Loan and Lease Financings

Total loans and leases outstanding were recorded net of unearned income and deferred loan fees and costs at December 31, 2013 and 2012, and totaled $3.55 billion and $3.33 billion, respectively. At December 31, 2013 and 2012, net deferred loan and lease costs were $3.81 million and $3.68 million, respectively.

The loan and lease portfolio includes direct financing leases, which are included in auto, light truck and environmental equipment, medium and heavy duty truck, aircraft financing, and construction equipment financing on the Statements of Financial Condition.

The following table shows the summary of the gross investment in lease financing and the components of the investment in lease financing at December 31, 2013 and 2012:



(Dollars in thousands)	2013			2012
Direct finance leases:
Rentals receivable	$	245,207		$	256,851
Estimated residual value of leased assets	12,537			13,131
Gross investment in lease financing	257,744			269,982
Unearned income	(38,946		)	(43,209		)
Net investment in lease financing	$	218,798		$	226,773

At December 31, 2013, the direct financing minimum future lease payments receivable for each of the years 2014 through 2018 were $46.33 million, $41.48 million, $35.61 million, $30.03 million, and $27.47 million, respectively.

In the ordinary course of business, the Company has extended loans to certain directors, executive officers, and principal shareholders of equity securities of 1st Source and to their affiliates. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not related to the Company and did not involve more than the normal risk of collectability, or present other unfavorable features. The loans are consistent with sound banking practices and within applicable regulatory and lending limitations. The aggregate dollar amounts of these loans were $17.96 million and $14.94 million at December 31, 2013 and 2012, respectively. During 2013, $3.77 million of new loans and other additions were made and repayments and other reductions totaled $0.75 million.

The Company evaluates loans and leases for credit quality at least annually but more frequently if certain circumstances occur (such as material new information which becomes available and indicates a potential change in credit risk). The Company uses two methods to assess credit risk: loan or lease credit quality grades and credit risk classifications. The purpose of the loan or lease credit quality grade is to document the degree of risk associated with individual credits as well as inform management of the degree of risk in the portfolio taken as a whole. Credit risk classifications are used to categorize loans by degree of risk and to designate individual or committee approval authorities for higher risk credits at the time of origination. Credit risk classifications include categories for: Acceptable, Marginal, Special Attention, Special Risk, Restricted by Policy, Regulated and Prohibited by Law.

All loans and leases, except residential real estate loans and consumer loans, are assigned credit quality grades on a scale from 1 to 12 with grade 1 representing superior credit quality. The criteria used to assign grades to extensions of credit that exhibit potential problems or well-defined weaknesses are primarily based upon the degree of risk and the likelihood of orderly repayment, and their effect on our safety and soundness. Loans or leases graded 7 or weaker are considered “special attention” credits and, as such, relationships in excess of $100,000 are reviewed quarterly as part of management’s evaluation of the appropriateness of the reserve for loan and lease losses. Grade 7 credits are defined as “watch” and contain greater than average credit risk and are monitored to limit our exposure to increased risk; grade 8 credits are “special mention” and, following regulatory guidelines, are defined as having potential weaknesses that deserve management’s close attention. Credits that exhibit well-defined weaknesses and a distinct possibility of loss are considered ‘‘classified’’ and are graded 9 through 12 corresponding to the regulatory definitions of “substandard” (grades 9 and 10) and the more severe ‘‘doubtful’’ (grade 11) and ‘‘loss’’ (grade 12).

The following table shows the credit quality grades of the recorded investment in loans and leases, segregated by class, as of December 31:



	Credit Quality Grades
(Dollars in thousands)	1-6		7-12		Total
December 31, 2013
Commercial and agricultural loans	$	652,620	$	26,872	$	679,492
Auto, light truck and environmental equipment	410,652		13,848		424,500
Medium and heavy duty truck	203,205		1,798		205,003
Aircraft financing	704,997		33,136		738,133
Construction equipment financing	325,849		7,239		333,088
Commercial real estate	557,692		26,305		583,997
Total	$	2,855,015	$	109,198	$	2,964,213
December 31, 2012
Commercial and agricultural loans	$	612,567	$	26,502	$	639,069
Auto, light truck, and environmental equipment	428,582		9,565		438,147
Medium and heavy duty truck	170,116		1,886		172,002
Aircraft financing	648,316		48,163		696,479
Construction equipment financing	262,980		15,994		278,974
Commercial real estate	507,219		47,749		554,968
Total	$	2,629,780	$	149,859	$	2,779,639

For residential real estate and consumer loans, credit quality is based on the aging status of the loan and by payment activity. The following table shows the recorded investment in residential real estate and consumer loans by performing or nonperforming status as of December 31. Nonperforming loans are those loans which are on nonaccrual status or are 90 days or more past due.



(Dollars in thousands)	Performing		Nonperforming		Total
December 31, 2013
Residential real estate	$	458,385	$	2,596	$	460,981
Consumer	123,663		467		124,130
Total	$	582,048	$	3,063	$	585,111
December 31, 2012
Residential real estate	$	435,962	$	2,679	$	438,641
Consumer	108,814		459		109,273
Total	$	544,776	$	3,138	$	547,914

The following table shows the recorded investment of loans and leases, segregated by class, with delinquency aging and nonaccrual status as of December 31:



(Dollars in thousands)	Current		30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due and Accruing		Total Accruing Loans		Nonaccrual		Total Financing Receivables
December 31, 2013
Commercial and agricultural loans	$	667,462	$	263	$	2	$	—	$	667,727	$	11,765	$	679,492
Auto, light truck and environmental equipment	420,523		242		36		—		420,801		3,699		424,500
Medium and heavy duty truck	205,003		—		—		—		205,003		—		205,003
Aircraft financing	713,832		10,309		3,627		—		727,768		10,365		738,133
Construction equipment financing	331,083		973		—		—		332,056		1,032		333,088
Commercial real estate	576,933		—		—		—		576,933		7,064		583,997
Residential real estate	456,782		1,334		269		197		458,582		2,399		460,981
Consumer	122,657		786		220		84		123,747		383		124,130
Total	$	3,494,275	$	13,907	$	4,154	$	281	$	3,512,617	$	36,707	$	3,549,324
December 31, 2012
Commercial and agricultural loans	$	629,035	$	807	$	48	$	—	$	629,890	$	9,179	$	639,069
Auto, light truck and environmental equipment	437,087		202		—		—		437,289		858		438,147
Medium and heavy duty truck	171,950		—		—		—		171,950		52		172,002
Aircraft financing	691,187		—		—		—		691,187		5,292		696,479
Construction equipment financing	272,817		598		274		—		273,689		5,285		278,974
Commercial real estate	541,811		102		—		—		541,913		13,055		554,968
Residential real estate	434,434		1,019		509		356		436,318		2,323		438,641
Consumer	107,630		816		368		86		108,900		373		109,273
Total	$	3,285,951	$	3,544	$	1,199	$	442	$	3,291,136	$	36,417	$	3,327,553

Interest income for the years ended December 31, 2013, 2012, and 2011, would have increased by approximately $2.93 million, $3.58 million, and $3.90 million, respectively, if the nonaccrual loans and leases had earned interest at their full contract rate.

The following table shows impaired loans and leases, segregated by class, and the corresponding reserve for impaired loan and lease losses as of December 31:



(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Reserve
December 31, 2013
With no related reserve recorded:
Commercial and agricultural loans	$	11,231	$	11,230	$	—
Auto, light truck and environmental equipment	3,499		3,499		—
Medium and heavy duty truck	—		—		—
Aircraft financing	9,764		9,764		—
Construction equipment financing	938		938		—
Commercial real estate	14,897		14,897		—
Residential real estate	—		—		—
Consumer	—		—		—
Total with no related reserve recorded	40,329		40,328		—
With a reserve recorded:
Commercial and agricultural loans	—		—		—
Auto, light truck and environmental equipment	—		—		—
Medium and heavy duty truck	—		—		—
Aircraft financing	563		563		113
Construction equipment financing	—		—		—
Commercial real estate	—		—		—
Residential real estate	381		381		161
Consumer	—		—		—
Total with a reserve recorded	944		944		274
Total impaired loans	$	41,273	$	41,272	$	274
December 31, 2012
With no related reserve recorded:
Commercial and agricultural loans	$	2,572	$	2,572	$	—
Auto, light truck and environmental equipment	474		474		—
Medium and heavy duty truck	—		—		—
Aircraft financing	3,115		3,115		—
Construction equipment financing	5,109		5,107		—
Commercial real estate	19,597		19,597		—
Residential real estate	101		101		—
Consumer	—		—		—
Total with no related reserve recorded	30,968		30,966		—
With a reserve recorded:
Commercial and agricultural loans	6,075		6,074		729
Auto, light truck and environmental equipment	—		—		—
Medium and heavy duty truck	—		—		—
Aircraft financing	2,086		2,086		852
Construction equipment financing	—		—		—
Commercial real estate	1,588		1,588		42
Residential real estate	—		—		—
Consumer	—		—		—
Total with a reserve recorded	9,749		9,748		1,623
Total impaired loans	$	40,717	$	40,714	$	1,623

The following table shows average recorded investment and interest income recognized on impaired loans and leases, segregated by class, for years ending December 31, 2013, 2012 and 2011.



	2013				2012				2011
(Dollars in thousands)	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
Commercial and agricultural loans	$	10,077	$	143	$	9,322	$	16	$	11,256	$	340
Auto, light truck and environmental equipment	654		—		2,113		7		1,581		2
Medium and heavy duty truck	265		—		696		2		3,786		5
Aircraft financing	9,254		79		7,976		—		14,971		16
Construction equipment financing	2,799		5		4,409		6		5,634		36
Commercial real estate	17,655		610		22,126		441		27,172		186
Residential real estate	32		—		87		6		—		—
Consumer loans	—		—		—		—		88		5
Total	$	40,736	$	837	$	46,729	$	478	$	64,488	$	590

The following table shows the number of loans and leases classified as troubled debt restructuring (TDR) during 2013 and 2012, segregated by class, as well as the recorded investment as of December 31. The classification between nonperforming and performing is shown at the time of modification. During 2013 and 2012, modification programs focused on extending maturity dates or modifying payment patterns with most TDRs experiencing a combination of concessions. The modifications did not result in the contractual forgiveness of principal or interest. There was one modification during 2013 that resulted in an interest rate reduction below market rate. Consequently, the financial impact of the modifications was immaterial.



	2013			2012
(Dollars in thousands)	Number of Modifications	Recorded Investment		Number of Modifications	Recorded Investment
Performing TDRs:
Commercial and agricultural loans	1	$	750	1	$	127
Auto, light truck and environmental equipment	—	—		—	—
Medium and heavy duty truck	—	—		—	—
Aircraft financing	—	—		—	—
Construction equipment financing	—	—		—	—
Commercial real estate	—	—		1	7,014
Residential real estate	1	381		1	101
Consumer	—	—		—	—
Total performing TDR modifications	2	1,131		3	7,242
Nonperforming TDRs:
Commercial and agricultural loans	1	158		—	—
Auto, light truck and environmental equipment	—	—		—	—
Medium and heavy duty truck	—	—		—	—
Aircraft financing	1	4,157		—	—
Construction equipment financing	—	—		3	1,316
Commercial real estate	—	—		1	1,141
Residential real estate	—	—		—	—
Consumer	—	—		—	—
Total nonperforming TDR modifications	2	4,315		4	2,457
Total TDR modifications	4	$	5,446	7	$	9,699

The following table shows the number of troubled debt restructured loans and leases which had payment defaults within twelve months following modification during the years ended December 31, 2013 and 2012, segregated by class, as well as the recorded investment as of December 31. The classification between nonperforming and performing is shown at the time of modification. Default occurs when a loan or lease is 90 days or more past due under the modified terms or transferred to nonaccrual.



	2013			2012
(Dollars in thousands)	Number of Defaults	Recorded Investment		Number of Defaults	Recorded Investment
Performing TDRs:
Commercial and agricultural loans	1	$	750	—	$	—
Auto, light truck and environmental equipment	—	—		—	—
Medium and heavy duty truck	—	—		—	—
Aircraft financing	—	—		—	—
Construction equipment financing	—	—		—	—
Commercial real estate	—	—		—	—
Residential real estate	—	—		—	—
Consumer	—	—		—	—
Total performing TDR defaults	1	750		—	—
Nonperforming TDRs:
Commercial and agricultural loans	—	—		3	113
Auto, light truck and environmental equipment	—	—		—	—
Medium and heavy duty truck	—	—		—	—
Aircraft financing	—	—		—	—
Construction equipment financing	—	—		1	—
Commercial real estate	1	—		2	171
Residential real estate	—	—		—	—
Consumer	—	—		—	—
Total nonperforming TDR defaults	1	—		6	284
Total TDR defaults	2	$	750	6	$	284

The following table shows the recorded investment of loans and leases classified as troubled debt restructurings as of December 31.



Year Ended December 31 (Dollars in thousands)	2013		2012
Performing TDRs	$	8,786	$	8,839
Nonperforming TDRs	11,824		12,869
Total TDRs	$	20,610	$	21,708