Loan and Lease Financings

Total loans and leases outstanding were recorded net of unearned income and deferred loan fees and costs at December 31, 2017 and 2016, and totaled $4.53 billion and $4.19 billion, respectively. At December 31, 2017 and 2016, net deferred loan and lease costs were $3.85 million and $3.78 million, respectively.

The loan and lease portfolio includes direct financing leases, which are included in commercial and agricultural, auto and light truck, medium and heavy duty truck, aircraft, and construction equipment 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, 2017 and 2016.



(Dollars in thousands)	2017			2016
Direct finance leases:
Rentals receivable	$	208,295		$	218,543
Estimated residual value of leased assets	29,638			21,992
Gross investment in lease financing	237,933			240,535
Unearned income	(37,851		)	(35,751		)
Net investment in lease financing	$	200,082		$	204,784

At December 31, 2017, the direct financing minimum future lease payments receivable for each of the years 2018 through 2022 were $51.17 million, $44.04 million, $39.03 million, $30.45 million, and $27.83 million, respectively.

In the ordinary course of business, the Company has extended loans to certain directors, executive officers, and principal shareholders of equity securities of 1st Source and to their affiliates. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not related to the Company and did not involve more than the normal risk of collectability, or present other unfavorable features. The loans are consistent with sound banking practices and within applicable regulatory and lending limitations. The aggregate dollar amounts of these loans were $14.61 million and $31.46 million at December 31, 2017 and 2016, respectively. During 2017, $2.30 million of new loans and other additions were made and repayments and other reductions totaled $19.15 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 and home equity 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.



	Credit Quality Grades
(Dollars in thousands)	1-6		7-12		Total
December 31, 2017
Commercial and agricultural	$	906,074	$	23,923	$	929,997
Auto and light truck	482,455		14,361		496,816
Medium and heavy duty truck	293,318		3,617		296,935
Aircraft	815,956		28,701		844,657
Construction equipment	552,684		10,753		563,437
Commercial real estate	726,134		15,434		741,568
Total	$	3,776,621	$	96,789	$	3,873,410
December 31, 2016
Commercial and agricultural	$	784,811	$	27,453	$	812,264
Auto and light truck	407,931		3,833		411,764
Medium and heavy duty truck	291,558		3,232		294,790
Aircraft	772,802		29,612		802,414
Construction equipment	486,923		9,002		495,925
Commercial real estate	707,252		11,918		719,170
Total	$	3,451,277	$	85,050	$	3,536,327

For residential real estate and home equity 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 home equity and consumer loans by performing or nonperforming status. Nonperforming loans are those loans which are on nonaccrual status or are 90 days or more past due.



(Dollars in thousands)	Performing		Nonperforming		Total
December 31, 2017
Residential real estate and home equity	$	523,803	$	2,319	$	526,122
Consumer	127,982		164		128,146
Total	$	651,785	$	2,483	$	654,268
December 31, 2016
Residential real estate and home equity	$	518,896	$	3,035	$	521,931
Consumer	129,585		228		129,813
Total	$	648,481	$	3,263	$	651,744

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



(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, 2017
Commercial and agricultural	$	927,113	$	281	$	—	$	—	$	927,394	$	2,603	$	929,997
Auto and light truck	485,885		2,869		21		—		488,775		8,041		496,816
Medium and heavy duty truck	296,564		—		—		—		296,564		371		296,935
Aircraft	823,638		14,570		4,492		—		842,700		1,957		844,657
Construction equipment	561,665		333		448		—		562,446		991		563,437
Commercial real estate	738,006		23		121		—		738,150		3,418		741,568
Residential real estate and home equity	521,943		1,508		352		429		524,232		1,890		526,122
Consumer	127,107		776		99		30		128,012		134		128,146
Total	$	4,481,921	$	20,360	$	5,533	$	459	$	4,508,273	$	19,405	$	4,527,678
December 31, 2016
Commercial and agricultural	$	808,283	$	—	$	—	$	—	$	808,283	$	3,981	$	812,264
Auto and light truck	411,300		298		—		—		411,598		166		411,764
Medium and heavy duty truck	294,790		—		—		—		294,790		—		294,790
Aircraft	791,559		1,429		3,316		—		796,304		6,110		802,414
Construction equipment	493,131		1,546		—		—		494,677		1,248		495,925
Commercial real estate	713,482		133		—		—		713,615		5,555		719,170
Residential real estate and home equity	517,212		1,310		374		394		519,290		2,641		521,931
Consumer	129,000		453		132		22		129,607		206		129,813
Total	$	4,158,757	$	5,169	$	3,822	$	416	$	4,168,164	$	19,907	$	4,188,071

Interest income for the years ended December 31, 2017, 2016, and 2015, would have increased by approximately $1.14 million, $1.11 million, and $1.03 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.



(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Reserve
December 31, 2017
With no related reserve recorded:
Commercial and agricultural	$	2,439	$	2,439	$	—
Auto and light truck	—		—		—
Medium and heavy duty truck	371		371		—
Aircraft	1,901		1,901		—
Construction equipment	584		584		—
Commercial real estate	2,375		2,375		—
Residential real estate and home equity	—		—		—
Consumer	—		—		—
Total with no related reserve recorded	7,670		7,670		—
With a reserve recorded:
Commercial and agricultural	—		—		—
Auto and light truck	7,780		7,780		243
Medium and heavy duty truck	—		—		—
Aircraft	—		—		—
Construction equipment	344		344		108
Commercial real estate	971		971		181
Residential real estate and home equity	352		354		134
Consumer	—		—		—
Total with a reserve recorded	9,447		9,449		666
Total impaired loans	$	17,117	$	17,119	$	666
December 31, 2016
With no related reserve recorded:
Commercial and agricultural	$	1,700	$	1,700	$	—
Auto and light truck	115		115		—
Medium and heavy duty truck	—		—		—
Aircraft	2,918		2,918		—
Construction equipment	605		605		—
Commercial real estate	2,607		2,607		—
Residential real estate and home equity	—		—		—
Consumer	—		—		—
Total with no related reserve recorded	7,945		7,945		—
With a reserve recorded:
Commercial and agricultural	1,890		1,890		297
Auto and light truck	—		—		—
Medium and heavy duty truck	—		—		—
Aircraft	3,192		3,192		1,076
Construction equipment	562		562		35
Commercial real estate	2,765		2,765		322
Residential real estate and home equity	674		676		148
Consumer	—		—		—
Total with a reserve recorded	9,083		9,085		1,878
Total impaired loans	$	17,028	$	17,030	$	1,878

The following table shows average recorded investment and interest income recognized on impaired loans and leases, segregated by class, for years ending December 31, 2017, 2016 and 2015.



	2017				2016				2015
(Dollars in thousands)	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
Commercial and agricultural	$	4,526	$	1	$	3,484	$	6	$	5,362	$	32
Auto and light truck	766		—		10		—		—		—
Medium and heavy duty truck	658		—		—		—		—		—
Aircraft	4,873		5		6,291		2		7,285		6
Construction equipment	1,011		—		766		—		695		—
Commercial real estate	3,220		2		5,417		123		10,126		518
Residential real estate and home equity	355		15		415		15		370		16
Consumer loans	—		—		—		—		—		—
Total	$	15,409	$	23	$	16,383	$	146	$	23,838	$	572

The following table shows the number of loans and leases classified as troubled debt restructuring (TDR) during 2017, 2016 and 2015, 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. 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 were one modification during 2017, one modification during 2016, and no modifications during 2015 that resulted in an interest rate reduction below market rate. Consequently, the financial impact of the modifications was immaterial.



	2017			2016			2015
(Dollars in thousands)	Number of Modifications	Recorded Investment		Number of Modifications	Recorded Investment		Number of Modifications	Recorded Investment
Performing TDRs:
Commercial and agricultural	—	$	—	—	$	—	2	$	218
Auto and light truck	—	—		—	—		—	—
Medium and heavy duty truck	—	—		—	—		—	—
Aircraft	—	—		—	—		—	—
Construction equipment	—	—		—	—		—	—
Commercial real estate	—	—		—	—		—	—
Residential real estate and home equity	—	—		—	—		—	—
Consumer	—	—		—	—		—	—
Total performing TDR modifications	—	—		—	—		2	218
Nonperforming TDRs:
Commercial and agricultural	1	—		—	—		—	—
Auto and light truck	—	—		—	—		—	—
Medium and heavy duty truck	—	—		—	—		—	—
Aircraft	—	—		—	—		—	—
Construction equipment	—	—		1	562		—	—
Commercial real estate	—	—		—	—		—	—
Residential real estate and home equity	—	—		1	314		—	—
Consumer	—	—		—	—		—	—
Total nonperforming TDR modifications	1	—		2	876		—	—
Total TDR modifications	1	$	—	2	$	876	2	$	218

There were no performing TDRs which had payment defaults within the twelve months following modification during the years ended December 31, 2017, 2016 and 2015.

There was one nonperforming construction equipment TDR with a recorded investment of $0.41 million which had a payment default within the twelve months following modification for the year ended December 31, 2017 and no nonperforming TDRs which had payment defaults within the twelve months following modification during the years ended December 31, 2016 and 2015.

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.

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)	2017		2016
Performing TDRs	$	352	$	360
Nonperforming TDRs	537		1,642
Total TDRs	$	889	$	2,002