred securities of subsidiary trusts for 2000 and 1999, respectively. After this benefit, 2000 state income taxes were $2.43 million, compared to $3.01 million in 1999 and $4.02 million in 1998. State income tax declined in 2000 and 1999 due primarily to a change in Indiana tax law effective January 1, 1999, allowing resident banks to apportion their income to the state of its source. CREDIT EXPERIENCE PROVISION FOR LOAN LOSSES -- The ability of a bank to identify and assess the risk factors affecting its loan portfolio is crucial for profitability. Management follows a credit policy that balances the risk and return on loans and monitors potential credit problems to ensure that they are adequately managed and reserved. The provision made to the reserve for loan losses is determined by management based on the risk factors and current economic conditions affecting the loan portfolio, including changes to the portfolio mix and past loan loss experience. The provision for loan losses for 2000 was $14.88 million, compared to $7.44 million in 1999 and $9.16 million in 1998. The increase in the provision for loan losses in 2000 compared to 1999 reflects the higher net charge-offs in 2000. The higher net charge-offs occurred primarily in aircraft lending whose customers were impacted by higher fuel and borrowing costs. Net charge-offs of $7.40 million, $2.39 million, and $3.65 million were recorded in 2000, 1999, and 1998, respectively. The reserve for loan losses at December 31, 2000 totaled $44.64 million and was 1.93% of loans, compared to $40.21 million or 1.95% of loans at December 31, 1999, and $38.63 million or 2.05% of loans at December 31, 1998. It is management's opinion that the reserve for loan losses is adequate to absorb losses inherent in the loan portfolio as of December 31, 2000. NONPERFORMING ASSETS -- 1st Source's policy is to discontinue the accrual of interest on loans on which principal or interest is past due and remains unpaid for 90 days or more, unless the loan is well collateralized and in the process of collection. Nonperforming assets amounted to $25.00 million at December 31, 2000, compared to $15.36 million at December 31, 1999, and $10.57 million at December 31, 1998. Impaired loans totaled $37.01 million, $31.57 million and $13.30 million at December 31, 2000, 1999, and 1998, respectively. The overall increase in nonperforming assets for 2000 is the result of increases in nonaccrual loans and other nonperforming assets. The increase in nonaccrual loans is primarily attributed to commercial loans secured by transportation and construction equipment. In addition, there has been a moderate increase in nonaccruing small business loans. The increase in other nonperforming assets is due primarily to repossessions of an aircraft and certain construction equipment. (page 19) NONPERFORMING ASSETS AT DECEMBER 31 (Dollars in thousands)
2000 1999 1998 1997 1996 ------ ------ ------ ------ ------ Loans past due over 90 days $ 385 $ 254 $ 275 $ 730 $ 557 Nonaccrual loans 19,168 11,967 9,266 10,030 6,678 TOTAL NONPERFORMING LOANS 19,553 12,221 9,541 10,760 7,235 Other real estate 1,698 1,167 424 335 445 Other assets 3,745 1,967 606 341 93 TOTAL NONPERFORMING ASSETS $24,996 $15,355 $10,571 $11,436 $7,773 Nonperforming assets to loans, net of unearned discount 1.08% .74% .56% .64% .54%
CAPITAL RESOURCES 1st Source manages its capital resources to serve its customers, protect its depositors, support growth and provide a fair return to shareholders. As of December 31, 2000, there were 1,125 holders of record of 1st Source common stock. 1st Source's common stock is traded on the Nasdaq Stock Market under the National Market symbol "SRCE." High and low stock prices and cash dividends paid for the last two years by quarter were:
2000 SALES PRICE Cash 1999 Sales Price Cash ---------------- Dividends ---------------- Dividends Common Stock Prices High Low Paid High Low Paid ------------------- ---- --- ---- ---- --- ---- Quarter Ended: March 31 $ 24.29 $ 16.90 $.085 $ 34.05 $ 28.33 $.069 June 30 21.90 14.88 .086 31.67 28.10 .076 September 30 21.63 15.63 .090 31.31 22.74 .076 December 31 21.44 14.63 .090 28.45 23.69 .077
The above information gives retroactive recognition to a 5% stock dividend declared July 18, 2000. At December 31, 2000, the total market capitalization of 1st Source was approximately $359.8 million. EFFECTS OF INFLATION -- The results of operations can also be affected by inflation, although it is difficult to measure the precise impact on the various types of income and expense. Interest rates, in particular, are significantly affected by inflation, but neither the timing nor the magnitude of the changes coincide with changes in the consumer price index nor other measures of inflation. Additionally, increases in interest rates, such as those on consumer deposits, lag behind increases in overall rates. This, in turn, affects the composition of sources of funds by reducing core deposit growth and increasing the need for purchased funds. Another significant effect of inflation is on noninterest expenses, which tend to rise during periods of general inflation. (page 20) CAPITAL RESOURCES (concluded) LEVERAGE CAPITAL RATIO [GRAPH]
96 97 98 99 00 (8.48) (9.98) (9.51) (10.01) (9.79)
COMMON STOCK PRICE RANGE [GRAPH]
1999 2000 1st 2nd 3rd 4th 1st 2nd 3rd 4th ------------------------------------- ------------------------------------- High 34.05 31.67 31.31 28.45 24.29 21.90 21.63 21.44 Low 28.33 28.10 22.74 23.69 16.90 14.88 15.63 14.63 Quarter Ending 28.33 30.48 22.86 23.81 18.63 14.94 21.00 18.25
BOOK VALUE PER COMMON SHARE * [GRAPH]
96 97 98 99 00 (8.68) (9.75) (10.93) (12.03) (13.72)
* Book value is not necessarily indicative of the value of 1st Source common stock. CASH DIVIDENDS PER COMMON SHARE [GRAPH]
96 97 98 99 00 (.208) (.238) (.265) (.298) (.351)
(page 21) CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands)
December 31 ----------- 2000 1999 ---- ---- ASSETS Cash and due from banks ...................................... $ 118,123 $ 101,911 Federal funds sold and interest bearing deposits with other banks ......................... 901 1,399 Investment securities, available-for-sale (amortized cost of $503,238 and $475,390 at December 31, 2000 and 1999, respectively) ................. 503,910 470,040 Investment securities, held-to-maturity (fair value of $60,332 and $78,462 at December 31, 2000 and 1999, respectively) ................. 59,212 77,190 Loans, net of unearned discount: Commercial and agricultural loans ......................... 460,944 440,909 Commercial loans secured by transportation and construction equipment ................. 1,055,145 896,848 Loans secured by real estate .............................. 645,041 591,401 Consumer loans ............................................ 147,932 134,031 ----------- ----------- Total loans .................................................. 2,309,062 2,063,189 Less, reserve for loan losses ............................ (44,644) (40,210) ----------- ----------- Net loans .................................................... 2,264,418 2,022,979 Equipment owned under operating leases, (net of accumulated depreciation of $29,616 and $20,284 at December 31, 2000 and 1999, respectively)....... 84,892 65,956 Premises and equipment Land ...................................................... 4,509 4,509 Buildings and improvements ................................ 33,910 32,418 Furniture and equipment ................................... 25,024 23,748 ----------- ----------- Total premises and equipment ................................. 63,443 60,675 Less, accumulated depreciation ............................ (29,860) (26,930) ----------- ----------- Net premises and equipment ................................... 33,583 33,745 Other assets ................................................. 117,142 99,725 ----------- ----------- Total assets ................................................. $ 3,182,181 $ 2,872,945 =========== =========== LIABILITIES Deposits: Noninterest bearing ....................................... $ 293,564 $ 268,825 Interest bearing .......................................... 2,169,160 1,858,627 ----------- ----------- Total deposits ............................................... 2,462,724 2,127,452 Short-term borrowings Federal funds purchased and securities sold under agreements to repurchase ....................... 192,307 263,253 Other ..................................................... 141,083 146,489 Total short-term borrowings .................................. 333,390 409,742 Long-term debt ............................................... 12,060 12,174 Other liabilities ............................................ 58,685 40,007 ----------- ----------- Total liabilities ............................................ 2,866,859 2,589,375 Guaranteed preferred beneficial interests in the Company's subordinated debentures ..................... 44,750 44,750 SHAREHOLDERS' EQUITY Common stock; no par value Authorized 40,000,000 shares; issued 20,510,393 shares in 2000 and 19,531,519 shares in 1999, less unearned shares (147,516 - 2000 and 137,798 - 1999) ....................... 7,227 6,883 Capital surplus .............................................. 195,197 179,905 Retained earnings ............................................ 80,881 68,309 Cost of common stock in treasury (647,944 shares - 2000 and 492,704 shares - 1999) ............ (14,954) (14,382) Accumulated other comprehensive income (loss)................. 2,221 (1,895) ----------- ----------- Total shareholders' equity ................................... 270,572 238,820 ----------- ----------- Total liabilities and shareholders' equity ................... $ 3,182,181 $ 2,872,945 =========== ===========
The accompanying notes are a part of the consolidated financial statements. (pages 22 & 23) CONSOLIDATED STATEMENTS OF INCOME 1st Source Corporation and Subsidiaries (Dollars in thousands, except per share data)
Year Ended December 31 ---------------------- 2000 1999 1998 ------ ------ ------ Interest and fee income: Loans ...................................................... $ 203,717 $ 171,575 $ 168,462 Investment securities, taxable ............................. 22,264 20,049 17,419 Investment securities, tax-exempt .......................... 7,955 7,895 7,919 --------- --------- --------- Total investment securities .............................. 30,219 27,944 25,338 Other ...................................................... 1,456 910 2,348 --------- --------- --------- Total interest income ......................................... 235,392 200,429 196,148 Interest expense: Deposits ................................................... 109,866 84,839 86,264 Short-term borrowings ...................................... 19,664 14,995 15,034 Long-term debt ............................................. 895 892 929 --------- --------- --------- Total interest expense ........................................ 130,425 100,726 102,227 --------- --------- --------- Net interest income ........................................... 104,967 99,703 93,921 Provision for loan losses .................................. 14,877 7,442 9,156 --------- --------- --------- Net interest income after provision for loan losses ........... 90,090 92,261 84,765 Noninterest income: Trust fees ................................................. 9,612 8,954 8,257 Service charges on deposit accounts ........................ 8,073 6,897 5,845 Loan servicing and sale income ............................. 22,002 19,490 15,852 Equipment rental income .................................... 21,224 17,407 12,557 Other income ............................................... 10,675 10,359 10,357 Investment securities and other investment gains (losses) .. 2,328 153 (612) --------- --------- --------- Total noninterest income ...................................... 73,914 63,260 52,256 Noninterest expense: Salaries and employee benefits ............................. 54,572 52,472 47,265 Net occupancy expense ...................................... 5,651 5,303 4,966 Furniture and equipment expense ............................ 8,874 8,150 7,241 Depreciation - leased equipment ............................ 16,790 12,978 8,941 Supplies and communications ................................ 5,098 5,331 4,767 Business development and marketing expense ................. 3,692 4,346 3,564 Other expense .............................................. 9,326 10,443 8,756 --------- --------- --------- Total noninterest expense ..................................... 104,003 99,023 85,500 --------- --------- --------- Income before income taxes and subsidiary trust distributions ................................ 60,001 56,498 51,521 Income taxes .................................................. 20,030 18,471 17,843 Distribution on preferred securities of subsidiary trusts net of income tax benefit of $1,465 in 2000 and $1,416 in 1999. 2,398 2,259 2,221 --------- --------- --------- Net income .................................................... $ 37,573 $ 35,768 $ 31,457 ========= ========= ========= Basic net income per common share ............................. $ 1.90 $ 1.80 $ 1.58 Diluted net income per common share ........................... $ 1.88 $ 1.77 $ 1.55
The accompanying notes are a part of the consolidated financial statements. (page 24) CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Dollars in thousands, except per share data)
Cost of Accumulated Common Other Common Capital Retained Stock Comprehensive Total Stock Surplus Earnings in Treasury Income (Loss), Net --------- --------- --------- --------- ----------- ------------------ Balance at January 1, 1998 ................. $ 194,953 $ 5,700 $ 69,947 $ 124,394 $ (6,978) $ 1,890 Comprehensive income, net of tax: Net income .............................. 31,457 -- -- 31,457 -- -- Change in unrealized appreciation of available- for-sale securities (net of $1,090 income tax expense)............ 1,600 -- -- -- -- 1,600 --------- Total comprehensive income ................. 33,057 Cost of 231,440 shares of common stock acquired for treasury ................ (7,116) -- -- -- (7,116) -- Cash dividends ($.265 per share) ........... (5,296) -- -- (5,296) -- -- 10% common stock dividend ($13 cash paid in lieu of fractional shares) (13) 570 51,509 (52,092) -- -- Other ...................................... 1,208 -- -- (163) 1,371 -- --------- --------- --------- --------- --------- --------- Balance at December 31, 1998 ............... 216,793 6,270 121,456 98,300 (12,723) 3,490 Comprehensive income, net of tax: Net income .............................. 35,768 -- -- 35,768 -- -- Change in unrealized appreciation of available- for-sale securities (net of $3,669 income tax benefit)............ (5,385) -- -- -- -- (5,385) --------- Total comprehensive income ................. 30,383 -- -- -- -- -- Cost of 210,966 shares of common stock acquired for treasury ................ (6,646) -- -- -- (6,646) -- Cash dividends ($.298 per share) ........... (5,922) -- -- (5,922) -- -- 10% common stock dividend ($17 cash paid in lieu of fractional shares) (17) 613 58,449 (59,079) -- -- Other ...................................... 4,229 -- -- (758) 4,987 -- --------- --------- --------- --------- --------- --------- Balance at December 31, 1999 ............... $ 238,820 $ 6,883 $ 179,905 $ 68,309 $ (14,382) $ (1,895) Comprehensive income, net of tax: Net income .............................. 37,573 -- -- 37,573 -- -- Change in unrealized appreciation of available- for-sale securities (net of $2,804 income tax expense)............ 4,116 -- -- -- -- 4,116 --------- Total comprehensive income ................. 41,689 -- -- -- -- -- Cost of 282,903 shares of common stock acquired for treasury ................ (4,990) -- -- -- (4,990) -- Cash dividends ($.351 per share) ........... (6,956) -- -- (6,956) -- -- 5% common stock dividend ($9 cash paid in lieu of fractional shares). (9) 344 15,292 (15,645) -- -- Other ...................................... 2,018 -- -- (2,400) 4,418 -- --------- --------- --------- --------- --------- --------- Balance at December 31, 2000 ............... $ 270,572 $ 7,227 $ 195,197 $ 80,881 $ (14,954) $ 2,221 ========= ========= ========= ========= ========= =========
The accompanying notes are a part of the consolidated financial statements. (page 25) CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year Ended December 31 ---------------------- 2000 1999 1998 --------- --------- --------- Operating activities: Net income .................................................... $ 37,573 $ 35,768 $ 31,457 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses .................................. 14,877 7,442 9,156 Depreciation of premises and equipment ..................... 21,159 17,099 12,638 Amortization of investment security premiums and accretion of discounts, net ................ 757 1,432 1,039 Amortization of mortgage servicing rights .................. 5,485 5,787 4,086 Deferred income taxes ...................................... 3,013 (926) 8,133 Realized investment securities (gains) losses .............. (2,328) (153) 612 Realized (gains) on securitized loans ...................... (8,880) (6,702) (1,984) Increase in interest receivable ............................ (5,011) (1,705) (787) Increase (decrease) in interest payable .................... 17,148 (2,209) 2,023 Other ...................................................... (18 503) 602 348 --------- --------- --------- Net cash provided by operating activities ........................ 65,290 56,435 66,721 Investing activities: Proceeds from sales and maturities of investment securities ... 213,942 253,736 249,012 Purchases of investment securities ............................ (222,091) (271,441) (373,404) Net decrease (increase) in short-term investments ............. 348 40,552 (30,274) Loans sold or participated to others .......................... 259,126 335,205 377,608 Net increase in loans made to customers Increase in loans net of principal collections................. (522,526) (522,499) (468,670) Net increase in equipment owned under operating leases......... (20,701) (11,411) (23,069) Purchases of premises and equipment ........................... (3,905) (5,899) (3,795) Decrease (increase) in other assets ........................... 412 (8,584) (19,794) Other ......................................................... (535) (1,025) (9,288) --------- --------- --------- Net cash used in investing activities ............................ (295,930) (191,366) (301,674) Financing activities: Net increase (decrease) in demand deposits, NOW accounts and savings accounts .......................... 130,948 (66,741) 311,160 Net increase (decrease) in certificates of deposit ............ 204,325 17,086 (25,844) Net (decrease) increase in short-term borrowings .............. (76,352) 167,583 7,153 Proceeds from issuance of long-term debt ...................... 255 2,211 747 Payments on long-term debt .................................... (369) (3,226) (4,214) Acquisition of treasury stock ................................. (4,990) (6,646) (7,116) Cash dividends ................................................ (6,956) (5,922) (5,296) Other ......................................................... (9) (17) 13 --------- --------- --------- Net cash provided by financing activities ........................ 246,852 104,328 276,603 Increase (decrease) in cash and cash equivalents ................. 16,212 (30,603) 41,650 Cash and cash equivalents, beginning of year ..................... 101,911 132,514 90,864 --------- --------- --------- Cash and cash equivalents, end of year ........................... $ 118,123 $ 101,911 $ 132,514 ========= ========= =========
The accompanying notes are a part of the consolidated financial statements. (page 26) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1st Source Corporation and Subsidiaries NOTE A -- ACCOUNTING POLICIES The principal line of business of 1st Source Corporation ("1st Source") and subsidiaries is banking and closely related activities. The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements. PRINCIPLES OF CONSOLIDATION -- The financial statements consolidate 1st Source and its subsidiaries (principally 1st Source Bank and Trustcorp Mortgage Company). All significant intercompany balances and transactions have been eliminated. For purposes of the parent company only financial information presented in Note Q, investments in subsidiaries are carried at 1st Source's equity in the underlying net assets. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. INVESTMENT SECURITIES -- Securities that may be sold as part of 1st Source's asset/liability or liquidity management or in response to or in anticipation of changes in interest rates and resulting prepayment risk, or for other similar factors, are classified as available-for-sale and carried at fair market value. Unrealized holding gains and losses on securities available-for-sale are reported net of related deferred income taxes as a separate component of shareholders' equity, and the change in such items is a component of comprehensive income. Securities that 1st Source has the ability and positive intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. Trading securities are carried at fair market value with unrealized holding gains and losses included in earnings. There were no trading securities at December 31, 2000 or 1999. Realized gains and losses on the sales of all securities are reported in earnings and computed using the specific identification cost basis. LOANS -- Loans are reported at the principal amount outstanding, net of unearned income. Loans identified as held-for-sale are carried at the lower of cost or market determined on an aggregate basis. Included in real estate loans are loans held for sale totaling $51.8 million and $64.5 million at December 31, 2000 and 1999, respectively. SECURITIZED ASSETS -- The guidelines set forth in Statement of Financial Accounting Standards (SFAS) No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," are followed when accounting for securitizations. When 1st Source sells loans in securitizations, it retains servicing rights and interest-only strips. The interest-only strips are capitalized as retained interests in the securitized assets. Gain or loss on sale of the loans depends in part on the previous carrying amount of all retained interests, allocated in proportion to their fair value.1st Source generally estimates fair value based on the present value of future cash flows expected under management's best estimates of certain key assumptions. Key assumptions used by 1st Source in 2000 in its securitization model are as follows: discount rate (15%); loan loss assumption for cash flow purposes (0.50%); interest earned on the trust cash tied to the 30 day LIBOR; and future liquidations of securitized loans based on an 18 month rolling historical average. In conjunction with its securitization activities, 1st Source sold $248 million of aircraft and auto loans in 2000 and $276 million in 1999. Securitization activities generated income of $12.40 million in 2000 and $12.07 million in 1999. Included in the consolidated statements of financial condition, as other assets, are the retained interests in the securitized assets. The retained interests are assets of 1st Source Funding Corporation ("Funding"), a special-purpose subsidiary of 1st Source Bank, and represent Funding's beneficial interests in certain assets of the 1st Source Master Trust in accordance with 1st Source's loan securitization transactions. The recorded fair value of the retained interests increased to $22.5 million in 2000 from $14.8 million at year end 1999. Changes in fair value are recorded as a component of other comprehensive income. Declines in fair value that are other than temporary are reported in net income. The following analysis shows the impact on the fair value of the retained interests for unfavorable, hypothetical changes in the key assumptions used to value the retained interests: 1. An increase in the loss assumption from 0.50% to 0.75% and 1.00% reduces the fair value by $1.35 million and $2.70 million, respectively. 2. An increase in the discount rate from 15% to 18% and 20% reduces the fair value by $960,000 and $1.57 million, respectively. 3. A decrease of 0.50% and 1.00% in the trust cash earnings rate reduces the fair value by $298,000 and $596,000, respectively. 4. An increase in future liquidations from the current assumption by 50% and 100% reduces the fair value by $464,000 and $820,000, respectively. These results of the above analysis are hypothetical and should be used with caution. As some of the figures indicate, changes in fair value based on unfavorable variations in key assumptions generally cannot be projected, because the relationship of the change in the assumption to the change in fair value vary. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated above without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might alter the results. As of December 31, 2000, $350 million of securitized auto and aircraft loans are outstanding, all of which qualified for sale (page 27) NOTE A -- ACCOUNTING POLICIES (continued) accounting. In addition, $1.99 million of securitized loans are 60 days or more delinquent. During 2000, there were $160,000 of credit losses, net of recoveries. MORTGAGE SERVICING RIGHTS -- The costs of purchasing the rights to service mortgage loans originated by others are deferred and amortized as reductions of mortgage servicing fee income over the estimated servicing period in proportion to the estimated servicing income to be received. Gains and losses on the sale of mortgage servicing rights are recognized as noninterest income in the period in which such rights are sold on a servicing released basis. SFAS No. 125 allows companies to allocate a portion of the total costs of the originated mortgage loans to servicing rights, based on their relative fair value. Fair value is estimated based on market prices, when available, or the present value of future net servicing income, adjusted for such factors as discount and prepayment rates. As of December 31, 2000 and 1999, $18.7 million and $23.6 million, respectively, of mortgage servicing rights have been capitalized. As of these dates, the servicing rights had a fair value of $33.4 million and $40.0 million respectively. Mortgage servicing rights are being amortized using a method which approximates the income forecast method. For the years ended December 31, 2000, 1999, and 1998, $5.49 million, $5.79 million and $4.09million of amortization expense has been recognized. SFAS No. 125 also requires 1st Source to assess its capitalized servicing rights for impairment based on their current fair value. 1st Source disaggregates its servicing portfolio based on loan type and interest rate, and the predominant risk characteristics of the underlying loans. There were no valuation allowances associated with capitalized mortgage servicing rights at December 31, 2000 and 1999. REVENUE RECOGNITION -- Interest on loans is included in interest income, using the accrual method over the terms of the loans based upon principal balances outstanding. The accrual of interest on loans is discontinued when a loan becomes contractually delinquent for 90 days, except for installment loans where payments are being received regularly and mortgage loans, which are placed on nonaccrual at the time the loan is placed in foreclosure. When interest accruals are discontinued, interest credited to income in the current year is reversed, and interest accrued in the prior year is charged to the reserve for loan losses. Management may elect to continue the accrual of interest when the net realizable value of collateral is sufficient to cover the principal and accrued interest. Certain loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized to interest income generally over the contractual life of the related loan or commitment. RESERVE FOR LOAN LOSSES -- A loan is considered impaired, based on current information and events, if it is probable that 1st Source will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The provision for loan losses charged to expense is based upon the actual net loan losses incurred as determined by credit loss experience, the evaluation of inherent losses in the portfolio and the evaluation of impaired loans. Loans are charged against the reserve for loan losses when deemed uncollectible. PREMISES AND EQUIPMENT -- Premises and equipment are stated at cost, less accumulated depreciation. The provision for depreciation is computed generally by the straight-line method, primarily with useful lives of 5, 7, 15, and 31 1/2 years. LEASED ASSETS -- 1st Source finances various types of equipment and automobiles under leases principally classified as operating leases. These assets are being depreciated on a straight-line method over the life of the lease. TRUST FEES -- Trust fees are recognized on the accrual basis. INCOME TAXES -- Deferred income taxes are determined under the liability method. The significant components of the deferred tax assets and liabilities are the tax effect of net temporary differences related principally to differing methods of accounting for loan losses, accounting for depreciation on premises and leased equipment and amortization of mortgage servicing rights. NET INCOME PER COMMON SHARE -- Net income per common share is computed in accordance with SFAS No. 128, "Earnings per Share." Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding, which were as follows (in thousands): 2000, 19,780; 1999, 19,882; and 1998, 19,945. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding, plus the dilutive effect of outstanding stock options. The weighted average number of common shares, increased for the dilutive effect of stock options, used in the computation of diluted earnings per share were as follows (in thousands): 2000, 19,983; 1999, 20,201; and 1998, 20,339. The computation of weighted average number of shares gives retroactive effect to a 5% stock dividend declared July 18, 2000. FUNDS HELD IN TRUST FOR INVESTORS AND MORTGAGORS -- As of December 31, 2000 and 1999, serviced mortgage loans which were owned by investors aggregated $1.77 billion and $2.21 billion, respectively. Funds held in trust at 1st Source for the payment of principal, interest, taxes and insurance premiums (page 28) NOTE A -- ACCOUNTING POLICIES (concluded) applicable to mortgage loans being serviced for others, aggregated approximately $24.9 million and $29.2 million at December 31, 2000 and December 31, 1999, respectively. CASH FLOW INFORMATION -- For purposes of the consolidated and parent company only statements of cash flows, 1st Source considers cash and due from banks as cash and cash equivalents. Cash paid during the years ended December 31, 2000, 1999, and 1998 for interest and for income taxes was $113.3 million and $18.8 million, $102.9 million and $11.0 million, and $100.2 million and $7.8 million, respectively. SEGMENT INFORMATION -- 1st Source's principal business is banking, and management has not separately organized the business beyond commercial banking and mortgage banking. Its wholly owned mortgage subsidiary, Trustcorp Mortgage Company, constitutes a segment by definition of SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." However, it does not meet the quantitative thresholds for separate disclosure as set forth by this Statement. Trustcorp Mortgage Company's revenue is less than 10 percent of consolidated revenue, the absolute amount of its reported income is less than 10 percent of the absolute amount of the consolidated net income of 1st Source, and, finally, its assets are less than 10 percent of consolidated assets. OFF-BALANCE SHEET FINANCIAL INVESTMENTS -- 1st Source occasionally enters into interest rate swap agreements as part of its interest rate risk management strategies. For 1999 and 2000, these instruments are accounted for under the accrual basis of accounting, whereby the income or expense is recorded as a component of interest income. If a swap is terminated, the resulting gain or loss is deferred and amortized over the remaining life of the off-balance sheet investment product. RECENT ACCOUNTING PRONOUNCEMENTS -- In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments and for hedging activities. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on the intended use of the derivative and its resulting designation. In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities -- an Amendment of FASB Statement No. 133," which amends certain provisions of SFAS No. 133. 1st Source currently uses certain derivative contracts (interest rate swaps and forward contracts) which are subject to SFAS No. 133. Management has assessed the impact that the adoption of SFAS No. 133 will have on 1st Source's results of operations and its financial position and, based on current information, it is not expected to have a material impact on its financial statements. 1st Source adopted SFAS No. 133, concurrently with SFAS No. 138, on January 1, 2001. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," which replaces SFAS No. 125. This statement revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carries over most of the provisions of SFAS No. 125 without reconsideration. SFAS No. 140 is effective for transfers occurring after March 31, 2001 and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. This statement is not expected to have a material effect on 1st Source's financial position or results of operations. RECLASSIFICATIONS -- Certain amounts in the 1998 and 1999 consolidated financial statements have been reclassified to conform with the 2000 presentation. These reclassifications had no effect on total assets, shareholders' equity or net income as previously reported. NOTE B -- FAIR VALUES OF FINANCIAL INSTRUMENTS The fair values of 1st Source's financial instruments as of December 31, 2000 and 1999, are summarized in the table on page 30. The following methods and assumptions were used by 1st Source in estimating the fair value of its financial instruments: CASH AND CASH EQUIVALENTS -- The carrying values reported in the consolidated statements of financial condition for cash and due from banks, federal funds sold and interest bearing deposits with other banks approximate their fair values. INVESTMENT SECURITIES -- Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are estimated based on quoted market prices of comparable investments. LOANS -- For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for certain real estate loans (e.g., one-to-four single family residential mortgage loans) are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair values of all other loans are estimated using discounted cash flow analyses which use interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. (page 29) NOTE B -- FAIR VALUES OF FINANCIAL INSTRUMENTS (concluded) DEPOSITS -- The fair values for all deposits other than time deposits are equal to the amounts payable on demand (the carrying value). Fair values of variable rate time deposits are equal to their carrying values. Fair values for fixed rate time deposits are estimated using discounted cash flow analyses using interest rates currently being offered for deposits with similar remaining maturities. SHORT-TERM BORROWINGS -- The carrying values of federal funds purchased, securities sold under repurchase agreements and other short-term borrowings approximate their fair values. LONG-TERM DEBT -- The fair values of 1st Source's long-term debt are estimated using discounted cash flow analyses, based on 1st Source's current estimated incremental borrowing rates for similar types of borrowing arrangements. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN THE COMPANY'S SUBORDINATED DEBENTURES (CUMULATIVE TRUST PREFERRED SECURITIES) -- Fair values are based on quoted market prices. GUARANTEES AND LOAN COMMITMENTS -- Contract and fair values for certain of 1st Source's off-balance-sheet financial instruments (guarantees and loan commitments) are estimated based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. OFF-BALANCE-SHEET INSTRUMENTS -- Fair values for off-balance-sheet instruments are based on the net amount necessary to currently settle the transaction. LIMITATIONS -- Fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments. Because no market exists for a significant portion of 1st Source's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other such factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. In addition, the fair value estimates are based on existing on and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and of the assets and liabilities which are not considered financial instruments. For example, 1st Source has a substantial annual trust net fee income. The trust business is not considered a financial instrument and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial instruments include the mortgage banking operation, premises and equipment and other assets. In addition, for investment and mortgage-backed securities, the income tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates. Also, the fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.
Carrying or Carrying or Contract Value Fair Value Contract Value Fair Value -------------- ---------- -------------- ---------- (Dollars in thousands) 2000 1999 ASSETS: Cash and due from banks ............................. $ 118,123 $ 118,123 $ 101,911 $ 101,911 Federal funds sold and interest bearing deposits with other banks ................... 901 901 1,399 1,399 Investment securities, available-for-sale ........... 503,910 503,910 470,040 470,040 Investment securities, held-to-maturity ............. 59,212 60,332 77,190 78,462 Loans, net of reserve for loan losses ............... 2,264,418 2,309,459 2,022,979 2,030,450 LIABILITIES: Deposits ............................................ 2,462,724 2,474,091 2,127,452 2,126,901 Short-term borrowings ............................... 333,390 333,390 409,742 409,742 Long-term debt ...................................... 12,060 12,425 12,174 12,317 Guaranteed preferred beneficial interests in the Company's subordinated debentures ............ 44,750 41,714 44,750 42,993 OFF-BALANCE-SHEET INSTRUMENTS* ...................... -- (829) -- (1,622)
*Represents estimated cash outflows required to currently settle the obligations at current market rates. (page 30) NOTE C -- RESTRICTIONS ON CASH AND DUE FROM BANKS 1st Source Bank is required to maintain reserve balances with the Federal Reserve Bank. The average amount of those reserve balances for the year ended December 31, 2000 was approximately $5.1 million. Under available line of credit agreements, 1st Source may borrow up to $3 million. At December 31, 2000, there were no outstanding borrowings under these lines, which were assigned to support commercial paper borrowings. NOTE D -- INVESTMENT SECURITIES The amortized cost and estimated aggregate fair value of securities classified as available-for-sale and held-to-maturity at December 31, 2000, are as follows:
Available-For-Sale ------------------ Gross Gross Unrealized Unrealized Estimated (Dollars in thousands) Amortized Holding Holding Aggregate Cost Gains Losses Fair Value -------- -------- -------- ---------- Equity securities: Marketable securities .......................... $ 24,254 $ 780 $ (1,100) $ 23,934 Other equity securities ........................ 5,128 128 -- 5,256 -------- -------- -------- -------- Total equity securities ........................... 29,382 908 (1,100) 29,190 Debt securities: United States Treasury and agency securities ... 314,831 1,058 (307) 315,582 Obligations of states and political subdivisions 104,298 402 (185) 104,515 Debt securities issued by foreign governments .. 710 1 -- 711 Corporate securities ........................... 12,323 56 (1) 12,378 Mortgage-backed securities ..................... 24,892 67 (175) 24,784 Other debt securities .......................... 11,805 5 (57) 11,753 Commercial paper ............................... 4,997 -- -- 4,997 -------- -------- -------- -------- Total debt securities ............................. 473,856 1,589 (725) 474,720 -------- -------- -------- -------- Total investment securities ....................... $503,238 $ 2,497 $ (1,825) $503,910 ======== ======== ======== ======== Held-To-Maturity ------------------ Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding Aggregate Cost Gains Losses Fair Value -------- -------- -------- ---------- Equity securities: Other equity securities ........................ $ 12,226 -- -- $ 12,226 Debt securities: Obligations of states and political subdivisions 46,986 1,120 -- 48,106 -------- -------- -------- -------- Total investment securities ....................... $ 59,212 $ 1,120 $ -- $ 60,332 ======== ======== ======== ========
The amortized cost and estimated aggregate fair value of debt securities classified as available-for-sale and held-to-maturity at December 31, 2000, by contractual maturity (except for mortgage-backed securities), are shown at the top of page 32. 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. (page 31) NOTE D -- INVESTMENT SECURITIES (continued) (Dollars in thousands)
Available-For-Sale Held-To-Maturity ------------------ ---------------- Estimated Estimated Aggregate Aggregate Amortized Fair Amortized Fair Cost Value Cost Value --------- --------- --------- --------- Due in one year or less ........................... $187,646 $187,898 $ 5,422 $ 5,447 Due after one year through five years ............. 237,389 238,002 28,644 29,352 Due after five years through ten years ............ 6,152 6,184 12,117 12,500 Due after ten years ............................... 19,676 19,733 803 807 Mortgage-backed securities ........................ 22,993 22,903 -- -- -------- -------- -------- -------- Total ............................................. $473,856 $474,720 $ 46,986 $ 48,106 ======== ======== ======== ========
The amortized cost and estimated aggregate fair value of securities classified as available-for-sale and held-to-maturity at December 31, 1999, were as follows:
Available-For-Sale ------------------ Gross Gross Unrealized Unrealized Estimated (Dollars in thousands) Amortized Holding Holding Aggregate Cost Gains Losses Fair Value -------- -------- -------- ---------- Equity securities: Marketable securities .......................... $ 20,694 $ 534 $ (1,556) $ 19,672 Other equity securities ........................ 3,975 -- -- 3,975 -------- -------- -------- -------- Total equity securities ........................... 24,669 534 (1,556) 23,647 Debt securities: United States Treasury and agency securities ... 264,982 36 (2,632) 262,386 Obligations of states and political subdivisions 97,033 55 (920) 96,168 Debt securities issued by foreign governments .. 2,265 1,548 (1) 3,812 Corporate securities ........................... 20,137 8 (222) 19,923 Mortgage-backed securities ..................... 20,331 51 (455) 19,927 Other debt securities .......................... 17,593 24 (272) 17,345 Commercial paper ............................... 29,970 -- -- 29,970 -------- -------- -------- -------- Total debt securities ............................. 452,311 1,722 (4,502) 449,531 -------- -------- -------- -------- Total investment securities ....................... $476,980 $ 2,256 $ (6,058) $473,178 ======== ======== ======== ======== Held-To-Maturity ------------------ Gross Gross Unrealized Unrealized Estimated Amortized Holding Holding Aggregate Cost Gains Losses Fair Value -------- -------- -------- ---------- Equity securities: Other equity securities ........................ $ 12,233 -- -- $ 12,233 Debt securities: Obligations of states and political subdivisions 64,957 1,280 (8) 66,229 -------- -------- -------- -------- Total investment securities ....................... $ 77,190 $ 1,280 $ (8) $ 78,462 ======== ======== ======== ========
(page 32) NOTE D -- INVESTMENT SECURITIES (concluded) Other equity securities classified as held-to-maturity at December 31, 2000 and 1999 include securities such as Federal Reserve Bank and Federal Home Loan Bank stock, which are not traded on established exchanges and have only redemption capabilities. Fair values for such equity securities are considered to approximate cost. At December 31, 1999, debt securities issued by foreign governments (classified as available-for-sale) with an amortized cost of $1.59 million and estimated aggregate fair values of $3.14 million were included in the above debt securities, but were classified as loans in the accompanying 1999 consolidated statements of financial condition. In 2000, these debt securities were sold. 1st Source had no trading securities as of December 31, 2000 and 1999. The following represents the segregation of cash flows between securities available-for-sale and held-to-maturity:
2000 1999 1998 ---- ---- ---- Available- Held-To- Available- Held-To- Available- Held-To- For-Sale Maturity Total For-Sale Maturity Total For-Sale Maturity Total -------- -------- ----- -------- -------- ----- -------- -------- ----- (Dollars in thousands) Purchase of securities $222,091 $ -- $222,091 $270,835 $ 606 $271,441 $372,883 $ 521 $373,404 Proceeds from sales of securities 4,460 -- 4,460 3,315 -- 3,315 13,437 -- 13,437 Proceeds from maturities and prepayments of securities 195,108 17,974 213,082 231,121 19,300 250,421 216,752 18,823 235,575
Gross gains of $1,964,000 and $630,000 were realized during 2000 and 1999, respectively, on the sale of securities available-for-sale. The gross gain in 2000 was due to the sale of the $1.59 million of debt securities issued by foreign governments mentioned above. At December 31, 2000 and 1999, investment securities with carrying values of $272.5 million and $279.2 million, respectively, were pledged as collateral to secure government, public and trust deposits and for other purposes. The mortgage-backed securities held by 1st Source consist primarily of FNMA, GNMA and FHLMC pass-through certificates which are guaranteed by those respective agencies of the United States government. NOTE E -- LOANS TO RELATED PARTIES 1st Source and its subsidiaries have extended loans to officers and directors of 1st Source and its subsidiaries and to their associates. The aggregate dollar amount of these loans was $25.89 million and $20.83 million at December 31, 2000 and 1999, respectively. During 2000, $14.55 million of new loans were made and repayments and other reductions totaled $9.49 million. NOTE F -- RESERVE FOR LOAN LOSSES At December 31, 2000 and 1999, loans amounting to $19.17 million and $11.97 million, respectively, substantially all of which are collateralized, are considered to be nonaccrual. Currently, 1st Source has no restructured loans. Interest income for the years ended December 31, 2000, 1999, and 1998 would have increased by approximately $1,862,000, $866,000, and $719,000, respectively, if these loans earned interest at their full contract rate. As of December 31, 2000 and 1999, impaired loans totaled $37.01 million and $31.57 million, respectively, of which $15.19 million and $20.71 million had corresponding specific reserves for loan losses totaling $4.24 million and $5.59 million, respectively. The remaining balances of impaired loans had no specific reserves for loan losses associated with them. A total of $16.40 million of the impaired loans are nonaccrual loans; interest is not recognized (page 33) NOTE F-- RESERVE FOR LOAN LOSSES (concluded) on nonaccrual loans subsequent to the date the loan is placed in nonaccrual status. While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections on interest and principal are generally applied as a reduction to principal outstanding. Interest on the remainder of the impaired loans is recognized on the accrual basis. For 2000 and 1999, the average recorded investment in impaired loans was $34.92 million and $19.32 million, respectively, and interest income recognized on impaired loans totaled $1.98 million and $2.18 million, respectively. Changes in the reserve for loan losses for each of the three years ended December 31 were as follows: (Dollars in thousands) 2000 1999 1998 ------- ------- ------- Balance, beginning of year $40,210 $38,629 $35,424 Provision for loan losses 14,877 7,442 9,156 Charge-offs, net of recoveries of $1,673 in 2000, $639 in 1999 and $1,148 in 1998 (7,402) (2,388) (3,651) Recaptured reserve due to loan securitizations (3,041) (3,473) (2,300) ------- ------- ------- Balance, end of year $44,644 $40,210 $38,629 ======= ======= ======= NOTE G -- LONG-TERM DEBT Details of long-term debt are as follows: December 31 (Dollars in thousands) 2000 1999 ------- ------- Term loan (7.40%) $10,000 $10,000 Federal Home Loan Bank borrowings (5.54%-6.98%) 1,020 1,029 Other 1,040 1,145 ------- ------- Total long-term debt $12,060 $12,174 ======= ======= Annual maturities of long-term debt outstanding at December 31, 2000 for the next five years beginning in 2001 are as follows (in thousands): $319, $10,226, $434, $19, and $188. The $10.0 million term loan has a fixed interest rate of 7.40% payable quarterly with principal due at maturity, October 1, 2002. The Term Loan Agreement contains, among other provisions, a make-whole provision for early extinguishment of debt, and certain covenants relating to existence and mergers, capital structure and financial requirements. At December 31, 2000, the Federal Home Loan Bank borrowings represent a source of funding for certain residential mortgage activities and consist of five fixed rate notes with maturities ranging from 2003 to 2018. These notes are collateralized by $1.63 million of certain real estate loans. NOTE H -- COMMON STOCK Effective January 1, 1996, 1st Source adopted SFAS No. 123, "Accounting for Stock-Based Compensation," on a disclosure basis only. The disclosure requirements include reporting the pro forma effect on net income and net income per share of compensation expense attributable to the fair value of stock options and other stock-based compensation which have been issued to employees under the Stock Option Plans and the Employee Stock Purchase Plan. 1st Source will continue to apply APB No. 25 in accounting for these plans. In addition, the Executive Incentive Plan, the Special Long-Term Incentive Award Plan and the Restricted Stock Award Plan are also accounted for under the provisions of APB No. 25. Compensation cost charged against income for these plans was $3.64 million, $3.22 million, and $3.05 million for the years ended December 31, 2000, 1999, and 1998, respectively. (page 34) NOTE H -- COMMON STOCK (continued) STOCK OPTION PLANS -- 1st Source's incentive stock option plans include the 1992 Stock Option Plan (the "1992 Plan") and a certain other stock option agreement which became effective January 1, 1992. As of December 31, 2000, an aggregate 2,019,542 shares of common stock are reserved for issuance under the above plans. Under the 1992 Plan, the exercise price of each option equals the market price of 1st Source stock on the date of grant and an option's term is 10 years. Options under the 1992 Plan generally vest in one to five years from date of grant. Options are granted on a discretionary basis by the Executive Compensation Committee (the "Committee") of the 1st Source Board of Directors. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. The following is a summary of the activity with respect to 1st Source's stock option plans for the years ended December 31, 1998, 1999, and 2000: Weighted Number of Average Shares Exercise Price Options outstanding, January 1, 1998 790,525 $ 8.91 Options granted 349,388 32.62 Options exercised (46,505) 9.41 Options forfeited (397) 13.07 Options outstanding, December 31, 1998 1,093,011 16.47 Options granted 10,500 24.29 Options exercised (139,618) 6.72 Options forfeited (1,155) 33.76 Options outstanding, December 31, 1999 962,738 17.94 Options granted -- -- Options exercised (35,984) 8.77 Options forfeited (5,644) 14.59 Options outstanding, December 31, 2000 921,110 18.34 Options exercisable, December 31, 2000 872,172 $18.30 The following table summarizes information about stock options outstanding at December 31, 2000:
OPTIONS OUTSTANDING ------------------- Weighted- Average Weighted- Range of Number Remaining Average Exercise Outstanding Contractual Exercise Prices at 12/31/00 Life (Years) Price ------ ----------- ------------ ----- $ 5.00 to $12.99 385,598 2.35 $ 7.62 13.00 to 29.99 194,209 5.86 14.42 30.00 to 33.99 341,303 7.55 32.68
OPTIONS EXERCISABLE ------------------- Weighted- Range of Number Average Exercise Exercisable Exercise Prices at 12/31/00 Price ------ ----------- ----- $ 5.00 to $12.99 385,598 $ 7.62 13.00 to 29.99 152,432 13.78 30.00 to 33.99 334,142 32.68
EMPLOYEE STOCK PURCHASE PLAN -- 1st Source also has an employee stock purchase plan for substantially all employees with at least two years of service on the effective date of an offering under the plan. Eligible employees may elect to purchase any dollar amount of stock, so long as such amount does not exceed 25% of their base rate of pay and the aggregate stock accrual rate for all offerings does not exceed $25,000 in any calendar year. Payment for the stock is made through payroll deductions over the offering period, and employees may discontinue the deductions at any time and exercise the option or take the funds out of the program. The most recent offering began June 1, 2000, and runs through May 31, 2002, with $407,594 in stock value to be purchased at $17.74 per share. The fair value of the employees' purchase rights for the 2000 offering was estimated using the Black-Scholes model with the following assumptions: dividend yield of 1.08%; expected volatility of 18.23%; risk-free interest rate of 6.61%; and expected life of two years. Pro forma net income and diluted net income per common share, reported as if compensation expense had been recognized under the fair value provisions of SFAS No. 123 for the stock option and employee stock purchase plans, are as follows: 2000 1999 1998 ------- ------- ------- Net income (000s): As reported $37,573 $35,768 $31,457 Pro forma 37,234 34,376 30,345 Diluted net income per common share: As reported $1.88 $1.77 $1.55 Pro forma 1.87 1.71 1.50 (page 35) NOTE H -- COMMON STOCK (concluded) EXECUTIVE INCENTIVE PLAN -- 1st Source's Executive Incentive Plan is also administered by the Committee. Awards under the plan include "Book Value" shares of common stock. These shares are awarded annually based on weighted performance criteria and vest over a period of five years. The plan shares may only be sold to 1st Source, and such sale is mandatory in the event of death, retirement, disability or termination of employment. Grants under the plan for 2000, 1999, and 1998 are summarized below: 2000 1999 1998 ------ ------ ------ Number of shares 59,516 57,440 49,950 Weighted-average grant-date fair value $12.04 $10.73 $9.66 SPECIAL LONG-TERM INCENTIVE AWARD -- During February 1996 and March 1991, 1st Source granted special long-term incentive awards, including 1st Source common stock, to participants in the Executive Incentive Plan. Shares granted under the plan vest over a period of ten years. The first 10% was vested at the time of the grants. Subsequent vesting requires (i) the participant to remain an employee of 1st Source and (ii) that 1st Source be profitable on an annual basis based on the determination of the Committee. RESTRICTED STOCK AWARD PLAN -- 1st Source also has a restricted stock award plan for key employees. Awards under the plan are made to employees recommended by the Chief Executive Officer and approved by the Committee. Shares granted under the plan vest over a five to ten-year period, and vesting is based upon meeting certain criteria, including continued employment by 1st Source. Grants under the plan for 2000, 1999, and 1998 are summarized below: 2000 1999 1998 ------- ------- ------- Number of shares 2,363 1,223 5,045 Weighted-average grant-date fair value $19.42 $28.33 $30.51 NOTE I -- PREFERRED STOCK AND CUMULATIVE PREFERRED SECURITIES As of December 31, 2000, 1st Source has ten million shares of authorized but unissued preferred stock. The Board of Directors of 1st Source is authorized to determine the terms, preferences, limitations, voting rights and number of shares of each series it elects to issue. In 1997, 1st Source raised $44.75 million through the issuance of Cumulative Trust Preferred Securities. 1st Source Capital Trust I issued $27.5 million of 9.00% Cumulative Trust Preferred Securities. 1st Source Capital Trust II issued $17.25 million of floating rate Cumulative Trust Preferred Securities. 1st Source Capital Trust I and 1st Source Capital Trust II are wholly owned, consolidated subsidiaries of 1st Source. The holders of the fixed rate Cumulative Trust Preferred Securities are entitled to receive preferential cumulative cash distributions from 1st Source Capital Trust I. The annual rate is 9.00% of the liquidation amount of $25 per Preferred Security, accruing from the date of original issuance and payable quarterly in arrears on the last day of March, June, September and December of each year. Holders of the floating rate Cumulative Trust Preferred Securities are entitled to receive preferential cumulative cash distributions from 1st Source Capital Trust II. The annual rate is equal to the sum of the three-month Treasury adjusted to a constant maturity, plus 2.25%, applied to the liquidation amount of $25 per Floating Rate Preferred Security accruing from the date of original issuance and payable quarterly in arrears on the last day of March, June, September and December of each year. NOTE J -- EMPLOYEE BENEFIT PLANS 1st Source maintains a defined contribution money purchase pension plan covering the majority of its employees. Contributions to the plan are based on 2% of participants' eligible compensation. For the years ended December 31, 2000, 1999, and 1998, total pension expense for this plan amounted to $506,000, $445,000, and $422,000, respectively. 1st Source also maintains a defined contribution profit sharing and savings plan covering the majority of its employees. The plan allows eligible employees to make contributions by salary reduction pursuant to Section 401(k) of the Internal Revenue Code. 1st Source is required under the plan to match 100% of participant contributions up to 4% of compensation and one-half of any additional participant contributions up to 6% of compensation provided that 1st Source is profitable for the respective plan year. 1st Source may also make discretionary contributions to the plan, depending on its profitability. Contribution expense for this plan for the years ended December 31, 2000, 1999 and 1998, amounted to $1.68 million, $1.58 million, and $1.34 million, respectively. (page 36) NOTE J -- EMPLOYEE BENEFIT PLANS (concluded) Trustcorp Mortgage Company contributes to a defined contribution plan for all of its employees who meet the general eligibility requirements of the plan. The contributions, which in part are based on amounts of compensation deferred by the participants in the plan, were $84,000 in 2000, $94,000 in 1999 and $78,000 in 1998. In addition, Trustcorp Mortgage Company made discretionary contributions of $76,000 in 2000, $115,000 in 1999, and $145,000 in 1998. In addition to the pension and profit sharing plans, 1st Source provides certain health care and life insurance benefits for substantially all of their retired employees. All of 1st Source's full-time employees become eligible for these retiree benefits upon reaching age 55 with 20 years of credited service. Generally, the medical plan pays a stated percentage of eligible medical expenses reduced for any deductibles and payments made by government programs and other group coverage. The lifetime maximum benefit payable under the medical plan is $15,000 and $3,000 for life insurance. 1st Source's accrued postretirement benefit cost and net periodic postretirement benefit cost recognized in the consolidated financial statements for the years ended December 31, 2000, 1999 and 1998 were not material. NOTE K -- INCOME TAXES Income tax expense is comprised of the following: (Dollars in thousands) 2000 1999 1998 ------- ------- ------- Current: Federal $15,129 $15,897 $ 7,171 State 1,888 3,500 2,539 ------- ------- ------- Total current 17,017 19,397 9,710 Deferred: Federal 2,302 (637) 6,328 State 711 (289) 1,805 ------- ------- ------- Total deferred 3,013 (926) 8,133 ------- ------- ------- Total provision $20,030 $18,471 $17,843 ======= ======= ======= Deferred tax assets as of December 31, 2000 and 1999 consisted of the following: (Dollars in thousands) 2000 1999 ------- ------- Deferred tax assets: Reserve for loan losses $20,884 $19,480 Accruals for employee benefits 3,005 3,064 Asset securitization 397 1,432 Net unrealized losses on securities available-for-sale -- 1,291 Deferred income 127 292 Excess servicing 190 171 Mortgage loans-- Section 475 174 4 Other 856 1,163 ------- ------- Total $25,633 $26,897 ======= ======= Deferred tax liabilities as of December 31, 2000 and 1999 consisted of the following: (Dollars in thousands) 2000 1999 ------- ------- Deferred tax liabilities: Differing depreciable bases in premises and leased equipment $16,336 $13,426 Purchased servicing 4,548 6,360 Originated mortgage servicing rights 2,472 3,090 Net unrealized gains on securities available-for-sale 1,513 -- Differing bases in assets related to acquisitions 570 737 Other 339 416 ------- ------- Total $25,778 $24,029 ======= ======= There was no valuation allowance at December 31, 2000 or 1999. (page 37) NOTE K -- INCOME TAXES (concluded) The reasons for the difference between income tax expense and the amount computed by applying the statutory federal income tax rate (35 percent) to income before income taxes are as follows:
Year Ended December 31 ---------------------- 2000 1999 1998 ---- ---- ---- Percent of Percent of Percent of Pretax Pretax Pretax Amount Income Amount Income Amount Income ------ ------ ------ ------ ------ ------ (Dollars in thousands) Statutory federal income tax $21,000 35.0% $19,774 35.0% $18,032 35.0% Increase (decrease) in income taxes resulting from: Tax-exempt interest income (2,924) (4.9) (2,892) (5.1) (2,894) (5.6) State taxes, net of federal income tax benefit 1,689 2.8 2,087 3.7 2,823 5.4 Interest expense incurred to carry tax-exempt securities 521 0.9 406 0.7 403 0.8 Other (256) (0.4) (904) (1.6) (521) (1.0) Total $20,030 33.4% $18,471 32.7% $17,843 34.6%
The tax expense (benefit) applicable to securities gains and losses for the years 2000, 1999, and 1998 was $883,000, $58,000, and ($232,000), respectively. NOTE L -- LEASES 1st Source and its subsidiaries are obligated under operating leases for certain office premises and equipment. The headquarters building is leased for a remaining term of 11 years with options to renew for up to 15 additional years. Approximately 30% of the facility is subleased to other tenants. At December 31, 2000, future minimum rental commitments for all noncancellable operating leases, reduced by future minimum rentals from subleases of $1.14 million, aggregate $13.38 million. Annual rental commitments and sublease rentals for noncancellable operating leases (excluding operating costs) for the five years succeeding December 31, 2000, are as follows: Rental Sublease (Dollars in thousands) Commitments Rentals ----------- -------- 2001 $2,123 $388 2002 1,665 382 2003 1,465 76 2004 1,304 76 2005 1,174 76 Thereafter $6,791 $139 Rental expense of office premises and equipment and related sublease income were as follows: Year Ended December 31 (Dollars in thousands) 2000 1999 1998 ------ ------ ------ Gross rental expense $2,817 $2,596 $2,243 Sublease rental income (734) (700) (672) Net rental expense $2,083 $1,896 $1,571 NOTE M -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK To meet the financing needs of its customers, 1st Source and its subsidiaries are parties to financial instruments with off-balance-sheet risk in the normal course of business. These off-balance-sheet financial instruments include commitments to originate, purchase, and sell loans, standby letters of credit, and interest rate swaps. The instruments involve, to varying degrees, elements of (page 38) NOTE M-- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (concluded) credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. 1st Source's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the dollar amount of those instruments. 1st Source uses the same credit policies and collateral requirements in making commitments and conditional obligations as it does for on-balance-sheet instruments. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Trustcorp Mortgage Company grants mortgage loan commitments to borrowers, subject to normal loan underwriting standards. The interest rate risk associated with these loan commitments is managed by entering into contracts for future deliveries of loans. Letters of credit are conditional commitments issued by 1st Source to guarantee the performance of a customer to a third party. The credit risk involved and collateral obtained in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers. As of December 2000 and 1999, 1st Source and its subsidiaries had commitments outstanding to originate and purchase loans aggregating $135 million and $142 million, respectively. Outstanding commitments to sell loans aggregated $75 million at December 31, 2000 and $76 million at December 31, 1999. Commercial and standby letters of credit totaled $78 million and $92 million at December 31, 2000 and 1999, respectively. 1st Source Bank participates in interest rate swap agreements as part of its program to manage the impact of fluctuating interest rates, namely with respect to floating rate loans. Interest rate swaps generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying notional amount. Notional amounts represent agreed upon amounts on which calculations of interest payments to be exchanged are based. Notional amounts do not represent direct credit exposures. The actual market or credit exposure of this type of financial instrument is significantly less than the notional amount. 1st Source's direct credit exposure is limited to the net difference between the calculated "to be paid" and "to be received" amounts on each transaction, which is generally netted and paid or received monthly, and the inability of the counterparty to meet the terms of the contract. This risk is normally a small percentage of the notional amount and fluctuates as interest rates move up and down. Market risk to 1st Source is more directly measured by the fair values of the interest rate swap agreements. At December 31, 2000, 1st Source had one outstanding interest rate swap agreement with an aggregate notional value of $35.1 million. The agreement has a maturity date of April 10, 2003. The unrealized gain (loss) based on fair value approximated ($237,000) at December 31, 2000. At December 31, 1999, 1st Source had three interest rate swaps and the unrealized gain (loss) based on fair value approximated ($1,110,000). NOTE N -- CONCENTRATION OF CREDIT RISK Most of 1st Source's commercial and agricultural, real estate and consumer loan activity is with customers located in North Central Indiana and Southwest lower Michigan. 1st Source's commercial loans secured by transportation and construction equipment are with customers located throughout the United States. Included in loans as of December 31, 2000 and 1999 are business loans to companies in the following industries:
Percentage of Total Amount Business Loans ------ -------------- (Dollars in thousands) 2000 1999 2000 1999 -------- -------- ------ ------ Truck and auto rental and leasing agencies $264,048 $233,404 13.6% 14.2% Air transportation and aircraft dealers 249,852 258,460 12.9 15.7 Construction equipment and contractors 167,317 153,550 8.6 9.4 Real estate operators, managers and developers 111,736 93,601 5.8 5.7 Agriculture 68,123 62,441 3.5 3.8 Van conversion, manufactured housing and recreational vehicle industries 59,867 62,350 3.1 3.7
(page 39) NOTE N -- CONCENTRATION OF CREDIT RISK (concluded) Generally, these loans are collateralized by assets of the borrower. The loans are expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrower. 1st Source requires collateral on substantially all borrowings in these categories, which is typically the item being financed. NOTE O -- CAPITAL ADEQUACY 1st Source is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on 1st Source's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, 1st Source must meet specific capital guidelines that involve quantitative measures of 1st Source's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. 1st Source's capital amounts and classification are subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require 1st Source to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets. Management believes, as of December 31, 2000, that 1st Source meets all capital adequacy requirements to which it is subject. As of December 31, 2000, the most recent notification from the federal bank regulators categorized 1st Source Bank, the largest of 1st Source's subsidiaries, as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized" 1st Source must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes changed the institution's category. The actual capital amounts and ratios of 1st Source and its largest subsidiary, 1st Source Bank, are presented in the table below:
To Be Well Minimum Capitalized Under Capital Prompt Corrective Actual Adequacy Action Provisions ------ -------- ----------------- (Dollars in thousands) $ Amount Ratio $ Amount Ratio $ Amount Ratio -------- ----- -------- ----- -------- ----- As of December 31, 2000: Total Capital (to Risk-Weighted Assets): Consolidated $344,063 13.04% $211,035 8.00% $263,793 10.00% 1st Source Bank 321,404 12.43 206,776 8.00 258,470 10.00 Tier I Capital (to Risk-Weighted Assets): Consolidated 310,945 11.79 105,517 4.00 158,276 6.00 1st Source Bank 288,943 11.18 103,388 4.00 155,082 6.00 Tier I Capital (to Average Assets): Consolidated 310,945 9.79 127,028 4.00 158,785 5.00 1st Source Bank 288,943 9.28 124,521 4.00 155,652 5.00
NOTE P -- COMMITMENTS AND CONTINGENT LIABILITIES 1st Source and its subsidiaries are defendants in various legal proceedings arising in the normal course of business. In the opinion of management, based on the advice of legal counsel, the ultimate resolution of these proceedings will not have a material effect on 1st Source's consolidated financial position or results of operations. The consolidated financial statements do not reflect various commitments and contingent liabilities, such as guarantees and liability for assets held in trust, which arise in the normal course of business. (page 40) NOTE Q -- 1ST SOURCE CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands) December 31 2000 1999 -------- -------- ASSETS Cash ...................................... $ 7 $ 1 Short-term investments with bank subsidiary 6,403 3,988 Investment securities, available for sale (amortized cost of $19,504 and $18,942 at December 31, 2000 and 1999, respectively) 19,586 18,892 Investments in: Bank subsidiaries ....................... 291,319 255,904 Non-bank subsidiaries ................... 11,968 11,529 Loan receivables: Non-bank subsidiaries ................... 9,082 9,000 Premises and equipment, net ............... 4,687 4,757 Other assets .............................. 2,915 3,525 -------- -------- Total assets .............................. $345,967 $307,596 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Commercial paper borrowings ............... $ 14,756 $ 8,806 Other liabilities ......................... 4,251 3,492 Long-term debt ............................ 56,388 56,478 Total liabilities ......................... 75,395 68,776 Shareholders' equity ...................... 270,572 238,820 -------- -------- Total liabilities and shareholders' equity $345,967 $307,596 ======== ======== STATEMENTS OF INCOME (Dollars in thousands) Year Ended December 31 2000 1999 1998 ------- ------- ------- Income: Dividends from bank and non-bank subsidiaries $ 8,260 $ 7,439 $ 6,596 Rental income from subsidiaries .............. 2,664 2,422 2,363 Other ........................................ 2,937 2,814 2,883 ------- ------- ------- Total income .................................... 13,861 12,675 11,842 Expenses: Interest on long-term debt ................... 4,748 4,556 4,612 Interest on commercial paper and other short-term borrowings .............. 800 402 264 Rent expense ................................. 1,059 1,074 1,076 Other ........................................ 2,272 2,099 2,501 ------- ------- ------- Total expenses .................................. 8,879 8,131 8,453 Income before income tax credits and equity in undistributed income of subsidiaries .. 4,982 4,544 3,389 Income tax credits .............................. 1,273 1,162 1,556 ------- ------- ------- Income before equity in undistributed income of subsidiaries .......................... 6,255 5,706 4,945 Equity in undistributed income of subsidiaries: Bank subsidiaries ............................ 28,959 27,817 23,631 Non-bank subsidiaries ........................ 2,359 2,245 2,881 ------- ------- ------- Net income ...................................... $37,573 $35,768 $31,457 ======= ======= ======= (page 41) NOTE Q-- 1ST SOURCE CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION (concluded) STATEMENTS OF CASH FLOWS (Dollars in thousands)
Year Ended December 31 2000 1999 1998 -------- -------- -------- Operating activities: Net income ....................................................... $ 37,573 $ 35,768 $ 31,457 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of subsidiaries ................ (31,318) (30,062) (26,512) Depreciation of premises and equipment ........................ 336 264 225 Realized and unrealized investment securities (gains) losses .. (367) (553) 99 Other ......................................................... 2,850 6,381 2,284 -------- -------- -------- Net cash provided by operating activities ........................ 9,074 11,798 7,553 Investing activities: Proceeds from sales and maturities of investment securities ... 1,050 2,254 3,603 Purchase of investment securities ............................. (1,260) (321) (6,195) (Purchase) sale of premises and equipment, net ................ (266) (1,871) 23 Increase in short-term investments with bank subsidiary ....... (2,415) (586) (1,158) (Increase) decrease in loans made to subsidiaries, net ........ (82) (1,245) 6,245 -------- -------- -------- Net cash (used in) provided by investing activities .............. (2,973) (1,769) 2,518 Financing activities: Net increase in commercial paper and other short-term borrowings ............................... 5,950 2,635 1,973 Proceeds from issuance of long-term debt ...................... 2 112 434 Payments on long-term debt .................................... (92) (191) (107) Acquisition of treasury stock ................................. (4,990) (6,646) (7,116) Cash dividends ................................................ (6,956) (5,922) (5,296) Other ......................................................... (9) (17) 12 -------- -------- -------- Net cash (used in) financing activities .......................... (6,095) (10,029) (10,100) -------- -------- -------- Increase (decrease) in cash and cash equivalents ................. 6 0 (29) Cash and cash equivalents, beginning of year ..................... 1 1 30 -------- -------- -------- Cash and cash equivalents, end of year ........................... $ 7 $ 1 $ 1 ======== ======== ========
(page 42) REPORT OF INDEPENDENT AUDITORS [ERNST & YOUNG LOGO] FROM THOUGHT TO FINISH. TM To the Board of Directors and Shareholders of 1st Source Corporation: We have audited the accompanying consolidated statement of financial condition of 1st Source Corporation and Subsidiaries at December 31, 2000 and the related consolidated statements of income, shareholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of 1st Source Corporation as of December 31, 1999, and for each of the two years in the period ended December 31, 1999, were audited by other auditors whose report dated February 15, 2000 expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2000 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of 1st Source Corporation and Subsidiaries at December 31, 2000, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Columbus, Ohio January 16, 2001 (page 43) OFFICERS AND DIRECTORS [1ST SOURCE CORPORATION LOGO] OFFICERS Christopher J. Murphy III ... Chairman of the Board, President and Chief Executive Officer Wellington D. Jones III ..... Executive Vice President Larry E. Lentych ............ Treasurer and Chief Financial Officer Vincent A. Tamburo .......... Secretary and General Counsel DIRECTORS Rev. E. William Beauchamp ... Executive Vice President Emeritus, University of Notre Dame Paul R. Bowles .............. Former Vice President, Corporate Development, Clark Equipment Company Daniel B. Fitzpatrick ....... Chairman, President and Chief Executive Officer, Quality Dining, Inc. Lawrence E. Hiler ........... Chairman, Hiler Industries William P. Johnson .......... President, Flying J, LLC Wellington D. Jones III ..... Executive Vice President Rex Martin .................. Chairman, President and Chief Executive Officer, NIBCO INC. Dane A. Miller .............. President and Chief Executive Officer, Biomet, Inc. Christopher J. Murphy III ... Chairman, President and Chief Executive Officer Timothy K. Ozark ............ Chairman and Chief Executive Officer, Aim Financial Corporation Richard J. Pfeil ............ Chairman and President, Koontz-Wagner Electric Company, Inc. Claire C. Skinner ........... Chairman, President and Chief Executive Officer, Coachmen Industries, Inc. [1ST SOURCE BANK LOGO] OFFICERS Christopher J. Murphy III ... Chairman of the Board and Chief Executive Officer Wellington D. Jones III ..... President and Chief Operating Officer Allen R. Qualey ............. President and Chief Operating Officer, Specialty Finance Group Richard Q. Stifel ........... Executive Vice President, Business Banking Group Larry E. Lentych ............ Senior Vice President, Treasurer and Chief Financial Officer, Finance and Administrative Services Group James S. Jackson ............ Senior Vice President, Funds Management Division Larry A. Gardner ............ Senior Vice President, Operations Group Steven J. Wessell ........... Senior Vice President, Personal Asset Management Group Vincent A. Tamburo .......... Senior Vice President and Secretary, General Counsel Maggie M. Kernan ............ Senior Vice President, Marketing Division Dan L. Craft ................ Senior Vice President, Human Resources Division DIRECTORS Rev. E. William Beauchamp ... Executive Vice President Emeritus, University of Notre Dame Marilou Eldred, Ph.D......... President, Saint Mary's College Daniel B. Fitzpatrick ....... Chairman, President and Chief Executive Officer, Quality Dining, Inc. Terry L. Gerber ............. President and Chief Executive Officer, Gerber Manufacturing Company, Inc. Lawrence E. Hiler ........... Chairman, Hiler Industries Hollis E. Hughes, Jr. ....... Executive Director, United Way of St. Joseph County H. Thomas Jackson ........... Chairman, Bornemann Coated Fabrics, Bornemann Products William P. Johnson .......... President, Flying J, LLC Wellington D. Jones III ..... President Craig A. Kapson ............. President, Jordan Automotive Group David L. Lerman ............. Chief Executive Officer, Steel Warehouse Co. Inc. Christopher J. Murphy III ... Chairman and Chief Executive Officer Timothy K. Ozark ............ Chairman and Chief Executive Officer, Aim Financial Corporation Richard J. Pfeil ............ Chairman and President, Koontz-Wagner Electric Company, Inc. John T. Phair ............... President, Holladay Partners- Midwest, Inc. Mark D. Schwabero ........... President and Chief Executive Officer, Hendrickson International Elmer H. Tepe ............... President, E.H. Tepe Co. (page 44) SHAREHOLDERS' INFORMATION 2000 STOCK PERFORMANCE AND DIVIDENDS 1st Source Corporation common stock is traded on the Over-The-Counter market and is listed on the Nasdaq Stock Market under the symbol "SRCE." 1st Source is also listed on the National Market System tables in many daily papers under the symbol "1stSrc." High and low common stock prices, cash dividends paid for 2000 and book value were: Cash Dividends Quarter Ended High Low Paid ------------- ------- ------- ------ March 31 $24.29 $16.90 $.085 June 30 21.90 14.88 .086 September 30 21.63 15.63 .090 December 31 21.44 14.63 .090 Book value per common share at December 31, 2000: $13.72 ANNUAL MEETING OF SHAREHOLDERS The Annual Meeting of Shareholders has been called for 10:00 am, EST, Tuesday, April 24, 2001, at 1st Source Center, 100 N. Michigan Street, South Bend, Indiana. All shareholders are invited to attend the meeting. COMMON STOCK LISTING The Nasdaq Stock Market National Market Symbol: "SRCE" CUSIP #336901 10 3 TRANSFER AGENT, REGISTRAR AND DIVIDEND DISBURSING AGENT 1st Source Bank Post Office Box 1602 South Bend, IN 46634 INDEPENDENT AUDITORS Ernst & Young LLP 1100 Huntington Center 41 S. High Street Columbus, OH 43215 SHAREHOLDER INQUIRIES 1st Source Corporation Larry E. Lentych Chief Financial Officer Post Office Box 1602 South Bend, IN 46634 (219) 235-2702 FORM 10-K INQUIRIES A copy of 1st Source Corporation's Annual Report on Form 10-K for the year ended December 31, 2000, as required to be filed with the Securities and Exchange Commission, is available upon request. MARKET MAKERS (as of February 16, 2001) The following firms make a market in the common shares of 1st Source Corporation: Dain Rauscher, Inc. Herzog, Heine, Geduld, Inc. Keefe, Bruyette & Woods, Inc. NatCity Investments, Inc. Raymond James and Associates Sandler, O'Neill and Partners Schwab Capital Markets Sherwood Securities Corporation Spear, Leeds and Kellogg Stifel, Nicolaus & Company William Blair and Company (page 45)