-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AUYZKydQKdDqoXpLSPLEsf+0fzTn0PwZQZg2olq4USc3M9DBqhG5sUIkbjEot8s7 cUgP+TrK6GOkROjiQafO1Q== 0000950137-99-000147.txt : 19990309 0000950137-99-000147.hdr.sgml : 19990309 ACCESSION NUMBER: 0000950137-99-000147 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990308 FILER: COMPANY DATA: COMPANY CONFORMED NAME: 1ST SOURCE CORP CENTRAL INDEX KEY: 0000034782 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 351068133 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-06233 FILM NUMBER: 99559511 BUSINESS ADDRESS: STREET 1: 100 N MICHIGAN ST CITY: SOUTH BEND STATE: IN ZIP: 46601 BUSINESS PHONE: 2192352702 MAIL ADDRESS: STREET 1: P O BOX 1602 STREET 2: P O BOX 1602 CITY: SOUTH BEND STATE: IN ZIP: 46634 FORMER COMPANY: FORMER CONFORMED NAME: FBT BANCORP INC DATE OF NAME CHANGE: 19820818 10-K 1 FORM 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________________ to ____________________ Commission file number 0-6233 1st SOURCE CORPORATION - ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Indiana 35-1068133 - -------------------------------- -------------------- (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 N. Michigan Street, South Bend, Indiana 46601 - -------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 219/235-2000 ------------- Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: 9% Cumulative Trust Preferred Securities and related guarantee - $25 par value - -------------------------------------------------------------------------------- (Title of Class) Floating Rate Cumulative Trust Preferred Securities and related guarantee - - -------------------------------------------------------------------------------- $25 par value - ------------- (Title of Class) ---------------- Common Stock - without par value -------------------------------- (Title of Class) ---------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No -------- -------- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of February 16, 1999. Common Stock, without par value - $309,154,359. The number of shares outstanding of each of the registrant's classes of stock as of February 16, 1999. Common Stock, without par value - 19,069,575 shares. -------------------------------------------------------- 9% Cumulative Trust Preferred Securities and related guarantee, $25 par value - - ------------------------------------------------------------------------------- 1,100,000 shares. - ------------------------------------------------------------------------------- Floating Rate Cumulative Trust Preferred Securities and - ------------------------------------------------------------------------------- related guarantee, $25 par value - 690,000 shares. - ------------------------------------------------------------------------------- DOCUMENTS INCORPORATED BY REFERENCE Portions of the annual shareholders report for the year ended December 31, 1998, are incorporated by reference into Part II. Portions of the annual proxy statement for the 1999 annual meeting of shareholders are incorporated by reference into Parts II and III. 2 PART I ITEM 1. BUSINESS GENERAL 1st Source Corporation is an Indiana corporation and registered bank holding company headquartered in South Bend, Indiana which commenced operations as a bank holding company in 1971. As used herein, unless the context otherwise requires, the term "1st Source" refers to 1st Source Corporation and its subsidiaries. At December 31, 1998, 1st Source had assets of $2.73 billion, deposits of $2.18 billion and total shareholders' equity of $215.9 million. Pages 24 through 46 of 1st Source's Annual Report to Shareholders for the year ended December 31, 1998 are incorporated herein by reference. 1st Source, through its principal subsidiary 1st Source Bank (the "Bank"), delivers a comprehensive range of consumer and commercial banking services to individual and business customers through 47 banking locations in the northern Indiana/southwestern Michigan market area. The Bank also competes for business nationwide by offering specialized financing services for used private aircraft, automobiles for leasing and rental agencies, heavy duty trucks and construction equipment. The Bank, which was chartered as an Indiana state bank in 1922, is a member of the Federal Reserve System and its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC") to the extent provided by law. The Bank is headquartered in South Bend, Indiana, which is in northern Indiana, approximately 95 miles east of Chicago and 140 miles north of Indianapolis. Its principal market area consists of nine counties in northern Indiana and three counties in southwestern lower Michigan. South Bend, in St. Joseph County, is the largest city in its market area, and is a regional center for educational institutions, health care, financial, accounting and legal services and retailing. 1st Source's other subsidiaries include 1st Source Leasing, Inc., an originator and servicer of personal property leases to businesses nationwide, 1st Source Insurance, Inc., a general property and casualty insurance agency in South Bend, 1st Source Capital Corporation, a licensed small business investment company, 1st Source Capital Trust I and II, subsidiaries created to issue $44.75 million of Trust Preferred Securities, Michigan Transportation Finance Corporation, a company which manages the non-Indiana assets of our national niche lending businesses, 1st Source Funding Corporation, a special purpose entity established for purposes of administering securitization activity, and Trustcorp Mortgage Company, a mortgage banking company with four offices in Indiana and one in Ohio. 1st Source's inactive subsidiaries include 1st Source Travel, Inc., 1st Source Auto Leasing, Inc., and FBT Capital Corporation. The principal executive office of 1st Source is located at 100 North Michigan Street, South Bend, Indiana 46601 and its telephone number is (219) 235-2000. BUSINESS STRATEGY AND OBJECTIVES 1st Source, as part of its "Vision 2000" strategic planning process commenced in 1995, has identified several business objectives and strategies which focus on growth and customer service. The principal objectives of 1st Source under Vision 2000 have been to (i) increase financial performance and market share, (ii) provide exceptional customer service, (iii) enhance credit quality, and (iv) maintain cost controls. 1st Source has employed the following strategies to further its Vision 2000 objectives: 1. Increase market share in each market served and as a percentage of each customer's relationship. 1st Source has opened 15 new banking locations from 1995 through 1998 as part of its banking center expansion program designed to maintain its position as one of the dominant financial institutions in its market area -- which 2 3 includes nine counties in northern Indiana and three counties in southwestern lower Michigan. Management believes that such a strategy allows the most effective and efficient use of 1st Source's marketing resources and assures that 1st Source's banking offices are accessible to a majority of the people residing in the markets served. 1st Source's goal is to deliver highly personal and superior customer services through each of its banking facilities and to meet a higher percentage of each customer's financial needs through personal relationship management. 2. Expand fee-based businesses. 1st Source currently provides a number of fee-based services to its clients, the major services being trust, mortgage banking, and insurance. 1st Source believes that additional sources of fee income are available from existing relationships and that existing fee-based product lines can be used effectively in developing new relationships with customers. 1st Source also believes that customers are more loyal and responsive to its products and services when a large percentage of a customer's financial services are provided directly by 1st Source. 1st Source's fee-based businesses are designed to strengthen the relationship between 1st Source and its customers. 3. Expand the national niche businesses across the United States taking advantage of specialized opportunities. 1st Source caters to specialized national market niches that management believes are not being well served by either the credit subsidiaries of manufacturers or by other financial institutions. Asset-based lending and personal relationship management of the customer base, together with an efficient method of operation, is the focus of the Bank's Specialty Finance Group, which provides such services. Additional experienced sales people have been and will be added to ensure better geographic coverage in areas of opportunity. 1st Source has also pursued a strategy of securitizing loan receivables so that this Group's business growth is not totally dependent on deposit funding. 4. Actively managing credit quality. 1st Source has adopted a proactive credit management process with loan officers maintaining responsibility for the quality of the credits they originate and manage. The credit management process is supported by a collective and collaborative review and approval process and is balanced by a review, evaluation and grading process undertaken by an objective third party. Senior management is actively involved in the management of the process and incentive compensation is based on 1st Source's overall credit experience. BANKING AND FINANCIAL SERVICES The organization offers a broad range of consumer and commercial banking services through its lending operations, retail branches and fee based businesses. Loans and Leases - 1st Source's commercial and agriculture loans at December 31, 1998, were approximately $399 million and were 21.2% of total loans outstanding. The primary focus of this lending area is with privately-held or closely-controlled firms in 1st Source's regional market area of Northern Indiana and Southwest Michigan. - Commercial loans secured by transportation and construction equipment totaled $732 million, or 38.9% of total loans outstanding, at December 31, 1998. This loan area concentrates on specialty finance lending for automobile leasing and rental companies, truck leasing companies, privately-owned aircraft for businesses and individuals and heavy duty trucks and other equipment used in the construction business. Currently, 1st Source has 14 locations nationwide supporting these lending activities. Loan sale and servicing income resulting from loan securitizations from these specialty 3 4 finance lending activities totaled $8.57 million in 1998. 1st Source also generates equipment rental income through the leasing of various automobiles, construction equipment and other equipment to customers through operating leases, where 1st Source retains ownership of the property being leased. Total equipment rental income for 1998 totaled $12.6 million with depreciation on this equipment amounting to $8.9 million. - Loans secured by real estate amounted to $631 million, which was approximately 33.5% of total loans outstanding, at December 31, 1998. The primary focus of this lending area is commercial real estate and residential mortgage lending in the regional market area of Northern Indiana and Southwest Michigan. Most of the residential mortgages are sold into the secondary market and serviced by 1st Source's mortgage subsidiary, Trustcorp Mortgage Company. - 1st Source's consumer loans at December 31, 1998, amounted to $119 million and 6.4% of total loans outstanding. Consumer loans are primarily all other non-real estate loans to individuals in 1st Source's regional market area. Deposits Through its network of 47 branches in 12 counties in Indiana and Michigan, 1st Source generates deposits to fund its lending activities. The total deposits at December 31, 1998 were $2.18 billion. Enhancing customer service, 1st Source offers banking services, in addition to its traditional branches, through its network of 48 automatic teller machines, bank by phone services and through the internet. Service charges on deposit accounts totaled $5.8 million for 1998. Fee Based Businesses 1st Source maintains various fee based businesses to complement net interest income. - Trust fees are generated from employee benefit services, personal and agency trusts and estate planning. In 1998, trust fees were approximately $8.3 million. - Mortgage loan sale and servicing income for 1998 amounted to $6.55 million. Income from loan sale and servicing is generated from the mortgage banking operations of Trustcorp Mortgage Company. Trustcorp serviced approximately $1.87 billion of mortgage loans at December 31, 1998. - Insurance commissions from 1st Source's property and casualty insurance agency totaled $1.30 million for 1998. COMPETITION The activities in which 1st Source and the Bank engage are highly competitive. Those activities and the geographic markets served involve primarily competition with other banks, some of which are affiliated with large bank holding companies headquartered outside of 1st Source's principal market. Larger financial institutions competing within 1st Source's principal market, but headquartered elsewhere, include KeyBank, Norwest Bank, Banc One, Standard Federal Bank and National City Corporation. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans and other credit and service charges, the quality of services rendered, the convenience of banking facilities and, in the case of loans to large commercial borrowers, relative lending limits. 4 5 In addition to competing with other banks within its primary service areas, the Bank also competes with other financial intermediaries, such as credit unions, industrial loan associations, securities firms, insurance companies, small loan companies, finance companies, mortgage companies, real estate investment trusts, certain governmental agencies, credit organizations and other enterprises. Additional competition for depositors' funds comes from United States Government securities, private issuers of debt obligations and suppliers of other investment alternatives for depositors. Many of 1st Source's non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and banks. Such non-bank competitors may, as a result, have certain advantages over 1st Source in providing some services. 1st Source competes against these financial institutions by offering innovative products and highly personalized services. 1st Source also relies on a history in the market dating back to 1863, relationships that long-term employees have with their customers, and the capacity for quick local decision-making. EMPLOYEES 1st Source employs approximately 1,036 persons on a full-time equivalent basis. 1st Source provides a wide range of employee benefits and considers employee relations to be good. REGULATION AND SUPERVISION GENERAL. 1st Source and the Bank are extensively regulated under federal and state law. These laws and regulations are intended to protect depositors, not shareholders. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of 1st Source. The operations of 1st Source may be affected by legislative changes and by the policies of various regulatory authorities. 1st Source is unable to predict the nature or the extent of the effects on its business and earnings that fiscal or monetary policies, economic controls or new federal or state legislation may have in the future. 1st Source is a registered bank holding company under the Bank Holding Company Act of 1956 (the "BHCA") and, as such, is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). 1st Source is required to file annual reports with the Federal Reserve and to provide the Federal Reserve such additional information as it may require. The Bank, as an Indiana state bank, is supervised by the Indiana Department of Financial Institutions (the "DFI") and the Federal Reserve. As such, the Bank is regularly examined by and subject to regulations promulgated by the DFI and the Federal Reserve. Because the FDIC provides deposit insurance to the Bank, the Bank is also subject to supervision and regulation by the FDIC (even though the FDIC is not its primary federal regulator). BANK AND BANK HOLDING COMPANY REGULATION. As noted above, both 1st Source and the Bank are subject to extensive regulation and supervision. Bank Holding Company Act. Under the BHCA, as amended, the activities of a bank holding company, such as 1st Source, are limited to business so closely related to banking, managing or controlling banks as to be a proper incident thereto. 1st Source is also subject to capital requirements applied on a consolidated basis in a form 5 6 substantially similar to those required of the Bank. The BHCA also requires a bank holding company to obtain approval from the Federal Reserve before (i) acquiring, or holding more than 5% voting interest in any bank or bank holding company, (ii) acquiring all or substantially all of the assets of another bank or bank holding company, or (iii) merging or consolidating with another bank holding company. The BHCA also restricts non-bank activities to those which, by statute or by Federal Reserve regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks. Financial Institutions Reform, Recovery, and Enforcement Act of 1989. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") reorganized and reformed the regulatory structure applicable to financial institutions generally. The Federal Deposit Insurance Corporation Improvement Act of 1991. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was adopted to supervise and regulate a wide variety of banking issues. In general, FDICIA provides for the recapitalization of the Bank Insurance Fund ("BIF"), deposit insurance reform, including the implementation of risk-based deposit insurance premiums, the establishment of five capital levels for financial institutions ("well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized") that would impose more scrutiny and restrictions on less capitalized institutions, along with a number of other supervisory and regulatory issues. Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Congress enacted the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") in September 1994. Beginning in September 1995, bank holding companies have the right to expand, by acquiring existing banks, into all states, even those which had theretofore restricted entry. The legislation also provides that, subject to future action by individual states, a holding company has the right to convert the banks which its owns in different states to branches of a single bank. The states of Indiana and Michigan have adopted the interstate branching provisions of the Interstate Act. Economic Growth and Regulatory Paperwork Reduction Act of 1996. The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the "EGRPRA") was signed into law on September 30, 1996. EGRPRA streamlined the non-banking activities application process for well-capitalized and well-managed bank holding companies. Regulations Governing Capital Adequacy. The federal bank regulatory agencies use capital adequacy guidelines in their examination and regulation of bank holding companies and banks. If the capital falls below the minimum levels established by these guidelines, the bank holding company or bank may be denied approval to acquire or establish additional banks or nonbank businesses or to open facilities. The various regulatory capital requirements that 1st Source is subject to are disclosed on page 42 in Footnote "O" of the annual shareholders report for year ended December 31, 1998, and is incorporated herein by reference. Management of 1st Source believes that the risk-weighting of assets and the risk-based capital guidelines do not have a material adverse impact on 1st Source's operations or on the operations of the Bank. Community Reinvestment Act. The Community Reinvestment Act of 1977 requires that, in connection with examinations of financial institutions within their jurisdiction, the federal banking regulators must evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. 6 7 Regulations Governing Extensions of Credit. The Bank is subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to the bank holding company or its subsidiaries, or investments in their securities and on the use of their securities as collateral for loans to any borrowers. These regulations and restrictions may limit the ability of 1st Source to obtain funds from the Bank for its cash needs, including funds for acquisitions and for payment of dividends, interest and operating expenses. Further, under the BHCA and certain regulations of the Federal Reserve, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. The Bank is also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons. Extensions of credit (i) must be made on substantially the same terms, including interest-rates and collateral, and following credit underwriting procedures that are not less stringent than, as those prevailing at the time for comparable transactions with persons not covered above and who are not employees, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. The Bank is also subject to certain lending limits and restrictions on overdrafts to such persons. Reserve Requirements. The Federal Reserve requires all depository institutions to maintain reserves against their transaction accounts and non-personal time deposits. Reserves of 3% must be maintained against total transaction accounts of $47.8 million or less (subject to adjustment by the Federal Reserve) and 10% must be maintained against that portion of total transaction accounts in excess of such amount. Dividends. The ability of the Bank to pay dividends and management fees is limited by various state and federal laws, by the regulations promulgated by its primary regulators and by the principles of prudent bank management. Monetary Policy and Economic Control. The commercial banking business in which 1st Source engages is affected not only by general economic conditions, but also by the monetary policies of the Federal Reserve. Changes in the discount rate on member bank borrowing, availability of borrowing at the "discount window," open market operations, the imposition of changes in reserve requirements against member banks deposits and assets of foreign branches, and the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates are some of the instruments of monetary policy available to the Federal Reserve. These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments and deposits, and such use may affect interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve have had a significant effect on the operating results of commercial banks and are expected to do so in the future. The monetary policies of the Federal Reserve are influenced by various factors, including inflation, unemployment, short-term and long-term changes in the international trade balance and in the fiscal policies of the U.S. Government. Future monetary policies and the effect of such policies on the future business and earnings of 1st Source and the Bank cannot be predicted. Pending Legislation. Because of concerns relating to competitiveness and the safety and soundness of the banking industry, Congress often considers a number of wide-ranging proposals for altering the structure, regulation and competitive relationships of the nation's financial institutions. It cannot be predicted whether or in what form any proposals will be adopted or the extent to which the business of 1st Source may be affected thereby. FORWARD LOOKING STATEMENTS The information regarding "forward-looking statements" on page 11 of the annual shareholders report for the year ended December 31, 1998, is incorporated herein by reference. 7 8 ITEM 1. BUSINESS (Continued)
SELECTED STATISTICAL INFORMATION Distribution of Assets, Liabilities and Shareholders' Equity Interest Rates and Interest Differential (Dollars in Thousands) Year ended December 31, 1998 1997 1996 ---------------------------------- ------------------------------ ------------------------------- 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 $ 294,632 $ 17,419 5.91% $ 272,400 $ 16,638 6.11% $ 254,033 $ 15,337 6.04% Tax-exempt (1) 150,678 11,327 7.52% 151,686 11,723 7.73% 146,176 11,787 8.06% Net loans (2 & 3) 1,853,537 168,664 9.10% 1,610,889 148,061 9.19% 1,348,089 124,467 9.23% Other investments 45,708 2,348 5.14% 11,662 592 5.09% 18,757 995 5.30% ------------- --------- ----- ------------- --------- ----- ------------- ---------- ----- Total Earning Assets 2,344,555 199,758 8.52% 2,046,637 177,014 8.65% 1,767,055 152,586 8.64% Cash and due from banks 86,452 73,246 75,378 Reserve for loan losses (38,861) (31,966) (28,482) Other assets 158,072 110,383 81,263 ------------ ------------- ------------- Total $2,550,218 $2,198,300 $1,895,214 ========== ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest bearing deposits $1,748,759 $ 86,264 4.93% $1,488,287 $73,150 4.92% $1,337,345 $64,214 4.80% Short-term borrowings 243,431 15,034 6.18% 227,757 13,014 5.71% 156,003 7,843 5.03% Long-term debt 13,036 929 7.13% 16,527 1,160 7.02% 19,876 1,372 6.90% ------------- ---------- ----- ------------- --------- ----- ------------- --------- ----- Total Interest Bearing Liabilities 2,005,226 102,227 5.10% 1,732,571 87,324 5.04% 1,513,224 73,429 4.85% ----------- --------- ----- ----------- -------- ----- ----------- -------- ----- Noninterest bearing deposits 250,755 210,686 186,804 Other liabilities 89,057 72,500 33,862 Shareholders' equity 205,180 182,543 161,324 ------------ ------------ ------------ Total $2,550,218 $2,198,300 $1,895,214 ========== ========== ========== ------- ------- ------- Net Interest Income $97,531 $89,690 $79,157 ======= ======= ======= Net Yield on Earning Assets on ----- ----- ----- a Taxable Equivalent Basis 4.16% 4.38% 4.48% ===== ===== =====
(1) Interest income including the effects of taxable equivalent adjustments, using a 40.525% rate. Tax equivalent adjustments were $3,408 in 1998, $3,536 in 1997 and $3,635 in 1996. (2) Loan income includes fees on loans of $4,889 in 1998, $4,097 in 1997 and $3,136 in 1996. Loan income also includes the effects of taxable equivalent adjustments, using a 40.525% rate. Tax equivalent adjustments were $202 in 1998, $162 in 1997 and $131 in 1996. (3) For purposes of this computation, nonaccruing loans are included in the daily average loan amounts outstanding. 8 9 ITEM 1. BUSINESS (Continued) The following table sets forth for the periods indicated a summary of the changes in interest earned and interest paid, resulting from changes in volume and changes in rates:
Increase (Decrease) Due to (1) --------------------------------------------------------------------- Volume Rate Net --------- ---------- --------- (In Thousands) 1998 compared to 1997 Interest earned on: Loans $ 22,038 $ (1,435) $ 20,603 Investment securities: Taxable 1,297 (516) 781 Tax-exempt (80) (317) (397) Interest-bearing deposits with other banks (1) 27 26 Federal funds sold and other money market investments 1,764 (33) 1,731 ----------- ------------ ------------ Total Earning Assets $ 25,018 $ (2,274) $ 22,744 Interest paid on: Savings deposits 2,084 1,113 3,197 Other time deposits 10,463 (546) 9,917 Short-term borrowings 909 1,111 2,020 Long-term debt (249) 18 (231) ----------- ------------ ----------- Total Interest-Bearing Liabilities 13,207 1,696 14,903 ----------- ------------ ----------- Net Interest Income $ 11,811 $ (3,970) $ 7,841 ========= ========== ========= 1997 compared to 1996 Interest earned on: Loans $ 23,782 $ (405) $ 23,377 Investment securities: Taxable 1,367 151 1,518 Tax-exempt 607 (671) (64) Interest-bearing deposits with other banks (53) (62) (115) Federal funds sold and other money market investments (316) 28 (288) ----------- ------------ ----------- Total Earning Assets 25,387 (959) 24,428 Interest paid on: Savings deposits 91 (419) (328) Other time deposits 8,688 576 9,264 Short-term borrowings 3,999 1,172 5,171 Long-term debt (232) 20 (212) ----------- ------------ ----------- Total Interest-Bearing Liabilities 12,546 1,349 13,895 ----------- ------------ ----------- Net Interest Income $ 12,841 $ (2,308) $ 10,533 ========= ========= =========
(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. 9 10 ITEM 1. BUSINESS (Continued) INVESTMENT PORTFOLIO The carrying amounts of investment securities at the dates indicated are summarized as follows:
December 31 ---------------------------------------------- 1998 1997 1996 ---------- ---------- ---------- (In Thousands) U.S. Treasury and government agencies and corporations $284,327 $228,884 $253,434 States and political subdivisions 154,473 148,228 150,044 Other 100,899 37,796 19,618 --------- ---------- ---------- Total $539,699 $414,908 $423,096
The following table shows the maturities of investment securities at December 31, 1998, at the carrying amounts and the weighted average yields (for tax-exempt obligations on a fully taxable basis assuming a 40.525% tax rate) of such securities. 10 11 ITEM 1. BUSINESS (Continued)
Maturing ------------------------------------------------------------------------------------------------------- After One After Five Within But Within But Within After One Year Five Years Ten Years Ten Years -------------------- ------------------ ---------------- -------------------- Amount Yield Amount Yield Amount Yield Amount Yield ----------- -------- -------- -------- ---------- -------- ------- -------- (Dollars in Thousands) U.S. Treasury and government agencies and corporations $ 99,487 5.68% $145,608 5.40% $ 3,582 5.95% $35,650 6.01% States and political subdivisions 16,628 6.43% 84,249 6.87% 44,411 8.13% 9,185 6.58% Other 31,464 5.58% 22,538 5.77% 254 7.01% 46,643 6.32% ---------- ----- ---------- ----- --------- ----- -------- ----- Total $147,579 5.74% $252,395 5.92% $48,247 7.96% $91,478 6.23%
================================================================================ 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 adjustments. LOAN PORTFOLIO The following table shows 1st Source's loan distribution at the end of each of the last five years for December 31:
1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- (Dollars in Thousands) Loans: Commercial and agricultural $ 399,013 $ 364,391 $ 335,192 $ 314,421 $ 293,171 Commercial loans secured by transportation and construction equipment 732,488 752,677 561,042 457,930 358,128 Loans secured by real estate 630,915 568,136 468,109 408,028 377,532 Consumer loans 119,280 111,577 91,220 79,036 71,882 ------------ ------------- ------------- ------------- ------------- Total Loans $1,881,696 $1,796,781 $1,455,563 $1,259,415 $1,100,713 ========== ========== ========== ========== ==========
11 12 ITEM 1. BUSINESS (Continued) LOAN PORTFOLIO (Continued) The following table shows the rate sensitivity of loans (excluding residential mortgages for 1-4 family residences, consumer loans and lease financing) outstanding as of December 31, 1998. The amounts due after one year are also classified according to the sensitivity to changes in interest rates.
Rate Sensitivity -------------------------------------------------------------------------------------------- Within After One But After One Year Within Five Years Five Year Total --------- ----------------- --------- -------- (In Thousands) Commercial loans secured by transportation and construction equipment $397,980 $304,326 $16,530 $ 718,836 Commercial and agricultural 263,268 80,986 5,346 349,600 Loans secured by real estate 207,455 41,625 7,238 256,318 --------- ---------- --------- ------------ Total $868,703 $426,937 $29,114 $1,324,754 ======== ======== ======= ========== Rate Sensitivity -------------------------------------- Fixed Variable Rate Rate ---------- ---------- Due after one year but within five years $411,325 $15,612 Due after five years 25,559 3,555 ----------- --------- Total $436,884 $19,167 ======== =======
The following table summarizes the nonaccrual, past due and restructured loans:
December 31 --------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (Dollars in Thousands) Nonaccrual Loans $9,266 $10,030 $6,678 $4,893 $3,314 Accruing loans past due 90 days or more 275 730 557 274 477 Restructured loans -- -- -- -- 133 ---------- ------------ ---------- ---------- -------- Total Nonperforming Loans $9,541 $10,760 $7,235 $5,167 $3,924 ========== ============ ========== ========== ========
12 13 ITEM 1. BUSINESS (Continued) LOAN PORTFOLIO (Concluded) Information with respect to nonaccrual and restructured loans at December 31, 1998 and 1997 is as follows:
December 31 ----------------------------- 1998 1997 -------- -------- (In Thousands) Nonaccrual loans $9,266 $10,030 Interest income which would have been recorded under original terms 1,129 1,173 Interest income recorded during the period 410 387
At December 31, 1998, $8,492,000 of the nonaccrual loans are collateralized. Potential Problem Loans At December 31, 1998, management was not aware of any potential problem loans that would have a material affect on loan delinquency or loan charge-offs. Loans are subject to constant review and are given management's attention whenever a problem situation appears to be developing. Loan Concentrations At December 31, 1998, 13.9% of total business loans were concentrated with borrowers in truck and automobile leasing companies. Loans to air transportation and aircraft dealers accounted for 13.9% of all business loans at December 31, 1998. 13 14 ITEM 1. BUSINESS (Continued) SUMMARY OF LOAN LOSS EXPERIENCE The following table summarizes the Company's loan loss experience for each of the last five years:
December 31 ---------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- -------- ------- -------- -------- (In Thousands) Amount of loans outstanding at end of period $1,881,696 $1,796,781 $1,455,563 $1,259,415 $1,100,713 ========== ========== ========== ========== ========== Average amount of net loans outstanding during period $1,853,537 $1,610,889 $1,348,489 $1,172,438 $1,066,752 ========== ========== ========== ========== ========== Balance of reserve for loan losses at beginning of period $ 35,424 $ 29,516 $ 27,470 $ 23,868 $ 22,350 Charge-offs: Commercial and agricultural 1,295 293 2,385 985 1,007 Commercial loans secured by transportation and construction equipment 1,671 317 347 36 29 Loans secured by real estate 323 157 230 597 816 Consumer loans 1,510 643 324 372 205 ------------- ------------- --------------- --------------- --------------- Total charge-offs 4,799 1,410 3,286 1,990 2,057 ------------- ------------- --------------- --------------- --------------- Recoveries: Commercial and agricultural 255 101 383 287 166 Commercial loans secured by transportation and construction equipment 419 917 593 2,224 225 Loans secured by real estate 47 87 359 122 215 Consumer loans 427 161 172 202 214 ------------- ------------- --------------- --------------- --------------- Total recoveries 1,148 1,266 1,507 2,835 820 ------------- ------------- -------------- -------------- --------------- Net charge-offs (recoveries) 3,651 144 1,779 (845) 1,237 Additions charged to operating expense 9,156 6,052 4,649 2,757 4,197 Recaptured reserve due to loan securitization -- -- (824) -- (1,442) ------------- ------------- --------------- --------------- --------------- Balance at end of period $ 40,929 $ 35,424 $ 29,516 $ 27,470 $ 23,868 ============= ============= =============== =============== =============== Ratio of net charge-offs (recoveries) to average net loans outstanding 0.20% 0.01% 0.13% (0.07%) 0.12%
14 15 1st Source's reserve for loan losses is provided for by direct charges to operations. Losses on loans are charged against the reserve and likewise, recoveries during the period for prior losses are credited to the reserve. The loss reserve is maintained at a level considered by management to be adequate to absorb anticipated losses from loans presently outstanding. The provision made to this reserve is determined by management based on the risk factors and general economic conditions affecting the loan portfolio, including changes in the portfolio mix and past loan loss experience. Management of 1st Source is constantly reviewing the status of the loan portfolio to identify borrowers that might develop financial problems, in order to aid borrowers in the handling of their accounts and to prevent sizable unexpected losses. In 1998, after management's assessment of loan quality, 1st Source made a charge of $9.16 million to operations as a provision for loan losses. At December 31, 1998, the reserve for loan losses was $40.93 million, or 2.18% of loans outstanding net of unearned discount. 15 16 ITEM 1. BUSINESS (Continued) SUMMARY OF LOAN LOSS EXPERIENCE (Concluded) The reserve for loan losses has been allocated according to the amount deemed necessary to provide for the possibility of losses being incurred within the categories of loans set forth in the table below. The amount of such components of the reserve at December 31, and the ratio of such loan categories to total outstanding loan balances, are as follows:
(Dollars in Thousands) 1998 1997 1996 ------------------------ ----------------------- ------------------------ Percent Percent Percent Of Loans Of Loans Of Loans In Each In Each In Each Category Category Category Reserve to Total Reserve to Total Reserve to Total Amount Loans Amount Loans Amount Loans ------ ---------- ------ ---------- ------ --------- Commercial and agricultural $ 8,016 21.2% $ 6,325 20.3% $ 8,011 19.5% Commercial loans secured by transportation and construction equipment 23,121 38.9% 18,188 41.9% 12,867 38.0% Loans secured by real estate 6,845 33.5% 7,177 31.6% 5,535 28.5% Consumer loans 2,947 6.4% 3,734 6.2% 3,103 14.0% --------- -------- --------- -------- -------- ------- Total $40,929 100.0% $35,424 100.0% $29,516 100.0% ======= ====== ======= ====== ======= ====== (Dollars in Thousands) 1995 1994 ------------------------- ------------------------ Percent Percent Of Loans Of Loans In Each In Each Category Category Reserve to Total Reserve to Total Amount Loans Amount Loans ------ ---------- ------ ---------- Commercial and agricultural $ 8,250 25.0% $ 5,822 26.6% Commercial loans secured by transportation and construction equipment 10,258 36.4% 7,998 32.5% Loans secured by real estate 6,185 32.4% 6,852 34.4% Consumer loans 2,777 6.2% 3,196 6.5% --------- -------- --------- -------- Total $27,470 100.0% $23,868 100.0% ======= ====== ======= ======
Allowance for potential losses not specifically identified is allocated on a pro rata basis to all loan categories. 16 17 ITEM 1. BUSINESS (Continued) DEPOSITS The average daily amounts of deposits and rates paid on such deposits are summarized as follows:
Year Ended December 31 ------------------------------------------------------------------------------------- 1998 1997 1996 --------------------------- --------------------------- ------------------------ Amount Rate Amount Rate Amount Rate ---------- ---- ---------- ---- ---------- ---- Noninterest bearing demand deposits $ 250,755 -- % $ 210,685 -- % $ 186,804 -- % Interest bearing demand deposits 123,571 3.27% 75,765 2.30% 135,328 2.21% Savings deposits 373,495 2.55% 341,777 2.52% 279,608 2.76% Other time deposits 1,251,693 5.81% 1,070,746 5.86% 922,409 5.80% ---------- ---------- ---------- Total $1,999,514 $1,698,973 $1,524,149 ========== ========== ==========
The amount of time certificates of deposit of $100,000 or more and other time deposits of $100,000 or more outstanding at December 31, 1998, by time remaining until maturity is as follows (in thousands):
Under 3 months $120,163 4 - 6 months 47,506 7 - 12 months 67,364 Over 12 months 56,503 ---------- Total $291,536 ==========
17 18 ITEM 1. BUSINESS (Continued) RETURN ON EQUITY AND ASSETS The ratio of net income to average shareholders= equity and average total assets, and certain other ratios, are presented below:
Year Ended December 31 ----------------------------------------------------------------------- 1998 1997 1996 ---------- ---------- ---------- Percentage of net income to: Average shareholders' equity 15.12% 14.51% 14.38% Average total assets 1.22% 1.21% 1.22% Percentage of dividends declared per common share to diluted net income per common share 17.38% 18.38% 18.16% Percentage of average shareholders' equity to average total assets 8.05% 8.30% 8.51%
18 19 ITEM 1. BUSINESS (Concluded) SHORT-TERM BORROWINGS The following table shows the distribution of 1st Source's short-term borrowings and the weighted average interest rates thereon at the end of each of the last three years. Also provided are the maximum amount of borrowings and the average amount of borrowings in thousands, as well as weighted average interest rates for the last three years.
Federal Funds Purchased and Security Other Repurchase Commercial Short-Term Total 1998 Agreements Paper Borrowings Borrowings - -------------------------------- ------------- ---------------- -------------- -------------- Balance at December 31, 1998 $159,478 $5,856 $76,825 $242,159 Maximum amount outstanding at any month-end 181,364 6,556 141,030 328,950 Average amount outstanding 149,794 4,646 88,991 243,431 Weighted average interest rate during the year 4.84% 5.29% 8.48% 6.18% Weighted average interest rate for outstanding amounts at December 31, 1998 4.34% 4.63% 5.33% 4.66% 1997 - -------------------------------- Balance at December 31, 1997 $117,987 $3,892 $113,127 $235,006 Maximum amount outstanding at any month-end 217,039 6,641 113,127 336,807 Average amount outstanding 136,208 5,321 86,228 227,757 Weighted average interest rate during the year 5.12% 5.46% 6.66% 5.71% Weighted average interest rate for outstanding amounts at December 31, 1997 5.00% 5.39% 6.08% 5.53% 1996 - -------------------------------- Balance at December 31, 1996 $112,580 $6,109 $106,174 $224,863 Maximum amount outstanding at any month-end 129,335 7,758 106,174 243,267 Average amount outstanding 94,171 5,082 56,751 156,004 Weighted average interest rate during the year 5.01% 5.13% 5.05% 5.03% Weighted average interest rate for outstanding amounts at December 31, 1996 5.10% 5.21% 5.99% 5.52%
Federal funds purchased and securities sold under agreements to repurchase generally mature within 1 to 30 days of the transaction date. Commercial paper and other short-term borrowings generally mature within 30 to 180 days. 19 20 ITEM 2. PROPERTIES 1st Source's headquarters building is located in downtown South Bend. In 1982, the land was leased from the City of South Bend on a 49-year lease, with a 50-year renewal option. The building is part of a larger complex, including a 300-room hotel and a 500-car parking garage. 1st Source sold the building and entered into a leaseback agreement with the purchaser for a term of 30 years. The bank building is a structure of approximately 160,000 square feet, with 1st Source and its subsidiaries occupying approximately 70% of the available office space, and approximately 30% presently subleased to unrelated tenants. 1st Source also owns property and/or buildings on which 28 of the bank subsidiary's 47 banking offices are located, including the facilities in Elkhart, LaPorte, Marshall, Porter, St. Joseph and Starke Counties in the state of Indiana, as well as a parking facility, two buildings housing drive-in banking plazas, a records retention facility, and a computer operations center. In 1995, 1st Source reacquired its former headquarters building through foreclosure. It is being refurbished for additional tenants and 1st Source use. The remaining properties utilized by the subsidiary are leased from unrelated parties. ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information regarding common stock prices and dividends on page 22 of the annual shareholders report for the year ended December 31, 1998, is incorporated herein by reference. There were 1,137 shareholders of 1st Source Common Stock as of December 31, 1998. ITEM 6. SELECTED FINANCIAL DATA The information under the caption "Selected Consolidated Financial Data" on page 12 of the annual shareholders report for the year ended December 31, 1998, is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 10 through 23 of the annual shareholders report for the year ended December 31, 1998, is incorporated herein by reference. 1st Source cautions that any forward looking statements contained in this report, in a report incorporated by reference into this report or made by management of 1st Source involve risks and uncertainties and are subject to change based on various factors. Actual results could differ materially from those expressed or implied. 20 21 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information under the caption. "Quantitative and Qualitative Disclosures about Market Risk" on pages 15 and 16 of the annual shareholders report for the year ended December 31, 1998, is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The report of independent accountants and the consolidated financial statements of 1st Source and its subsidiaries are included on pages 24 through 46 in the annual shareholders report for the year ended December 31, 1998, and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information under the caption "Directors and Executive Officers" on pages 3 through 6 and under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" on page 16 of the proxy statement dated March 8, 1999, is incorporated herein by reference with respect to Directors. ITEM 11. EXECUTIVE COMPENSATION The information under the caption "Renumeration of Executive Officers" on pages 7 through 14 of the proxy statement dated March 8, 1999, is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information under the caption "Voting Securities and Principal Holders Thereof" on page 2 and under the caption "Directors and Executive Officers" on pages 3 through 6 of the proxy statement dated March 8, 1999, is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information on page 6 of the proxy statement dated March 8, 1999, is incorporated herein by reference. 21 22 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) and (2) -- The response to this portion of Item 14 is submitted as a separate section of this report. (3) -- The response to this portion of Item 14 is submitted as a separate section of this report. (b) Reports on Form 8-K -- None filed during the fourth quarter of 1998. (c) Exhibits -- The response to this portion of Item 14 is submitted as a separate section of this report. (d) Financial Statement Schedules -- None. 22 23 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 1st SOURCE CORPORATION Registrant By: /s/ CHRISTOPHER J. MURPHY III -------------------------------------------------- Christopher J. Murphy III Chairman of the Board, President and Chief Executive Officer Date: March 5, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ CHRISTOPHER J. MURPHY III - -------------------------------------------------- Christopher J. Murphy III, Chairman of the Board, President and Chief Executive Officer Date: March 5, 1999 -------------------------------------------- /s/ WELLINGTON D JONES III - -------------------------------------------------- Wellington D. Jones III, Executive Vice President and a Director Date: March 5, 1999 -------------------------------------------- /s/ VINCENT A . TAMBURO - -------------------------------------------------- Vincent A. Tamburo, Secretary and General Counsel Date: March 5, 1999 -------------------------------------------- /s/ LARRY E. LENTYCH - -------------------------------------------------- Larry E. Lentych, Treasurer and Chief Financial Officer Date: March 5, 1999 --------------------------------------------
23 24 /s/ VINCE TAMBURO, P/A - -------------------------------------------------- Reverend E. William Beauchamp, Director Date: March 5, 1999 -------------------------------------------- /s/ PAUL R. BOWLES - -------------------------------------------------- Paul R. Bowles, Director Date: March 5, 1999 -------------------------------------------- /s / PHILIP J. FACCENDA - -------------------------------------------------- Philip J. Faccenda, Director Date: March 5, 1999 -------------------------------------------- /s/ DANIEL B. FITZPATRICK - -------------------------------------------------- Daniel B. Fitzpatrick, Director Date: March 5, 1999 -------------------------------------------- /s/ LAWRENCE E. HILER - -------------------------------------------------- Lawrence E. Hiler, Director Date: March 5, 1999 -------------------------------------------- /s/ WILLIAM P. JOHNSON - -------------------------------------------------- William P. Johnson, Director Date: March 5, 1999 -------------------------------------------- /s/ REX MARTIN - -------------------------------------------------- Rex Martin, Director Date: March 5, 1999 --------------------------------------------
24 25 /s/ DANE A. MILLER - -------------------------------------------------- Dane A. Miller, Director Date: March 5, 1999 ---------------------------------------------- /s/ RICHARD J. PFEIL - -------------------------------------------------- Richard J. Pfeil, Director Date: March 5, 1999 ----------------------------------------------
25 26 ANNUAL REPORT ON FORM 10-K ITEM 14(a) (1) AND (2) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES YEAR ENDED DECEMBER 31, 1998 1ST SOURCE CORPORATION SOUTH BEND, INDIANA F-1 27 FORM 10-K -- ITEM 14(a) (1) and (2) 1st SOURCE CORPORATION AND SUBSIDIARIES LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES The following report of independent accountants and consolidated financial statements of 1st Source Corporation and subsidiaries, included in the annual report of the registrant to its shareholders for the year ended December 31, 1998, are incorporated by reference in Item 8: Report of independent accountants Consolidated statements of financial condition -- December 31, 1998 and 1997 Consolidated statements of income -- Years ended December 31, 1998, 1997 and 1996 Consolidated statements of shareholders' equity -- Years ended December 31, 1998, 1997 and 1996 Consolidated statements of cash flows -- Years ended December 31, 1998, 1997 and 1996 Notes to consolidated financial statements -- December 31, 1998, 1997 and 1996 Financial statement schedules required by Article 9 of Regulation S-X are not required under the related instructions, or are inapplicable and, therefore, have been omitted. F-2 28 ANNUAL REPORT ON FORM 10-K ITEM 14(a)(3) AND 14(c) LIST OF EXHIBITS YEAR ENDED DECEMBER 31, 1998 1ST SOURCE CORPORATION SOUTH BEND, INDIANA E-1 29 FORM 10-K -- Item 14(a)(3) and 14(c) 1st SOURCE CORPORATION AND SUBSIDIARIES LIST OF EXHIBITS * 3(a) -- Articles of Incorporation of Registrant, as amended April 30, 1996, and filed as exhibit to Form 10-K, dated December 31, 1996, and incorporated herein by reference. 3(b) -- By-Laws of Registrant, as amended April 16, 1998, filed as exhibit to Form 10-K, dated December 31, 1998, and attached hereto. 4(a) -- Form of Common Stock Certificates of Registrant filed as exhibit to Registration Statement 2-40481 and incorporated herein by reference. Note: No long-term debt of the Registrant exceeds 10% of the consolidated total assets of the Registrant and its subsidiaries. In accordance with paragraph (4)(iii) of Item 601(b) of Regulation S-K, the Registrant will furnish the Commission upon request copies of long-term debt instruments and related agreements. 4(b)(1) -- Form of 9% Cumulative Trust Preferred Securities Indenture, dated March 21, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 4(b)(2) -- Form of 9% Cumulative Trust Preferred Securities Trust Agreement, dated March 21, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 4(b)(3) -- Form of 9% Cumulative Trust Preferred Securities Guarantee Agreement, dated March 21, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 4(c)(1) -- Form of Floating Rate Cumulative Trust Preferred Securities Indenture, dated March 21, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 4(c)(2) -- Form of Floating Rate Cumulative Trust Preferred Securities Trust Agreement, dated March 21, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 4(c)(3) -- Form of Floating Rate Cumulative Trust Preferred Securities Guarantee Agreement, dated March 21, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 10(a)(1) -- Employment Agreement of Christopher J. Murphy III, dated April 16, 1998, filed as exhibit to Form 10-K, dated December 31, 1998, and attached hereto. E-2 30 10(a)(2) -- Employment Agreement of Wellington D. Jones III, dated April 16, 1998, filed as exhibit to Form 10-K, dated December 31, 1998, and attached hereto. 10(a)(3) -- Employment Agreement of Allen R. Qualey, dated April 16, 1998, filed as exhibit to Form 10-K, dated December 31, 1998, and attached hereto. 10(a)(4) -- Employment Agreement of Larry E. Lentych, dated April 16, 1998, filed as exhibit to Form 10-K, dated December 31, 1998, and attached hereto. 10(a)(5) -- Employment Agreement of Richard Q. Stifel, dated April 16, 1998, filed as exhibit to Form 10-K, dated December 31, 1998, and attached hereto. 10(b) -- Form of Company's Employees' Money Purchase Pension Plan and Trust Agreement dated January 1, 1989, and amendment to the Company's Employees' Money Purchase Pension Plan and Trust dated April 1, 1994, filed as exhibit to Form 10-K dated December 31, 1994, and incorporated herein by reference. 10(c)(1) -- Form of Company's Employees' Profit Sharing Plan and Trust Agreement dated January 1, 1989, and amendment to the Company's Profit Sharing Plan and Trust Agreement dated April 1, 1994, filed as exhibit to Form 10-K dated December 31, 1994, and incorporated herein by reference. 10(c)(2) -- An amendment to 1st Source Corporation Employees' Profit Sharing Plan and Trust Agreement dated September 30, 1996, and filed as exhibit to Form 10-K, dated December 31, 1996, and incorporated herein by reference. 10(d) -- 1st Source Corporation Employee Stock Purchase Plan dated April 17, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 10(e) -- 1st Source Corporation 1982 Executive Incentive Plan, amended April 19, 1988, and filed as exhibit to Form 10-K, dated December 31, 1988, and incorporated herein by reference. 10(f) -- 1st Source Corporation 1982 Restricted Stock Award Plan, as amended February 19, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 10(h) -- 1st Source Corporation Non-Qualified Stock Option Agreement with Christopher J. Murphy III, dated January 1, 1992, as amended December 11, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. 10(i) -- 1st Source Corporation 1992 Stock Option Plan, dated April 23, 1992, as amended December 11, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and incorporated herein by reference. E-3 31 10(j) -- 1st Source Corporation 1998 Performance Compensation Plan, dated February 19, 1998, filed as exhibit to Form 10-K, dated December 31, 1998, and attached hereto. 10(k) -- Consulting Agreement of Ernestine M. Raclin, dated April 14, 1998, filed as exhibit to Form 10-K, dated December 31, 1998, and attached hereto. 13 -- Portions of Annual Report to Security Holders for the year ended December 31, 1998, attached hereto. 21 -- Subsidiaries of Registrant, attached hereto. 23 -- Consent of Independent Accountants, attached hereto. 27 -- Financial Data Schedule, attached hereto. * The exhibits included under exhibit 10 constitute all management contracts, compensatory plans and arrangements required to be filed as an exhibit to this form pursuant to Item 14(c) of this report. E-4 EX-3.B 2 BY-LAWS OF REGISTRANT 1 EXHIBIT 3(b) AMENDMENTS 1ST SOURCE CORPORATION 04-16-98 Article 4, Section 4.01. Duties and Number, amended. RESOLUTION OF BOARD OF DIRECTORS OF 1ST SOURCE CORPORATION APRIL 16, 1998 RESOLVED, that the By-Laws of this Corporation shall be amended at Article 4 (Board of Directors), Section 4.01 (Duties and Number), by deleting in its entirety the last sentence thereof, which states: "In the absence of a resolution by the Board fixing or changing the number of Directors, the number shall be eleven (11)", because this Board has determined on the advice of counsel that such action is not required by law or regulation. EX-10.A(1) 3 EMPLOYMENT AGREEMENT 1 EXHIBIT 10(a)(1) EMPLOYMENT AGREEMENT THIS AGREEMENT, dated as of April 16, 1998, by and between CHRISTOPHER J. MURPHY III, hereinafter referred to as "Executive", and lst SOURCE CORPORATION, an Indiana corporation, hereinafter referred to as "Employer," WITNESSETH; That WHEREAS, Executive is currently employed as the President of Employer and Employer's subsidiary, lst Source Bank, hereinafter referred to as "Bank," pursuant to the terms of an Employment Agreement between Employer and Executive dated as of January 1, 1992, hereinafter referred to as the "Prior Agreement"; and WHEREAS, Employer desires to assure the continued service of Executive, and Executive is willing to provide such service on the terms and conditions specified herein. NOW THEREFORE, in consideration of the premises and the mutual covenants and agreements contained in this Agreement, Employer and Executive hereby agree as follows: 1. Employment Position. The parties agree that the employment of Executive by Employer shall continue for the term referred to in Section 2. Employer agrees to continue the employment of Executive in a senior officer position with the titles of Chairman of the Board, President and Chief Executive Officer of Employer and Chairman of the Board and Chief Executive Officer of Bank, and agrees that Executive will serve as a director of both Employer and Bank. Executive shall devote his full time during business hours to the performance of his duties hereunder and shall at all times use his best effort to promote the best interests of Employer. Executive shall report to the Board of Directors of Employer and the Board of Directors of Bank. The assignments of Executive initially shall include: (a) full management responsibility for all operating divisions of Employer and its subsidiaries; (b) such additional and specific duties as may be reasonably assigned to Executive by either the Board of Directors or Executive Committee of Employer. Employer also agrees to provide to Executive during the term of this Agreement an adequate staff, together with such facilities and secretarial support consistent 2 with a senior employment position to permit the performance by Executive of the duties assigned to him. For the purpose of this Agreement, the Board of Directors of Employer is sometimes referred to herein as "Board." 2. Term. The term of this Agreement shall be from the date hereof until December 31, 2003, unless terminated sooner in accordance with Section 5 or Section 6 hereof, provided, however, that the term shall be automatically extended for an additional year on January 1, 1999 and on January 1 of each year thereafter, unless either party hereto gives written notice of an intention not to extend this Agreement on or before September 30 of the preceding year, in which case no further automatic extension shall occur and the term of this Agreement shall end on December 31, five (5) years subsequent to the date of the last automatic extension. 3. Compensation and Benefits. (a) Base Salary. Executive shall be paid a Base Salary of not less than Four Hundred Fifty Thousand Dollars ($450,000) per annum initially, increasing to Five Hundred Thousand Dollars ($500,000) per annum effective March 1, 1999, with increases effective on January 1 of each year thereafter as may be determined by Employer, but not less than five per cent (5%) in excess of the Base Salary paid during the previous year. (b) Incentive Compensation. In addition to amounts paid to Executive as salary and for other benefits, Executive will participate on a "phantom" basis in Employer's Executive Incentive Plan at a minimum "partnership" rate of 25% of base salary. All amounts awarded will be received and earned as if awarded under the plan except that Executive may elect to receive cash compensation in lieu of stock. (c) Benefit Plans. During the term of this agreement, Executive shall be entitled to participate, at a level commensurate with his position, in all benefit plans Employer presently has or hereafter adopts for its officers or employees, including (without limitation) pension, profit sharing, stock option or any group life or health insurance, hospitalization or other similar plans, any eligibility or waiting periods to be waived to the extent feasible. In plans where stock is awarded and Executive is not permitted to receive such stock, cash or its equivalent will be paid to Executive. 2 3 (d) Life Insurance. Employer will purchase $2 million ($2,000.000.00) of life insurance for the benefit of Executive, his family or estate as he may direct. (e) Death Benefit. If Executive should die during the term of this Agreement, Employer shall pay to his estate or such other beneficiary that the Executive may designate in writing an additional death benefit equal to three (3) times the base salary and bonus paid to Executive in the preceding year. (f) Additional Benefits. Executive shall be entitled to receive six (6) weeks vacation each year without reduction of compensation during the term of this Agreement. A club membership will be provided by Employer for Executive to at least one country club and to one club in downtown South Bend, Indiana, with the initiation fees, monthly fee and appropriate business related expenses paid by Employer. One automobile shall be provided by Employer to Executive on a full lease basis consistent with the title and position of Executive. 4. Disability. In the event that this Agreement is terminated by reason of Executive's Disability, Executive will continue to receive his Base Salary for up to one year from the date of the termination and shall also participate in any other disability compensation programs, including any Salary Continuance Plan in effect at that time for officers or executives of Employer. For purposes of this Agreement, "Disability" means Executive's inability by reason of illness or other physical or mental impairment to perform the duties required by his employment for any consecutive one hundred eighty (180) day period, provided that written notice of any termination for Disability shall have been given by Employer to Executive prior to the full resumption by him of the performance of such duties. 5. Termination by Employer; Death or Disability. (a) With Cause. In the event the Board determines that Executive is guilty of gross dereliction of duty or of fraud or dishonesty in connection with the performance of his duties under this Agreement, the Board may terminate this Agreement such termination to be effective thirty (30) days after the Board gives written notice to Executive setting forth with specificity the reason or cause for terminating the Agreement. In such event, the compensation and other benefits provided for in this Agreement shall 3 4 terminate on the date specified by the Board in the written notice of termination delivered to Executive. (b) Without Cause. If Employer shall discharge Executive from his employment hereunder for any reason other than one set forth in Section 5(a), or if it shall be determined by a court of competent jurisdiction that the discharge under Section 5(a) was not justified, or if Employer violates the provisions of this Agreement in a material manner, Executive shall have the right to terminate his obligations and duties hereunder, but the rights of Executive to receive the compensation provided for in Section 3 shall continue nevertheless to be fully in effect for the remaining term of this Agreement in the same manner as would have been payable absent such termination. Notwithstanding the foregoing Employer shall have the right at any time after the termination contemplated by this Section 5(b) to pay Executive in a lump sum the then present value of the amount payable to Executive discounted at the then current savings rate for Bank under this Section (b). (c) Death or Disability. This Agreement shall terminate in the event of the death or Disability of Executive. In such event, Executive, his estate or designee shall be entitled to the death or Disability benefits provided in Sections 3(e) and 4 of this Agreement. 6. Termination By Executive. Executive may, at any time upon written notice to Employer, immediately terminate his employment for Good Reason. For purposes of this Agreement, "Good Reason" shall mean any adverse change in Executive's status or position as Chairman of the Board, President and Chief Executive Officer of Employer or as Chairman of the Board and Chief Executive Officer of Bank or as a director of either including, without limitation, as a result of a material diminution of his duties or responsibilities or the assignment to him of duties or responsibilities which, in his reasonable judgment, are inconsistent with such status or positions, or any removal of Executive from, or any failure to reappoint or reelect him to, any such position (except in connection with the termination of his employment pursuant to Section 5(a) or 5(c) or by him for other than Good Reason), or any attempt to require Executive to relocate outside of the metropolitan area of his current residence. (a) If such termination does not follow a Change of Control of Employer or Bank, Executive shall continue to receive his Base Salary as then in effect for a period of twelve (12) months after the effective date of such termination, in the same manner as such Base Salary would have become payable pursuant to this Agreement absent such termination. 4 5 (b) If such termination occurs within one (1) year after a Change of Control of Employer or Bank, as severance pay and in lieu of any further compensation for periods subsequent to the effective date of such termination, Executive shall receive an amount in cash equal to 2.99 times his "annualized includable compensation for the base period" (as defined in Section 280G(d)(1) of the Internal Revenue Code of 1986, as amended (the "Code")). (c) Each of the events specified in the following clauses (i) through (iii) of this Section 6(c) shall be deemed a "Change in Control": (i) any third person, including a "group" within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, shall become the beneficial owner of 20% or more of the then outstanding shares of common stock of Employer or the combined voting power of the then outstanding voting securities of Employer entitled to vote for the election of the Board of Directors of Employer (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, or combination of the foregoing, the persons who were directors of Employer shall cease to constitute a majority of such Board of Directors or (iii) the shareholders of Employer shall approve an agreement providing a sale or other disposition of all or substantially all the assets of Employer. 7. Assignment. This Agreement is a personal contract, and the rights and interest of Executive hereunder may not be sold, transferred, assigned, pledged or hypothecated. Except as otherwise may be herein expressly provided, this Agreement shall inure to the benefit of and be binding upon Employer and its successors and assigns. 8. Amendment. This Agreement may be amended only by a written instrument signed by the parties hereto after approval by either the Board or Executive Committee of Employer. 9. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Indiana. 10. Fees and Expenses. If a dispute arises regarding the interpretation or enforcement of this Agreement and Executive obtains a final judgment in his favor in a court of competent jurisdiction or his claim is settled by Employer prior to the rendering of a judgment by such a court, all reasonable legal fees and expenses incurred by Executive in seeking to obtain or enforce any right or benefit provided for in this Agreement or otherwise pursuing his claim shall be paid by Employer, to the fullest extent permitted by law. 5 6 11. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in a writing signed by the parties hereto. No waiver by any party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. This Agreement supersedes the Prior Agreement in its entirety. 12. Restrictive Covenants. In order to induce Employer to enter into this Agreement, Executive hereby agrees as follows: (a) While Executive is employed by Employer and for a period of twenty-four (24) months after the effective date of termination of such employment for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not divulge or furnish any trade secrets (as defined in IND. CODE Section 24-2-3-2) of Employer or any confidential information acquired by him while employed by Employer concerning the policies, plans, procedures or customers of Employer to any person, firm or corporation, other than Employer or with its prior written consent, or use any such trade secret or confidential information directly or indirectly for Executive's own benefit or for the benefit of any person, firm or corporation other than Employer, as such trade secrets and confidential information are confidential and shall at all times remain the property of Employer. (b) For a period of twenty-four (24) months after the effective date of termination of Executive's employment hereunder for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not, directly or indirectly, provide banking or bank-related services to, or solicit the banking or bank-related business of, any customer of Employer at the time of such provision of services or solicitation which Employee served either alone or with others while employed by Employer within St. Joseph, Elkhart, Marshall or LaPorte Counties in the State of Indiana, or assist any actual or potential competitor of Employer to provide banking or bank-related services to, or solicit the banking or bank-related business of, any such customer in any such area, and Executive shall not, directly or indirectly, as principal, agent, or trustee, or through the agency of any corporation, partnership, trade association, agent or agency, engage in any banking or bank-related business or venture which competes with the business of Employer as conducted during Executive's employment by Employer within such area; provided, however, that Executive may own not more than five percent of the voting securities of 6 7 any entity providing banking or bank-related services within such area if the voting securities of such entity are traded on a national securities exchange or quoted on a national interdealer quotation system. (c) Executive acknowledges that any violation of this Section 12 would cause irreparable harm to Employer, that damages for such harm would be incapable of precise measurement and that, accordingly, Employer would not have an adequate remedy at law to redress the harm caused by such violation. Therefore, Executive agrees that, in addition to any other remedy, Employer shall be entitled to immediate (i.e., without prior notice) preliminary and final injunctive relief to enjoin and restrain any violation of this Section 12. If Executive's employment is terminated during the Term of this Agreement for reasons set forth in Section 5(b) of this Agreement, Executive shall have no obligations to Employer with respect to trade secrets, confidential information or noncompetition under this Section 12. 13. Certain Additional Payments by Employer. (a) In the event that Section 280G of the Code is determined to apply to the payments to be made by Employer to Executive under this Agreement or other compensation or benefit programs, and in the event any excise tax ("Excise Tax") that may be imposed by Section 4999 of the Code become payable by Executive because of any of the payments made to Executive under this Agreement or otherwise, Employer will pay to Executive an additional amount ("Gross-up Payment") at least 60 days prior to the due date for payment of the Excise Tax. The Gross-up Payment shall be in an amount such that, after payment by Executive of all taxes (including, without limitation, all income and employment tax and Excise Tax and treating as a tax the disallowance of any deduction of Executive by virtue of the inclusion of the Gross-up Payment in Executive's adjusted gross income) and interest and penalties with respect to such taxes imposed upon the Gross-up Payment, Executive retains an amount equal to the Excise Tax. Employer shall notify Executive of its determination of the amount of payments under this Agreement subject to the Excise Tax (which determination shall be made by an accounting firm selected by Employer) and shall provide Executive with a receipt for the Excise Tax paid. Executive shall report the amount indicated in Employer's notice as the amount subject to the Excise Tax on Executive's Federal income tax return. 7 8 (b) If, for any reason, the Internal Revenue Service or any other taxing authority proposes an adjustment to the amount of Excise Tax due with respect to any payments or with respect to any additional amounts received by Executive pursuant to this Agreement, Executive will notify Employer immediately of such proposed adjustment and shall give Employer the right to contest such proposed adjustment on Executive's behalf; provided, however, that Executive may pay such claim if Employer does not take any action prior to the time such payment is due. Employer shall bear and pay directly all costs related to or associated with any contest, regardless of outcome, and shall have complete control over such contest as it relates to the Excise Tax, including whether such contest shall be by way of non-payment of the Excise Tax, payment of the Excise Tax under protest, or payment of the Excise Tax accompanied by a claim for a refund. Employer shall pay to Executive (i) an amount equal to the Excise Tax required to be paid to the Internal Revenue Service by Executive as a result of the outcome of any contest, any penalties or interest thereon, and (ii) a Gross-up Payment computed in the same manner and subject t the same adjustments as other Gross-up Payments previously described. Payment by Employer of an amount equal to the Excise tax and Gross-up Payment shall be made to Executive in advance of the due date for payment of Excise Taxes. (c) In the event that the amount of any additional payments made pursuant to this Section 13 exceeds the amount determined to have been due, the excess additional amounts made shall constitute a loan by Employer to Executive payable within 30 days after receipt by Executive of the refund from the Internal Revenue Service together with any interest received. 14. No Duty to Mitigate. Executive is not required to mitigate the amount of salary or benefits payable pursuant to this Agreement upon termination of his employment by seeking other employment or otherwise, nor shall any amount provided to be paid by Employer pursuant to this Agreement upon termination of Executive's employment be reduced by any compensation earned by Employee as a result of employment by another employer that is not in violation of Executive's obligations under Section 12. 15. Severability. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 16. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. 8 9 17. Resolution of Disputes. Employer agrees to pay promptly as incurred, to the full extent permitted by law, all legal fees and expenses which Executive may reasonably incur as a result of any contest, regardless of outcome, by Employer, Executive or others of the validity of enforceability of, or liability under, any provision of this Agreement or any guarantee of performance (including as a result of any contest by Executive concerning the amount of any payment pursuant to this Agreement). IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first written above. ----------------------------------- Christopher J. Murphy, III lst SOURCE CORPORATION, an Indiana corporation By: -------------------------------- Philip J. Facenda, Chairman of the Executive Compensation Committee 9 EX-10.A(2) 4 EMPLOYMENT AGREEMENT OF WELLINGTON D. JONES III 1 EXHIBIT 10(a)(2) EMPLOYMENT AGREEMENT THIS AGREEMENT, dated as of April 16, 1998, by and between WELLINGTON D. JONES III, hereinafter referred to as "Executive", and lst SOURCE CORPORATION, an Indiana corporation, hereinafter referred to as "Employer," WITNESSETH; That WHEREAS, Executive is currently employed as an executive officer of Employer's subsidiary, lst Source Bank, hereinafter referred to as "Bank;" and WHEREAS, Employer desires to assure the continued service of Executive, and Executive is willing to provide such service on the terms and conditions specified herein. NOW THEREFORE, in consideration of the premises and the mutual covenants and agreements contained in this Agreement, Employer and Executive hereby agree as follows: 1. Employment Position. The parties agree that the employment of Executive by Employer shall continue for the term referred to in Section 2. Employer agrees to continue the employment of Executive in a senior officer position with the title of President of Bank. Executive shall devote his full time during business hours to the performance of his duties hereunder and shall at all times use his best effort to promote the best interests of Employer. Executive shall report to the Chairman of the Board and Chief Executive Officer of Bank and/or Employer. 2. Term. The term of this Agreement shall be from the date hereof until December 31, 2003, unless terminated sooner in accordance with Section 5 or Section 6 hereof, provided, however, that the term shall be automatically extended for an additional year on January 1, 2004 and on January 1 of each year thereafter, unless either party hereto gives written notice of an intention not to extend this Agreement on or before September 30 of the preceding year, in which case no further automatic extension shall occur and the term of this Agreement shall end. 3. Compensation and Benefits. (a) Base Salary. Executive shall be paid a Base Salary of Two Hundred Fifty Thousand Dollars ($250,000) per annum, with such increases thereafter as may be determined by Employer. 2 (b) Incentive Compensation. In addition to amounts paid to Executive as salary and for other benefits, Executive will participate in Employer's Executive Incentive Plan at a minimum "partnership" rate of 20% of base salary for purposes of determining awards under the Plan. All amounts awarded are subject to the terms and conditions of the Plan. (c) Benefit Plans. During the term of this agreement, Executive shall be entitled to participate, at a level commensurate with his position, in all benefit plans Employer presently has or hereafter adopts for its officers or employees, including (without limitation) pension, profit sharing, stock option or any group life or health insurance, hospitalization or other similar plans, any eligibility or waiting periods to be waived to the extent feasible. (d) Life Insurance. Employer will purchase term life insurance coverage equal to two (2) times the initial Base Salary provided in Section 3(b) for the benefit of Executive, his family or estate as he may direct and as provided under Employer's insurance benefit programs. (e) Club Membership. A club membership will be provided by Employer for Executive to at least one country club and to one club in downtown South Bend, Indiana, with the initiation fees, monthly fee and appropriate business related expenses paid by Employer. 4. Disability. In the event that this Agreement is terminated by reason of Executive's Disability, Executive will continue to receive his Base Salary for up to one year from the date of the termination and shall also participate in any other disability compensation programs, including any Salary Continuance Plan in effect at that time for officers or executives of Employer. For purposes of this Agreement, "Disability" means Executive's inability by reason of illness or other physical or mental impairment to perform the duties required by his employment for any consecutive one hundred eighty (180) day period, provided that written notice of any termination for Disability shall have been given by Employer to Executive prior to the full resumption by him of the performance of such duties. 5. Termination by Employer; Death or Disability. (a) With Cause. In the event the Board determines that Executive is guilty of gross dereliction of duty or of fraud or dishonesty in connection with the performance of his duties under this Agreement, the Board may terminate this Agreement such termination to be effective thirty (30) days after the Board gives written notice to Executive setting forth with specificity the 2 3 reason or cause for terminating the Agreement. In such event, the compensation and other benefits provided for in this Agreement shall terminate on the date specified by the Board in the written notice of termination delivered to Executive. (b) Without Cause. If Employer shall discharge Executive from his employment hereunder for any reason other than one set forth in Section 5(a), or if it shall be determined by a court of competent jurisdiction that the discharge under Section 5(a) was not justified, or if Employer violates the provisions of this Agreement in a material manner, Executive shall have the right to terminate his obligations and duties hereunder, but the rights of Executive to receive the compensation provided for in Section 3 shall continue nevertheless to be fully in effect for the remaining term of this Agreement in the same manner as would have been payable absent such termination. Notwithstanding the foregoing Employer shall have the right at any time after the termination contemplated by this Section 5(b) to pay Executive in a lump sum the then present value of the amount payable to Executive discounted at the then current savings rate for Bank under this Section (b). (c) Death or Disability. This Agreement shall terminate in the event of the death or Disability of Executive. 6. Termination By Executive. Executive may, at any time upon written notice to Employer, immediately terminate his employment for Good Reason. For purposes of this Agreement, "Good Reason" shall mean any adverse change in Executive's status or position as the President of Bank including, without limitation, as a result of a material diminution of his duties or responsibilities or the assignment to him of duties or responsibilities which, in his reasonable judgment, are inconsistent with such status or positions, or any removal of Executive from, or any failure to reappoint or reelect him to, any such position (except in connection with the termination of his employment pursuant to Section 5(a) or 5(c) or by him for other than Good Reason). (a) If such termination does not follow a Change of Control of Employer or Bank, Executive shall continue to receive his Base Salary as then in effect for a period of twelve (12) months after the effective date of such termination, in the same manner as such Base Salary would have become payable pursuant to this Agreement absent such termination. (b) If such termination occurs within one (1) year after a Change of Control of Employer or Bank, as severance pay and in lieu of any further compensation for periods subsequent to the effective date of such termination, 3 4 Executive shall receive an amount in cash equal to 2.99 times his "annualized includable compensation for the base period" (as defined in Section 280G(d)(1) of the Internal Revenue Code of 1986, as amended (the "Code")). (c) Each of the events specified in the following clauses (i) through (iii) of this Section 6(c) shall be deemed a "Change in Control": (i) any third person, including a "group" within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, shall become the beneficial owner of 50% or more of the then outstanding shares of common stock of Employer or the combined voting power of the then outstanding voting securities of Employer entitled to vote for the election of the Board of Directors of Employer (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, or combination of the foregoing, the persons who were directors of Employer shall cease to constitute a majority of such Board of Directors or (iii) the shareholders of Employer shall approve an agreement providing a sale or other disposition of all or substantially all the assets of Employer. 7. Assignment. This Agreement is a personal contract, and the rights and interest of Executive hereunder may not be sold, transferred, assigned, pledged or hypothecated. Except as otherwise may be herein expressly provided, this Agreement shall inure to the benefit of and be binding upon Employer and its successors and assigns. 8. Amendment. This Agreement may be amended only by a written instrument signed by the parties hereto after approval by either the Board or Executive Committee of Employer. 9. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Indiana. 10. Fees and Expenses. If a dispute arises regarding the interpretation or enforcement of this Agreement and Executive obtains a final judgment in his favor in a court of competent jurisdiction or his claim is settled by Employer prior to the rendering of a judgment by such a court, all reasonable legal fees and expenses incurred by Executive in seeking to obtain or enforce any right or benefit provided for in this Agreement or otherwise pursuing his claim shall be paid by Employer, to the fullest extent permitted by law. 11. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in a writing 4 5 signed by the parties hereto. No waiver by any party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. 12. Restrictive Covenants. In order to induce Employer to enter into this Agreement, Executive hereby agrees as follows: (a) While Executive is employed by Employer and for a period of twenty-four (24) months after the effective date of termination of such employment for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not divulge or furnish any trade secrets (as defined in IND. CODE Section 24-2-3-2) of Employer or any confidential information acquired by him while employed by Employer concerning the policies, plans, procedures or customers of Employer to any person, firm or corporation, other than Employer or with its prior written consent, or use any such trade secret or confidential information directly or indirectly for Executive's own benefit or for the benefit of any person, firm or corporation other than Employer, as such trade secrets and confidential information are confidential and shall at all times remain the property of Employer. (b) For a period of twenty-four (24) months after the effective date of termination of Executive's employment hereunder for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not, directly or indirectly, provide banking or bank-related services to, or solicit the banking or bank-related business of, any customer of Employer at the time of such provision of services or solicitation which Employee served either alone or with others while employed by Employer within St. Joseph, Elkhart, Marshall or LaPorte Counties in the State of Indiana, or assist any actual or potential competitor of Employer to provide banking or bank-related services to, or solicit the banking or bank-related business of, any such customer in any such area, and Executive shall not, directly or indirectly, as principal, agent, or trustee, or through the agency of any corporation, partnership, trade association, agent or agency, engage in any banking or bank-related business or venture which competes with the business of Employer as conducted during Executive's employment by Employer within such area; provided, however, that Executive may own not more than five percent of the voting securities of any entity providing banking or bank-related services within such area if the voting securities of such entity are traded on a national securities exchange or quoted on a national interdealer quotation system. 5 6 (c) Executive acknowledges that any violation of this Section 12 would cause irreparable harm to Employer, that damages for such harm would be incapable of precise measurement and that, accordingly, Employer would not have an adequate remedy at law to redress the harm caused by such violation. Therefore, Executive agrees that, in addition to any other remedy, Employer shall be entitled to immediate (i.e., without prior notice) preliminary and final injunctive relief to enjoin and restrain any violation of this Section 12. If Executive's employment is terminated during the Term of this Agreement for reasons set forth in Section 5(b) of this Agreement, Executive shall have no obligations to Employer with respect to trade secrets, confidential information or noncompetition under this Section 12. 13. Certain Additional Payments by Employer. (a) In the event that Section 280G of the Code is determined to apply to the payments to be made by Employer to Executive under this Agreement or other compensation or benefit programs, and in the event any excise tax ("Excise Tax") that may be imposed by Section 4999 of the Code become payable by Executive because of any of the payments made to Executive under this Agreement or otherwise, Employer will pay to Executive an additional amount ("Gross-up Payment") at least 60 days prior to the due date for payment of the Excise Tax. The Gross-up Payment shall be in an amount such that, after payment by Executive of all taxes (including, without limitation, all income and employment tax and Excise Tax and treating as a tax the disallowance of any deduction of Executive by virtue of the inclusion of the Gross-up Payment in Executive's adjusted gross income) and interest and penalties with respect to such taxes imposed upon the Gross-up Payment, Executive retains an amount equal to the Excise Tax. Employer shall notify Executive of its determination of the amount of payments under this Agreement subject to the Excise Tax (which determination shall be made by an accounting firm selected by Employer) and shall provide Executive with a receipt for the Excise Tax paid. Executive shall report the amount indicated in Employer's notice as the amount subject to the Excise Tax on Executive's Federal income tax return. (b) If, for any reason, the Internal Revenue Service or any other taxing authority proposes an adjustment to the amount of Excise Tax due with respect to any payments or with respect to any additional amounts received by Executive pursuant to this Agreement, Executive will notify Employer 6 7 immediately of such proposed adjustment and shall give Employer the right to contest such proposed adjustment on Executive's behalf; provided, however, that Executive may pay such claim if Employer does not take any action prior to the time such payment is due. Employer shall bear and pay directly all costs related to or associated with any contest, regardless of outcome, and shall have complete control over such contest as it relates to the Excise Tax, including whether such contest shall be by way of non-payment of the Excise Tax, payment of the Excise Tax under protest, or payment of the Excise Tax accompanied by a claim for a refund. Employer shall pay to Executive (i) an amount equal to the Excise Tax required to be paid to the Internal Revenue Service by Executive as a result of the outcome of any contest, any penalties or interest thereon, and (ii) a Gross-up Payment computed in the same manner and subject to the same adjustments as other Gross-up Payments previously described. Payment by Employer of an amount equal to the Excise tax and Gross-up Payment shall be made to Executive in advance of the due date for payment of Excise Taxes. (c) In the event that the amount of any additional payments made pursuant to this Section 13 exceeds the amount determined to have been due, the excess additional amounts made shall constitute a loan by Employer to Executive payable within 30 days after receipt by Executive of the refund from the Internal Revenue Service together with any interest received. 14. No Duty to Mitigate. Executive is not required to mitigate the amount of salary or benefits payable pursuant to this Agreement upon termination of his employment by seeking other employment or otherwise, nor shall any amount provided to be paid by Employer pursuant to this Agreement upon termination of Executive's employment be reduced by any compensation earned by Employee as a result of employment by another employer that is not in violation of Executive's obligations under Section 12. 15. Severability. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 16. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. 17. Resolution of Disputes. Employer agrees to pay promptly as incurred, to the full extent permitted by law, all legal fees and expenses which Executive may reasonably incur as a result of any contest, regardless of outcome, by Employer, Executive 7 8 or others of the validity of enforceability of, or liability under, any provision of this Agreement or any guarantee of performance (including as a result of any contest by Executive concerning the amount of any payment pursuant to this Agreement). IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first written above. --------------------------------------- Wellington D. Jones, III lst SOURCE CORPORATION, an Indiana corporation By: ------------------------------------ Christopher J. Murphy, III Chairman of the Board, President and Chief Executive Officer 8 EX-10.A(3) 5 EMPLOYMENT AGREEMENT OF ALLEN R. QUALEY 1 EXHIBIT 10(a)(3) EMPLOYMENT AGREEMENT THIS AGREEMENT, dated as of April 16, 1998, by and between AL QUALEY, hereinafter referred to as "Executive", and lst SOURCE CORPORATION, an Indiana corporation, hereinafter referred to as "Employer," WITNESSETH; That WHEREAS, Executive is currently employed as the President of 1st Source Transportation and Equipment Finance division, a specialty finance group, of Employer and its subsidiary, lst Source Bank, hereinafter referred to as "Bank;" and WHEREAS, Employer desires to assure the continued service of Executive, and Executive is willing to provide such service on the terms and conditions specified herein. NOW THEREFORE, in consideration of the premises and the mutual covenants and agreements contained in this Agreement, Employer and Executive hereby agree as follows: 1. Employment Position. The parties agree that the employment of Executive by Employer shall continue for the term referred to in Section 2. Employer agrees to continue the employment of Executive in a senior officer position with the title of President of 1st Source Transportation and Equipment Finance or similar position for the specialty finance business of Employer. Executive shall devote his full time during business hours to the performance of his duties hereunder and shall at all times use his best effort to promote the best interests of Employer. Executive shall report to the Chief Executive Officer of the Corporation and/or Bank. 2. Term. The term of this Agreement shall be from the date hereof until December 31, 2003, unless terminated sooner in accordance with Section 5 or Section 6 hereof, provided, however, that the term shall be automatically extended for an additional year on January 1, 2004 and on January 1 of each year thereafter, unless either party hereto gives written notice of an intention not to extend this Agreement on or before September 30 of the preceding year, in which case no further automatic extension shall occur and the term of this Agreement shall end. 3. Compensation and Benefits. (a) Base Salary. Executive shall be paid a Base Salary of One Hundred Seventy-Five Thousand Dollars ($175,000) per annum, with such increases thereafter as may be determined by Employer. 2 (b) Incentive Compensation. In addition to amounts paid to Executive as salary and for other benefits, Executive will participate in Employer's Executive Incentive Plan at a "partnership" rate of 15% of base salary for purposes of determining awards under the Plan. All amounts awarded are subject to the terms and conditions of the Plan. (c) Benefit Plans. During the term of this agreement, Executive shall be entitled to participate, at a level commensurate with his position, in all benefit plans Employer presently has or hereafter adopts for its officers or employees, including (without limitation) pension, profit sharing, stock option or any group life or health insurance, hospitalization or other similar plans, any eligibility or waiting periods to be waived to the extent feasible. (d) Life Insurance. Employer will purchase term life insurance coverage equal to two (2) times the initial Base Salary provided in Section 3(b) for the benefit of Executive, his family or estate as he may direct and as provided under Employer's insurance benefit programs. (e) Club Membership. A club membership will be provided by Employer for Executive to at least one country club and to one club in downtown South Bend, Indiana, with the initiation fees, monthly fee and appropriate business related expenses paid by Employer. 4. Disability. In the event that this Agreement is terminated by reason of Executive's Disability, Executive will continue to receive his Base Salary for up to one year from the date of the termination and shall also participate in any other disability compensation programs, including any Salary Continuance Plan in effect at that time for officers or executives of Employer. For purposes of this Agreement, "Disability" means Executive's inability by reason of illness or other physical or mental impairment to perform the duties required by his employment for any consecutive one hundred eighty (180) day period, provided that written notice of any termination for Disability shall have been given by Employer to Executive prior to the full resumption by him of the performance of such duties. 5. Termination by Employer; Death or Disability. (a) With Cause. In the event the Board determines that Executive is guilty of gross dereliction of duty or of fraud or dishonesty in connection with the performance of his duties under this Agreement, the Board may terminate this Agreement such termination to be effective thirty (30) days after 2 3 the Board gives written notice to Executive setting forth with specificity the reason or cause for terminating the Agreement. In such event, the compensation and other benefits provided for in this Agreement shall terminate on the date specified by the Board in the written notice of termination delivered to Executive. (b) Without Cause. If Employer shall discharge Executive from his employment hereunder for any reason other than one set forth in Section 5(a), or if it shall be determined by a court of competent jurisdiction that the discharge under Section 5(a) was not justified, or if Employer violates the provisions of this Agreement in a material manner, Executive shall have the right to terminate his obligations and duties hereunder, but the rights of Executive to receive the compensation provided for in Section 3 shall continue nevertheless to be fully in effect for the remaining term of this Agreement in the same manner as would have been payable absent such termination. Notwithstanding the foregoing Employer shall have the right at any time after the termination contemplated by this Section 5(b) to pay Executive in a lump sum the then present value of the amount payable to Executive discounted at the then current savings rate for Bank under this Section (b). (c) Death or Disability. This Agreement shall terminate in the event of the death or Disability of Executive. 6. Termination By Executive. Executive may, at any time upon written notice to Employer, immediately terminate his employment for Good Reason. For purposes of this Agreement, "Good Reason" shall mean any adverse change in Executive's status or position as the President of 1st Source Transportation Finance including, without limitation, as a result of a material diminution of his duties or responsibilities or the assignment to him of duties or responsibilities which, in his reasonable judgment, are inconsistent with such status or positions, or any removal of Executive from, or any failure to reappoint or reelect him to, any such position (except in connection with the termination of his employment pursuant to Section 5(a) or 5(c) or by him for other than Good Reason). (a) If such termination does not follow a Change of Control of Employer or Bank, Executive shall continue to receive his Base Salary as then in effect for a period of twelve (12) months after the effective date of such termination, in the same manner as such Base Salary would have become payable pursuant to this Agreement absent such termination. (b) If such termination occurs within one (1) year after a Change of Control of Employer or Bank, as severance pay and in lieu of any further 3 4 compensation for periods subsequent to the effective date of such termination, Executive shall receive an amount in cash equal to 2.99 times his "annualized includable compensation for the base period" (as defined in Section 280G(d)(1) of the Internal Revenue Code of 1986, as amended (the "Code")). (c) Each of the events specified in the following clauses (i) through (iii) of this Section 6(c) shall be deemed a "Change in Control": (i) any third person, including a "group" within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, shall become the beneficial owner of 50% or more of the then outstanding shares of common stock of Employer or the combined voting power of the then outstanding voting securities of Employer entitled to vote for the election of the Board of Directors of Employer (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, or combination of the foregoing, the persons who were directors of Employer shall cease to constitute a majority of such Board of Directors or (iii) the shareholders of Employer shall approve an agreement providing a sale or other disposition of all or substantially all the assets of Employer. 7. Assignment. This Agreement is a personal contract, and the rights and interest of Executive hereunder may not be sold, transferred, assigned, pledged or hypothecated. Except as otherwise may be herein expressly provided, this Agreement shall inure to the benefit of and be binding upon Employer and its successors and assigns. 8. Amendment. This Agreement may be amended only by a written instrument signed by the parties hereto after approval by either the Board or Executive Committee of Employer. 9. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Indiana. 10. Fees and Expenses. If a dispute arises regarding the interpretation or enforcement of this Agreement and Executive obtains a final judgment in his favor in a court of competent jurisdiction or his claim is settled by Employer prior to the rendering of a judgment by such a court, all reasonable legal fees and expenses incurred by Executive in seeking to obtain or enforce any right or benefit provided for in this Agreement or otherwise pursuing his claim shall be paid by Employer, to the fullest extent permitted by law. 4 5 11. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in a writing signed by the parties hereto. No waiver by any party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. 12. Restrictive Covenants. In order to induce Employer to enter into this Agreement, Executive hereby agrees as follows: (a) While Executive is employed by Employer and for a period of twenty-four (24) months after the effective date of termination of such employment for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not divulge or furnish any trade secrets (as defined in IND. CODE ' 24-2-3-2) of Employer or any confidential information acquired by him while employed by Employer concerning the policies, plans, procedures or customers of Employer to any person, firm or corporation, other than Employer or with its prior written consent, or use any such trade secret or confidential information directly or indirectly for Executive's own benefit or for the benefit of any person, firm or corporation other than Employer, as such trade secrets and confidential information are confidential and shall at all times remain the property of Employer. (b) For a period of twenty-four (24) months after the effective date of termination of Executive's employment hereunder for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not, directly or indirectly, provide banking or bank-related services to, or solicit the banking or bank-related business of, any customer of Employer at the time of such provision of services or solicitation which Employee served either alone or with others while employed by Employer within St. Joseph, Elkhart, Marshall or LaPorte Counties in the State of Indiana, or assist any actual or potential competitor of Employer to provide banking or bank-related services to, or solicit the banking or bank-related business of, any such customer in any such area, and Executive shall not, directly or indirectly, as principal, agent, or trustee, or through the agency of any corporation, partnership, trade association, agent or agency, engage in any banking or bank-related business or venture which competes with the business of Employer as conducted during Executive's employment by Employer within such area; provided, however, that Executive may own not more than five percent of the voting securities of any entity providing banking or bank-related services within such area if the 5 6 voting securities of such entity are traded on a national securities exchange or quoted on a national interdealer quotation system. (c) Executive acknowledges that any violation of this Section 12 would cause irreparable harm to Employer, that damages for such harm would be incapable of precise measurement and that, accordingly, Employer would not have an adequate remedy at law to redress the harm caused by such violation. Therefore, Executive agrees that, in addition to any other remedy, Employer shall be entitled to immediate (i.e., without prior notice) preliminary and final injunctive relief to enjoin and restrain any violation of this Section 12. If Executive's employment is terminated during the Term of this Agreement for reasons set forth in Section 5(b) of this Agreement, Executive shall have no obligations to Employer with respect to trade secrets, confidential information or noncompetition under this Section 12. 13. Certain Additional Payments by Employer. (a) In the event that Section 280G of the Code is determined to apply to the payments to be made by Employer to Executive under this Agreement or other compensation or benefit programs, and in the event any excise tax ("Excise Tax") that may be imposed by Section 4999 of the Code become payable by Executive because of any of the payments made to Executive under this Agreement or otherwise, Employer will pay to Executive an additional amount ("Gross-up Payment") at least 60 days prior to the due date for payment of the Excise Tax. The Gross-up Payment shall be in an amount such that, after payment by Executive of all taxes (including, without limitation, all income and employment tax and Excise Tax and treating as a tax the disallowance of any deduction of Executive by virtue of the inclusion of the Gross-up Payment in Executive's adjusted gross income) and interest and penalties with respect to such taxes imposed upon the Gross-up Payment, Executive retains an amount equal to the Excise Tax. Employer shall notify Executive of its determination of the amount of payments under this Agreement subject to the Excise Tax (which determination shall be made by an accounting firm selected by Employer) and shall provide Executive with a receipt for the Excise Tax paid. Executive shall report the amount indicated in Employer's notice as the amount subject to the Excise Tax on Executive's Federal income tax return. 6 7 (b) If, for any reason, the Internal Revenue Service or any other taxing authority proposes an adjustment to the amount of Excise Tax due with respect to any payments or with respect to any additional amounts received by Executive pursuant to this Agreement, Executive will notify Employer immediately of such proposed adjustment and shall give Employer the right to contest such proposed adjustment on Executive's behalf; provided, however, that Executive may pay such claim if Employer does not take any action prior to the time such payment is due. Employer shall bear and pay directly all costs related to or associated with any contest, regardless of outcome, and shall have complete control over such contest as it relates to the Excise Tax, including whether such contest shall be by way of non-payment of the Excise Tax, payment of the Excise Tax under protest, or payment of the Excise Tax accompanied by a claim for a refund. Employer shall pay to Executive (i) an amount equal to the Excise Tax required to be paid to the Internal Revenue Service by Executive as a result of the outcome of any contest, any penalties or interest thereon, and (ii) a Gross-up Payment computed in the same manner and subject to the same adjustments as other Gross-up Payments previously described. Payment by Employer of an amount equal to the Excise tax and Gross-up Payment shall be made to Executive in advance of the due date for payment of Excise Taxes. (c) In the event that the amount of any additional payments made pursuant to this Section 13 exceeds the amount determined to have been due, the excess additional amounts made shall constitute a loan by Employer to Executive payable within 30 days after receipt by Executive of the refund from the Internal Revenue Service together with any interest received. 14. No Duty to Mitigate. Executive is not required to mitigate the amount of salary or benefits payable pursuant to this Agreement upon termination of his employment by seeking other employment or otherwise, nor shall any amount provided to be paid by Employer pursuant to this Agreement upon termination of Executive's employment be reduced by any compensation earned by Employee as a result of employment by another employer that is not in violation of Executive's obligations under Section 12. 15. Severability. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 16. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. 7 8 17. Resolution of Disputes. Employer agrees to pay promptly as incurred, to the full extent permitted by law, all legal fees and expenses which Executive may reasonably incur as a result of any contest, regardless of outcome, by Employer, Executive or others of the validity of enforceability of, or liability under, any provision of this Agreement or any guarantee of performance (including as a result of any contest by Executive concerning the amount of any payment pursuant to this Agreement). IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first written above. ---------------------------------------- Allen R. Qualey lst SOURCE CORPORATION, an Indiana corporation By: ------------------------------------ Christopher J. Murphy, III Chairman of the Board, President and Chief Executive Officer 8 EX-10.A(4) 6 EMPLOYMENT AGREEMENT OF LARRY E. LENTYCH 1 EXHIBIT 10(a)(4) EMPLOYMENT AGREEMENT THIS AGREEMENT, dated as of April 16, 1998, by and between LARRY E. LENTYCH, hereinafter referred to as "Executive", and lst SOURCE CORPORATION, an Indiana corporation, hereinafter referred to as "Employer," WITNESSETH; That WHEREAS, Executive is currently employed as an executive officer of Employer and Employer's subsidiary, lst Source Bank, hereinafter referred to as "Bank;" and WHEREAS, Employer desires to assure the continued service of Executive, and Executive is willing to provide such service on the terms and conditions specified herein. NOW THEREFORE, in consideration of the premises and the mutual covenants and agreements contained in this Agreement, Employer and Executive hereby agree as follows: 1. Employment Position. The parties agree that the employment of Executive by Employer shall continue for the term referred to in Section 2. Employer agrees to continue the employment of Executive in a senior officer position with the title of Chief Financial Officer of Employer and Bank. Executive shall devote his full time during business hours to the performance of his duties hereunder and shall at all times use his best effort to promote the best interests of Employer. Executive shall report to the Chief Executive Officer of Employer, and/or the Chief Executive Officer of Bank. 2. Term. The term of this Agreement shall be from the date hereof until December 31, 2001, unless terminated sooner in accordance with Section 5 or Section 6 hereof, provided, however, that the term shall be automatically extended for an additional year on January 1, 2002 and on January 1 of each year thereafter, unless either party hereto gives written notice of an intention not to extend this Agreement on or before September 30 of the preceding year, in which case no further automatic extension shall occur and the term of this Agreement shall end. 3. Compensation and Benefits. (a) Base Salary. Executive shall be paid a Base Salary of One Hundred Thirty-Five Thousand Dollars ($135,000) per annum, with such increases thereafter as may be determined by Employer. 2 (b) Incentive Compensation. In addition to amounts paid to Executive as salary and for other benefits, Executive will participate in Employer's Executive Incentive Plan at a "partnership" rate of 15% of base salary for purposes of determining awards under the Plan. All amounts awarded are subject to the terms and conditions of the Plan. (c) Benefit Plans. During the term of this agreement, Executive shall be entitled to participate, at a level commensurate with his position, in all benefit plans Employer presently has or hereafter adopts for its officers or employees, including (without limitation) pension, profit sharing, stock option or any group life or health insurance, hospitalization or other similar plans, any eligibility or waiting periods to be waived to the extent feasible. (d) Life Insurance. Employer will purchase term life insurance coverage equal to two (2) times the initial Base Salary provided in Section 3(b) for the benefit of Executive, his family or estate as he may direct and as provided under Employer's insurance benefit programs. (e) Club Membership. A club membership will be provided by Employer for Executive to at least one country club and to one club in downtown South Bend, Indiana, with the initiation fees, monthly fee and appropriate business related expenses paid by Employer. 4. Disability. In the event that this Agreement is terminated by reason of Executive's Disability, Executive will continue to receive his Base Salary for up to one year from the date of the termination and shall also participate in any other disability compensation programs, including any Salary Continuance Plan in effect at that time for officers or executives of Employer. For purposes of this Agreement, "Disability" means Executive's inability by reason of illness or other physical or mental impairment to perform the duties required by his employment for any consecutive one hundred eighty (180) day period, provided that written notice of any termination for Disability shall have been given by Employer to Executive prior to the full resumption by him of the performance of such duties. 5. Termination by Employer; Death or Disability. (a) With Cause. In the event the Board determines that Executive is guilty of gross dereliction of duty or of fraud or dishonesty in connection with the performance of his duties under this Agreement, the Board may terminate this Agreement such termination to be effective thirty (30) days after the Board gives written notice to Executive setting forth with specificity the 2 3 reason or cause for terminating the Agreement. In such event, the compensation and other benefits provided for in this Agreement shall terminate on the date specified by the Board in the written notice of termination delivered to Executive. (b) Without Cause. If Employer shall discharge Executive from his employment hereunder for any reason other than one set forth in Section 5(a), or if it shall be determined by a court of competent jurisdiction that the discharge under Section 5(a) was not justified, or if Employer violates the provisions of this Agreement in a material manner, Executive shall have the right to terminate his obligations and duties hereunder, but the rights of Executive to receive the compensation provided for in Section 3 shall continue nevertheless to be fully in effect for the remaining term of this Agreement in the same manner as would have been payable absent such termination. Notwithstanding the foregoing Employer shall have the right at any time after the termination contemplated by this Section 5(b) to pay Executive in a lump sum the then present value of the amount payable to Executive discounted at the then current savings rate for Bank under this Section (b). (c) Death or Disability. This Agreement shall terminate in the event of the death or Disability of Executive. 6. Termination By Executive. Executive may, at any time upon written notice to Employer, immediately terminate his employment for Good Reason. For purposes of this Agreement, "Good Reason" shall mean any adverse change in Executive's status or position as Chief Financial Officer including, without limitation, as a result of a material diminution of his duties or responsibilities or the assignment to him of duties or responsibilities which, in his reasonable judgment, are inconsistent with such status or positions, or any removal of Executive from, or any failure to reappoint or reelect him to, any such position (except in connection with the termination of his employment pursuant to Section 5(a) or 5(c) or by him for other than Good Reason). (a) If such termination does not follow a Change of Control of Employer or Bank, Executive shall continue to receive his Base Salary as then in effect for a period of twelve (12) months after the effective date of such termination, in the same manner as such Base Salary would have become payable pursuant to this Agreement absent such termination. (b) If such termination occurs within one (1) year after a Change of Control of Employer or Bank, as severance pay and in lieu of any further compensation for periods subsequent to the effective date of such termination, 3 4 Executive shall receive an amount in cash equal to 2.99 times his "annualized includable compensation for the base period" (as defined in Section 280G(d)(1) of the Internal Revenue Code of 1986, as amended (the "Code")). (c) Each of the events specified in the following clauses (i) through (iii) of this Section 6(c) shall be deemed a "Change in Control": (i) any third person, including a "group" within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, shall become the beneficial owner of 50% or more of the then outstanding shares of common stock of Employer or the combined voting power of the then outstanding voting securities of Employer entitled to vote for the election of the Board of Directors of Employer (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, or combination of the foregoing, the persons who were directors of Employer shall cease to constitute a majority of such Board of Directors or (iii) the shareholders of Employer shall approve an agreement providing a sale or other disposition of all or substantially all the assets of Employer. 7. Assignment. This Agreement is a personal contract, and the rights and interest of Executive hereunder may not be sold, transferred, assigned, pledged or hypothecated. Except as otherwise may be herein expressly provided, this Agreement shall inure to the benefit of and be binding upon Employer and its successors and assigns. 8. Amendment. This Agreement may be amended only by a written instrument signed by the parties hereto after approval by either the Board or Executive Committee of Employer. 9. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Indiana. 10. Fees and Expenses. If a dispute arises regarding the interpretation or enforcement of this Agreement and Executive obtains a final judgment in his favor in a court of competent jurisdiction or his claim is settled by Employer prior to the rendering of a judgment by such a court, all reasonable legal fees and expenses incurred by Executive in seeking to obtain or enforce any right or benefit provided for in this Agreement or otherwise pursuing his claim shall be paid by Employer, to the fullest extent permitted by law. 11. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in a writing 4 5 signed by the parties hereto. No waiver by any party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. 12. Restrictive Covenants. In order to induce Employer to enter into this Agreement, Executive hereby agrees as follows: (a) While Executive is employed by Employer and for a period of twenty-four (24) months after the effective date of termination of such employment for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not divulge or furnish any trade secrets (as defined in IND. CODE Section 24-2-3-2) of Employer or any confidential information acquired by him while employed by Employer concerning the policies, plans, procedures or customers of Employer to any person, firm or corporation, other than Employer or with its prior written consent, or use any such trade secret or confidential information directly or indirectly for Executive's own benefit or for the benefit of any person, firm or corporation other than Employer, as such trade secrets and confidential information are confidential and shall at all times remain the property of Employer. (b) For a period of twenty-four (24) months after the effective date of termination of Executive's employment hereunder for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not, directly or indirectly, provide banking or bank-related services to, or solicit the banking or bank-related business of, any customer of Employer at the time of such provision of services or solicitation which Employee served either alone or with others while employed by Employer within St. Joseph, Elkhart, Marshall or LaPorte Counties in the State of Indiana, or assist any actual or potential competitor of Employer to provide banking or bank-related services to, or solicit the banking or bank-related business of, any such customer in any such area, and Executive shall not, directly or indirectly, as principal, agent, or trustee, or through the agency of any corporation, partnership, trade association, agent or agency, engage in any banking or bank-related business or venture which competes with the business of Employer as conducted during Executive's employment by Employer within such area; provided, however, that Executive may own not more than five percent of the voting securities of any entity providing banking or bank-related services within such area if the voting securities of such entity are traded on a national securities exchange or quoted on a national interdealer quotation system. 5 6 (c) Executive acknowledges that any violation of this Section 12 would cause irreparable harm to Employer, that damages for such harm would be incapable of precise measurement and that, accordingly, Employer would not have an adequate remedy at law to redress the harm caused by such violation. Therefore, Executive agrees that, in addition to any other remedy, Employer shall be entitled to immediate (i.e., without prior notice) preliminary and final injunctive relief to enjoin and restrain any violation of this Section 12. If Executive's employment is terminated during the Term of this Agreement for reasons set forth in Section 5(b) of this Agreement, Executive shall have no obligations to Employer with respect to trade secrets, confidential information or noncompetition under this Section 12. 13. Certain Additional Payments by Employer. (a) In the event that Section 280G of the Code is determined to apply to the payments to be made by Employer to Executive under this Agreement or other compensation or benefit programs, and in the event any excise tax ("Excise Tax") that may be imposed by Section 4999 of the Code become payable by Executive because of any of the payments made to Executive under this Agreement or otherwise, Employer will pay to Executive an additional amount ("Gross-up Payment") at least 60 days prior to the due date for payment of the Excise Tax. The Gross-up Payment shall be in an amount such that, after payment by Executive of all taxes (including, without limitation, all income and employment tax and Excise Tax and treating as a tax the disallowance of any deduction of Executive by virtue of the inclusion of the Gross-up Payment in Executive's adjusted gross income) and interest and penalties with respect to such taxes imposed upon the Gross-up Payment, Executive retains an amount equal to the Excise Tax. Employer shall notify Executive of its determination of the amount of payments under this Agreement subject to the Excise Tax (which determination shall be made by an accounting firm selected by Employer) and shall provide Executive with a receipt for the Excise Tax paid. Executive shall report the amount indicated in Employer's notice as the amount subject to the Excise Tax on Executive's Federal income tax return. (b) If, for any reason, the Internal Revenue Service or any other taxing authority proposes an adjustment to the amount of Excise Tax due with respect to any payments or with respect to any additional amounts received by Executive pursuant to this Agreement, Executive will notify Employer 6 7 immediately of such proposed adjustment and shall give Employer the right to contest such proposed adjustment on Executive's behalf; provided, however, that Executive may pay such claim if Employer does not take any action prior to the time such payment is due. Employer shall bear and pay directly all costs related to or associated with any contest, regardless of outcome, and shall have complete control over such contest as it relates to the Excise Tax, including whether such contest shall be by way of non-payment of the Excise Tax, payment of the Excise Tax under protest, or payment of the Excise Tax accompanied by a claim for a refund. Employer shall pay to Executive (i) an amount equal to the Excise Tax required to be paid to the Internal Revenue Service by Executive as a result of the outcome of any contest, any penalties or interest thereon, and (ii) a Gross-up Payment computed in the same manner and subject to the same adjustments as other Gross-up Payments previously described. Payment by Employer of an amount equal to the Excise tax and Gross-up Payment shall be made to Executive in advance of the due date for payment of Excise Taxes. (c) In the event that the amount of any additional payments made pursuant to this Section 13 exceeds the amount determined to have been due, the excess additional amounts made shall constitute a loan by Employer to Executive payable within 30 days after receipt by Executive of the refund from the Internal Revenue Service together with any interest received. 14. No Duty to Mitigate. Executive is not required to mitigate the amount of salary or benefits payable pursuant to this Agreement upon termination of his employment by seeking other employment or otherwise, nor shall any amount provided to be paid by Employer pursuant to this Agreement upon termination of Executive's employment be reduced by any compensation earned by Employee as a result of employment by another employer that is not in violation of Executive's obligations under Section 12. 15. Severability. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 16. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. 17. Resolution of Disputes. Employer agrees to pay promptly as incurred, to the full extent permitted by law, all legal fees and expenses which Executive may reasonably incur as a result of any contest, regardless of outcome, by Employer, Executive 7 8 or others of the validity of enforceability of, or liability under, any provision of this Agreement or any guarantee of performance (including as a result of any contest by Executive concerning the amount of any payment pursuant to this Agreement). IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first written above. ------------------------------------------ Larry E. Lentych lst SOURCE CORPORATION, an Indiana corporation By: -------------------------------------- Christopher J. Murphy, III Chairman of the Board, President and Chief Executive Officer 8 EX-10.A(5) 7 EMPLOYMENT AGREEMENT OF RICHARD Q. STIFEL 1 EXHIBIT 10(a)(5) EMPLOYMENT AGREEMENT THIS AGREEMENT, dated as of April 16, 1998, by and between RICHARD STIFEL, hereinafter referred to as "Executive", and lst SOURCE CORPORATION, an Indiana corporation, hereinafter referred to as "Employer," WITNESSETH; That WHEREAS, Executive is currently employed as an executive officer (currently Executive Vice President) of Employer's subsidiary, lst Source Bank, hereinafter referred to as "Bank;" and WHEREAS, Employer desires to assure the continued service of Executive, and Executive is willing to provide such service on the terms and conditions specified herein. NOW THEREFORE, in consideration of the premises and the mutual covenants and agreements contained in this Agreement, Employer and Executive hereby agree as follows: 1. Employment Position. The parties agree that the employment of Executive by Employer shall continue for the term referred to in Section 2. Employer agrees to continue the employment of Executive in a senior officer position with the title of Executive Vice President of Bank. Executive shall devote his full time during business hours to the performance of his duties hereunder and shall at all times use his best effort to promote the best interests of Employer. Executive shall report to the President of Bank, or such other senior executive officer of Employer or its subsidiary, 1st Source Bank, as the Chief Executive Officer of Employer or the Board of Directors shall direct. 2. Term. The term of this Agreement shall be from the date hereof until December 31, 2001, unless terminated sooner in accordance with Section 5 or Section 6 hereof, provided, however, that the term shall be automatically extended for an additional year on January 1, 2002 and on January 1 of each year thereafter, unless either party hereto gives written notice of an intention not to extend this Agreement on or before September 30 of the preceding year, in which case no further automatic extension shall occur and the term of this Agreement shall end. 3. Compensation and Benefits. (a) Base Salary. Executive shall be paid a Base Salary of One Hundred Sixty-Five Thousand Dollars ($165,000) per annum, with such increases thereafter as may be determined by Employer. 2 (b) Incentive Compensation. In addition to amounts paid to Executive as salary and for other benefits, Executive will participate in Employer's Executive Incentive Plan at a "partnership" rate of 15% of base salary for purposes of determining awards under the Plan. All amounts awarded are subject to the terms and conditions of the Plan. (c) Benefit Plans. During the term of this agreement, Executive shall be entitled to participate, at a level commensurate with his position, in all benefit plans Employer presently has or hereafter adopts for its officers or employees, including (without limitation) pension, profit sharing, stock option or any group life or health insurance, hospitalization or other similar plans, any eligibility or waiting periods to be waived to the extent feasible. (d) Life Insurance. Employer will purchase term life insurance coverage equal to two (2) times the initial Base Salary provided in Section 3(b) for the benefit of Executive, his family or estate as he may direct and as provided under Employer's insurance benefit programs. (e) Club Membership. A club membership will be provided by Employer for Executive to at least one country club and to one club in downtown South Bend, Indiana, with the initiation fees, monthly fee and appropriate business related expenses paid by Employer. 4. Disability. In the event that this Agreement is terminated by reason of Executive's Disability, Executive will continue to receive his Base Salary for up to one year from the date of the termination and shall also participate in any other disability compensation programs, including any Salary Continuance Plan in effect at that time for officers or executives of Employer. For purposes of this Agreement, "Disability" means Executive's inability by reason of illness or other physical or mental impairment to perform the duties required by his employment for any consecutive one hundred eighty (180) day period, provided that written notice of any termination for Disability shall have been given by Employer to Executive prior to the full resumption by him of the performance of such duties. 5. Termination by Employer; Death or Disability. (a) With Cause. In the event the Board determines that Executive is guilty of gross dereliction of duty or of fraud or dishonesty in connection with the performance of his duties under this Agreement, the Board may terminate this Agreement such termination to be effective thirty (30) days after the Board gives written notice to Executive setting forth with specificity the 2 3 reason or cause for terminating the Agreement. In such event, the compensation and other benefits provided for in this Agreement shall terminate on the date specified by the Board in the written notice of termination delivered to Executive. (b) Without Cause. If Employer shall discharge Executive from his employment hereunder for any reason other than one set forth in Section 5(a), or if it shall be determined by a court of competent jurisdiction that the discharge under Section 5(a) was not justified, or if Employer violates the provisions of this Agreement in a material manner, Executive shall have the right to terminate his obligations and duties hereunder, but the rights of Executive to receive the compensation provided for in Section 3 shall continue nevertheless to be fully in effect for the remaining term of this Agreement in the same manner as would have been payable absent such termination. Notwithstanding the foregoing Employer shall have the right at any time after the termination contemplated by this Section 5(b) to pay Executive in a lump sum the then present value of the amount payable to Executive discounted at the then current savings rate for Bank under this Section (b). (c) Death or Disability. This Agreement shall terminate in the event of the death or Disability of Executive. 6. Termination By Executive. Executive may, at any time upon written notice to Employer, immediately terminate his employment for Good Reason. For purposes of this Agreement, "Good Reason" shall mean any adverse change in Executive's status or position as the Executive Vice President of Bank including, without limitation, as a result of a material diminution of his duties or responsibilities or the assignment to him of duties or responsibilities which, in his reasonable judgment, are inconsistent with such status or positions, or any removal of Executive from, or any failure to reappoint or reelect him to, any such position (except in connection with the termination of his employment pursuant to Section 5(a) or 5(c) or by him for other than Good Reason). (a) If such termination does not follow a Change of Control of Employer or Bank, Executive shall continue to receive his Base Salary as then in effect for a period of twelve (12) months after the effective date of such termination, in the same manner as such Base Salary would have become payable pursuant to this Agreement absent such termination. (b) If such termination occurs within one (1) year after a Change of Control of Employer or Bank, as severance pay and in lieu of any further compensation for periods subsequent to the effective date of such termination, 3 4 Executive shall receive an amount in cash equal to 2.99 times his "annualized includable compensation for the base period" (as defined in Section 280G(d)(1) of the Internal Revenue Code of 1986, as amended (the "Code")). (c) Each of the events specified in the following clauses (i) through (iii) of this Section 6(c) shall be deemed a "Change in Control": (i) any third person, including a "group" within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, shall become the beneficial owner of 50% or more of the then outstanding shares of common stock of Employer or the combined voting power of the then outstanding voting securities of Employer entitled to vote for the election of the Board of Directors of Employer (ii) as a result of, or in connection with, any cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, or combination of the foregoing, the persons who were directors of Employer shall cease to constitute a majority of such Board of Directors or (iii) the shareholders of Employer shall approve an agreement providing a sale or other disposition of all or substantially all the assets of Employer. 7. Assignment. This Agreement is a personal contract, and the rights and interest of Executive hereunder may not be sold, transferred, assigned, pledged or hypothecated. Except as otherwise may be herein expressly provided, this Agreement shall inure to the benefit of and be binding upon Employer and its successors and assigns. 8. Amendment. This Agreement may be amended only by a written instrument signed by the parties hereto after approval by either the Board or Executive Committee of Employer. 9. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Indiana. 10. Fees and Expenses. If a dispute arises regarding the interpretation or enforcement of this Agreement and Executive obtains a final judgment in his favor in a court of competent jurisdiction or his claim is settled by Employer prior to the rendering of a judgment by such a court, all reasonable legal fees and expenses incurred by Executive in seeking to obtain or enforce any right or benefit provided for in this Agreement or otherwise pursuing his claim shall be paid by Employer, to the fullest extent permitted by law. 11. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in a writing 4 5 signed by the parties hereto. No waiver by any party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. 12. Restrictive Covenants. In order to induce Employer to enter into this Agreement, Executive hereby agrees as follows: (a) While Executive is employed by Employer and for a period of twenty-four (24) months after the effective date of termination of such employment for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not divulge or furnish any trade secrets (as defined in IND. CODE Section 24-2-3-2) of Employer or any confidential information acquired by him while employed by Employer concerning the policies, plans, procedures or customers of Employer to any person, firm or corporation, other than Employer or with its prior written consent, or use any such trade secret or confidential information directly or indirectly for Executive's own benefit or for the benefit of any person, firm or corporation other than Employer, as such trade secrets and confidential information are confidential and shall at all times remain the property of Employer. (b) For a period of twenty-four (24) months after the effective date of termination of Executive's employment hereunder for reasons other than those set forth in Section 5(b) of this Agreement, Executive shall not, directly or indirectly, provide banking or bank-related services to, or solicit the banking or bank-related business of, any customer of Employer at the time of such provision of services or solicitation which Employee served either alone or with others while employed by Employer within St. Joseph, Elkhart, Marshall or LaPorte Counties in the State of Indiana, or assist any actual or potential competitor of Employer to provide banking or bank-related services to, or solicit the banking or bank-related business of, any such customer in any such area, and Executive shall not, directly or indirectly, as principal, agent, or trustee, or through the agency of any corporation, partnership, trade association, agent or agency, engage in any banking or bank-related business or venture which competes with the business of Employer as conducted during Executive's employment by Employer within such area; provided, however, that Executive may own not more than five percent of the voting securities of any entity providing banking or bank-related services within such area if the voting securities of such entity are traded on a national securities exchange or quoted on a national interdealer quotation system. 5 6 (c) Executive acknowledges that any violation of this Section 12 would cause irreparable harm to Employer, that damages for such harm would be incapable of precise measurement and that, accordingly, Employer would not have an adequate remedy at law to redress the harm caused by such violation. Therefore, Executive agrees that, in addition to any other remedy, Employer shall be entitled to immediate (i.e., without prior notice) preliminary and final injunctive relief to enjoin and restrain any violation of this Section 12. If Executive's employment is terminated during the Term of this Agreement for reasons set forth in Section 5(b) of this Agreement, Executive shall have no obligations to Employer with respect to trade secrets, confidential information or noncompetition under this Section 12. 13. Certain Additional Payments by Employer. (a) In the event that Section 280G of the Code is determined to apply to the payments to be made by Employer to Executive under this Agreement or other compensation or benefit programs, and in the event any excise tax ("Excise Tax") that may be imposed by Section 4999 of the Code become payable by Executive because of any of the payments made to Executive under this Agreement or otherwise, Employer will pay to Executive an additional amount ("Gross-up Payment") at least 60 days prior to the due date for payment of the Excise Tax. The Gross-up Payment shall be in an amount such that, after payment by Executive of all taxes (including, without limitation, all income and employment tax and Excise Tax and treating as a tax the disallowance of any deduction of Executive by virtue of the inclusion of the Gross-up Payment in Executive's adjusted gross income) and interest and penalties with respect to such taxes imposed upon the Gross-up Payment, Executive retains an amount equal to the Excise Tax. Employer shall notify Executive of its determination of the amount of payments under this Agreement subject to the Excise Tax (which determination shall be made by an accounting firm selected by Employer) and shall provide Executive with a receipt for the Excise Tax paid. Executive shall report the amount indicated in Employer's notice as the amount subject to the Excise Tax on Executive's Federal income tax return. (b) If, for any reason, the Internal Revenue Service or any other taxing authority proposes an adjustment to the amount of Excise Tax due with respect to any payments or with respect to any additional amounts received by Executive pursuant to this Agreement, Executive will notify Employer 6 7 immediately of such proposed adjustment and shall give Employer the right to contest such proposed adjustment on Executive's behalf; provided, however, that Executive may pay such claim if Employer does not take any action prior to the time such payment is due. Employer shall bear and pay directly all costs related to or associated with any contest, regardless of outcome, and shall have complete control over such contest as it relates to the Excise Tax, including whether such contest shall be by way of non-payment of the Excise Tax, payment of the Excise Tax under protest, or payment of the Excise Tax accompanied by a claim for a refund. Employer shall pay to Executive (i) an amount equal to the Excise Tax required to be paid to the Internal Revenue Service by Executive as a result of the outcome of any contest, any penalties or interest thereon, and (ii) a Gross-up Payment computed in the same manner and subject to the same adjustments as other Gross-up Payments previously described. Payment by Employer of an amount equal to the Excise tax and Gross-up Payment shall be made to Executive in advance of the due date for payment of Excise Taxes. (c) In the event that the amount of any additional payments made pursuant to this Section 13 exceeds the amount determined to have been due, the excess additional amounts made shall constitute a loan by Employer to Executive payable within 30 days after receipt by Executive of the refund from the Internal Revenue Service together with any interest received. 14. No Duty to Mitigate. Executive is not required to mitigate the amount of salary or benefits payable pursuant to this Agreement upon termination of his employment by seeking other employment or otherwise, nor shall any amount provided to be paid by Employer pursuant to this Agreement upon termination of Executive's employment be reduced by any compensation earned by Employee as a result of employment by another employer that is not in violation of Executive's obligations under Section 12. 15. Severability. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 16. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. 17. Resolution of Disputes. Employer agrees to pay promptly as incurred, to the full extent permitted by law, all legal fees and expenses which Executive may reasonably incur as a result of any contest, regardless of outcome, by Employer, Executive 7 8 or others of the validity of enforceability of, or liability under, any provision of this Agreement or any guarantee of performance (including as a result of any contest by Executive concerning the amount of any payment pursuant to this Agreement). IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first written above. ---------------------------------------- Richard Q. Stifel lst SOURCE CORPORATION, an Indiana corporation By: ------------------------------------ Christopher J. Murphy, III Chairman of the Board, President and Chief Executive Officer 8 EX-10.J 8 1ST SOURCE CORP 1998 PERFORMANCE COMPENSATION PLAN 1 EXHIBIT 10(j) 1ST SOURCE CORPORATION 1998 PERFORMANCE COMPENSATION PLAN SECTION 1 PURPOSE The purpose of the 1st Source Corporation ("Company") 1998 Performance Compensation Plan ("Plan") is to promote the interests of the Company and its shareholders through the (i) attraction and retention of executive officers and other key employees ("Employees") essential to the success of the Company and its subsidiaries; (ii) motivation of Employees using performance-related incentives linked to longer range performance goals and the interests of Company shareholders; and (iii) enabling of the Employees to share in the long term growth and success of the Company. SECTION 2 ADMINISTRATION The Plan will be administered by the Executive Compensation Committee ("Committee") of the Board of Directors of the Company, which will consist of two or more members. The Committee will have the sole, final and conclusive authority to administer, construe and interpret the Plan. All members of the Committee must be non-employee, outside directors as defined in applicable IRS Regulations. SECTION 3 ELIGIBILITY The Committee in its sole and complete discretion will select full-time Employees of the Company and its subsidiaries, who in its opinion, can contribute significantly to the growth and profitability of, or perform services of major importance to, the Company and its subsidiaries. No non-employee director of the Company will be eligible to participate under the Plan. No member of the Committee will be eligible to participate under the Plan. SECTION 4 GRANTS AND AWARDS Any awards made to Employees under the Plan will be performance-based compensation ("Awards") subject to the attainment of pre-established objective performance goals, including one or more of the following criteria: (i) net income; (ii) pre-tax income; (iii) earnings per share; (iv) return on 2 equity; (v) return on assets; (vi) Economic Value Added and/or increase in Economic Value Added; (vii) increase in the market price of the Company's common stock; (viii) total shareholder return (stock price appreciation plus dividends); and (ix) the performance of the Company in any of the items mentioned in clauses (i) through (viii) in comparison to the average performance of companies combined into a Company-constructed peer group. All performance measures, formulas and determination of eligibility for a performance period will be established by the Committee in writing no later than ninety (90) days after the beginning of the performance period or by such other date as may be permitted under Section 162(m) of the Internal Revenue Code of 1986 and the regulations. Performance measures may be based on one or more of the business criteria listed herein. No Award to any single Employee will exceed $5 million in one calendar year. No performance measures will allow for any discretion by the Committee to increase any Award, but discretion to lower Awards is permissible. The payment of any Award under the Plan to an Employee with respect to a relevant performance period will be contingent upon certification by the Committee prior to any such payment that the applicable performance measure(s) relating to the Award have been satisfied. Payment of the award will not be conditioned upon it being deductible by the Company. Notwithstanding any other provision of the Plan, the Committee may impose such conditions on any Award, and the Board may amend the plan in any such respects, as may be required to satisfy the requirements of Section 162(m) of the Internal Revenue Code (or any successor or similar rule relating thereto). If an Employee's employment with the Company is terminated by reason of death or total and permanent disability that occurs before the end of a Performance Period, the Employee will be entitled to a pro rata award based upon the number of days elapsed at the time of termination. The amount of any Award due a deceased Employee will be paid to the beneficiary designated by the Employee in writing to the Company, or if none, the Employee's Estate. SECTION 5 NO EMPLOYMENT CONTRACT The Plan is not and is not intended to be an employment contract with respect to any of the Employees, and the Company's rights to continue or to terminate the employment relationship of any Employee will not be affected by the Plan. SECTION 6 AMENDMENT AND TERMINATION The Board of Directors of the Company may amend, suspend or terminate the Plan or any portion thereof at any time, but it may not adversely affect the 3 rights of any Employee under an award. Any material amendment will require shareholder approval. SECTION 7 INDEMNITY Each person who is or will have been a member of the Board of Directors or the Committee will be indemnified and held harmless by the Company against and from any loss, cost, liability, or expense that may be imposed upon or reasonably incurred in connection with or resulting from any claim, action, suit, or proceeding to which such person may be a party or in which they may be involved by reason of any action taken or failure to act under the Plan and against and from any and all amounts paid by such persons in settlement thereof with the Company's approval, or paid in satisfaction of a judgment in any such action, suit or proceeding against them, provided they will give the Company an opportunity, at its own expense, to handle and defend the same before they undertake to handle and defend it on their behalf. The foregoing right of indemnification will not be exclusive of any other rights of indemnification to which such persons may be entitled under the Company Articles of Incorporation or Code of By-Laws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless. SECTION 8 EXPENSES OF PLAN The expenses of administering the Plan will be borne by the Company. SECTION 9 SUCCESSORS The Plan will be binding upon the successors and assigns of the Company. SECTION 10 TAX WITHHOLDING The Company will have the right to withhold from the payment of any Award the amount of any federal, state or local taxes which the Company is required to withhold. SECTION 11 GOVERNING LAW AND NOTICE The Plan, and its rules, rights, agreements and regulations, will be 4 governed, construed, interpreted and administered solely in accordance with the laws of the State of Indiana. In the event any provision of the Plan will be held invalid, illegal or unenforceable, in whole or in part, for any reason, such determination will not affect the validity, legality or enforceability of any remaining provision, portion of provision or Plan overall, which will remain in full force and effect as if the Plan has been absent the invalid, illegal or unenforceable provision or portion thereof. Unless otherwise specifically provided herein, any notice to be given to the Committee under the Plan will be given in writing and will be deemed delivered for all purposes of the Plan if personally delivered to a member of the Committee or mailed to such Committee addressed to the Company by postpaid, certified United States mail. SECTION 12 EFFECTIVE DATE AND DURATION OF PLAN The Plan was adopted on February 19, 1998, by the Executive Committee of the Board of Directors of the Company and will be effective as of that date, subject to shareholder approval at the annual shareholders meeting of the Company to be held in South Bend, Indiana, on April 16, 1998. The Plan will have no termination date, unless otherwise required by law or otherwise terminated by the Committee. EX-10.K 9 CONSULTING AGREEMENT OF ERNESTINE M. RACLIN 1 EXHIBIT 10(k) CONSULTING AGREEMENT This CONSULTING AGREEMENT (the "Agreement") is entered into this 14th day of April, 1998, between ERNESTINE M. RACLIN ("Raclin") and 1ST SOURCE CORPORATION ("1ST Source"). RECITALS A. Effective April 16, 1998, Ernestine M. Raclin is retiring after long and distinguished service as Chairman of the Board of 1ST Source and its bank subsidiary. B. Because Raclin possesses valuable experience, knowledge, and expertise concerning the operations, customers, markets, business plans, and other matters of vital importance to 1ST Source and its subsidiaries, 1ST Source desires to ensure its continued and exclusive access to that experience, knowledge, and expertise by entering into a consulting arrangement with her. C. Raclin desires to make herself available as a consultant to 1ST Source. D. 1ST Source and Raclin desire to set forth in writing the terms and conditions of the consulting relationship. AGREEMENT In consideration of the premises and the following mutual undertakings, the parties agree as follows: 1. Consulting Relationship. Effective April 16, 1998, Raclin shall provide consulting services to 1ST Source under the terms of this Agreement. 2. Term. Raclin's consulting relationship under this Agreement shall commence as of April 16, 1998, and shall continue through April 15, 2008, unless and until otherwise terminated pursuant to Paragraph 6 (the "Term"). 3. Responsibilities of Raclin. 3.1 Consultant. As requested by 1ST Source, Raclin, shall use her best efforts to consult with the Board of Directors and executive officers of 1ST Source, to foster existing and potential customer relationships for the benefit of 2 1ST Source, to represent the interests of 1ST Source in civic, banking, and other business organizations, and otherwise to make available her experience, knowledge, and expertise for the benefit of 1ST Source. Raclin shall be available to provide up to 400 hours of service per calendar year under the terms of this Agreement. 3.2 Independent Contractor. Raclin shall perform her services under this Agreement as an independent contractor. Except as otherwise provided in this Agreement, she shall have the sole discretion and responsibility for the selection of procedures, processes, personnel, materials, working hours, and other incidents of performance of services. So long as Raclin performs services in accordance with this Agreement and complies with the restrictive covenants of Paragraph 7, nothing shall prevent her from performing services for other noncompeting businesses or entities. 3.3 Taxes. Raclin shall be solely responsible for all tax obligations with respect to consulting fees received under this Agreement. 3.4 Authority and Responsibilities. Raclin's specific responsibilities shall be assigned, from time to time, by the Chairman and Chief Executive Officer of 1ST Source. Except as expressly provided by the terms of a particular assignment, Raclin shall not have the authority to bind 1ST Source. 4. Consulting Fees and Support Services. For the first five years of the Term, Raclin shall receive an annual consulting fee of $150,000, payable monthly or as the parties may from time to time agree; for the remainder of the Term, Raclin shall receive an annual consulting fee of $100,000. In addition, 1ST Source shall provide Raclin the following: 4.1 Office Facilities and Clerical Services. To assist Raclin in performing consulting services under this Agreement, 1ST Source shall provide Raclin with an office suite and clerical services. 2 3 4.2 Other Support Services. To assist her in performing consulting services under this Agreement, 1ST Source shall make available to Raclin the use of its corporate aircraft for up to 50 hours per calendar year. 1ST Source shall also provide, at its expense, memberships in one country club and one business club located in the area of South Bend, Indiana, or other geographic area in which a membership can reasonably be used for the benefit of 1ST Source. 4.3 Expense Reimbursement. 1ST Source shall reimburse Raclin for reasonable and necessary business and travel and entertainment expenses that she incurs in performing consulting services under this Agreement. 4.4 Medical/Physical Exam. 1ST Source shall reimburse Raclin for the monthly insurance premiums required for the purchase of Medicare supplemental insurance Plan J and shall also reimburse Raclin for her annual physical conducted at the Mayo Clinic or such other comparable diagnostic facility for the period of this Agreement. 5. Deferral of Fees. In Raclin's discretion, she may elect to defer the payment of all or a portion of the consulting fees that she is to receive under this Agreement, according to the following procedures: 5.1 Election. To defer fees to be earned during a calendar year, Raclin shall deliver a written deferral election to 1ST Source before the beginning of that calendar year. For the period from April 16, 1998, through December 31, 1998, however, Raclin may make such an election before the beginning of that period. Each election shall be irrevocable and shall designate the amount to be deferred and the date the deferred amounts are to be paid. 5.2 Account. 1ST Source shall maintain an individual bookkeeping account in Raclin's name on the accounting records of 1ST Source. The account shall be credited monthly with the amount of Raclin's deferrals, as well as earnings at 1ST Source Bank's current prime lending rate. 3 4 5.3 Unfunded Status. The obligation of 1ST Source to pay the deferred fees is only a contractual obligation to make payments when due. The obligation shall not be secured, and 1ST Source shall not set aside assets beyond the reach of its general creditors for the purpose of paying the deferred fees. 5.4 Payment of Deferred Fees. The account balance shall be paid in a lump sum payment to Raclin (or, in the event of her death, to her beneficiary) upon the earlier of the date designated by her written election or the termination of the consulting relationship under Paragraph 6. In accordance with procedures prescribed by 1ST Source, Raclin may designate as beneficiary the person or persons, including a trustee, to receive the balance of her account in the event of her death. If no beneficiary has been designated or if no designated beneficiary survives Raclin, her beneficiary shall be her estate. 5.5 Transferability. Neither Raclin nor her beneficiary shall have the power to transfer, pledge, or otherwise encumber any of the deferred fees due under this Agreement, and any attempt to do so shall be void. Any rights to deferred fees under this Agreement shall not be subject to attachment, garnishment, execution, or other transfer by operation of law in the event of bankruptcy, insolvency, or otherwise. 6. Termination. Raclin's consulting relationship under this Agreement shall terminate upon the earliest to occur of the following events: 6.1 Death. The death of Raclin. 6.2 Disability. Raclin's incapacity to perform her responsibilities under this Agreement by reason of physical or mental condition for a period of at least 365 consecutive days, as reasonably determined by 1ST Source. 6.3 Termination for Cause. Termination of Raclin's consulting relationship by 1ST Source for cause. For purposes 4 5 of this Agreement, "cause" shall mean solely (i) conviction of a felony or a lesser crime, which lesser crime results in injury to the business, reputation or property of 1ST Source, (ii) material acts of malfeasance in the performance of Raclin's duties, including misuse or diversion of 1ST Source funds or willful and material misrepresentations or concealments on any reports submitted to 1ST Source, or (iii) material breach of this Agreement. 6.4 Termination Not for Cause. Termination of Raclin's consulting relationship by 1ST Source for reasons that do not constitute cause. 6.5 Resignation. Termination of Raclin's consulting relationship voluntarily by Raclin. 6.6 Accrual of Fees Through Termination. Upon termination of Raclin's consulting relationship under Paragraph 6.3 or 6.5, Raclin's accrual of fees shall cease as of the date of the termination. Upon termination of Raclin's consulting relationship under Paragraph 6.4, Raclin's accrual of fees shall continue through April 15, 2008. Upon termination of Raclin's consulting relationship under other circumstances, Raclin's accrual of fees shall cease as of the end of the year in which the termination occurs. 7. Restrictive Covenants. In connection with Raclin's consulting relationship, Raclin will become acquainted with 1ST Source's services, products, business practices, current and prospective customers and their requirements, trade secrets, and other information that is not generally known or readily ascertainable by others (collectively, the "Confidential Information") and will develop business relationships with employees, customers, and potential customers of 1ST Source and its subsidiaries. Therefore, as an essential ingredient and consideration of this Agreement, Raclin enters into the following covenants: 7.1 Confidential Information. Raclin shall use the Confidential Information only in the course of her duties as a consultant to 1ST Source, and she shall not disclose, during or at any time after the term of her consulting relationship, any Confidential Information to anyone except as authorized by 1ST Source. 5 6 7.2 Corporation Records. Raclin agrees that all records of 1ST Source containing or referring to Confidential Information are the sole property of 1ST Source. Raclin shall keep those records subject to 1ST Source's custody and control and shall return them promptly to 1ST Source at the termination of her consulting services, without retaining any copies or notes of those records. 7.3 Competition. During the term of Raclin's consulting relationship and for the period of two (2) years after her consulting relationship terminates for any reason, Raclin shall not directly or indirectly - whether as an individual, employee, sole proprietor, partner, corporate shareholder, officer, director, agent, consultant, formal or informal advisor or by lending any other form of assistance - do any of the following: (a) Engage in any activity that is in material competition with the business of 1ST Source or any of its subsidiaries; (b) Solicit, assist others in soliciting, or engage in any other effort to obtain for any entity other than 1ST Source the business of any customer with whom 1ST Source did business at any time during the one (1) year period immediately preceding the termination of Raclin's consulting relationship; or (c) Hire away, attempt to hire away, or assist in the departure from employment from 1ST Source of any person who was an employee of 1ST Source at the time of the termination of Raclin's consulting arrangement with 1ST Source. These covenants supplement, and do not supersede, the provisions of the Indiana Uniform Trade Secrets Act and the duties Raclin owes to 1ST Source under common law. 8. Enforcement of Restrictive Covenants. Raclin agrees that any violation by Raclin of any provision of Paragraph 7 of this Agreement will cause 1ST Source to suffer irreparable harm, that damages for such harm will be incapable of precise measurement, and that 1ST Source will therefore not have an adequate remedy at 6 7 law to redress the violation. Therefore, if Raclin violates or threatens to violate any provision of that Paragraph, 1ST Source shall be entitled, in addition to its other remedies, to temporary restraining orders and preliminary and permanent injunctions to restrain and enjoin any violation or threatened violation of this Agreement. Raclin waives any right to raise questions of personal jurisdiction or venue in any action 1ST Source may bring against Raclin in any state or federal court in the county where a violation occurs or is threatened to occur. In addition to the other relief to which it shall be entitled, 1ST Source shall be entitled to recover from Raclin its costs and reasonable attorneys' fees incurred by 1ST Source in seeking enforcement of this Agreement. 9. Separability. Should any clause, portion or paragraph of this Agreement be unenforceable or invalid for any reason, that shall not affect the enforceability or validity of the remainder of this Agreement. Should any particular provision or restriction including, but not limited to, the covenants and restrictions of Paragraph 7, be held to be unreasonable or unenforceable for any reason, including the time period, geographical area or scope of activity covered by the covenant or restriction, then that covenant or restriction shall be given effect and enforced to whatever extent would be reasonable and enforceable. 10. Notices. All notices and other communications required or permitted under this Agreement shall be in writing and shall be deemed to have been properly given if delivered by hand, sent by telecopy, or mailed, certified or registered mail with postage and fees prepaid: If to 1ST Source, to: Vincent A. Tamburo, Secretary 1st Source Corporation 100 North Michigan Street 4th Floor South Bend, Indiana 46601 If to Raclin, to: Ernestine M. Raclin 110 N. Esther Steet South Bend, Indiana 46617 or to such other person or address as the party to whom such notice or communication is to be given shall have notified the other party in accordance with this Paragraph. Any mailed communication shall be deemed to have been given on the third "business day" (such term excluding, for purposes of this Agreement, Saturdays, Sundays, and legal holidays) after the day of mailing. Any communication sent by telecopy shall be deemed 7 8 to have been given on the date receipt of the telecopy transmission is confirmed by telecopy; provided, that if any communication sent by telecopy is also mailed by certified mail, return receipt requested, in accordance with this Paragraph, such communication shall be deemed to have been given on the date receipt of the telecopy transmission is confirmed by telecopy or the third business day after the day of mailing, whichever is earlier. 11. Successors and Assigns. 1ST Source shall require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business or assets of 1ST Source, by agreement in form and substance satisfactory to Raclin, to expressly assume and agree to perform this Agreement in the same manner and to the same extent that 1ST Source would be required to perform it if no such succession had taken place. Failure of 1ST Source to obtain such agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle Raclin to consulting fees from 1ST Source under Paragraph 4 and its subparagraphs for the remaining Term. As used in this Paragraph, "1ST Source" shall mean 1ST Source Corporation and any successor to its business or assets. 12. Oral Modifications Not Binding. This Agreement may not be modified or terminated orally. No modification, termination or attempted waiver shall be valid unless in writing signed by the party against whom it is sought to be enforced. 13. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Indiana. 14. Entire Agreement. With respect to the subject matter hereof, this Agreement sets forth the entire agreement of the parties and supersedes all prior agreements, representations or communications between them, whether written or oral. 15. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original and all of which taken together shall constitute one and the same instrument. The parties have executed this Agreement on the date and year first written above. -------------------------------------- ERNESTINE M. RACLIN 8 9 1ST SOURCE CORPORATION By:_______________________________________ Christopher J. Murphy III, President By:_______________________________________ Philip J. Faccenda, Chairman Executive Compensation Committee of the Board of Directors 9 EX-13 10 PORTIONS OF ANNUAL REPORT TO SECURITY HOLDERS 1 EXHIBIT 13 1998 ANNUAL REPORT CONTENTS Corporate Description 3 1998 in Brief 3 Letter to Shareholders 4 Financial Highlights 9 Banking Center Locations 10 Financial Report 11 Officers and Directors 47 Shareholders' Information 48 1999 1st Source Corporation All rights reserved The body of this annual report is printed on recycled paper. - --Page 1-- ERNESTINE M. RACLIN, CHAIRMAN EMERITUS 1ST SOURCE CORPORATION With 21 years of distinguished service, Ernestine Raclin retired as Chairman of the Board of 1st Source Corporation and was elected Chairman Emeritus. Our deepest thanks go to "Ernie" for her life's work. With her strength, she made a commitment to the independence of 1st Source, building something of value and meaning, while giving people an opportunity to grow. Her grace and style have set a tone for us all; her caring attitude has become the beacon for our decision making; and her pride in the bank and in the community has become our badge of honor. May her sage advice and enduring memory still lead us to success. - --Page 2-- THE ERNESTINE M. RACLIN COMMUNITY LEADERSHIP AWARD Exceptional leadership to the community through volunteer service. It is only fitting that our tribute to Ernestine Raclin, Chairman Emeritus of 1st Source, exemplifies her distinct and powerful accomplishments. The Ernestine M. Raclin Community Leadership Award has been established by 1st Source Bank to honor and encourage those who give of themselves to benefit others. The award will be given annually to as many as five 1st Source employees and five employees of locally owned companies in our regional communities. Inaugurated in the spring of 1999, those honored will receive a Globe of Leadership, a monetary award, and a donation to the charity of their choice. 2 - --Page 3-- 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 used private aircraft, automobiles for leasing and rental agencies, heavy duty trucks, and construction equipment. The corporation's principal subsidiary, 1st Source Bank, has 47 banking centers in 12 counties in Indiana and Michigan and 14 locations nationwide supporting its Specialty Finance Group. 1st Source's wholly-owned mortgage banking subsidiary, Trustcorp Mortgage Company, has five offices in Indiana and Ohio. 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. 1998 IN BRIEF 1998 net income of $31.0 million was the highest in 1st Source history and 17.1% higher than the $26.5 million earned in 1997. Adjusting for a 10% stock dividend declared January 14, 1999, diluted net income per common share for 1998 was $1.60, up 17.6% from the $1.36 for 1997. Return on average total assets was 1.22% compared to 1.21% a year ago. Return on average common equity was 15.12% for 1998 compared to 14.51% for 1997. The average common equity-to-assets ratio for 1998 was 8.05% compared to 8.30% last year. At year-end 1998, total assets were $2.73 billion, up 13.0% from a year earlier. Loans were up 4.7%, deposits were up 15.1% and shareholders' equity increased from $195.0 million at the end of 1997 to $215.9 million at the end of 1998. The reserve for loan losses at year-end 1998 was 2.18% of total loans, while nonperforming assets amounted to 0.56% of total loans. NET INCOME (In Millions) [GRAPH]
94 95 96 97 98 (18.5) (21.0) (23.2) (26.5) (31.0)
DILUTED NET INCOME PER COMMON SHARE [GRAPH]
94 95 96 97 98 (.96) (1.08) (1.20) (1.36) (1.60)
3 RETURN ON AVERAGE COMMON EQUITY (As a Percent) [GRAPH]
94 95 96 97 98 (14.49) (14.75) (14.38) (14.51) (15.12)
RETURN ON AVERAGE TOTAL ASSETS (As a Percent) [GRAPH]
94 95 96 97 98 (1.19) (1.25) (1.22) (1.21) (1.22)
- --Page 4-- TO OUR SHAREHOLDERS: 1998 was a year of both continued good performance and change. By pursuing our original Vision 2000 goals defined in 1995, we realized growth and record earnings. For the year, our net income was up 17.1 percent over last year to $31,020,000, with diluted net income per common share up 17.6 percent to $1.60. The banking centers opened over the last few years performed well, leading us to expect the same from the two branches we established in new markets in 1998. New investment products and services were introduced by our Personal Wealth Management Division. We also reorganized our reporting structures to ensure continued management development through more direct authority and accountability. We experienced record-setting growth in mortgage production at both 1st Source Bank and at our mortgage company subsidiary, Trustcorp Mortgage. Growth of our specialty finance businesses continued with the addition of sales representatives in new markets and an increase in securitized loans in the aircraft and auto finance industries. Substantial progress too was made in ensuring that all our mission-critical operating and business systems are Year 2000 compliant; we expect few, if any, problems at the turn of the century. Before outlining in greater detail the results of the past year and the issues to be addressed in the coming one, I want to recognize and thank an extraordinary woman, Ernestine Raclin, who retired as Chairman of the Board at our Annual Meeting in April. For the last 20 years we have been signing this shareholders' letter together. As Chairman of 1st Source she set a standard and an example that ennobles us and challenges all of us to do our very best for all of the constituencies we serve. She committed us to independence when others were selling out, and to high performance for the benefit of our shareholders and the community. She has imbued 1st Source with positive values, a family atmosphere, and a commitment to service. As a result, and in tribute, we have dedicated this Annual Report to her and have recently established the Ernestine M. Raclin Community Leadership Awards to continue her legacy of a working commitment to the communities we serve. Her unshakable values, distinctive personality, incredible energy, and nonstop leadership have set an example for all of us. 4 GROWTH 1998 was again a year of growth. In 1995, we committed the company to a plan to realize such growth. The prior five years had been spent trying to bring our costs more into line. This was successful, yet it was apparent we had to find ways to increase the number of customers we served and to increase the size of our relationship with each customer. Since we had (and are) committed to staying an independent company, we had to have profitable growth to meet the long term needs of our shareholders; we naturally focused on ways to do just that. We had a belief that there was more value in serving present customers well and in attracting new customers on a one on one basis than in trying to grow by acquisition. During the late 1980's and the early 1990's, we had made a number of bids to purchase other banks, savings and loans, or bank branch offices. In nearly every case, we came in second place and sometimes by a large financial amount. Perhaps the people we were bidding against were smarter or simply better managers. In any event, we could never figure out how to make the purchase target profitable enough at the levels being paid. There was an internal rate of return we were determined to achieve; we couldn't justify the prices many buyers were willing to pay. If we couldn't see a way to return 15 percent based on our investment, we refused to bid up. The result of this sound fiscal discipline was that we acquired very little. We resolved instead to "grow the old-fashioned way: one customer at a time." By opening 15 new banking centers from the end of 1995 through 1998, we entered new markets and developed new customers. We also opened two new offices at Trustcorp Mortgage and added four sales officers and markets in our specialty finance businesses. As a result, our assets have grown from $1.80 billion at the beginning of the period to over $2.73 billion today. This has been fueled by annual loan growth averaging 18.7% over these three years. In 1998, our total loans (including those securitized) grew 15.5 percent and ended the year at $1.88 billion on the balance sheet and $321 million off the balance sheet. Our annual mortgage production both in the bank and at Trustcorp Mortgage was $1.42 billion, an 87.9 percent increase - --Page 5-- over the prior year and up a full 362 percent over the $306 million dollars produced in 1995. Today, Trustcorp services a portfolio of some $1.87 billion of conventional, FHA and VA mortgages. This is up 57.2 percent from the $1.19 billion dollars serviced at the close of 1995. Our business loans also grew substantially during this period, benefiting from expansion into new markets in the Michiana area, the purchase of the last of our local business lending competitors by out of town banks, and the continued growth of our specialty finance lending. This growth since the end of 1995 was 71.5 percent from $805 million to $1.38 billion. Our consumer loans and leases excluding first mortgages grew 87.0 percent over the same period and now total $119.3 million. Deposit growth has followed the same pattern. After a slow start with some of our new branches, many began to grow nicely this year. It takes time to enter a market and develop the trust necessary for people to switch their "business." By the close of the year our Quantum Leap branches, those we've added as part of our Vision 2000 growth strategy, accounted for $129.7 million of our deposits. At year's end, our total deposits stood at $2.18 billion, up 15.1 percent from the prior year end and up 51 percent since the end of 1995. We continue to be focused on expanding our physical presence with new banking centers offering service and convenience to our customers. As I write this letter, we are preparing to open a new full service [PHOTO] Al Qualey, Chris Murphy and Duke Jones discuss opportunities 5 - --Page 6-- branch in Warsaw, Indiana and will open at least one more before the end of 1999. We hope to open one Trustcorp Mortgage office in the Midwest region and plan to add one or two more sales officers in our specialty lending businesses. If the economy remains solid and we can continue to find good people, we will pursue a similar set of objectives in 2000. YEAR 2000 COMPUTER COMPLIANCE A topic receiving enormous attention in the press these days is the Year 2000 computer glitch and its predicted impact on banking and other critical industries. At 1st Source, we have been working diligently to identify, test, and install date-correcting software to ensure that all our systems are compliant. We have made significant progress and should have all our mission critical systems compliant by the end of the second quarter of 1999. We are confident that we will be ready for the change of the calendar with minimal disruptions. We have also been developing contingency plans should systems on which we rely outside of 1st Source become a problem. We know that the end of the year will present some challenges, but it always does. Computer calculation problems have occurred before, and we and the industry have been able to handle them. I am more worried about the expectations and concerns of people leading to irrational actions in anticipation of problems than I am of the problems themselves. Unfortunately, there is a whole industry of people who have sprung up to take advantage of the concerns surrounding Year 2000. Profiteers are calling for everything from a computer meltdown to the end of the world. . . and selling their wares to the unprepared. If nothing is going to work next year, how are all these people expecting to get paid or enjoy their newfound wealth, generated by preying on the fear of others? I suspect most of them know that things will be okay and are planning to enjoy their riches! Clearly, there is no need to panic. We are not talking about insoluble problems. Again, while there may indeed be concerns with the "millennium" date change, they will most likely be manageable. ORGANIZATION With Ernie's retirement and my taking on the title of Chairman of the holding company, it seems only appropriate to recognize two of the people who drive our businesses. "Duke" Jones (officially Wellington D. Jones III) and Allen Qualey were promoted to President of their respective businesses, and they will continue to report to me. Duke is President of 1st Source Bank and is responsible for the deposit and lending business carried on in our regional market. The branches, marketing, mortgage, consumer lending, commercial banking, insurance, wealth management, trust and human resources report to him. He is responsible for the "sales and service" side of the traditional bank. Duke began his business career with IBM, joining 1st Source as head of our systems area in 1975. He took over the consumer banking business in 1979 and became Executive Vice President of both the bank and the holding company in 1989. He and I have worked in close cooperation for the last 20 years and he is well prepared for his new duties and has certainly earned his new title. He has an excellent team of executive managers and senior officers working with him throughout the bank. Allen Qualey is responsible for our specialty finance businesses which include auto and truck financing, turbine and piston aircraft financing and construction machinery financing. Allen came to 1st Source in 1985 and started our aircraft finance business. In 1993, he took over the Specialty Finance Group and has done an excellent job integrating it into the bank. He has added product lines, new markets and people and has built an efficient and effective infrastructure to support our national businesses. This title change recognizes the role he already plays. For the last seven years we have worked closely in building our customer base and this Group's support operations. Allen will do an excellent job leading these businesses into the next century. Larry Lentych, our Chief Financial Officer, continues to report to me and has taken on new responsibilities. Administrative Services including buildings and grounds management, purchasing, communications, and security have joined finance, accounting and audit as his area of responsibility. This has allowed Larry Gardner, Senior Vice President and head of Operations and Information 6 Services, to focus on the Year 2000 issue and the continued upgrade of our mainframe and PC systems. These are such strategically important areas to our continued success that it is appropriate that a tighter focus be developed. Strong management from elsewhere in the bank and some from outside have been added to ensure the talent necessary to keep 1st Source technologically and operationally competitive. Jim Kunzler, President of Trustcorp Mortgage, Jim Jackson, Senior Vice President of our Funds Management Division and Vince Tamburo, General - --Page 7-- [PHOTO] Christopher J. Murphy III Chairman, President and Chief Executive Officer Counsel, continue with their previous responsibilities and complete the officer group reporting directly to me. Inherent in the structure outlined above is a belief in a decentralized operating environment with strong senior managers running their businesses. Having said that, none of us is so good that we don't need our colleagues. One of the strengths of 1st Source is the collegial nature of its management team. We have all made mistakes and we all know we are fallible. We seek each others' advice and we use it. We have a respect for the people here, throughout the organization. We try to move decision making as close to the customer as possible. This allows us to grow by developing people so they can manage more diverse businesses and markets. PEOPLE Our future success depends on the ability to attract, train, motivate, and retain good people. That is getting more difficult. We have always been blessed with a great group of colleagues who truly like being in service to others. This is what we do: serve others. We have been blessed, as well, with people who have a strong set of values. They are attracted to a company that commits itself to being in the leadership of the communities it serves by using both its financial and human resources to improve them. Traditionally, our products have been rather simple and our competition benign. Those days are gone for good. Competition is rigorous and it comes from a number of areas: at the consumer level, it is primarily the credit unions who have the advantage of no federal income tax cost. It is also now the stock brokerages, mutual funds, insurance companies, credit card companies and a variety of other consumer financial service providers. For the commercial business it is banks all over the country, insurance companies, investment banking firms and commercial finance companies. They have all upgraded their product offerings and sales processes. To compete, we must as well. Our focus has to be on fully developing relationship management with our customers and doing so with people who are intelligent enough to represent and discuss a broad array of products and services. We must deliver on our commitment to keep our customers' best - --Page 8-- interest in mind; therefore, we need people who are not driven to make every sale because it results in more income to the individual or the company or both! Rather, we have to have people who work with their clients on a day to day basis making sure they are using the right array of products and services to properly meet their clients' needs. Our colleague's interest must be in building a relationship of trust where we are proactively working for the client. Our colleagues need to be much more sales oriented than in the past, they must be proactive for the benefit of the client! We can no 7 longer wait until the client hears about a product or service elsewhere and then asks if we have it, we need to understand needs and fill them. On the other hand, we must be very careful of not falling into the trap of trying to have every bell and whistle out there. Often a need is perceived by the client which is not real and in these cases it is our responsibility to educate the client as to the value proposition and then fill their real need. Over the next year, we will continue to refine our training programs so we are better able to prepare our colleagues for the competitive markets of the next century. We must instill the basics and then upgrade our follow-up systems. We will also have to look for more highly qualified students to fill our entry level positions. Raw intelligence is important in a knowledge business. However, it is worthless without the right value system. Our ethical culture at 1st Source is very strong and we will work hard to see that it is maintained and enhanced by the next generation of customer service people and sales officers entering the business. COMMUNITY INVOLVEMENT We can't end this letter without talking about community involvement. It has always been a core value at 1st Source. As a business we believe we have a responsibility to make our communities better places to live. We do it by encouraging our colleagues to become involved in a leadership way. We do it by continuing a tradition of United Way leadership. We do it by direct financial support to programs and projects throughout our region that make this a better place to live. Two examples of this in the past year were the Indiana University-South Bend Piano Festival which brought international masters and young talent from all over the country here to collaborate as they prepare themselves to move to the highest levels of international performance. A week of incredible study and performance was concluded with a stirring performance by the Kirov Orchestra from St. Petersburg, Russia. Their tour of the U.S. included Boston, New York, South Bend, Chicago and San Francisco. 1st Source's leadership support in money and administration put us among a select few. 1st Source Bank has also offered long term support to Urban Youth Services. For almost twenty years, we have provided board member involvement and underwriting of the 1st Source Bank Academic Awards honoring African-American and Hispanic high-school students in the program. To recognize our own colleagues who give their time in leadership in the communities we serve and to encourage other businesses to do the same, we have established the Ernestine M. Raclin Community Leadership Awards which will be presented for the first time in 1999. Up to five 1st Source employees and five employees of 1st Source business customers will be recognized. In each case they will receive the leadership award itself, a $1000 award, and a $1000 contribution to the charity of their choice. A panel of recognized regional community leaders will make the first selections in February with the awards presented at a luncheon at the end of March. We believe this is an excellent way to recognize people's efforts; to bring attention to the importance of businesses encouraging volunteer commitment; and to honor a woman who taught us all how to serve. Thank you for your commitment and support this past year. /s/ Christopher J. Murphy Chairman, President and Chief Executive Officer 8 - --Page 9-- FINANCIAL HIGHLIGHTS EARNINGS AND DIVIDENDS (Dollars in thousands, except per share amounts)
1998 1997 1996 1995 1994 Operating income$ 247,669 $208,972 $174,299 $154,607 $127,816 Operating expense 196,883 166,353 138,700 122,564 101,483 Net income 31,020 26,489 23,203 21,042 18,465 Cash dividends 5,296 4,723 4,123 3,594 3,204 Per Common Share (1): Diluted net income $1.60 $1.36 $1.20 $1.08 $0.96 Cash dividends .278 .250 .218 .189 .168 Book value 11.43 10.24 9.11 8.10 6.80 Return on average common equity 15.12% 14.51% 14.38% 14.75% 14.49% Return on average total assets 1.22% 1.21% 1.22% 1.25% 1.19% STATEMENT OF CONDITION Average Balances: Assets $2,550,218 $2,198,300 $1,895,214 $1,686,560 $1,546,965 Earning assets 2,344,555 2,046,637 1,767,055 1,569,703 1,435,892 Loans 1,853,537 1,610,889 1,348,089 1,172,438 1,066,752 Reserve for loan losses 38,861 31,966 28,482 26,081 23,685 Investment securities 445,310 424,086 400,209 373,976 360,276 Deposits 1,999,514 1,698,973 1,524,149 1,354,453 1,256,430 Shareholders' equity 205,180 182,543 161,324 142,667 127,451
(1) The computation of per common share data gives retroactive recognition to a 10% stock dividend declared January 14, 1999; a 10% stock dividend declared January 20, 1998; a five-for-four stock split declared January 21, 1997; a 5% stock dividend declared January 22, 1996; a three-for-two stock split declared July 18, 1995; and a 5% stock dividend declared January 23, 1995. [1ST SOURCE CORPORATION LOGO] - --Page 10-- BANKING CENTER LOCATIONS [1ST SOURCE BANK LOGO] [MAP OF BANKING CENTER LOCATIONS] 1st Source Bank is also located online at www.1stsource.com 9 - --Page 11-- 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 $2.73 billion in total assets, $2.18 billion in total deposits, $1.88 billion in total loans, and $215.9 million in total shareholders' equity. 1st Source's principal subsidiary is 1st Source Bank with its main office in South Bend, Indiana. The assets of the bank account for 96% 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; and heavy duty trucks and construction 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; customers and vendors of critical systems or services failing to comply with Year 2000 programming issues; 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]
94 95 96 97 98 (1,547) (1,687) (1,895) (2,198) (2,550)
AVERAGE LOANS (In Millions) [GRAPH]
94 95 96 97 98 (1,067) (1,172) (1,348) (1,611) (1,854)
AVERAGE DEPOSITS (In Millions) [GRAPH]
94 95 96 97 98 (1,256) (1,354) (1,524) (1,699) (2,000)
10 AVERAGE SHAREHOLDERS' EQUITY (In Millions) [GRAPH]
94 95 96 97 98 (127) (143) (161) (183) (205)
- --Page 12-- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Continued SELECTED CONSOLIDATED FINANCIAL DATA (Dollars in thousands, except per share amounts)
1998 1997 1996 1995 1994 Interest income $196,148 $173,316 $148,820 $135,115 $112,942 Interest expense 102,227 87,324 73,429 64,946 47,709 Net interest income 93,921 85,992 75,391 70,169 65,233 Provision for loan losses 9,156 6,052 4,649 2,757 4,197 Net interest income after provision for loan losses 84,765 79,940 70,742 67,412 61,036 Noninterest income 51,521 35,656 25,479 19,492 14,874 Noninterest expense 85,500 72,977 60,622 54,861 49,577 Income before income taxes 50,786 42,619 35,599 32,043 26,333 Income taxes 17,545 14,392 12,396 11,001 7,868 Distribution on preferred securities of subsidiary trusts, net of income tax benefit 2,221 1,738 -- -- -- NET INCOME $31,020 $26,489 $23,203 $21,042 $18,465 Assets $2,732,021 $2,418,154 $2,079,767 $1,799,257 $1,583,027 Long-term debt 13,189 16,656 18,596 21,819 28,084 Shareholders' equity 215,859 194,953 171,833 152,601 129,082 Basic net income per common share (1) 1.63 1.40 1.23 1.11 0.97 Diluted net income per common share (1) 1.60 1.36 1.20 1.08 0.96 Cash dividends per common share (1) .278 .250 .218 .189 .168 Return on average common equity 15.12% 14.51% 14.38% 14.75% 14.49% Return on average total assets 1.22% 1.21% 1.22% 1.25% 1.19%
(1) The computation of per share data gives retroactive recognition to a 10% stock dividend declared January 14, 1999; a 10% stock dividend declared January 20, 1998; a five-for-four stock split declared January 21, 1997; a 5% stock dividend declared January 22, 1996; a three-for-two stock split declared July 18, 1995; and a 5% stock dividend declared January 23, 1995. 11 - --Page 13-- 1st Source Corporation and Subsidiaries RESULTS OF OPERATIONS Net income in 1998 was $31.0 million, up from $26.5 million in 1997 and $23.2 million in 1996. Diluted net income per common share was $1.60 in 1998, $1.36 in 1997 and $1.20 in 1996 after giving retroactive recognition to stock splits and stock dividends. Return on average total assets was 1.22% in 1998, compared to 1.21% in 1997 and 1.22% in 1996. Return on average common equity was 15.12% in 1998 versus 14.51% in 1997 and 14.38% in 1996. Net income in 1998 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. Offsetting the increase in noninterest income were expense increases in salaries, leased equipment depreciation and other expense. Dividends declared on common stock in 1998 amounted to $.278 per share, compared to $.250 in 1997 and $.218 in 1996. 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, 1998 and 1997 are summarized below. QUARTERLY RESULTS OF OPERATIONS (Dollars in thousands, except per share amounts)
Three Months Ended March 31 June 30 Sept. 30 Dec. 31 1998 Interest income $47,892 $49,318 $ 49,355 $49,583 Net interest income 23,244 23,611 23,512 23,554 Provision for loan losses 2,401 2,689 2,042 2,024 Investment securities and other investment gains (losses) (122) (584) -- 94 Income before income taxes and subsidiary trust distributions 11,651 12,211 13,133 13,791 Net incom 7,160 7,342 7,861 8,657 Diluted net income per common share (1) .36 .38 .41 .45 1997 Interest income $39,146 $42,758 $44,842 $46,570 Net interest income 19,671 21,675 22,092 22,554 Provision for loan losses 1,229 479 2,130 2,214 Investment securities and other investment gains (losses) 181 (484) 24 (183) Income before income taxes and subsidiary trust distributions 9,360 10,224 11,033 12,002 Net income 6,066 6,441 6,638 7,344 Diluted net income per common share (1) .31 .33 .34 .38
(1) The computation of per share data gives retroactive recognition to a 10% stock dividend declared January 14, 1999. - --Page 14-- 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. 12 SOURCE OF FUNDS CORE DEPOSITS -- 1st Source's major source of investable funds is provided by stable core deposits consisting of all interest bearing and non-interest bearing deposits, excluding brokered certificates of deposit and certain certificates of deposit of $100,000 and over. In 1998, average core deposits equaled 62.51% of average total assets, compared to 63.36% in 1997 and 68.32% in 1996. The effective cost rate of core deposits in 1998 was 3.94%, compared to 3.97% in 1997 and 3.98% in 1996. Average demand deposits (non-interest bearing core deposits) increased 19.02% in 1998, compared to an increase of 12.78% in 1997. They represented 15.73% of total core deposits in 1998 compared to 15.13% in 1997 and 14.43% in 1996. 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 1998, 1st Source's reliance on purchased funds increased to 25.44% of average total assets from 24.29% in 1997. 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 wholly-owned, special purpose subsidiary of 1st Source Bank. The special purpose subsidiary 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 subsidiary generally retains the right to receive any excess cash flows of the trust. 1st Source sold $346 million of loans in 1998 and $63 million of loans in 1997 in conjunction with aircraft and auto loan securitization transactions, and revolving agreements related to all current and previous years' securitizations. SHAREHOLDERS' EQUITY -- Management continues to emphasize profitable asset growth and retention of equity in the business. Average shareholders' equity equated to 8.05% of average total assets in 1998 compared to 8.30% in 1997. Shareholders' equity was 7.90% of total assets at year-end 1998, compared to 8.06% at year-end 1997. INVESTMENT OF FUNDS INVESTMENT SECURITIES -- Investment securities at year-end 1998 increased 30.08% from 1997, following a 1.94% decrease from year-end 1996 to year-end 1997. The increase in 1998 is attributed to deposit growth. The decrease in 1997 was attributed to the sale of various securities used to fund a $20 million bank-owned life insurance program. LOANS -- Average loans, net of unearned discount, increased 15.06% in 1998, following a 19.49% increase in 1997. Loans, net of unearned discount, at December 31, 1998, were $1.88 billion and were 68.88% of total assets, compared to $1.80 billion or 74.30% of total assets at December 31, 1997. Commercial and agricultural lending outstandings, excluding those secured by real estate, increased 9.50% during 1998. 1st Source has experienced success 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 1998 decreased 2.68% from year-end 1997. The decrease is reflective of the $346 million of aircraft and auto loans sold through securitizations in 1998. Despite this, there were strong originations in construction equipment, auto rental franchises, aircraft and truck, and automobile leasing company financings. Real estate loans recorded growth of 11.05% during 1998. This increase was led by residential mortgage loans held for sale with an increase of 44.83%, - --Page 15-- MATURITIES OF INVESTMENT SECURITIES AT DECEMBER 31, 1998 (Dollars in thousands) U.S. Treasury States and Political Other and Agencies Subdivisions Securities Total 13
Amount Yield Amount Yield Amount Yield Amount Yield 0 - 1 Year $ 99,487 5.68% $ 16,628 6.43% $ 31,464 5.58% $ 147,579 5.74% 1 - 5 Years 145,608 5.40 84,249 6.87 22,538 5.77 252,395 5.92 5 - 10 Years 3,582 5.95 44,411 8.13 254 7.01 48,247 7.96 Over 10 Years 35,650 6.01 9,185 6.58 46,643 6.32 91,478 6.23 Total $284,327 5.58% $154,473 7.17% $100,899 5.96% $ 539,699 6.11%
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. followed by an increase of 9.89% in commercial real estate lending. Portfolio residential mortgage loans decreased 13.34% from 1997. Consumer loans grew a modest 6.90% in 1998. 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 use 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, 1998, securities maturing in one year amounted to $147.6 million which represented 27.34% of the investment portfolio as compared to 23.59% at year-end 1997. 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. Under the current interest rate swaps, 1st Source entered into agreements with another party to exchange, at specific intervals, the difference between fixed-rate and floating-rate interest amounts as calculated by reference to a notional amount as a means to convert floating rate loans to a fixed rate. The notional amounts total $26.9 million at December 31, 1998. The current positions are not leveraged and are not held for trading. A hypothetical change in earnings was modeled by calculating an immediate 100 basis point (1.00%) change in interest rates across all maturities. This analysis presents the hypothetical change in earnings of those rate sensitive financial instruments and interest rate swaps held by 1st Source (excluding Trustcorp Mortgage) at December 31, 1998. The aggregate hypothetical loss in pre-tax earnings is estimated to be $2,440,690 on an annualized basis on all rate sensitive financial instruments and the interest rate swaps 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 $2,386,140 on an annualized basis on all rate sensitive financial instruments and the interest rate swaps 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. - --Page 16-- INVESTMENT OF FUNDS -- CONCLUDED 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 14 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]
94 95 96 97 98 Loans (net of unearned discount and loss reserve) 1,043.1 1,146.3 1,323.6 1,578.9 1,814.7 Investments 368.2 396.2 411.9 434.1 489.3 Other earning assets 1.0 1.4 12.3 25.0 47.4 Other assets 134.7 142.7 147.4 160.3 198.8 Total 1,547.0 1,686.6 1,895.2 2,198.3 2,550.2
COMPOSITION OF AVERAGE LIABILITIES AND SHAREHOLDERS' EQUITY (In millions) [GRAPH]
94 95 96 97 98 Noninterest bearing deposits 162.2 173.2 186.8 210.7 250.8 Interest bearing core deposits 967.1 1,034.3 1,108.0 1,182.2 1,343.3 Purchased funds & long-term debt 264.2 305.7 405.2 585.3 706.6 Other liabilities 26.0 30.7 33.9 37.6 44.3 Shareholders' equity 127.5 142.7 161.3 182.5 205.2 Total 1,547.0 1,686.6 1,895.2 2,198.3 2,550.2
EARNING 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 8.74% in 1998, following a 13.31% increase in 1997. 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 4.16% in 1998 compared to 4.38% in 1997 and 4.48% in 1996. The interest margin has decreased the last two years due to competitive pricing pressures. In addition, 1st Source has relied more on purchased funds to meet loan demand. The yield on earning assets in 1998 was 8.52%, compared to 8.65% in 1997 and 8.64% in 1996. Average earning assets in 1998 increased 14.56%, following a 15.82% increase in 1997. The effective rate on interest bearing liabilities was 5.10% in 1998, compared to 5.04% for 1997 and 4.85% for 1996. NONINTEREST INCOME -- Supplementing the growth in net interest income was an increase in noninterest income of 44.49% over 1997. The factors influencing the growth were increased aircraft - --Page 17-- and auto loan securitization and servicing income, revenues generated from operating leases, and the origination and sale of mortgage loans and servicing. Noninterest income in 1997 increased 39.94% over 1996 15 primarily for the same reasons as in the current year. Trust fees in 1998 were $8.26 million, compared to $7.31 million in 1997 and $6.73 million in 1996. Trust fees increased 12.92% in 1998, following an 8.62% increase in 1997. Service charges on deposit accounts increased by 8.64% resulting in $5.84 million of income for 1998. The $5.38 million recorded in 1997 was an increase of 11.41% from the $4.83 million of service charges on deposit accounts generated in 1996. Loan servicing and sale income generated from 1st Source's aircraft and auto loan securitization and mortgage banking activities increased 56.88% to $15.12 million in 1998. The $9.64 million recorded in 1997 represented a 78.28% increase over 1996. 1st Source recognized loan securitization gains of $1.95 million during 1998, compared to $800,000 during 1997. Aircraft and auto loan servicing income in 1998 was $6.62 million, compared to $3.76 million in 1997. Servicing income has increased as the result of additional loan sales. The outstanding servicing portfolio grew to $321 million at year-end 1998, compared to $111 million at the end of 1997. Gains of $4.86 million were recognized on the origination and sale of mortgage loans and servicing in 1998, compared to gains of $3.38 million in 1997. In addition, net servicing fees on mortgages remained steady at $1.69 million for both 1998 and 1997. As of year-end 1998, Trustcorp Mortgage Company's mortgage servicing portfolio aggregates $1.87 billion, as compared to $1.30 billion one year ago. Equipment rental income generated from operating leases increased to $12.56 million in 1998, nearly an 81% increase over 1997. The $6.95 million recorded in 1997 was nearly a 154% increase over 1996. Revenues from operating leases for construction equipment, automobiles and other equipment, and the related depreciation on the equipment, have increased significantly in the past three years as 1st Source has focused on increasing this line of business. Other income increased 51.42% during 1998, following an increase of 23.44% in 1997. This growth in 1998 was generated primarily by an increase in mortgage loan fees as homeowners took advantage of lower interest rates to refinance their mortgages. In addition, increases were realized in insurance commissions, standby letter of credit fees and appreciation in cash surrender value of bank-owned life insurance (BOLI). The growth in 1997 was fueled by increases in cash surrender value of BOLI, mortgage underwriting fees and standby letter of credit fees. The 1998 and 1997 net losses recorded for investment securities and other represent, primarily, the write-offs of venture capital investments. NONINTEREST EXPENSE -- During 1998, 1st Source experienced an increase in noninterest expense of 17.16% primarily attributed to costs to attract and retain quality people. In addition, the depreciation on our growing operating lease portfolio and professional consulting expenses contributed to the overall increase in operating expenses. Cost control across all business units and better utilization of resources continues to be a major focus at 1st Source. The increase in noninterest expense during 1997 of 20.38% was primarily due to the branch expansion, salaries, operating lease depreciation and additional provisions needed for our stock incentive reserves. Salaries and employee benefits comprised approximately 55% of total noninterest expense in 1998 compared to 57% in 1997. Salaries and employee benefits increased 13.20% in 1998, following a 15.80% increase in 1997. Salaries and wages increased 15.61% in 1998 and 12.73% in 1997. The number of full-time equivalent employees stood at 1,036 at the end of 1998, compared to 966 and 895 at the end of 1997 and 1996, respectively. Employee benefits increased 5.34% in 1998, following a 27.07% increase in 1997. The smaller increase in employee benefits was primarily the result of additional provisions made during 1997 to fund the stock incentive reserves due to the significant 63% increase in the market price of 1st Source common stock during that period. Group insurance expense increased 20.01% in 1998, following a 9.86% decrease in 1997. Occupancy expense in 1998 increased 9.26% from 1997, following a 3.22% decrease in 1997. The increase in occupancy expense in 1998 is primarily due to the full year impact of the previous year's branch expansion. The reduction in occupancy expense in 1997 is attributed to greater tenant occupancy of our head-quarters building. Furniture and equipment expense increased in 1998 16 - --Page 18-- SELECTED STATISTICAL INFORMATION Distribution of Assets, Liabilities and Shareholders' Equity Interest Rates and Interest Differential (Dollars in thousands)
Year ended December 31, 1998 Interest Average Income/ Yield/ ASSETS Balance Expense Rate Investment securities: Taxable $ 294,632 $17,419 5.91% Tax exempt (1) 150,678 11,327 7.52 Net loans (2 & 3) 1,853,537 168,664 9.10 Other investments 45,708 2,348 5.14 Total earning assets 2,344,555 199,758 8.52 Cash and due from banks 86,452 Reserve for loan losses (38,861) Other assets 158,072 Total $2,550,218 LIABILITIES AND SHAREHOLDERS' EQUITY Interest bearing deposits $1,748,759 86,264 4.93 Short-term borrowings 243,431 15,034 6.18 Long-term debt 13,036 929 7.13 Total interest bearing liabilities 2,005,226 102,227 5.10 Noninterest bearing deposits 250,755 Other liabilities 89,057 Shareholders' equity 205,180 Total $2,550,218 Net interest income $ 97,531 Net yield on earning assets on a taxable equivalent basis 4.16%
(1) Interest income includes the effects of taxable equivalent adjustments, using a 40.525% rate. Tax equivalent adjustments were $3,408 in 1998, $3,536 in 1997 and $3,635 in 1996. (2) Loan income includes fees on loans of $4,889 in 1998, $4,097 in 1997 and $3,136 in 1996. Loan income also includes the effects of taxable equivalent adjustments, using a 40.525% rate. Tax equivalent adjustments were $202 in 1998, $162 in 1997 and $131 in 1996. (3) For purposes of this computation, nonaccruing loans are included in the daily average loan balance outstanding. - --Page 19--
1997 1996 Interest Interest Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate $ 272,400 $ 16,638 6.11% $ 254,033 $ 15,337 6.04% 151,686 11,723 7.73 146,176 11,787 8.06 1,610,889 148,061 9.19 1,348,089 124,467 9.23
17 11,662 592 5.09 18,757 995 5.30 2,046,637 177,014 8.65 1,767,055 152,586 8.64 73,246 75,378 (31,966) (28,482) 110,383 81,263 $2,198,300 $1,895,214 $1,488,287 73,150 4.92 $1,337,345 64,214 4.80 227,757 13,014 5.71 156,003 7,843 5.03 16,527 1,160 7.02 19,876 1,372 6.90 1,732,571 87,324 5.04 1,513,224 73,429 4.85 210,686 186,804 72,500 33,862 182,543 161,324 $2,198,300 $1,895,214 $ 89,690 $ 79,157 4.38% 4.48%
- --Page 20-- EARNING RESULTS -- CONTINUED by 7.15%, following a 15.07% increase in 1997. The increase in 1997 is attributed to depreciation on new furniture and equipment. Depreciation on operating leases increased 80% in 1998, following a 176% increase in 1997 due to the increased volume of operating leases. Business development and marketing expense increased 2.98% in 1998, following an increase of 33.78% in 1997. Contributions to the 1st Source Foundation declined in 1998 compared to 1997. An increase of 17.72% occurred in other expenses during 1998, compared to a 19.56% increase in 1997. During 1998, the majority of the increase in other expenses was in professional consulting. The increase in professional consulting expenses was attributed to loan securitization activity and costs in upgrading various computer systems for Year 2000 (Y2K) compliance. During 1997, 1st Source experienced increases in employee acquisition and training, communications, professional consulting and collection and repossession expenses. YEAR 2000 -- The Y2K issue is the result of potential problems with computer systems or any equipment with computer chips that store the year portion of the date as just two digits (e.g., 98 for 1998). Systems using this two-digit approach may not be able to determine whether "00" represents the Year 2000 or 1900. The problem, if not corrected, may make those systems fail altogether or, even worse, allow them to generate incorrect calculations causing a disruption of normal operations. In 1997, a comprehensive project plan to address the Y2K issue as it relates to 1st Source's operations was developed, approved by the Board of Directors and implemented. The scope of the plan has five phases comprising Awareness, Assessment, Renovation, Validation and Implementation as defined by federal banking regulatory agencies. Two project teams were assigned. The first consisted of key members of the technology staff, representatives of functional business units and senior management. The second primarily consisted of lenders and credit personnel. The first team assessed our systems and equipment and vendors to ascertain their readiness and to develop the overall plan to bring our systems into compliance. The second team assessed the readiness of our customers and determined what risk, if any, our key customers pose to the bank with regards to their Y2K readiness. Additionally, the duties of the Senior Vice President of Operations were realigned to allow him to serve as the Year 2000 Project Manager. The scope of the project also includes other operational and environmental systems since they may be impacted if embedded computer chips control the functionality of those systems. From the assessment, 1st 18 Source has identified and prioritized those systems deemed to be mission critical or those that have a significant impact on normal operations. 1st Source relies on third-party vendors and service providers for much of its data processing capabilities and to maintain its computer systems. Formal communications with these providers and other external counterparties were initiated in 1997 to assess the Y2K readiness of their products and services. Their progress in meeting their targeted schedules is being monitored continually for any indication that they may not be able to address the problems in time. Thus far, responses indicate that all of the significant providers currently have compliant versions available or are well into the renovation and testing phases. However, 1st Source can give no guarantee that the systems of these service providers and vendors on which 1st Source's systems rely will be timely renovated. Additionally, 1st Source has implemented a plan to manage the potential risk posed by the impact of the Y2K issue on its major borrowing customers. Formal communications have been initiated, and the assessment was substantially complete on December 31, 1998. Loan losses attributed to the Y2K issue are not anticipated to be material to 1st Source. However, there can be no guarantee that any loss incurred will be immaterial. 1st Source's total cost for the Y2K project is estimated to be between $900,000 and $1,700,000. The total amount expended on the project through December 31, 1998, was $630,000 of which approximately $610,000 related to the cost to repair or replace software. Approximately $9,000 was related to the cost of replacing equipment and approximately $11,000 was related to miscellaneous items such as training for employees and communications with customers. - --Page 21-- Funds have been provided from our normal operating budget and costs are expensed as they are incurred. The total cost to 1st Source of these Year 2000 readiness activities has not been, and is not anticipated to be, material to its financial position or results of operations in any given year. The project teams feels that 1st Source's Y2K readiness project is on schedule. The following table provides a summary of the current status of the five phases involved and a projected timetable for completion. TARGET DATES FOR MISSION CRITICAL SYSTEMS Project Phase %Completed Projected Completion Date Awareness 100% -- Assessment 100% -- Renovation 97% March 31, 1999 Validation 79% March 31, 1999 Implementation 70% June 30, 1999 No specific other projects have been deferred due to this project. Much of the work done within this project is an acceleration of work that would have been done in the normal course of business. The costs and timetable in which 1st Source plans to complete the Year 2000 readiness activities are based on management's best estimates, which were derived using numerous assumptions of future events including the continued availability of certain resources, third-party plans and other factors. 1st Source can make no guarantee that these estimates will be achieved and actual results could differ from such plans. Based upon current information related to the progress of its major vendors and service providers, management has determined that the Y2K issue will not pose significant operational problems for its computer systems. This determination is based on the ability of those vendors and service providers to renovate, in a timely manner, the products and services on which 1st Source's systems rely. However, 1st Source can give no guarantee that the systems of these suppliers will be renovated in a timely manner. Realizing that some disruption may occur despite its best efforts, 1st Source is in the process of developing contingency plans for each critical system in the event that one or more of those systems fail. While this is an ongoing process, 1st Source expects to have the plans substantially documented by June 30, 1999. INCOME TAXES -- Federal income taxes were $13.26 million and $10.79 million, prior to the tax benefit of $1,196,000 and $936,000 relating to the distribution on preferred securities of subsidiary trusts for 1998 and 19 1997, respectively. After this benefit, 1998 federal income taxes were $12.06 million, or 28.01% of income after state taxes, compared to $9.86 million or 27.12% in 1997 and $9.13 million or 28.24% in 1996. The higher percentage of federal income taxes in 1998 is the result of less tax-exempt income. A settlement with the Internal Revenue Service was reached during 1997 over a 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 $4.28 million and $3.60 million in 1998 and 1997, respectively, prior to the tax benefit of $318,000 and $248,000 relating to the distribution on preferred securities of subsidiary trusts for 1998 and 1997, respectively. After this benefit, 1998 state income taxes were $3.96 million, compared to $3.35 million in 1997 and $3.27 million in 1996. 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 general economic conditions affecting the loan portfolio, including changes to the portfolio mix and past loan loss experience. The provision for loan losses for 1998 was $9.16 million, compared to $6.05 million in 1997 and $4.65 million in 1996. Net charge-offs of $3.65 million, $144,000, and $1.78 million were recorded in 1998, - --Page 22-- 1997 and 1996, respectively. The reserve for loan losses at December 31, 1998 totaled $40.93 million and was 2.18% of loans, compared to $35.42 million or 1.97% of loans at December 31, 1997, and $29.52 million or 2.03% of loans at December 31, 1996. It is management's opinion that the reserve for loan losses is adequate to absorb anticipated losses in the loan portfolio as of December 31, 1998. 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 $10.57 million at December 31, 1998, compared to $11.44 million at December 31, 1997 and $7.77 million at December 31, 1996. Impaired loans totaled $13.30 million, $9.39 million and $8.13 million at December 31, 1998, 1997 and 1996, respectively.
NONPERFORMING ASSETS AT DECEMBER 31 (Dollars in thousands) 1998 1997 1996 1995 1994 Loans past due over 90 days $ 275 $ 730 $ 557 $ 274 $ 477 Nonaccrual loans 9,266 10,030 6,678 4,893 3,314 Restructured loans - - - - 133 TOTAL NONPERFORMING LOANS 9,541 10,760 7,235 5,167 3,924 Other real estate 424 335 445 1,359 763 Other assets 606 341 93 58 13 TOTAL NONPERFORMING ASSETS $10,571 $11,436 $7,773 $6,584 $4,700 Nonperforming assets to loans, net of unearned discount .56% .64% .54% .52% .43%
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, 1998, there were 1,137 holders of record of 1st Source common stock. 1st Source's leverage capital ratio decreased from 9.98% at December 31, 1997, to 9.50% at December 31, 1998. 1st Source's common stock is traded on the Nasdaq Stock Market under the National Market symbol 20 "SRCE." High and low stock prices and cash dividends paid for the last two years by quarter were:
1998 Sales Price 1997 Sales Price Cash Cash Dividends Dividends Common Stock Prices High Low Paid High Low Paid Quarter Ended: March 31 $33-3/4 $25-1/4 $.066 $20-1/4 $15-3/4 $.060 June 30 36-3/4 30-3/4 .066 22-3/4 17-3/4 .062 September 30 36 27-1/2 .073 23-1/2 21-1/4 .062 December 31 32 25-3/4 .073 27-1/2 22-1/4 .066
The above information gives retroactive recognition to a 10% stock dividend declared January 14, 1999; and a 10% stock dividend declared January 20, 1998. At December 31, 1998, the total market capitalization of 1st Source was approximately $575 million. - --Page 23-- CAPITAL RESOURCES -- CONCLUDED Leverage Capital Ratio (As a Percent) [GRAPH]
94 95 96 97 98 (8.33) (8.44) (8.48) (9.98) (9.5)
Common Stock Price Range (In Dollars) [GRAPH]
1997 1998 1st 2nd 3rd 4th 1st 2nd 3rd 4th ------------------------------------------- ------------------------------------------- High 20 1/4 22 3/4 23 1/2 27 1/2 33 3/4 36 3/4 36 32 Low 15 3/4 17 3/4 21 1/4 22 1/4 25 1/4 30 3/4 27 1/2 25 3/4 Quarter Ending 19 22 23 26 1/4 33 32 1/2 29 1/4 30 1/2
Book Value Per Common Share [GRAPH]
94 95 96 97 98 (6.80) (8.10) (9.11) (10.24) (11.43) Book value is not necessarily indicative of the value of 1st Source common stock.
21 Cash Dividends Per Common Share [GRAPH]
94 95 96 97 98 (.168) (.189) (.218) (.250) (.278)
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 24--
December 31 1998 1997 (Dollars in thousands) ASSETS Cash and due from banks $132,514 $90,864 Federal funds sold and interest bearing deposits with other banks 41,951 11,677 Investment securities, available-for-sale (amortized cost of $440,147 and $298,439 at December 31, 1998 and 1997, respectively) 443,691 299,933 Investment securities, held-to-maturity (fair value of $99,734 and $119,369 at December 31, 1998 and 1997, respectively) 96,008 114,975 Loans, net of unearned discount: Commercial and agricultural loans 399,013 364,391 Commercial loans secured by transportation and construction equipment 732,488 752,677 Loans secured by real estate 630,915 568,136 Consumer loans 119,280 111,577 Total Loans 1,881,696 1,796,781 Less, Reserve for loan losses 40,929 35,424 Net Loans 1,840,767 1,761,357 Operating leases, net of accumulated depreciation of $12,997 and $7,260 at December 31, 1998 and 1997, respectively. 54,170 32,046 Premises and equipment: Land 4,130 4,123 Buildings and improvements 28,948 25,868 Furniture and equipment 21,996 23,750 Construction in progress 1,322 555 Total Premises and Equipment 56,396 54,296 Less, Accumulated depreciation 25,169 23,514 Net Premises and Equipment 31,227 30,782
22
Other assets 91,693 76,520 Total Assets $2,732,021 $2,418,154
The accompanying notes are a part of the consolidated financial statements. - --Page 25--
December 31 1998 1997 (Dollars in thousands) LIABILITIES Deposits: Noninterest bearing $ 294,810 $ 274,906 Interest bearing 1,882,297 1,616,885 Total Deposits 2,177,107 1,891,791 Short-term borrowings: Federal funds purchased and securities sold under agreements to repurchase 159,478 117,987 Other 82,681 117,019 Total Short-Term Borrowings 242,159 235,006 Other liabilities 38,957 34,998 Long-term debt 13,189 16,656 Total Liabilities 2,471,412 2,178,451 Commitments and contingencies (Notes L, M and P) 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 17,756,636 shares in 1998 and 16,147,791 shares in 1997, less unearned shares 6,270 5,700 Capital surplus 121,456 69,947 Retained earnings 97,863 124,394 Cost of common stock in treasury (1998 -- 465,405 shares and 1997 -- 289,627 shares) (12,723) (6,978) Net unrealized appreciation of securities available-for-sale 2,993 1,890 Total Shareholders' Equity 215,859 194,953 Total Liabilities and Shareholders' Equity $2,732,021 $2,418,154
23 - --Page 26-- CONSOLIDATED STATEMENTS OF INCOME 1st Source Corporation and Subsidiaries
Year Ended December 31 1998 1997 1996 (Dollars in thousands, except per share data) Interest income: Loans $168,462 $147,899 $124,553 Investment securities, taxable 17,419 16,638 15,121 Investment securities, tax-exempt 7,919 8,187 8,152 Total Investment Securities 25,338 24,825 23,273 Other 2,348 592 994 Total Interest Income 196,148 173,316 148,820 Interest expense: Deposits 86,264 73,150 64,214 Short-term borrowings 15,034 13,014 7,843 Long-term debt 929 1,160 1,372 Total Interest Expense 102,227 87,324 73,429 Net Interest Income 93,921 85,992 75,391 Provision for loan losses 9,156 6,052 4,649 Net Interest Income After Provision for Loan Losses 84,765 79,940 70,742 Noninterest income: Trust fees 8,257 7,312 6,732 Service charges on deposit accounts 5,845 5,380 4,829 Loan servicing and sale income 15,117 9,636 5,405 Equipment rental income 12,557 6,950 2,741 Other income 10,357 6,840 5,541 Investment securities and other investment gains (losses) (612) (462) 231 Total Noninterest Income 51,521 35,656 25,479 Noninterest expense: Salaries and employee benefits 47,265 41,755 36,058 Net occupancy expense 4,966 4,545 4,696 Furniture and equipment expense 7,241 6,758 5,873 Depreciation - leased equipment 8,941 4,971 1,800 Business development and marketing expense 3,564 3,461 2,587 Other expense 13,523 11,487 9,608 Total Noninterest Expense 85,500 72,977 60,622 Income Before Income Taxes and Subsidiary Trust Distributions 50,786 42,619 35,599 Income taxes 17,545 14,392 12,396 Distribution on preferred securities of subsidiary trusts, net of income tax benefit of $1,514 in 1998 and $1,184 in 1997 2,221 1,738 - Net Income $ 31,020 $ 26,489 $ 23,203 Basic Net Income Per Common Share $ 1.63 $ 1.40 $ 1.23 Diluted Net Income Per Common Share $ 1.60 $ 1.36 $ 1.20
The accompanying notes are a part of the consolidated financial statements. 24 - --Page 27--
Consolidated Statements of Shareholders' Equity 1st Source Corporation and Subsidiaries Net Unrealized Cost of Appreciation Common of Securities Common Capital Retained Stock Available- Total Stock Surplus Earnings in Treasury For-Sale (Dollars in thousands, except per share data) Balance at January 1, 1996 $152,601 $5,429 $56,337 $96,952 $(6,497) $380 Comprehensive income, net of tax: Net income 23,203 - - 23,203 - - Change in unrealized appreciation of available-for-sale securities (net of $52 income tax) 77 - - - - 77 Total comprehensive income 23,280 Cost of 67,267 shares of com- mon stock acquired for treasury (1,488) - - - (1,488) - Cash dividends ($.218 per share) (4,123) - - (4,123) - - 5% common stock dividend ($11 cash paid in lieu of fractional shares) (11) 271 13,610 (13,892) - - Other 1,574 - - 259 1,315 - Balance at December 31, 1996 171,833 5,700 69,947 102,399 (6,670) 457 Comprehensive income, net of tax: Net income 26,489 - - 26,489 - - Change in unrealized appreciation of available-for-sale securities (net of $977 income tax) 1,433 - - - - 1,433 Total comprehensive income 27,922 Cost of 179,025 shares of com- mon stock acquired for treasury (5,023) - - - (5,023) - Cash dividends ($.250 per share) (4,723) - - (4,723) - - Five-for-four common stock split ($8 cash paid in lieu of fractional shares) (8) - - (8) - - Other 4,952 - - 237 4,715 - Balance at December 31, 1997 194,953 5,700 69,947 124,394 (6,978) 1,890 Comprehensive income, net of tax: Net income 31,020 - - 31,020 - -
25 Change in unrealized appreciation of available-for-sale securities (net of $751 income tax) 1,103 - - - - 1,103 Total comprehensive income 32,123 Cost of 231,440 shares of com- mon stock acquired for treasury (7,116) - - - (7,116) - Cash dividends ($.278 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 $215,859 $ 6,270 $121,456 $97,863 $(12,723) $2,993
The accompanying notes are a part of the consolidated financial statements. - --Page 28-- Consolidated Statements of Cash Flows 1st Source Corporation and Subsidiaries
Year Ended December 31 1998 1997 1996 (Dollars in thousands) Operating Activities: Net income $31,020 $26,489 $23,203 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 9,156 6,052 4,649 Depreciation of premises and equipment 12,638 8,372 4,363 Amortization of investment security pre- miums and accretion of discounts, net 1,039 817 739 Deferred income taxes 8,133 4,839 (1,147) Realized investment securities (gains) losses 612 462 (231) Realized (gains) on securitized loans (1,948) (800) - Increase in interest receivable (787) (1,836) (573) Increase in interest payable 2,023 3,660 120 Other (627) (3,303) (5,818) Net Cash Provided by Operating Activities 61,259 44,752 25,305 Investing Activities: Proceeds from sales and maturities of investment securities 249,012 159,564 116,813 Purchase of investment securities (373,404) (144,491) (144,286) Net (increase) decrease in short-term investments (30,274) (11,077) 2,34 Loans sold or participated to others 377,608 154,609 156,727 Net increase in loans made to customers and principal collections on loans (466,370) (495,632) (355,104) Net increase in leased assets (23,069) (16,585) (4,984)
26 Funding of bank-owned life insurance policies - (20,000) - Purchase of premises and equipment (3,795) (4,455) (6,646) Increase in servicing assets (16,632) (1,408) (251) Other (9,288) (13,014) (2,115) Net Cash Used in Investing Activities (296,212) (392,489) (237,500) Financing Activities: Net increase in demand deposits, NOW accounts and savings accounts 311,160 46,384 57,688 Net increase (decrease) in certificates of deposit (25,844) 211,429 134,540 Net increase in short-term borrowings 7,153 10,143 71,884 Proceeds from issuance of long-term debt 747 1,559 123 Payments on long-term debt (4,214) (3,499) (3,346) Proceeds from issuance of cumulative trust preferred securities - 44,750 - Acquisition of treasury stock (7,116) (5,023) (1,488) Cash dividends (5,296) (4,723) (4,123) Other 13 (7) (12) Net Cash Provided by Financing Activities 276,603 301,013 255,266 Increase (Decrease) in Cash and Cash Equivalents 41,650 (46,724) 43,071 Cash and cash equivalents, beginning of year 90,864 137,588 94,517 Cash and Cash Equivalents, End of Year $132,514 $90,864 $137,588
The accompanying notes are a part of the consolidated financial statements. - --Page 29-- 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, 1998 or 1997. 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 $188.2 million and $130.0 million at December 31, 1998 and 1997, respectively. 27 SECURITIZED ASSETS -- The guidelines set forth in Statement of Financial Accounting Standards (SFAS) No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities," are followed when accounting for securitizations. When 1st Source sells loans in securitizations, it retains servicing rights and interest-only strips, which are 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 the key assumptions - credit losses, prepayment speeds, forward yield curves and discount rates commensurate with the risks involved and regularly reviews all assets for impairment. In conjunction with its securitization activities, 1st Source sold $346 million of aircraft and auto loans in 1998 resulting in a recognized gain of $1.95 million. Approximately $83,000 of cash and $9.1 million of other assets shown on the December 31, 1998 consolidated statement of financial condition are assets of 1st Source Funding Corporation ("Funding"), a special-purpose subsidiary of 1st Source Bank, and represent Funding's beneficial (i.e. residual) interest in certain assets of the 1st Source Master Trust in accordance with 1st Source's loan securitization transactions. Funding was established in 1998 as a qualifying special-purpose entity for purposes of SFAS No. 125 and has been structured to be bankruptcy-remote from 1st Source and its other affiliates. 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 non-interest income in the period in which such rights are sold on a servicing released basis. SFAS No. 125 also requires companies that intend to sell originated or purchased loans and retain the related servicing rights, to allocate a portion of the total costs of the loans to servicing rights, based on estimated 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, 1998, and 1997, $20.3 million and $11.0 million, respectively, of mortgage servicing rights have been capitalized. As of these dates, the servicing rights had a fair value of $35.7 million and $21.0 million respectively. Mortgage servicing rights are being amortized using a method which approximates the effective yield method and for the years ended December 31, 1998, 1997 and 1996, - --Page 30-- NOTE A -- ACCOUNTING POLICIES -- CONTINUED $4.09 million, $2.72 million and $2.68 million 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, the predominant risk characteristics of the underlying loans. There were no valuation allowances associated with capitalized mortgage servicing rights at December 31, 1998 and 1997. REVENUE RECOGNITION -- Interest on loans is included in interest income on 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 potential losses in the portfolio and the evaluation of impaired loans. Loans are charged against the reserve for loan losses when deemed uncollectible. 157 28 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 31H 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 net deferred tax assets are comprised of the tax effect of net temporary differences related principally to differing methods of accounting for loan losses offset by differing methods of accounting for depreciation on premises and leased equipment and amortization of purchased 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): 1998, 18,995; 1997, 18,935; and 1996, 18,893. 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): 1998, 19,371; 1997, 19,543; and 1996, 19,357. The computations of the weighted average number of common shares used for the determination of both basic and diluted earnings per share give retroactive recognition to a 10% stock dividend declared January 14, 1999, payable February 12, 1999, to shareholders of record on February 4, 1999. FUNDS HELD IN TRUST FOR INVESTORS AND MORTGAGORS -- As of December 31, 1998 and 1997, serviced loans which were owned by investors aggregated $1.87 billion and $1.30 billion, respectively. Funds held in trust at 1st Source for the payment of principal, interest, taxes and insurance premiums applicable to mortgage loans being serviced for others, aggregated approximately $50.8 million and $23.0 million at December 31, 1998 and December 31, 1997, 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, 1998, 1997 and 1996, for interest and for income taxes was $100.2 million and $7.8 million, $83.7 - --Page 31-- NOTE A -- ACCOUNTING POLICIES -- CONCLUDED million and $10.7 million, and $73.3 million and $14.9 million, respectively. OFF-BALANCE SHEET FINANCIAL INVESTMENTS -- 1st Source enters into interest rate swap agreements as part of its interest rate risk management strategies. 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 -- 1st Source has adopted SFAS No. 130, "Reporting Comprehensive Income," as of January 1, 1998. SFAS No. 130 establishes standards for the reporting and disclosure of comprehensive income and its components in a full set of general purpose financial statements. The only component of comprehensive income not included in 1st Source's net income is unrealized gains or losses on available-for-sale investment securities, net of related income taxes. Prior year financial statements have been restated in order to conform to the requirements of SFAS No. 130. In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 131,"Disclosure about Segments of an Enterprise and Related Information." This Statement changes the manner in which public companies report segment information in annual reports and requires companies to report selected segment information in interim financial reports. Companies are now required to report financial and descriptive information about the company's operating segments. 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, 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. 158 29 In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999 (January 1, 2000 for 1st Source). 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. 1st Source anticipates that due to its limited use of derivative instruments, the adoption of SFAS No. 133 will not have a significant effect on 1st Source's results of operations or its financial position. RECLASSIFICATIONS -- Certain amounts in the 1996 and 1997 consolidated financial statements have been reclassified to conform with the 1998 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, 1998 and 1997, are summarized in the following table. 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, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. - --Page 32-- 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. INTEREST RATE SWAPS -- Fair values for interest rate swaps 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 the value of assets and liabilities that 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, 159 30 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 Carrying or Contract Fair or Contract Fair Value Value Value Value 1998 1997 ASSETS: (Dollars in thousands) Cash and due from banks $ 132,514 $ 132,514 $ 90,864 $ 90,864 Federal funds sold and interest bearing deposits with other banks 41,951 41,951 11,677 11,677 Investment securities, available-for-sale 443,691 443,691 299,933 299,933 Investment securities, held-to-maturity 96,008 99,734 114,975 119,369 Loans, net of reserve for loan losses 1,840,767 1,905,335 1,761,357 1,788,005 LIABILITIES: Deposits 2,177,107 2,189,910 1,891,791 1,896,130 Short-term borrowings 242,159 242,159 235,006 235,006 Long-term debt 13,189 13,755 16,656 16,807 Guaranteed preferred beneficial interests in the Company's subordinated debentures 44,750 47,036 44,750 46,726 OFF-BALANCE-SHEET INSTRUMENTS* - (351) - (392) * Represents estimated cash outflows required to currently settle the obligations at current market rates.
- --Page 33-- NOTE C -- RESTRICTIONS ON CASH 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, 1998 was approximately $13.0 million. Under available line of credit agreements, 1st Source may borrow up to $3 million. At December 31, 1998, 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, 1998, are as follows:
Available-For-Sale Gross Gross Estimated Unrealized Unrealized Aggregate Amortized Holding Holding Fair Cost Gains Losses Value EQUITY SECURITIES: (Dollars in thousands) Marketable securities $ 14,315 $1,304 $ (91) $ 15,528 Other equity securities 3,465 17 - 3,482 Total equity securities 17,780 1,321 (91) 19,010 DEBT SECURITIES: United States Treasury and agency securities 243,003 1,019 (85) 243,937 Obligations of states and political subdivisions 69,115 1,007 (24) 70,098 Debt securities issued by foreign governments 2,205 1,492 - 3,697 Corporate securities 20,276 394 (31) 20,639 Mortgage-backed securities 40,681 172 (211) 40,642
160 31
Other debt securities 20,549 105 (36) 20,618 Commercial paper 28,128 - - 28,128 Total debt securities 423,957 4,189 (387) 427,759 TOTAL INVESTMENT SECURITIES $441,737 $5,510 $(478) $446,769 Held-To- Maturity Gross Estimated Unrealized Unrealized Aggregate Amortized Holding Holding Fair Cost Gains Losses Value EQUITY SECURITIES: (Dollars in thousands) Other equity securities $11,633 $ - $- $11,633 DEBT SECURITIES: Obligations of states and political subdivisions 84,375 3,726 - 88,101 TOTAL INVESTMENT SECURITIES $96,008 $3,726 $- $99,734
- --Page 34-- The amortized cost and estimated aggregate fair value of securities classified as available-for-sale and held-to-maturity at December 31, 1997, were as follows: NOTE D -- INVESTMENT SECURITIES -- CONTINUED The amortized cost and estimated aggregate fair value of debt securities classified as available-for-sale and held-to-maturity at December 31, 1998, by contractual maturity (except for mortgage-backed securities), are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Available-For-Sale Held-To-Maturity Estimated Estimated Aggregate Aggregate Amortized Fair Amortized Fair Cost Value Cost Value (Dollars in thousands) Due in one year or less $138,823 $139,273 $ 8,200 $ 8,309 Due after one year through five years 214,826 216,067 35,243 36,622 Due after five years through ten years 8,203 8,405 36,296 38,429 Due after ten years 21,424 23,372 4,636 4,741 Mortgage-backed securities 40,681 40,642 - - TOTAL $423,957 $427,759 $84,375 $88,101
The amortized cost and estimated aggregate fair value of securities classified as available-for-sale and held-to-maturity at December 31, 1997, were as follows:
Available-For-Sale Gross Gross Estimated Unrealized Unrealized Aggregate Amortized Holding Holding Fair Cost Gains Losses Value EQUITY SECURITIES: (Dollars in thousands) Marketable securities $ 14,315 $1,304 $(91) $ 15,528 Other equity securities 3,465 17 - 3,482 Total equity securities 17,780 1,321 (91) 19,010 DEBT SECURITIES: United States Treasury and agency securities 243,003 1,019 (85) 243,937
161 32
Obligations of states and political subdivisions 69,115 1,007 (24) 70,098 Debt securities issued by foreign governments 2,205 1,492 - 3,697 Corporate securities 20,276 394 (31) 20,639 Mortgage-backed securities 40,681 172 (211) 40,642 Other debt securities 20,549 105 (36) 20,618 Commercial paper 28,128 - - 28,128 Total debt securities 423,957 4,189 (387) 427,759 TOTAL INVESTMENT SECURITIES $441,737 $5,510 $(478) $446,769
- --Page 35--
Held-To-Maturity Gross Gross Estimated Unrealized Unrealized Aggregate Amortized Holding Holding Fair Cost Gains Losses Value EQUITY SECURITIES: (Dollars in thousands) Other equity securities $ 11,648 $ - $ - $ 11,648 DEBT SECURITIES: Obligations of states and political subdivisions 103,327 4,395 (1) 107,721 TOTAL INVESTMENT SECURITIES $114,975 $4,395 $(1) $119,369
Other equity securities classified as held-to-maturity at December 31, 1998 and 1997 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. 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 $3.08 million and $3.27 million at December 31, 1998 and 1997, respectively, are included in the above debt securities, but are classified as loans in the accompanying 1998 and 1997 consolidated statements of financial condition. 1st Source had no trading securities as of December 31, 1998 and 1997. The following represents the segregation of cash flows between securities available-for-sale and held-to-maturity:
1998 1997 1996 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 $372,883 $ 521 $373,404 $139,534 $4,957 $144,491 $143,146 $1,140 $144,286 Proceeds from sales of securities 13,437 - 13,437 16,684 - 16,684 207 - 207 Proceeds from maturities and prepayments of securities 216,752 18,823 235,575 133,051 9,829 142,880 110,233 6,373 116,606
Gross losses of $199,135 were realized during 1998 on the sale of securities available-for-sale. There were no gains or losses for 1997 or 1996 on the sale of securities available-for-sale. During 1998 and 1997, gross losses of $300,000 and $324,037, respectively, were realized on the sales of securities held-to-maturity. These gross losses were due to the write-off of venture capital investments. There were no gains or losses on the sale of securities held-to-maturity in 1996. At December 31, 1998 and 1997, investment securities with carrying values of $237.9 million and $210.1 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 $15.74 million and $12.92 million at December 31, 1998 and 1997, 162 33 respectively. During 1998, $12.26 million of new loans were made and repayments and other reductions totaled $9.44 million. - --Page 36-- NOTE F -- RESERVE FOR LOAN LOSSES Changes in the reserve for loan losses for each of the three years ended December 31 were as follows:
1998 1997 1996 (Dollars in thousands) Balance, beginning of year $35,424 $29,516 $27,470 Provision for loan losses 9,156 6,052 4,649 Charge-offs, net of recoveries of $1,148 in 1998, $1,266 in 1997 and $1,507 in 1996 (3,651) (144) (1,779) Recaptured reserve due to loan securitization - - (824) Balance, end of year $40,929 $35,424 $29,516
At December 31, 1998 and 1997, loans amounting to $9.27 million and $10.03 million, respectively, substantially all of which are collateralized, are considered to be nonaccrual or restructured loans. Interest income for the years ended December 31, 1998, 1997 and 1996 would have increased by approximately $719,000, $786,000, and $533,000, respectively, if these loans earned interest at their full contract rate. As of December 31, 1998 and 1997, impaired loans totaled $13.30 million and $9.39 million, respectively, of which $3.73 million and $1.14 million had corresponding specific reserves for loan losses totaling $1.18 million and $0.61 million, respectively. The remaining balances of impaired loans had no specific reserves for loan losses associated with them. The vast majority of the impaired loans are nonaccrual loans; interest is not recognized 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 1998 and 1997, the average recorded investment in impaired loans was $13.28 million and $9.46 million, respectively, and interest income recognized on impaired loans totaled $1.23 million and $508,000, respectively. 163 34 NOTE G -- LONG-TERM DEBT Details of long-term debt are as follows:
December 31 1998 1997 (Dollars in thousands) Term loan (7.4%) $10,000 $10,000 Subordinated capital notes (4.47%) 1,145 5,075 Federal Home Loan Bank borrowings (5.54% - 6.98%) 1,037 956 Other 1,007 625 TOTAL LONG-TERM DEBT $13,189 $16,656
Annual maturities of long-term debt at December 31, 1998 are as follows (in thousands): 1999, $886; 2000, $237; 2001, $136; 2002, $10,659; and, 2003, $353. The $10.0 million term loan has a fixed interest rate of 7.4% 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. The subordinated capital notes include $572,000 due June 18, 1999 and $573,000 due June 18, 2002. The interest rate on these notes is adjusted monthly and was 4.47% at December 31, 1998. The notes are callable in whole or in part by 1st Source at par value. The notes are unsecured and are subordinated to the claims of depositors and other creditors of 1st Source Bank. At December 31, 1998, 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 $1.66 million of certain real estate loans. - --Page 37-- NOTE H -- COMMON STOCK Effective January 1, 1996, 1st Source adopted SFAS No. 123, "Accounting for Stock-Based Com-pensation," 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 that is attributable to the fair value of stock options and other stock-based compensation that 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. The Executive Incentive Plan, the Special Long-Term Incentive Award Plan and the Restricted Stock Award Plan are already being accounted for as compensatory plans in accordance with the provisions of SFAS No. 123. Compensation cost that has been charged against income for these plans was $3.05 million, $1.83 million, and $1.52 million for the years ended December 31, 1998, 1997 and 1996, respectively. 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, 1998, an aggregate of 2,090,619 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 with the following weighted-average assumptions used for grants in 1998: dividend yield of .74%; expected volatility of 19.60%; risk-free interest rate of 5.50%; and expected life of 6.47 years. The following is a summary of the activity with respect to 1st Source's stock option plans for the years ended December 31, 1996, 1997 and 1998: Weighted- 164 35
Average Number of Exercise Shares Price Options outstanding, January 1, 1996 840,442 $ 6.95 Options granted 177,435 13.72 Options exercised (8,751) 9.05 Options outstanding, December 31, 1996 1,009,126 8.13 Options granted 12,100 17.98 Options exercised (259,649) 4.82 Options forfeited (8,701) 9.86 Options outstanding, December 31, 1997 752,876 9.36 Options granted 332,750 34.25 Options exercised (44,287) 9.88 Options forfeited (378) 13.72 Options outstanding, December 31, 1998 1,040,961 17.29 Options exercisable, December 31, 1998 622,965 $ 8.66
The following table summarizes information about stock options outstanding at December 31, 1998:
OPTIONS OUTSTANDING Weighted- Average Weighted- Range of Number Remaining Average Exercise Outstanding Contractual Exercise Prices at 12/31/98 Life (Years) Price $ 6.00 to $12.99 530,742 5.11 $ 7.76 13.00 to 29.99 177,469 7.63 14.01 30.00 to 35.99 332,750 9.55 34.25 OPTIONS EXERCISABLE Weighted- Range of Number Average Exercise Exercisable Exercise Prices at 12/31/98 Price $ 6.00 to $12.99 530,742 $ 7.76 13.00 to 29.99 92,223 13.83 30.00 to 35.99 _ _
- --Page 38-- NOTE H -- COMMON STOCK -- CONCLUDED 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 165 36 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, 1998, and runs through May 31, 2000, with $386,216 in stock value to be purchased at $32.05 per share. The fair value of the employees' purchase rights for the 1998 offering was estimated using the Black-Scholes model with the following assumptions: dividend yield of .74%; expected volatility of 17.53%; risk-free interest rate of 5.52%; 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:
1998 1997 1996 Net income (000s): As reported $31,020 $26,489 $23,203 Pro forma 29,908 26,146 23,049 Diluted net income per common share: As reported $1.60 $1.36 $1.20 Pro forma 1.55 1.35 1.20
EXECUTIVE INCENTIVE PLAN 1st Source has an Executive Incentive Plan which is 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 1998, 1997 and 1996 are summarized below:
1998 1997 1996 Number of shares 47,996 39,491 48,246 Weighted-average grant-date fair value $ 10.14 $ 9.07 $ 8.08
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. Grants under the plan for 1996 are summarized below:
1996 Number of shares 28,079 Weighted-average grant-date fair value $ 14.79
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 1998, 1997 and 1996 are summarized below:
1998 1997 1996 Number of shares 4,805 1,915 2,212 Weighted-average grant-date fair value $32.04 $19.01 $14.79
- --Page 39-- 166 37 NOTE I -- PREFERRED STOCK AND CUMULATIVE PREFERRED SECURITIES As of December 31, 1998, 1st Source has 10 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, at the annual rate of 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, at an annual rate 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, 1998, 1997 and 1996, total pension expense for this plan amounted to $422,000, $433,000 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, 1998, 1997 and 1996, amounted to $1.34 million, $1.29 million, and $1.21 million, respectively. 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 $78,000 in 1998, $54,000 in 1997 and $40,000 in 1996. In addition, Trustcorp Mortgage Company made discretionary contributions of $145,000 in 1998, $103,000 in 1997, and $100,000 in 1996. 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, 1998, 1997 and 1996 were not material. - --Page 40-- NOTE K -- INCOME TAXES
Income tax expense is comprised of the following: 1998 1997 1996 Current: (Dollars in thousands) Federal $6,935 $6,969 $10,036 State 2,477 2,584 3,507 Total Current 9,412 9,553 13,543 Deferred: Federal 6,328 3,824 (906) State 1,805 1,015 (241)
167 38
Total Deferred 8,133 4,839 (1,147) Total Provision $17,545 $14,392 $12,396
Deferred tax assets and liabilities as of December 31, 1998 and 1997 consisted of the following:
1998 1997 Deferred tax assets: (Dollars in thousands) Reserve for loan losses $17,303 $14,991 Accruals for employee benefits 3,323 2,554 Asset securitization 1,627 2,309 Mortgage loans - Section 475 416 441 Deferred income 376 427 Excess servicing 249 119 Other 792 511 Total $24,086 $21,352 1998 1997 Deferred tax liabilities: Differing depreciable bases in premises and leased equipment $10,597 $5,373 Purchased servicing 5,259 1,728 Originated mortgage servicing rights 2,456 1,017 Net unrealized appreciation of securities available-for-sale 2,039 1,288 Differing bases in assets related to acquisitions 1,000 1,235 Discounts accreted on investment securities 157 210 Other 636 426 Total $22,144 $11,277
There was no valuation allowance at December 31, 1998 and 1997. 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 1998 1997 1996 Percent of Percent of Percent of Pretax Pretax Pretax Amount Income Amount Income Amount Income (Dollars in thousands) Statutory federal income tax $17,775 35.0% $14,917 35.0% $12,460 35.0% Increase (decrease) in income taxes resulting from: Tax-exempt interest income (2,894) (5.7) (2,968) (7.0) (2,922) (8.2) State taxes, net of federal income tax benefit 2,783 5.4 2,339 5.5 2,123 5.9 Interest expense incurred to carry tax-exempt securities 403 0.8 417 1.0 376 1.1 Contribution of appreciated stock (150) (0.3) (358) (0.8) - - Other (372) (0.7) 45 0.1 359 1.0 Total $17,545 34.5% $14,392 33.8% $12,396 34.8%
168 39 - --Page 41-- 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 13 years with options to renew for up to 15 additional years. Approximately 30% of the facility is subleased to other tenants. At December 31, 1998, future minimum rental commitments for all noncancellable operating leases, reduced by future minimum rentals from subleases of $1.91 million, aggregate $17.41 million. Annual rental commitments and sublease rentals for noncancellable operating leases (excluding operating costs) for the five years succeeding December 31, 1998, are as follows:
Rental Sublease Commitments Rentals (Dollars in thousands) 1999 $ 2,105 $389 2000 1,845 388 2001 1,648 386 2002 1,395 382 2003 1,327 76 Thereafter $10,999 $291
Rental expense of office premises and equipment and related sublease income were as follows:
Years Ended December 31 1998 1997 1996 (Dollars in thousands) Gross rental expense $2,243 $2,190 $2,203 Sublease rental income (672) (677) (677) Net Rental Expense $1,571 $1,513 $1,526
NOTE M -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK 1st Source and its subsidiaries are parties to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. 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 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 1998 and 1997, 1st Source and its subsidiaries had commitments outstanding to originate and purchase loans aggregating $362 million and $410 million, respectively. Outstanding commitments to sell loans aggregated $198 million at December 31, 1998 and $120 million at December 31, 1997. Commercial and standby letters of credit totaled $82 million and $57 million at December 31, 1998 and 1997, respectively. 1st Source Bank participates in interest rate swap agreements as part of its program to manage the impact of fluctuating interest 40 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 - --Page 42-- NOTE M -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK -- CONCLUDED 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, 1998, 1st Source had two outstanding amortizing interest rate swap agreements with an aggregate notional value of $26.9 million. The agreements have maturities of January 25, 2002 and March 25, 2001. The notional amounts and lives of amortizing swaps change based on certain interest rate indices. Generally, as rates fall, the notional amounts of amortizing swaps decline more rapidly and as rates increase notional amounts decline more slowly. Unrealized gains/(losses) based on fair value approximated $70,000 at December 31, 1998 and ($137,000) at December 31, 1997. NOTE N -- CONCENTRATIONS 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, 1998 and 1997, are business loans to companies in the following industries:
Percentage of Total Amount Business Loans 1998 1997 1998 1997 (Dollars in thousands) Truck and automobile leasing $200,005 $267,596 13.9% 18.9% Air transportation and aircraft dealers 199,459 179,653 13.9 12.7 Construction equipment and contractors 149,288 124,148 10.4 8.8 Real estate operators, managers and developers 64,381 74,542 4.5 5.3 Van conversion, manufactured housing and recreational vehicle industries 61,405 52,870 4.3 3.7
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 capi-tal to average assets. Management believes, as of De-cember 31, 1998, that 1st Source meets all capital adequacy requirements to which it is subject. As of December 31, 1998, 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 41 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 - --Page 43-- NOTE O -- CAPITAL ADEQUACY -- CONCLUDED the table. There are no conditions or events since that notification that management believes changed the institution's category. 1st Source and its largest subsidiary, 1st Source Bank's actual capital amounts and ratios are presented in the table below:
To Be Well Capitalized Under Minimum Capital Prompt Corrective Actual Adequacy Action Provisions $ Amount Ratio $ Amount Ratio $ Amount Ratio As of December 31, 1998: (Dollars in thousands) Total Capital (to Risk- Weighted Assets): Consolidated $281,604 13.37% $168,444 8.00% $210,555 10.00% 1st Source Bank 253,379 12.42 163,203 8.00 204,003 10.00 Tier I Capital (to Risk- Weighted Assets): Consolidated 254,760 12.10 84,222 4.00 126,333 6.00 1st Source Bank 227,344 11.14 81,601 4.00 122,402 6.00 Tier I Capital (to Average Assets): Consolidated 254,760 9.50 107,219 4.00 134,024 5.00 1st Source Bank 227,344 8.84 102,870 4.00 128,587 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. NOTE Q -- 1ST SOURCE CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION STATEMENTS OF FINANCIAL CONDITION
December 31 1998 1997 ASSETS (Dollars in thousands) Cash $1 $30 Short-term investments with bank subsidiary 3,402 2,244 Investment securities, available-for-sale (amortized cost of $20,341 and $17,889 at December 31, 1998 and 1997, respectively) 20,999 18,873 Investments in: Bank subsidiaries 229,713 182,919 Non-bank subsidiaries 11,687 11,098 Loan receivables: Bank subsidiary _ 30,000 Non-bank subsidiary 7,755 4,000 Premises and equipment, net 3,150 3,398 Other assets 4,568 4,174 Total Assets $281,275 $256,736
42
December 31 1998 1997 LIABILITIES AND (Dollars in thousands) SHAREHOLDERS' EQUITY Commercial paper borrowings $6,171 $4,198 Other liabilities 2,689 1,356 Long-term debt 56,556 56,229 Total Liabilities 65,416 61,783 Shareholders' Equity 215,859 194,953 Total Liabilities and Shareholders' Equity $281,275 $256,736
- --Page 44-- NOTE Q -- 1ST SOURCE CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION -- CONTINUED STATEMENTS OF INCOME
Year Ended December 31 1998 1997 1996 (Dollars in thousands) Income: Dividends from bank subsidiaries $6,596 $5,725 $5,029 Rental income from subsidiaries 2,363 2,273 2,071 Other 2,883 3,447 679 Total Income 11,842 11,445 7,779 Expenses: Interest on long-term debt 4,612 3,810 1,015 Interest on commercial paper and other short-term borrowings 264 309 274 Rent expense 1,076 1,076 1,074 Other 2,501 2,681 1,775 Total Expenses 8,453 7,876 4,138 Income Before Income Tax Credits and Equity in Undistributed Income of Subsidiaries 3,389 3,569 3,641 Income tax credits 1,556 925 639 Income Before Equity in Undistributed Income of Subsidiaries 4,945 4,494 4,280 Equity in undistributed income of subsidiaries: Bank subsidiaries 23,194 19,736 18,257 Non-bank subsidiaries 2,881 2,259 666 Net Income $31,020 $26,489 $23,203
- --Page 45-- NOTE Q -- 1ST SOURCE CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION -- CONCLUDED STATEMENTS OF CASH FLOWS
Year Ended December 31 1998 1997 1996 (Dollars in thousands) Operating Activities: Net income $31,020 $ 26,489 $23,203 Adjustments to reconcile net income to net cash provided by operating activities:
43
Equity in undistributed income of subsidiaries (26,075) (21,995) (18,923) Depreciation of premises and equipment 225 201 175 Realized and unrealized investment securities gains (losses) 99 176 (52) Other 2,284 3,054 2,854 Net Cash Provided by Operating Activities 7,553 7,925 7,257 Investing Activities: Proceeds from sales and maturities of investment securities 3,603 8,759 3,804 Purchase of investment securities (6,195) (15,788) (2,955) Sale (purchase) of premises and equipment, net 23 (422) (471) Contributed capital for new non-bank subsidiary - (1,384) - Decrease (increase) in short-term investments with bank subsidiary (1,158) 3,593 (582) Decrease (increase) in loans made to subsidiaries, net 6,245 (34,000) 300 Net Cash Provided by (Used in) Investing Activities 2,518 (39,242) 96 Financing Activities: Net increase (decrease) in commercial paper and other short-term borrowings 1,973 (2,269) 1,616 Proceeds from issuance of cumulative trust preferred securities - 44,750 - Proceeds from issuance of long-term debt 434 1,45 - Payments on long-term debt (107) (2,834) (3,346) Acquisition of treasury stock (7,116) (5,023) (1,488) Cash dividends (5,296) (4,723) (4,123) Other 12 (7) (12) Net Cash Provided by (Used in) Financing Activities (10,100) 31,346 (7,353) Increase (Decrease) in Cash and Cash Equivalents (29) 29 - Cash and cash equivalents, beginning of year 30 1 1 Cash and Cash Equivalents, End of Year $1 $30 $ 1
- --Page 46-- REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of 1st Source Corporation: In our opinion, the accompanying consolidated statements of financial condition and the related consolidated statements of income, shareholders' equity and of cash flows present fairly, in all material respects, the financial position of 1st Source Corporation and its subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. 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 audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP South Bend, Indiana January 14, 1999 44 - --Page 47--
OFFICERS AND DIRECTORS OFFICERS [1ST SOURCE CORPORATION LOGO] 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, University of Notre Dame Paul R. Bowles Former Vice President, Corporate Development, Clark Equipment Company Philip J. Faccenda General Counsel Emeritus, University of Notre Dame Daniel B. Fitzpatrick Chairman, President and Chief Executive Officer, Quality Dining, Inc. Lawrence E. Hiler Chairman, Hiler Industries William P. Johnson Chairman and Chief Executive Officer, Goshen Rubber Company, Inc. 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 Richard J. Pfeil Chairman and President, Koontz-Wagner Electric Company, 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 Vice President, Trust Operations Group Vincent A. Tamburo Senior Vice President and Secretary, General Counsel Maggie M. Kernan Senior Vice President, Marketing Division
45
Dan L. Craft Senior Vice President, Human Resources Division DIRECTORS Rev. E. William Beauchamp Executive Vice President, University of Notre Dame Paul R. Bowles Former Vice President, Corporate Development, Clark Equipment Company Philip J. Faccenda General Counsel Emeritus, University of Notre Dame 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 Anne M. Hillman Civic Leader Hollis E. Hughes, Jr. Executive Director, United Way of St. Joseph County H. Thomas Jackson Chairman, Bornemann Coated Fabrics, Bornemann Products William P. Johnson Chairman and Chief Executive Officer, Goshen Rubber Company, Inc. Wellington D. Jones III President Craig A. Kapson President, Jordan Ford, Toyota, Volvo, Lincoln Mercury David L. Lerman President, Steel Warehouse Co. Inc. Christopher J. Murphy III Chairman and Chief Executive Officer 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 48-- SHAREHOLDERS' INFORMATION 1998 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 1998 and book value were:
Cash Dividends Quarter Ended High* Low* Paid* March 31 $ 33 3/4 $25 1/4 $.066 June 30 36 3/4 30 3/4 .066 September 30 36 27 1/2 .073 December 31 32 25 3/4 .073 Book value per common share at December 31, 1998: $11.43.*
46 *Adjusted for a 10% stock dividend declared January 14, 1999. ANNUAL MEETING OF SHAREHOLDERS The Annual Meeting of Shareholders has been called for 10:00 am, EST, Thursday, April 15, 1999, 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 PricewaterhouseCoopers LLP P.O. Box 6877 South Bend, IN 46660-6877 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, 1998, as required to be filed with the Securities and Exchange Commission, is available upon request. MARKET MAKERS (AS OF JANUARY 14, 1999) The following firms make a market in the common shares of 1st Source Corporation: ABN-AMRO Securities (USA) City Securities Corporation Herzog, Heine, Geduld, Inc. Howe, Barnes Investments, Inc. Keefe, Bruyette & Woods, Inc. NatCity Investments, Inc. Roney Capital Markets Stifel, Nicolaus & Company, Incorporated Troster Singer Corporation - --Outside Back Cover-- 100 North Michigan Street Post Office Box 1602 South Bend, Indiana 46634 EX-21 11 SUBSIDIARIES OF REGISTRANT, ATTACHED HERETO 1 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT The following is a listing of all subsidiaries of 1st Source Corporation. Unless otherwise indicated, each subsidiary does business under its own name. The activities of each is described in Part I, Item I, of Form 10-K.
NAME DATE OF INCORPORATION JURISDICTION ---- ---------------------- ------------ 1st Source Bank April 19, 1922 Indiana 1st Source Auto Leasing, Inc.* October 29, 1973 Indiana (Inactive) 1st Source Insurance, Inc.* July 12, 1978 Indiana 1st Source Travel, Inc.* March 4, 1982 Indiana (Inactive) FBT Capital Corporation February 6, 1970 Indiana (Inactive) 1st Source Leasing, Inc. November 29, 1979 Indiana 1st Source Capital Corporation* November 16, 1983 Indiana Trustcorp Mortgage Company December 5, 1973 Indiana 1st Source Capital Trust I February 20, 1997 Delaware 1st Source Capital Trust II February 27, 1997 Delaware Michigan Transportation Finance Corporation* August 1, 1997 Michigan 1st Source Funding Corporation* June 12, 1998 Delaware * Wholly-owned subsidiaries of 1st Source Bank
EX-23 12 CONSENT OF INDEPENDENT ACCOUNTANTS 1 EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of 1st Source Corporation on Forms S-8 of our report dated January 14, 1999, on our audits of the consolidated financial statements of 1st Source Corporation and subsidiaries as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, which report is incorporated by reference in this Annual Report on Form 10-K of 1st Source Corporation for the year ended December 31, 1998. PricewaterhouseCoopers LLP South Bend, Indiana March 1, 1999 EX-27 13 FINANCIAL DATA SCHEDULE
9 1,000 12-MOS DEC-31-1998 DEC-31-1998 132,514 1,951 40,000 0 443,691 96,008 99,734 1,881,696 40,929 2,732,021 2,177,107 242,159 38,957 57,939 6,270 0 0 209,589 2,732,021 168,462 25,338 2,348 196,148 86,264 102,227 93,921 9,156 (612) 85,500 50,786 31,020 0 0 31,020 1.63 1.60 4.16 9,266 275 0 0 35,424 4,799 (1,148) 40,929 18,513 0 22,416
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