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, 1997 ------------------------------------------------ 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. [ X ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of February 17, 1998. Common Stock, without par value - $279,966,444. - ----------------------------------------------- The number of shares outstanding of each of the registrant's classes of stock as of February 17, 1998. Common Stock, without par value - 17,450,797 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, 1997, are incorporated by reference into Part II. Portions of the annual proxy statement for the 1998 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 "Company" refers to 1st Source Corporation and its subsidiaries. At December 31, 1997, the Company had assets of $2.42 billion, deposits of $1.89 billion and total shareholders' equity of $195.0 million. Pages 18 through 41 of the Company's Annual Report to Shareholders for the year ended December 31, 1997 are incorporated herein by reference. The Company, 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 45 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 eight counties in northern Indiana and three counties in southwestern lower Michigan. South Bend, in St. Joseph County, is the largest city in a 55-mile radius, and is a regional center for educational institutions, health care, financial, accounting and legal services and retailing. The Company'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, and Trustcorp Mortgage Company, a mortgage banking company with four offices in Indiana and one in Ohio. The Company's inactive subsidiaries include 1st Source Travel, Inc., 1st Source Auto Leasing, Inc., and FBT Capital Corporation. The principal executive office of the Company is located at 100 North Michigan Street, South Bend, Indiana 46601 and its telephone number is (219) 235-2000. BUSINESS STRATEGY AND OBJECTIVES The Company, 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 the Company 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. The Company 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. The Company opened three new banking locations in 1997 and ten in 1996 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 includes eight counties in northern Indiana and three counties in southwestern lower Michigan. Management 2
3 believes that such a strategy allows the most effective and efficient use of the Company's marketing resources and assures that the Company's banking offices are accessible to a majority of the people residing in the markets served. The Company'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. The Company currently provides a number of fee-based services to its clients, the major services being trust, mortgage banking, equipment leasing, property and casualty insurance, and securitized loan servicing. The Company 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. The Company 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 the Company. The Company's fee-based businesses are designed to strengthen the relationship between the Company and its customers. 3. Expand the national niche businesses across the United States taking advantage of specialized opportunities. The Company 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 Transportation and Equipment Financing Group, which provides such services. Additional experienced sales people have been and will be added to ensure better geographic coverage in areas of opportunity. The Company 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. The Company 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 the Company's overall credit experience. BANKING AND FINANCIAL SERVICES The organization provides financial services through the following groups: * Personal and Small Business Banking Group -- The Bank's Personal and Small Business Banking Group serves individuals and small businesses with direct lending, credit cards, auto leasing, personal trust, brokerage services, and a wide range of deposit products. The Group's operations are conducted through the Bank's main office, its 45 branch offices, two free-standing drive-up facilities and 47 automatic teller machines. Loans of approximately $462 million and deposits of approximately $1.56 billion were attributable to the Group at December 31, 1997. The Bank's Personal Trust Division managed approximately 1,626 accounts at December 31, 1997, consisting of $929 million in assets. The Personal Trust Division earned $4.77 million in fee income during 1997. 3
4 Besides traditional branch locations, alternative delivery systems are in place to enhance customer service. Certificates of Deposit and the ability to pay bills are offered on the Internet and customers also can use their telephone to check their account balances and transfer funds 24 hours a day. A centralized "loan by phone" system provides customers with immediate loan decisions while they are on the phone and coordinates product delivery through the local banking offices. The organization's goal is to continue to improve the match between a customer's individual needs and the Bank's products and services. * Commercial Banking Group -- The Bank's Commercial Banking Group provides a wide range of services to business customers, including loans and leases, investments, international services, corporate cash management and employee benefit trust services. Customers can initiate deposit and loan transactions, check balances and account clearings, and transfer funds among accounts on a daily basis using a direct-access PC to communicate with the Bank. The Group's primary focus is privately-held or closely-controlled firms, which have annual sales between $2 million and $100 million and are doing business or are located within an 80-mile radius of South Bend. Loans of approximately $541 million and deposits of approximately $71 million were attributable to the Group at December 31, 1997. The Bank's Employee Benefit Division managed approximately 526 retirement plans at December 31, 1997, consisting of $626 million in assets. The Employee Benefit Division earned $2.54 million in fee income during 1997. * Transportation and Equipment Financing Group -- The Bank's Transportation and Equipment Financing Group offers specialized financing services nationwide. The Group serves a limited number of high-quality automobile leasing and rental companies, truck leasing companies and manufacturers of specialized truck bodies, finances used aircraft nationwide, and provides lending services to dealers, contractors and other end users of construction equipment. The Group has employees located in Alaska, Georgia, Indiana, Kansas, Michigan, North Carolina, Pennsylvania, Washington and Wisconsin. Loans of approximately $743 million, or 41.3% of the Company's consolidated total loans, were attributable to the Group at December 31, 1997. The Group also services approximately $167 million of off-balance sheet loans, primarily as the result of securitizations. * Mortgage Banking Group -- Trustcorp Mortgage Company, a subsidiary of the Company, is a mortgage banking company operating on a regional basis. The principal business activities include origination, purchase, sale and servicing of mortgage loans for investors. Locations include four offices in Indiana and one in Columbus, Ohio. As of December 31, 1997, Trustcorp Mortgage Company had outstanding loans of $49 million and serviced a mortgage portfolio of $1.35 billion. OWNERSHIP As of February 17, 1998, the directors and executive officers of the Company and their immediate families owned approximately 44.2% of the Company's common stock and, as a result, exercise substantial control over the Company. 4
5 COMPETITION The activities in which the Company 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 the Company's principal market. Larger financial institutions competing within the Company's principal market, but headquartered elsewhere, include KeyBank, Norwest Bank, Standard Federal Bank and Valley American Bank and Trust Company. 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. In addition to competing with other banks within their 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 the Company'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 the Company in providing some services. The Company competes against larger financial institutions, which have the advantage of certain economies of scale not enjoyed by a financial institution the size of the Company. 1st Source counters by relying on a history in the market dating back to 1863, with the relationships long-term employees have with their customers and with the capacity for quick local decision-making. EMPLOYEES The Company employs approximately 966 persons on a full-time equivalent basis. The Company provides a wide range of employee benefits and considers employee relations to be good. REGULATION AND SUPERVISION GENERAL. The Company 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 the Company. The operations of the Company may be affected by legislative changes and by the policies of various regulatory authorities. The Company 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. The Company is a registered bank holding company under 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"). The Company is required to file annual reports with the Federal Reserve and to provide the Federal Reserve such additional information as it may require. 5
6 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). Recent and Pending Legislation. The enactment of the legislation described below has significantly affected the banking industry generally and will have an ongoing effect on the Company and the Bank in the future. 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. FIRREA, among other things, enhanced the supervisory and enforcement powers for the federal bank regulatory agencies, required insured financial institutions to guaranty repayment of losses incurred by the FDIC in connection with the failure of an affiliated financial institution, required financial institutions to provide their primary federal regulator with notice (under certain circumstances) of changes in senior management and broadened authority for bank holding companies to acquire savings institutions. Under FIRREA, federal banking regulators have greater flexibility to bring enforcement actions against insured institutions and institution-affiliated parties, including cease and desist orders, prohibition orders, civil money penalties, termination of insurance and the imposition of operating restrictions and capital plan requirements. These enforcement actions, in general, may be initiated for violations of laws and regulations and unsafe or unsound practices. FIRREA granted the FDIC back-up enforcement authority to recommend enforcement action to an appropriate federal banking agency and to bring such enforcement action against a financial institution or an institution-affiliated party if such federal banking agency fails to follow the FDIC's recommendation. FIRREA also requires, except under certain circumstances, public disclosure of final enforcement actions by the federal banking agencies. The Federal Deposit Insurance Corporation Improvement Act of 1991. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") was adopted to recapitalize the Bank Insurance Fund ("BIF") and impose certain supervisory and regulatory reforms on insured depository institutions. FDICIA, in general, includes provisions, among others, to (i) increase the FDIC's line of credit with the U.S. Treasury in order to provide the FDIC with additional funds to cover the losses of federally insured banks, (ii) reform the deposit insurance system, including the implementation of risk-based deposit insurance premiums, (iii) establish a format for closer monitoring of financial institutions to enable prompt corrective action by banking regulators when a financial institution begins to experience financial difficulty, (iv) establish 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, (v) require the banking regulators to set operational and managerial standards for all insured depository institutions and their holding companies, including limits on excessive compensation to executive officers, directors, employees and principal shareholders, and establish standards for loans secured by real estate, (vi) adopt certain accounting reforms and require annual on-site examinations of federally insured institutions, including the ability to require independent audits of banks and thrifts, (vii) revise risk-based capital standards to ensure that they (a) take adequate account of interest-rate changes, concentration of credit risk and the risks of nontraditional activities, and (b) reflect the actual performance and expected risk of loss of multi-family mortgages, and (viii) restrict state-chartered banks from engaging in activities not permitted for national banks unless they are adequately capitalized and have FDIC approval. FDICIA also permits the FDIC to make special assessments on insured depository institutions, in amounts determined by the FDIC to be necessary to give it adequate assessment income to repay amounts borrowed 6
7 from the U.S. Treasury and other sources or for any other purpose the FDIC deems necessary and grants authority to the FDIC to establish semiannual assessment rates on BIF and the Savings Association Insurance Fund ("SAIF") member banks so as to maintain these funds at the designated reserve ratios. FDICIA also contained the Truth in Savings Act, which requires clear and uniform disclosure of the rates of interest payable on deposit accounts by depository institutions, and the fees assessable against deposit accounts, so that consumers can make a meaningful comparison between the competing claims of financial institutions with regard to deposit accounts and products. 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. A state is permitted to "opt out" of portions of the law which will permit conversion of separate banks to branches, but is not permitted to "opt out" of portions of the law allowing bank holding companies from other states to enter the state. A state may also determine, at its option, to permit interstate branching through the establishment of de novo branches by out-of-state banks. The states of Indiana and Michigan have "opted in" early to the interstate branching provisions of the Interstate Act and have also authorized the establishment of de novo branches of out-of-state banks. The Bank established two such branches in Michigan during 1996 and 1997. The Interstate Act also establishes limits on acquisitions by large banking organizations, providing that no acquisition may be undertaken if it would result in the organization having deposits exceeding either 10% of all bank deposits in the United States or 30% of the bank deposits in the state in which the acquisition would occur. 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. Under EGRPRA, qualified bank holding companies may commence a regulatorily approved non-banking activity without prior notice to the Federal Reserve; written notice is required within 10 days after commencing the activity. Under EGRPRA, the prior notice period is reduced to 12 days in the event of any non-banking acquisition or share purchase, assuming the size of the acquisition does not exceed 10% of risk-weighted assets of the acquiring bank holding company and the consideration does not exceed 15% of Tier 1 capital. EGRPRA also provides for the recapitalization of SAIF, which generally insures the deposits of thrift institutions, in order to bring it into parity with the BIF. As a result of this recapitalization, the overall FDIC assessment rate for 1998 for the Bank is 1.26 basis points for each $100 of BIF assessable deposits. Pending Legislation. Because of concerns relating to competitiveness and the safety and soundness of the banking industry, Congress is considering a number of wide-ranging proposals for altering the structure, regulation and competitive relationships of the nation's financial institutions. Among such bills are new proposals to merge the BIF and the SAIF insurance funds, to alter the statutory separation of commercial and investment banking and to further expand the powers of banks, bank holding companies and competitors of banks. It cannot be predicted whether or in what form any of these proposals will be adopted or the extent to which the business of the Company may be affected thereby. 7
8 BANK AND BANK HOLDING COMPANY REGULATION. As noted above, both the Company and the Bank are subject to extensive regulation and supervision. Bank Holding Company Act. Under the Bank Holding Company Act of 1956, as amended (the "BHCA"), the activities of a bank holding company, such as the Company, are limited to business so closely related to banking, managing or controlling banks as to be a proper incident thereto. The Company is also subject to capital requirements applied on a consolidated basis in a form 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, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares), (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 Federal Reserve will not approve any acquisition, merger or consolidation that would have a substantially anticompetitive result, unless the anticompetitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also considers capital adequacy and other financial and managerial factors in reviewing acquisitions or mergers. The BHCA also prohibits a bank holding company, with certain limited exceptions, (i) from acquiring or retaining direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or (ii) from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities 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. The Federal Reserve, in making such determination, considers whether the performance of such activities by a bank holding company can be expected to produce benefits to the public such as greater convenience, increased competition or gains in efficiency in resources, which can be expected to outweigh the risks of possible adverse effects such as decreased or unfair competition, conflicts of interest or unsound banking practices. Insurance of Accounts. The FDIC provides insurance, through the BIF, to deposit accounts at the Bank to a maximum of $100,000 for each insured depositor. On January 1, 1996, the FDIC adopted an amendment to its BIF risk-based assessment schedule which effectively eliminated deposit insurance assessments for most commercial banks and other depository institutions with deposits insured by the BIF only. Following enactment of EGRPRA, the overall assessment rate for 1998 for institutions in the lowest risk-based premium category was revised to equal 1.26 cents for each $100 of BIF-assessable deposits. Deposits insured by the SAIF continue to be assessed at a higher rate. At this time, the deposit insurance assessment rate for institutions in the lowest risk-based premium category is zero, and all of the assessments paid by institutions in this category are used to service debt issued by the Financing Corporation, a federal agency established to finance the recapitalization of the former Federal Savings and Loan Insurance Corporation. 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 Federal Reserve and the FDIC adopted risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with 8
9 appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. Under these guidelines, all bank holding companies and federally regulated banks must maintain a minimum risk-based total capital ratio equal to 8%, of which at least one-half must be Tier 1 capital. The Federal Reserve also has implemented a leverage ratio, which is Tier 1 capital to total assets, to be used as a supplement to the risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base. The Federal Reserve requires a minimum leverage ratio of 3%. For all but the most highly-rated bank holding companies and for bank holding companies seeking to expand, however, the Federal Reserve expects that additional capital sufficient to increase the ratio by at least 100 to 200 basis points will be maintained. Management of the Company believes that the risk-weighting of assets and the risk-based capital guidelines do not have a material adverse impact on the Company'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. 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 the Company 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 as, and following credit underwriting procedures that are not less stringent than, 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 $49.3 million or less (subject to adjustment by the Federal Reserve) and an initial reserve of $1,479,000 plus 10% (subject to adjustment by the Federal Reserve to a level between 8% and 14%) must be maintained against that portion of total transaction accounts in excess of such amount. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements. 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. 9
10 Monetary Policy and Economic Control. The commercial banking business in which the Company 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 the Company and the Bank cannot be predicted. FORWARD LOOKING STATEMENTS Statements contained in this Report and in future filings by the Company with the Securities and Exchange Commission, in the Company's press releases and in oral statements made with the approval of an authorized executive officer which are not historical or current facts are "forward-looking statements" made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended). There can be no assurance, in light of these risks and uncertainties, that such forward-looking statements will in fact transpire. The following important factors, risks and uncertainties, among others, could cause actual results to differ materially from such forward-looking statements: * Credit risk: While the Company has had excellent credit quality in recent years, approximately 62% of its loans at December 31, 1997 were in commercial, financial, agricultural and transportation and equipment loans. Changes in local economic conditions could adversely affect credit quality in the Company's local business loan portfolio, while national regulatory or economic condition changes could negatively impact the quality of the transportation and equipment portfolio. * Interest rate risk: Although the Company actively manages its interest rate sensitivity, such management is not an exact science. Rapid increases or decreases in interest rates could adversely impact the Company's net interest margin if changes in its cost of funds do not correspond to the changes in income yields. Such fluctuations could also negatively impact the Company's mortgage banking operations, which are very interest rate sensitive, by increasing the runoff rates in the servicing portfolio, reducing loan origination activities, or increasing its funding costs. * Competition: The Company's activities in both its local and national niche businesses involve competition with other banks as well as other financial institutions and enterprises. Also, the financial service markets have and likely will continue to experience substantial changes, which could significantly change the Company's competitive environment in the future. * Retail expansion: The Company's planned future growth includes an emphasis on retail expansion, with the ten new branches opened in 1996, three in 1997, and those to be opened in 1998 and beyond. This expansion has and will continue to increase the Company's operating costs. The Company needs to achieve the revenue growth anticipated from this expansion in order to maintain its efficiency and profitability trends in future years. 10
11 * Legislative and regulatory environment: The Company operates in a rapidly changing legislative and regulatory environment. It cannot be predicted how or to what extent future developments in these areas will affect the Company. These developments could negatively impact the Company through increased operating expenses for compliance with new laws and regulations, restricted access to new products and markets, or in other ways. * General business and economic trends: These factors, including the impact of inflation levels, influence the Company's results in numerous ways, including operating expense levels, deposit and loan activity, and availability of trained individuals needed for future growth. The foregoing list should not be construed as exhaustive and the Company disclaims any obligation to subsequently update or revise any forward-looking statements after the date of this Report. 11
12 ITEM 1. BUSINESS (Continued) <TABLE> SELECTED STATISTICAL INFORMATION Distribution of Assets, Liabilities and Shareholders' Equity Interest Rates and Interest Differential (Dollars in Thousands) <CAPTION> Year ended December 31, 1997 1996 1995 --------------------------- -------------------------- --------------------------- Interest Interest Interest Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate --------------------------- -------------------------- --------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> ASSETS: Investment securities: Taxable $ 272,400 $ 16,638 6.11% $ 254,033 $ 15,337 6.04% $ 244,567 $ 15,184 6.21% Tax-exempt<F1> 151,686 11,723 7.73% 146,176 11,787 8.06% 129,409 11,285 8.72% Net loans<F2><F3> 1,610,889 148,061 9.19% 1,348,089 124,467 9.23% 1,172,438 111,115 9.48% Other investments 11,662 592 5.08% 18,757 995 5.30% 23,289 1,337 5.74% ---------- -------- ---- ---------- -------- ---- ---------- -------- ---- Total Earning Assets 2,046,637 177,014 8.65% 1,767,055 152,586 8.64% 1,569,703 138,921 8.85% Cash and due from banks 73,246 75,378 72,647 Reserve for loan losses (31,966) (28,482) (26,081) Other assets 110,383 81,263 70,291 ---------- ---------- ---------- Total $2,198,300 $1,895,214 $1,686,560 ========== ========== ========== <CAPTION> LIABILITIES AND SHAREHOLDERS' EQUITY: <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Interest bearing deposits $1,488,287 $73,150 4.92% $1,337,345 $64,214 4.80% $1,181,219 $56,185 4.76% Short-term borrowings 227,757 13,014 5.71% 156,003 7,843 5.03% 135,373 6,938 5.13% Long-term debt 16,527 1,160 7.02% 19,876 1,372 6.90% 23,302 1,823 7.82% Total Interest Bearing Liabilities 1,732,571 87,324 5.04% 1,513,224 73,429 4.85% 1,339,894 64,946 4.85% ---------- ------- ---- ---------- ------- ---- ---------- ------- ---- Noninterest bearing deposits 210,686 186,804 173,234 Other liabilities 72,500 33,862 30,765 Shareholders' equity 182,543 161,324 142,667 ---------- ---------- ---------- Total $2,198,300 $1,895,214 $1,686,560 ========== ========== ========== ------- ------- ------- Net Interest Income $89,690 $79,157 $73,975 ======= ======= ======= Net Yield on Earning Assets on ---- ---- ---- a Taxable Equivalent Basis 4.38% 4.48% 4.71% ==== ==== ==== <FN> <F1> Interest income including the effects of taxable equivalent adjustments, using a 40.525% rate. Tax equivalent adjustments were $3,536 in 1997, $3,635 in 1996 and $3,635 in 1995. <F2> Loan income includes fees on loans of $4,097 in 1997, $3,136 in 1996 and $2,739 in 1995. Loan income also includes the effects of taxable equivalent adjustments, using a 40.525% rate. Tax equivalent adjustments were $162 in 1997, $131 in 1996 and $171 in 1995. <F3> For purposes of this computation, nonaccruing loans are included in the daily average loan amounts outstanding. </TABLE> 12
13 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: <TABLE> <CAPTION> Increase (Decrease) Due to<F1> -------------------------------------------- Volume Rate Net ---------- -------- ------- (In Thousands) <S> <C> <C> <C> 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 ======= ======= ======= 1996 compared to 1995 Interest earned on: Loans $16,516 $(2,947) $13,569 Investment securities: Taxable 391 (455) (64) Tax-exempt 1,201 (699) 502 Interest-bearing deposits with other banks 88 36 124 Federal funds sold and other money market investments (361) (105) (466) ------- ------- ------- Total Earning Assets 17,835 (4,170) 13,665 Interest paid on: Savings deposits (44) (42) (86) Other time deposits 8,938 (823) 8,115 Short-term borrowings 1,037 (132) 905 Long-term debt (255) (196) (451) ------- ------- ------- Total Interest-Bearing Liabilities 9,676 (1,193) 8,483 ------- ------- ------- Net Interest Income $ 8,159 $(2,977) $ 5,182 ======= ======= ======= <FN> <F1> 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. </TABLE> 13
14 ITEM 1. BUSINESS (Continued) INVESTMENT PORTFOLIO The carrying amounts of investment securities at the dates indicated are summarized as follows: <TABLE> <CAPTION> December 31 ------------------------------- 1997 1996 1995 -------- -------- -------- (In Thousands) <S> <C> <C> <C> U.S. Treasury and government agencies and corporations $228,884 $253,434 $239,658 States and political subdivisions 148,228 150,044 140,319 Other 37,796 19,618 16,398 -------- -------- -------- Total $414,908 $423,096 $396,375 </TABLE> The following table shows the maturities of investment securities at December 31, 1997, 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. 14
15 ITEM 1. BUSINESS (Continued) <TABLE> <CAPTION> 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) <S> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Treasury and government agencies and corporations $77,994 5.66% $ 83,113 6.02% $ 6,096 6.02% $ 61,681 6.15% States and political subdivisions 19,776 6.98% 59,517 7.33% 57,612 8.41% 11,323 7.32% Other 120 6.76% 4,865 6.37% 1,953 7.14% 30,858 5.26% ------- ---- -------- ---- ------- ---- -------- ---- Total $97,890 5.93% $147,495 6.56% $65,661 8.15% $103,862 6.01% </TABLE> ============================================================================ 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 the Company's loan distribution at the end of each of the last five years for December 31: <TABLE> <CAPTION> 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> Domestic Loans: Transportation and equipment $ 752,677 $ 561,042 $ 457,930 $ 358,128 $ 382,483 Commercial, financial and agricultural 364,391 335,192 314,421 293,171 256,467 Real estate 568,136 468,109 408,028 377,532 316,758 Installment 111,577 91,220 79,036 71,882 64,105 ---------- ---------- ---------- ---------- ---------- Total Domestic Loans $1,796,781 $1,455,563 $1,259,415 $1,100,713 $1,019,813 ========== ========== ========== ========== ========== </TABLE> 15
16 ITEM 1. BUSINESS (Continued) LOAN PORTFOLIO (Continued) The following table shows the rate sensitivity of loans (excluding residential mortgages for 1-4 family residences, installment loans and lease financing) outstanding as of December 31, 1997. The amounts due after one year are also classified according to the sensitivity to changes in interest rates. <TABLE> <CAPTION> Rate Sensitivity ---------------------------------------------------------------- Within After One But After One Year Within Five Years Five Year Total -------- ----------------- --------- ---------- (In Thousands) <S> <C> <C> <C> <C> Transportation and equipment $422,833 $312,180 $ 7,317 $ 742,330 Commercial, financial and agricultural 263,019 45,392 5,210 313,621 Real Estate 196,261 30,459 9,099 235,819 -------- -------- ------- ---------- Total $882,113 $388,031 $21,626 $1,291,770 ======== ======== ======= ========== </TABLE> <TABLE> <CAPTION> Rate Sensitivity ---------------------------- Fixed Variable Rate Rate -------- -------- <S> <C> <C> Due after one year but within five years $376,874 $11,157 Due after five years 9,471 12,155 -------- ------- Total $386,345 $23,312 ======== ======= </TABLE> The following table summarizes the nonaccrual, past due and restructured loans: <TABLE> <CAPTION> December 31 ------------------------------------------------------------ 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ (Dollars in Thousands) <S> <C> <C> <C> <C> <C> Nonaccrual Loans $10,030 $6,678 $4,893 $3,314 $3,175 Accruing loans past due 90 days or more 730 557 274 477 494 Restructured loans -- -- -- 133 667 ------- ------ ------ ------ ------ Total Nonperforming Loans $10,760 $7,235 $5,167 $3,924 $4,336 ======= ====== ====== ====== ====== </TABLE> 16
17 ITEM 1. BUSINESS (Continued) LOAN PORTFOLIO (Concluded) Information with respect to nonaccrual and restructured loans at December 31, 1997 and 1996 is as follows: <TABLE> <CAPTION> December 31 -------------------- 1997 1996 ------ ------ (In Thousands) <S> <C> <C> Nonaccrual loans $10,030 $6,678 Interest income which would have been recorded under original terms 1,173 813 Interest income recorded during the period 387 280 </TABLE> At December 31, 1997, $9,561,000 of the nonaccrual loans are collateralized. Potential Problem Loans - ----------------------- At December 31, 1997, 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, 1997, 18.9% of total business loans were concentrated with borrowers in truck and automobile leasing companies. Loans to air transportation and aircraft dealers accounted for 12.7% of all business loans at December 31, 1997. 17
18 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: <TABLE> <CAPTION> December 31 -------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (In Thousands) <S> <C> <C> <C> <C> <C> Amount of loans outstanding at end of period $1,796,781 $1,455,563 $1,259,415 $1,100,713 $1,019,813 ========== ========== ========== ========== ========== Average amount of net loans outstanding during period $1,610,889 $1,348,489 $1,172,438 $1,066,752 $ 986,958 ========== ========== ========== ========== ========== Balance of reserve for loan losses at beginning of period $ 29,516 $ 27,470 $ 23,868 $ 22,350 $ 19,141 Charge-offs: Transportation and equipment 317 347 36 29 560 Commercial, financial and agricultural 293 2,385 985 1,007 809 Real Estate 157 230 597 816 92 Installment 643 324 372 205 560 ---------- ---------- ---------- ---------- ---------- Total charge-offs 1,410 3,286 1,990 2,057 2,021 ---------- ---------- ---------- ---------- ---------- Recoveries: Transportation and equipment 917 593 2,224 225 699 Commercial, financial and agricultural 101 383 287 166 359 Real estate 87 359 122 215 362 Installment 161 172 202 214 277 ---------- ---------- ---------- ---------- ---------- Total recoveries 1,266 1,507 2,835 820 1,697 ---------- ---------- ---------- ---------- ---------- Net charge-offs (recoveries) 144 1,779 (845) 1,237 324 Additions charged to operating expense 6,052 4,649 2,757 4,197 3,533 Recaptured reserve due to loan securitization -- (824) -- (1,442) -- ---------- ---------- ---------- ---------- ---------- Balance at end of period $ 35,424 $ 29,516 $ 27,470 $ 23,868 $ 22,350 ========== ========== ========== ========== ========== Ratio of net charge-offs (recoveries) to average net loans outstanding 0.01% 0.13% (0.07%) 0.12% 0.03% </TABLE> 18
19 The Company'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 possible losses from loans presently outstanding. The provision made to this reserve is determined by management based on assessment of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past loan loss experience and the financial condition of the borrower. Management of the Company 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 1997, after management's assessment of loan quality, the Company made a charge of $6.05 million to operations as a provision for loan losses. At December 31, 1997, the reserve for loan losses was $35.42 million, or 1.97% of loans outstanding net of unearned discount. As of December 31, 1997, impaired loans totaled $9.39 million, of which $1.14 million had corresponding specific reserves for loan losses totaling $0.61 million. The remaining $8.25 million 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. Interest on the remainder of the impaired loans is recognized on an accrual basis. For 1997, the average recorded investment in impaired loans was $9.46 million and interest income recognized on impaired loans totaled $376,000. 19
20 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: <TABLE> <CAPTION> (Dollars in Thousands) 1997 1996 1995 1994 1993 ----------------- ----------------- ----------------- ----------------- ----------------- Percent Percent Percent Percent Percent Of Loans Of Loans Of Loans Of Loans Of Loans In Each In Each In Each In Each In Each Category Category Category Category Category Reserve to Total Reserve to Total Reserve to Total Reserve to Total Reserve to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ------- -------- ------- -------- ------- -------- ------- -------- ------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Transportation and equipment $ 6,132 41.9% $ 4,553 38.5% $ 3,608 36.4% $ 2,917 32.5% $ 2,864 37.5% Commercial, financial and agricultural 2,864 20.3% 3,530 23.0% 3,396 25.0% 2,565 26.6% 3,011 25.1% Real estate 1,764 31.6% 1,360 32.2% 1,868 32.4% 2,060 34.4% 2,119 31.1% Installment 1,382 6.2% 1,212 6.3% 1,147 6.2% 1,166 6.5% 920 6.3% Unallocated $23,282 -- % 18,861 -- 17,451 -- 15,160 -- 13,436 -- ------- ----- ------- ----- ------- ----- ------- ----- ------- ----- Total $35,424 100.0% $29,516 100.0% $27,470 100.0% $23,868 100.0% $22,350 100.0% ======= ===== ======= ===== ======= ===== ======= ===== ======= ===== </TABLE> 20
21 ITEM 1. BUSINESS (Continued) DEPOSITS The average daily amounts of deposits and rates paid on such deposits are summarized as follows: <TABLE> <CAPTION> Year Ended December 31 ------------------------------------------------------------------- 1997 1996 1995 ------------------- ------------------- ------------------- Amount Rate Amount Rate Amount Rate ---------- ---- ---------- ---- ---------- ---- <S> <C> <C> <C> <C> <C> <C> Noninterest bearing demand deposits $ 210,685 -- % $ 186,804 -- % $ 173,234 -- % Interest bearing demand deposits 75,765 2.30% 135,328 2.21% 174,059 2.22% Savings deposits 341,777 2.52% 279,608 2.76% 242,504 2.85% Other time deposits 1,070,746 5.86% 922,409 5.80% 764,656 5.94% ---------- ---------- ---------- Total $1,698,973 $1,524,149 $1,354,453 ========== ========== ========== </TABLE> 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, 1997, by time remaining until maturity is as follows (in thousands): <TABLE> <S> <C> Under 3 months $220,399 4 - 6 months 71,148 7 - 12 months 52,592 Over 12 months 65,464 -------- $409,603 ======== </TABLE> 21
22 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: <TABLE> <CAPTION> Year Ended December 31 ------------------------------------------------ 1997 1996 1995 ------ ------ ------ <S> <C> <C> <C> Percentage of net income to: Average shareholders' equity 14.51% 14.38% 14.75% Average total assets 1.21% 1.22% 1.25% Percentage of dividends declared per common share to diluted net income per common share 18.46% 18.18% 17.48% Percentage of average shareholders' equity to average total assets 8.30% 8.51% 8.46% </TABLE> 22
23 ITEM 1. BUSINESS (Concluded) SHORT-TERM BORROWINGS The following table shows the distribution of the Company'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. <TABLE> <CAPTION> Federal Funds Purchased and Security Other Repurchase Commercial Short-Term Total 1997 Agreements Paper Borrowings Borrowings - ---------------------------- ------------- ---------- ---------- ---------- <S> <C> <C> <C> <C> 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% 1995 - ---------------------------- Balance at December 31, 1995 $101,166 $4,515 $ 47,298 $152,979 Maximum amount outstanding at any month-end 123,393 5,318 52,835 181,546 Average amount outstanding 96,091 4,369 34,913 135,373 Weighted average interest rate during the year 5.16% 5.61% 4.97% 5.13% Weighted average interest rate for outstanding amounts at December 31, 1995 5.13% 5.54% 6.84% 5.67% </TABLE> 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 days. 23
24 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. The Company also owns property and/or buildings on which 28 of the bank subsidiary's 45 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, the Company reacquired its former headquarters building through foreclosure. It is being refurbished for additional tenants and Company 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 17 of the annual shareholders report for the year ended December 31, 1997, is incorporated herein by reference. There were 1,165 shareholders of 1st Source Common Stock as of December 31, 1997. ITEM 6. SELECTED FINANCIAL DATA The information under the caption "Selected Consolidated Financial Data" on page 8 of the annual shareholders report for the year ended December 31, 1997, 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 7 through 17 of the annual shareholders report for the year ended December 31, 1997, 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. 24
25 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The report of independent accountants and the consolidated financial statements of the Company and its subsidiaries are included on pages 18 through 41 in the annual shareholders report for the year ended December 31, 1997, 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 6, 1998, 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 6, 1998, 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 6, 1998, is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information in the last paragraph on page 5 and in the first two paragraphs on page 6 of the proxy statement dated March 6, 1998, is incorporated herein by reference. 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 1997. (c) Exhibits -- The response to this portion of Item 14 is submitted as a separate section of this report. (d) Financial Statement Schedules -- None. 25
26 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 President and a Director Date: January 20, 1998 --------------------------------------------------- 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. <TABLE> <S> <C> /s/ ERNESTINE M. RACLIN, - --------------------------------------------------------- Ernestine M. Raclin, Chairman of the Board and a Director Date: January 20, 1998 --------------------------------------------------- /s/ CHRISTOPHER J. MURPHY III - --------------------------------------------------------- Christopher J. Murphy III, President and a Director (Principal Executive Officer) Date: January 20, 1998 --------------------------------------------------- /s/ VINCENT A . TAMBURO - --------------------------------------------------------- Vincent A. Tamburo, Secretary and General Counsel Date: January 20, 1998 --------------------------------------------------- /s/ LARRY E. LENTYCH - --------------------------------------------------------- Larry E. Lentych, Treasurer (Chief Financial and Accounting Officer) Date: January 20, 1998 --------------------------------------------------- 26
27 /s/ VINCE TAMBURO, P/A - --------------------------------------------------------- Reverend E. William Beauchamp, Director Date: January 20, 1998 --------------------------------------------------- /s/ PAUL R. BOWLES - --------------------------------------------------------- Paul R. Bowles, Director Date: January 20, 1998 --------------------------------------------------- /s/ PHILIP J. FACCENDA - --------------------------------------------------------- Philip J. Faccenda, Director Date: January 20, 1998 --------------------------------------------------- /s/ DANIEL B. FITZPATRICK - --------------------------------------------------------- Daniel B. Fitzpatrick, Director Date: January 20, 1998 --------------------------------------------------- /s/ LAWRENCE E. HILER - --------------------------------------------------------- Lawrence E. Hiler, Director Date: January 20, 1998 --------------------------------------------------- /s/ LEO J. MCKERNAN - --------------------------------------------------------- Leo J. McKernan, Director Date: January 20, 1998 --------------------------------------------------- /s/ WILLIAM P. JOHNSON - --------------------------------------------------------- William P. Johnson, Director Date: January 20, 1998 --------------------------------------------------- 27
28 /s/ REX MARTIN - --------------------------------------------------------- Rex Martin, Director Date: January 20, 1998 ---------------------------------------------------- /s/ DANE A. MILLER - --------------------------------------------------------- Dane A. Miller, Director Date: January 20, 1998 --------------------------------------------------- /s/ RICHARD J. PFEIL - --------------------------------------------------------- Richard J. Pfeil, Director Date: January 20, 1998 --------------------------------------------------- </TABLE> 28
29 ANNUAL REPORT ON FORM 10-K ITEM 14(a) (1) AND (2) LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES YEAR ENDED DECEMBER 31, 1997 1ST SOURCE CORPORATION SOUTH BEND, INDIANA F-1
30 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, 1997, are incorporated by reference in Item 8: Report of independent accountants Consolidated statements of financial condition -- December 31, 1997 and 1996 Consolidated statements of income -- Years ended December 31, 1997, 1996 and 1995 Consolidated statements of shareholders' equity -- Years ended December 31, 1997, 1996 and 1995 Consolidated statements of cash flows -- Years ended December 31, 1997, 1996 and 1995 Notes to consolidated financial statements -- December 31, 1997, 1996 and 1995 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
31 ANNUAL REPORT ON FORM 10-K ITEM 14(a) (3) AND 14(c) LIST OF EXHIBITS YEAR ENDED DECEMBER 31, 1997 1ST SOURCE CORPORATION SOUTH BEND, INDIANA E-1
32 FORM 10-K -- Item 14(a) (3) and 14(c) 1st SOURCE CORPORATION AND SUBSIDIARIES LIST OF EXHIBITS<F*> <TABLE> <C> <S> 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 19, 1993, filed as exhibit to Form 10-K, dated December 31, 1993, and incorporated herein by reference. 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 attached hereto. 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 attached hereto. 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 attached hereto. 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 attached hereto. 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 attached hereto. 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 attached hereto. 10(a) -- Employment Agreement of Christopher J. Murphy III, as amended February 1, 1997, filed as exhibit to Form 10-K, dated December 31, 1997, and attached hereto. E-2
33 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 attached hereto. 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 attached hereto. 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 attached hereto. 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 attached hereto. 13 -- Portions of Annual Report to Security Holders for the year ended December 31, 1997, attached hereto. 21 -- Subsidiaries of Registrant, attached hereto. 23 -- Consent of Independent Accountants, attached hereto. <FN> <F*> 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. </TABLE> E-3