Loan and Lease Financings

Total loans and leases outstanding were recorded net of unearned income and deferred loan fees and costs at December 31, 2018 and 2017, and totaled $4.84 billion and $4.53 billion, respectively. At December 31, 2018 and 2017, net deferred loan and lease costs were $4.54 million and $3.85 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 Consolidated 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, 2018 and 2017.



(Dollars in thousands)	2018			2017
Direct finance leases:
Rentals receivable	$	219,301		$	208,295
Estimated residual value of leased assets	38,138			29,638
Gross investment in lease financing	257,439			237,933
Unearned income	(46,709		)	(37,851		)
Net investment in lease financing	$	210,730		$	200,082

At December 31, 2018, the direct financing minimum future lease payments receivable for each of the years 2019 through 2023 were $53.04 million, $46.58 million, $38.69 million, $36.32 million, and $30.79 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 $11.38 million and $14.61 million at December 31, 2018 and 2017, respectively. During 2018, $8.73 million of new loans and other additions were made and repayments and other reductions totaled $11.96 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, 2018
Commercial and agricultural	$	1,043,019	$	30,186	$	1,073,205
Auto and light truck	528,174		31,813		559,987
Medium and heavy duty truck	281,834		1,710		283,544
Aircraft	768,442		34,669		803,111
Construction equipment	625,579		19,660		645,239
Commercial real estate	787,376		22,510		809,886
Total	$	4,034,424	$	140,548	$	4,174,972
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

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, 2018
Residential real estate and home equity	$	521,846	$	2,009	$	523,855
Consumer	136,423		214		136,637
Total	$	658,269	$	2,223	$	660,492
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

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, 2018
Commercial and agricultural	$	1,070,530	$	22	$	—	$	—	$	1,070,552	$	2,653	$	1,073,205
Auto and light truck	544,022		3,154		1,437		—		548,613		11,374		559,987
Medium and heavy duty truck	283,284		154		—		—		283,438		106		283,544
Aircraft	790,233		4,149		1,168		—		795,550		7,561		803,111
Construction equipment	641,270		1,643		—		—		642,913		2,326		645,239
Commercial real estate	807,793		109		—		—		807,902		1,984		809,886
Residential real estate and home equity	520,124		1,267		455		295		522,141		1,714		523,855
Consumer	135,591		682		150		73		136,496		141		136,637
Total	$	4,792,847	$	11,180	$	3,210	$	368	$	4,807,605	$	27,859	$	4,835,464
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

Interest income for the years ended December 31, 2018, 2017, and 2016, would have increased by approximately $2.18 million, $1.14 million, and $1.11 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, 2018
With no related reserve recorded:
Commercial and agricultural	$	2,471	$	2,471	$	—
Auto and light truck	7,504		7,504		—
Medium and heavy duty truck	106		106		—
Aircraft	556		556		—
Construction equipment	905		905		—
Commercial real estate	1,131		1,131		—
Residential real estate and home equity	—		—		—
Consumer	—		—		—
Total with no related reserve recorded	12,673		12,673		—
With a reserve recorded:
Commercial and agricultural	—		—		—
Auto and light truck	3,840		3,840		372
Medium and heavy duty truck	—		—		—
Aircraft	7,004		7,004		1,255
Construction equipment	1,340		1,340		279
Commercial real estate	759		759		51
Residential real estate and home equity	344		346		126
Consumer	—		—		—
Total with a reserve recorded	13,287		13,289		2,083
Total impaired loans	$	25,960	$	25,962	$	2,083
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

The following table shows average recorded investment and interest income recognized on impaired loans and leases, segregated by class, for years ending December 31, 2018, 2017 and 2016.



	2018				2017				2016
(Dollars in thousands)	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
Commercial and agricultural	$	2,812	$	—	$	4,526	$	1	$	3,484	$	6
Auto and light truck	9,352		—		766		—		10		—
Medium and heavy duty truck	247		—		658		—		—		—
Aircraft	9,987		20		4,873		5		6,291		2
Construction equipment	1,663		—		1,011		—		766		—
Commercial real estate	2,303		—		3,220		2		5,417		123
Residential real estate and home equity	347		15		355		15		415		15
Consumer loans	—		—		—		—		—		—
Total	$	26,711	$	35	$	15,409	$	23	$	16,383	$	146

The following table shows the number of loans and leases classified as troubled debt restructuring (TDR) during 2018, 2017 and 2016, 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 no modifications during 2018, one modification during 2017, and one modification during 2016 that resulted in an interest rate reduction below market rate. Consequently, the financial impact of the modifications was immaterial.



	2018			2017			2016
(Dollars in thousands)	Number of Modifications	Recorded Investment		Number of Modifications	Recorded Investment		Number of Modifications	Recorded Investment
Performing TDRs:
Commercial and agricultural	—	$	—	—	$	—	—	$	—
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	—	—		—	—		—	—
Nonperforming TDRs:
Commercial and agricultural	—	—		1	—		—	—
Auto and light truck	1	285		—	—		—	—
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	285		1	—		2	876
Total TDR modifications	1	$	285	1	$	—	2	$	876

There were no TDRs which had a payment default within the twelve months following modification during the year ended December 31, 2018, 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 TDRs which had payment defaults within the twelve months following modification during the year ended December 31, 2016.

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)	2018		2017
Performing TDRs	$	344	$	352
Nonperforming TDRs	316		537
Total TDRs	$	660	$	889