FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 ------------------ 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 North Michigan Street South Bend, Indiana 46601 - ------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (574) 235-2702 -------------- (Registrant's telephone number, including area code) Not Applicable -------------- (Former name, former address and former fiscal year, if changed since last report.) 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Number of shares of common stock outstanding as of September 30, 2002 - 20,962,421.
INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Page Consolidated statements of financial condition -- 3 September 30, 2002, and December 31, 2001 Consolidated statements of income -- 4 three months and nine months ended September 30, 2002 and 2001 Consolidated statements of cash flows -- 5 nine months ended September 30, 2002 and 2001 Notes to the Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Item 3. Quantitative and Qualitative Disclosures About Market Risk 14 Item 4. Controls and Procedures 15 PART II. OTHER INFORMATION 16 Item 1. Legal Proceedings 16 Item 2. Changes in Securities 16 Item 3. Defaults Upon Senior Securities 16 Item 4. Submission of Matters to a Vote of Security Holders 16 Item 5. Other Information. 16 Item 6. Exhibits 16 Exhibit 99.1 Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002 Exhibit 99.2 Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002 SIGNATURES 17 CERTIFICATIONS 18 2
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION 1st Source Corporation and Subsidiaries (Dollars in thousands) September 30, December 31, 2002 2001 ----------- ----------- (Unaudited) ASSETS Cash and due from banks .......................... $ 118,762 $ 129,431 Federal funds sold and interest bearing deposits with other banks ..... 61,162 17,038 Investment securities: Securities available-for-sale, at fair value (amortized cost of $601,432 and $632,712 at September 30, 2002 and December 31, 2001) . 610,846 640,478 Loans - net of unearned discount ................. 2,391,418 2,535,364 Reserve for loan losses ........................ (58,946) (57,624) ----------- ----------- Net loans ........................................ 2,332,472 2,477,740 Equipment owned under operating leases, net of accumulated depreciation ............... 101,560 115,754 Premises and equipment, net of accumulated depreciation ............... 42,077 41,923 Other assets ..................................... 143,504 140,327 ----------- ----------- Total assets ..................................... $ 3,410,383 $ 3,562,691 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing ............................ $ 399,848 $ 365,193 Interest bearing ............................... 2,361,536 2,517,613 ----------- ----------- Total deposits ................................... 2,761,384 2,882,806 Federal funds purchased and securities sold under agreements to repurchase ............ 203,457 214,709 Other short-term borrowings ...................... 48,466 49,764 Other liabilities ................................ 29,642 52,533 Long-term debt ................................... 11,698 11,939 ----------- ----------- Total liabilities ................................ 3,054,647 3,211,751 Guaranteed preferred beneficial interests in 1st Source's subordinated debentures ........ 44,750 44,750 Shareholders' equity: Common stock-no par value ...................... 7,579 7,579 Capital surplus ................................ 214,001 214,001 Retained earnings ............................. 91,853 91,591 Less cost of common stock in treasury ......... (7,462) (12,591) Accumulated other comprehensive income ........ 5,015 5,610 ----------- ----------- Total shareholders' equity ....................... 310,986 306,190 ----------- ----------- Total liabilities and shareholders' equity ....... $ 3,410,383 $ 3,562,691 =========== =========== The accompanying notes are a part of the consolidated financial statements. 3
<TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF INCOME 1st Source Corporation and Subsidiaries (Unaudited - Dollars in thousands, except per share amounts) Three Months Ended Nine Months Ended September 30 September 30 ------------------ ---------------- 2002 2001 2002 2001 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Interest and fee income: Loans ...................................................... $ 42,233 $ 52,939 $ 130,557 $ 161,592 Investment securities: Taxable ................................................ 4,294 5,570 13,986 17,289 Tax-exempt ............................................. 1,464 1,716 4,555 5,220 Other .................................................. 41 132 239 410 ----------- ------------ ------------ ------------ Total interest income ....................................... 48,032 60,357 149,337 184,511 Interest expense: Deposits ................................................. 17,129 26,707 55,035 84,605 Short-term borrowings .................................... 1,586 3,476 4,114 12,467 Long-term debt ........................................... 213 218 637 655 ----------- ------------ ------------ ------------ Total interest expense ...................................... 18,928 30,401 59,786 97,727 ----------- ------------ ------------ ------------ Net interest income ......................................... 29,104 29,956 89,551 86,784 Provision for loan losses ................................... 9,750 9,807 34,416 21,566 ----------- ------------ ------------ ------------ Net interest income after provision for loan losses ................................ 19,354 20,149 55,135 65,218 Noninterest income: Trust fees ............................................... 2,606 2,428 7,927 7,359 Service charges on deposit accounts ...................... 3,833 2,969 10,988 8,245 Loan servicing and sale income ........................... 788 4,519 8,104 24,999 Equipment rental income .................................. 7,157 6,922 21,901 18,970 Other income ............................................. 3,637 3,193 9,951 9,651 Investment securities and other investment (losses) gains (600) 0 (1,088) 1,084 ----------- ------------ ------------ ------------ Total noninterest income .................................... 17,421 20,031 57,783 70,308 ----------- ------------ ------------ ------------ Noninterest expense: Salaries and employee benefits ........................... 16,792 15,923 49,787 46,519 Net occupancy expense .................................... 1,745 1,508 5,125 4,547 Furniture and equipment expense .......................... 2,537 2,344 7,892 6,930 Depreciation - leased equipment .......................... 5,744 5,543 17,857 15,200 Supplies and communications .............................. 1,614 1,475 4,875 4,317 Business development and marketing expense ............... 314 1,078 1,924 3,160 Other expense ............................................ 4,766 2,463 11,960 7,743 ----------- ------------ ------------ ------------ Total noninterest expense ................................... 33,512 30,334 99,420 88,416 ----------- ------------ ------------ ------------ Income before income taxes and subsidiary trust distributions 3,263 9,846 13,498 47,110 Income taxes ................................................ 672 3,131 2,948 16,144 Distribution on preferred securities of subsidiary trusts, net of income tax benefit .............. 490 541 1,474 1,702 ----------- ------------ ------------ ------------ Net income .................................................. $ 2,101 $ 6,174 $ 9,076 $ 29,264 =========== ============ ============ ============ Other comprehensive income, net of tax: Change in unrealized appreciation of available-for-sale securities ........................... (614) 132 (595) 4,858 ----------- ------------ ------------ ------------ Total comprehensive income .................................. $ 1,487 $ 6,306 $ 8,481 $ 34,122 =========== ============ ============ ============ Per common share: Basic net income per common share ......................... $ 0.10 $ 0.30 $ 0.43 $ 1.41 =========== ============ ============ ============ Diluted net income per common share ....................... $ 0.10 $ 0.29 $ 0.43 $ 1.38 =========== ============ ============ ============ Dividends ................................................. $ 0.09 $ 0.09 $ 0.270 $ 0.261 =========== ============ ============ ============ Basic weighted average common shares outstanding ............ 20,963,707 20,779,292 20,927,734 20,762,987 ============ ============ ============ ============ Diluted weighted average common shares outstanding .......... 21,346,977 21,224,446 21,316,672 21,160,166 ============ ============ ============ ============ The accompanying notes are a part of the consolidated financial statements. </TABLE> 4
CONSOLIDATED STATEMENTS OF CASH FLOWS 1st Source Corporation and Subsidiaries (Unaudited - Dollars in thousands) Nine Months Ended September 30 2002 2001 --------- --------- Operating activities: Net income .................................... $ 9,076 $ 29,264 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses ..................... 34,416 21,566 Depreciation of premises and equipment ........ 21,609 18,647 Amortization of investment security premiums and accretion of discounts, net ............. 3,285 885 Amortization of mortgage servicing rights ..... 4,539 3,164 Mortgage servicing asset impairment charges ... 5,269 -- Deferred income taxes ......................... (11,316) (738) Realized investment securities losses (gains) 1,088 (1,084) Realized gains on securitized loans ........... (6,556) (6,012) Decrease in interest receivable ............... 4,129 439 Decrease in interest payable .................. (8,141) (6,845) Other ......................................... (5,811) (218) --------- --------- Net cash provided by operating activities 51,587 59,068 Investing activities: Proceeds from sales and maturities of investment securities .................... 228,515 254,914 Purchases of investment securities ............ (201,607) (286,491) Net (increase) decrease in short-term investments ........ ........................ (44,124) 30 Loans sold or participated to others .......... 395,229 1,707,978 Increase in loans net of principal collections ....................... (284,377) (1,911,084) Purchase of loans ............................. -- (29,054) Net increase in equipment owned under operating leases ...................... (3,663) (30,216) Purchases of premises and equipment ........... (4,298) (4,778) (Increase) decrease in other assets ........... (6,193) 7,671 Net cash paid in purchase acquisition ......... -- (6,208) Other ......................................... 392 (1,523) --------- --------- Net cash provided (used in) investing activities 79,874 (298,761) Financing activities: Net decrease in demand deposits, NOW accounts and savings accounts ............... (7,635) (90,506) Purchase of demand deposits and savings accounts ............................ -- 32,386 Net (decrease) increase in certificates of deposit ..................... (113,788) 263,135 Purchase of certificates of deposits .......... -- 27,628 Net (decrease) increase in short-term borrowings ....................... (12,550) 4,540 Proceeds from issuance of long-term debt ...... 126 217 Payments on long-term debt .................... (368) (205) Acquisition of treasury stock ................. (2,265) (1,125) Cash dividends ................................ (5,650) (5,436) ---------- --------- Net cash (used in ) provided by financing activities ........................ (142,130) 230,634 Decrease in cash and cash equivalents (10,669) (9,059) Cash and cash equivalents, beginning of period .. 129,431 118,123 --------- --------- Cash and cash equivalents, end of period ........ $ 118,762 $ 109,064 ========= ========= The accompanying notes are a part of the consolidated financial statements. 5
1ST SOURCE CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1. Basis of Presentation The accompanying unaudited consolidated financial statements reflect all adjustments (all of which are normal and recurring in nature) which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, the results of operations, and cash flows for the periods presented. These unaudited consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted. The Notes to the Consolidated Financial Statements appearing in 1st Source's 2001 Management's Discussion and Analysis of Financial Condition and Consolidated Financial Statements and Notes on Form 10-K (2001 Annual Report), which include descriptions of significant accounting policies, should be read in conjunction with these interim financial statements. The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. Note 2. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible Assets", effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill (and intangible assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets, such as core deposit intangibles, will continue to be amortized over their useful lives. 1st Source Corporation adopted the new rules on accounting for goodwill and other intangible assets beginning January 1, 2002. Approximately $25.8 million of goodwill and other intangible assets was on the balance sheet at December 31, 2001. 1st Source Corporation performed the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 and has determined no impairment exists. Application of the nonamortization provisions of the statement are not material for the second quarter of 2002 and are anticipated to result in an increase in net income of approximately $220,000, or $.01 per common share for the entire year. In October 2002, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards No. 147, "Acquisitions of Certain Financial Institutions - an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9", effective October 1, 2002. The Statement removes acquisitions of financial institutions from the scope of both Statement 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with FASB Statement No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible Assets". Thus the requirement in Statement 72 to recognize (and subsequently amortize) any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset no longer applies to business combinations. Management has evaluated the branch acquisitions that occurred in 2001 and determined that the acquisition of the branches in the Fort Wayne market from Standard Federal qualifies as a business combination. 6
Therefore the goodwill associated with this acquisition will not be amortized but will be reviewed annually for impairment. The intangible assets related to the branch purchases of Citizen Financial and Old Kent Bank will continue to be amortized over the estimated life of deposits acquired. Note 3. Reserve for Loan and Lease Losses The reserve for loan and lease losses is maintained at a level believed to be adequate by management to absorb probable losses inherent in the loan portfolio. The determination of the reserve requires significant judgement reflecting management's best estimate of probable loan losses related to specifically identified loans as well as probable losses in the remainder of the various loan portfolios. The methodology for assessing the appropriateness of the reserve consists of several key elements, which include: specific reserves for identified special attention loans (classified loans and leases and internal watch list credits), percentage allocations for special attention loans without specific reserves, formula reserves for each business lending division portfolio including a higher percentage reserve allocation for special attention loans without a specific reserve and reserves for pooled homogenous loans. Management's evaluation is based upon a continuing review of these portfolios, estimates of future customer performance, collateral values and disposition and forecasts of future economic and geopolitical events, all of which are subject to judgement and will change. Specific reserves are established for certain business and specialty finance credits based on a regular analysis of special attention loans. This analysis is performed by the Credit Policy Committee, the Loan Review Department, Credit Administration and the Loan Workout Departments. The specific reserves are based on a careful analysis of underlying collateral values, cash flow considerations and, if applicable, guarantor capacity. The formula reserves determined for each business lending division portfolio are calculated quarterly by applying loss factors to outstanding loans and certain unfunded commitments based upon a review of historical loss experience and qualitative factors, which include but are not limited to, economic trends, current market risk assessment by industry, recent loss experience in particular segments of the portfolios, movement in equipment values collateralizing specialized industry portfolios, concentrations of credit, delinquencies, trends in volume, experience and depth of relationship managers and division management, and the effects of changes in lending policies and practices, including changes in quality of the loan origination, servicing and risk management processes. Special attention loans without specific reserves receive a higher percentage allocation ratio than credits not considered special attention. Pooled loans are smaller credits and are generally homogenous in nature, such as consumer credits and residential mortgages. Pooled loan loss reserves are based on historical net charge-offs, adjusted for delinquencies, the effects of lending practices and programs and current economic conditions and projected trends in the geographic markets which we serve. Additional unallocated reserves are provided to recognize the exposure to inherent, but undetected losses within the overall loan portfolio. This exposure is caused by inherent delays in obtaining information regarding an individual borrower's or segments of borrowers' financial condition or change in its or their specific business condition; the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends; the volatility of general economic or specific customer conditions; and the sensitivity of assumptions used in establishing reserves for various loan portfolios. Management believes a general unallocated reserve is needed to recognize the imprecision inherent in the process of estimating expected credit losses. 7
A comprehensive analysis of the reserve is performed by management on a quarterly basis. Although management determines the amount of each element of the reserve separately and relies on this process as an important credit management tool, the entire reserve is available for the entire loan portfolio. The actual amount of losses incurred can vary significantly from the estimated amounts both positively and negatively. Management's methodology includes several factors intended to minimize the difference between estimated and actual losses. These factors allow management to adjust its estimate of losses based on the most recent information available. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for historical information contained herein, the matters discussed in this document express "forward- looking statements." Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "project," "will" and similar expressions indicate forward-looking statements. Those statements, including statements, projections, estimates or assumptions concerning future events or performance, and other statements that are other than statements of historical fact, are subject to material risks and uncertainties. 1st Source cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. 1st Source may make other written or oral forward-looking statements from time to time. Readers are advised that various important factors could cause 1st Source's actual results or circumstances for future periods to differ materially from those anticipated or projected in such forward-looking statements. Such factors, among others, include changes in laws, regulations or accounting principles generally accepted in the United States; 1st Source's competitive position within the markets it serves; increasing consolidation within the banking industry; unforeseen changes in interest rates; unforeseen downturns in or major events affecting the local, regional or national economies or the industries in which 1st Source has credit concentrations; and other risks discussed in 1st Source's filings with the Securities and Exchange Commission, including its Annual Report on Form 10-K, which filings are available from the SEC. 1st Source undertakes no obligation to publicly update or revise any forward-looking statements. The following management's discussion and analysis is presented to provide information concerning the financial condition of 1st Source as of September 30, 2002, as compared to December 31, 2001, and the results of operations for the nine months ended September 30, 2002 and 2001. This discussion and analysis should be read in conjunction with 1st Source's consolidated financial statements and the financial and statistical data appearing elsewhere in this report and 1st Source's 2001 Annual Report 8
FINANCIAL CONDITION 1st Source's assets at September 30, 2002 were $3.4 billion, down 4.3%, compared to December 31, 2001. Total loans were down 5.7% and total deposits decreased 4.2% over the comparable figures at the end of 2001. Nonperforming assets at September 30, 2002, were $81.3 million, compared to $43.3 million at December 31, 2001, an increase of 87.8%. At September 30, 2002, nonperforming assets were 3.26% of net loans and leases compared to 1.63% at December 31, 2001. 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. Loans held-for-sale were $128.1 million and $173.5 million at September 30, 2002 and December 31, 2001, respectively. The carrying value of mortgage servicing rights was $21.4 million and $20.1 million at September 30, 2002 and December 31, 2001, respectively. CAPITAL RESOURCES Shareholders' equity was $311.0 million, up 1.6% from the $306.2 million at December 31, 2001. As of September 30, 2002, the 1st Source equity-to-assets ratio was 9.1%, compared to 8.6% at the end of 2001. The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1 or core capital as a percentage of average assets, to measure the soundness of a financial institution. These guidelines require all banks to maintain a minimum leverage capital ratio of 4.00% for adequately capitalized banks and 5.00% for well-capitalized banks. 1st Source's leverage capital ratio was 9.60% at September 30, 2002. The Federal Reserve Board has established risk-based capital guidelines for U.S. banking organizations. The guidelines established a conceptual framework calling for risk weights to be assigned to on and off-balance sheet items in arriving at risk-adjusted total assets, with the resulting ratio compared to a minimum standard to determine whether a bank has adequate capital. The minimum standard risk-based capital ratios effective in 2002 are 4.00% for adequately capitalized banks and 6.00% for well-capitalized banks for Tier 1 risk-based capital and 8.00% and 10.00%, respectively, for total risk-based capital. 1st Source's Tier 1 risk-based capital ratio on September 30, 2002 was 11.42% and the total risk-based capital ratio was 12.73%. LIQUIDITY AND INTEREST RATE SENSITIVITY Asset and liability management includes the management of interest rate sensitivity and the maintenance of an adequate liquidity position. The purpose of liquidity management is to match the sources and uses of funds to anticipated customers' deposits and withdrawals, to anticipate borrowing requirements and to provide for the cash flow needs of 1st Source. The purpose of interest rate sensitivity management is to stabilize net interest income during periods of changing interest rates. Close attention is given to various interest rate sensitivity gaps and interest rate spreads. Maturities of rate sensitive assets are relative to the maturities of rate sensitive liabilities and interest rate forecasts. At September 30, 2002, the consolidated statement of financial condition was rate sensitive by $179.3 more assets than liabilities scheduled to reprice within one year or approximately 1.10%. 9
RESULTS OF OPERATIONS NET INCOME Net income for the three-month and nine-month periods ended September 30, 2002, was $2.1 million and $9.1 million respectively, compared to $6.2 million and $29.3 million for the same periods in 2001. For the nine-month period, the decrease in net income was attributed to increases in loan loss provision and noninterest expense, as well as a decrease in noninterest income, offset by an increase in net interest income. Diluted net income per common share was $0.10 and $0.43, respectively, for the three-month and nine-month periods ended September 30, 2002, compared to $0.29 and $1.38 for the same periods in 2001. Return on average common shareholders' equity was 3.90% for the nine months ended September 30, 2002, compared to 13.51% in 2001. The return on total average assets was 0.35% for the nine months ended September 30, 2002, compared to 1.18% in 2001. NET INTEREST INCOME Taxable equivalent net interest income for the three-month period ended September 30, 2002, was $29.9 million a decrease of 3.02% from the same period in 2001. The net interest margin on a fully taxable equivalent basis was 3.87% for the three-month period ended September 30, 2002 compared to 3.95% for the three-month period ended September 30, 2001. The taxable equivalent net interest income for the nine-month period ended September 30, 2002, was $91.9 million, an increase of 2.95% over 2001, resulting in a net yield of 3.94%, compared to 3.96% for the same period in 2001. Total average earning assets decreased $28.1 million, or 0.91%, for the three-month period and increased $109.1 million, or 3.62%, for the nine-month period ended September 30, 2002 over the comparative periods in 2001. Total average investment securities increased 9.28% and 13.58%, respectively, for the three-month and nine-month periods over one year ago primarily due to an increase in U.S. Government Securities. Average loans decreased 2.91% for the three-month period and increased 1.34% for the nine-month period, compared to the same periods in 2001. The three-month decrease is mainly due to a decrease in loans secured by aircraft, while the year-to-date increase is mainly due to growth in loan volume in commercial loans secured by medium and heavy duty trucks and construction equipment. The taxable equivalent yields on total average earning assets were 6.32% and 7.85% for the three-month periods ended September 30, 2002, and 2001, and 6.50% and 8.30% for the nine-month periods ended September 30, 2002 and 2001, respectively. Average interest bearing deposits decreased $0.4 million or 0.02%, and increased $136.7 or 6.02%, for the three-month and nine-month periods respectively over the same periods in 2001. The rate on average interest-bearing funds was 2.86% and 4.46% for the three-month periods ended September 30, 2002, and 2001 and 2.96% and 4.99% for the nine-month periods ended September 30, 2002 and 2001. The growth in deposits from last year has occurred in savings and NOW deposits partially offset by a decrease in time deposits. The following table sets forth consolidated information regarding average balances and rates. 10
<TABLE> <CAPTION> DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY INTEREST RATES AND INTEREST DIFFERENTIAL (Dollars in thousands) Three Months Ended September 30 ------------------------------------ 2002 2001 -------------------------------------------------------- Interest Interest Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate ------- ------- ---- ------- ------- ---- ASSETS: <S> <C> <C> <C> <C> <C> <C> Investment securities: Taxable ................. $ 460,744 $ 4,294 3.70% $ 409,423 $ 5,569 5.40% Tax exempt (1)........... 153,147 2,144 5.55% 152,330 2,486 6.47% Net loans (2)(3)........... 2,438,976 42,314 6.88% 2,512,027 53,008 8.37% Other investments ......... 10,263 41 1.59% 17,411 133 3.03% ---------- -------- ----- ---------- -------- ----- Total earning assets 3,063,130 48,793 6.32% 3,091,191 61,196 7.85% Cash and due from banks ... 87,905 102,521 Reserve for loan losses ... (57,959) (52,160) Other assets .............. 291,452 257,376 ---------- ---------- Total ..................... $3,384,528 $3,398,928 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest bearing deposits $2,341,369 $17,129 2.90% $2,341,770 $26,706 4.52% Short-term borrowings ... 274,765 1,586 2.29% 349,573 3,477 3.95% Long-term debt .......... 11,718 213 7.21% 12,035 218 7.19% ---------- ------- ----- ---------- ------- ----- Total interest bearing liabilities ............. 2,627,852 18,928 2.86% 2,703,378 30,401 4.46% Non-interest bearing deposits 358,419 295,012 Other liabilities ....... 86,806 101,286 Shareholders' equity .... 311,451 299,252 ---------- ---------- Total ..................... $3,384,528 $3,398,928 ========== ========== ------- ------- Net interest income ....... $29,865 $30,795 ======= ======= Net yield on earning assets on a taxable ----- ----- equivalent basis ........ 3.87% 3.95% ===== ===== Nine Months Ended September 30 ------------------------------------ 2002 2001 -------------------------------------------------------- Interest Interest Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate ------- ------- ---- ------- ------- ---- ASSETS: Investment securities: Taxable ................. $ 474,639 $13,986 3.94% $ 397,082 $17,289 5.82% Tax exempt (1)........... 149,909 6,683 5.96% 152,803 7,516 6.58% Net loans (2)(3)........... 2,482,704 130,791 7.04% 2,449,950 161,787 8.83% Other investments ......... 15,324 239 2.09% 13,609 410 4.03% ---------- -------- ----- ---------- -------- ----- Total earning assets 3,122,576 151,699 6.50% 3,013,444 187,002 8.30% Cash and due from banks ... 88,538 97,603 Reserve for loan losses ... (58,515) (49,216) Other assets .............. 294,477 248,252 ---------- ---------- Total ..................... $3,447,076 $3,310,083 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest bearing deposits $2,406,845 $55,035 3.06% $2,270,193 $84,605 4.98% Short-term borrowings ... 280,159 4,114 1.96% 338,315 12,467 4.93% Long-term debt .......... 11,824 637 7.20% 12,118 655 7.23% ---------- ------- ----- ---------- ------- ----- Total interest bearing liabilities ............. 2,698,828 59,786 2.96% 2,620,626 97,727 4.99% Non-interest bearing deposits 344,330 296,063 Other liabilities ....... 93,164 103,826 Shareholders' equity .... 310,754 289,568 ---------- ---------- Total ..................... $3,447,076 $3,310,083 ========== ========== ------- ------- Net interest income ....... $91,913 $89,275 ======= ======= Net yield on earning assets on a taxable ----- ----- equivalent basis ........ 3.94% 3.96% ===== ===== (1) Interest income includes the effects of taxable equivalent adjustments, using a 35% rate for 2002 and 2001. Tax equivalent adjustments for the three-month periods were $681 in 2002 and $769 in 2001 and for the nine-month periods were $2,128 in 2002 and $2,296 in 2001. (2) Loan income includes fees on loans for the three-month periods of $1,222 in 2002 and $1,359 in 2001 and for the nine-month periods of $3,779 in 2002 and $4,346 in 2001. Loan income also includes the effects of taxable equivalent adjustments, using a 35% rate for 2002 and 2001. The tax equivalent adjustments for the three-month periods were $80 in 2002 and $70 in 2001 and for the nine-month periods were $234 in 2002 and $195 in 2001. (3) For purposes of this computation, non-accruing loans are included in the daily average loan amounts outstanding. </TABLE> 11
PROVISION AND RESERVE FOR LOAN LOSSES The provision for loan losses for the three-month periods ended September 30, 2002, and 2001 was $9.8 million for each period, and was $34.4 million and $21.6 million for the nine-month periods ended September 30, 2002 and 2001. Net Charge-offs of $7.2 million were recorded for the third quarter 2002, compared to $5.9 million for the same quarter a year ago. Net Charge-offs for the second quarter 2002 were $11.2 million and $11.5 million for the first quarter of 2002. Year-to-date Net Charge-offs of $30.0 million have been recorded in 2002, compared to Net Charge-offs of $10.0 million through September 2001. Loan delinquencies were down to 1.41% on September 30, 2002, as compared to 2.90% on September 30, 2001 and 2.40% at the end of 2001. In the third quarter 2002, 1st Source continued to see substantial weakness in the durable goods manufacturing sector of the economy and in the transportation related sectors, especially in aircraft use and auto rental. 1st Source also experienced some increased delinquency among construction equipment customers due to the slow down in their collection of municipal and state government receivables. The main focus during the third quarter was to convert non-performing loans to repossessed assets and reposition those assets for sale. However, the continued slow down in the economy and downward pressure in the stock markets adversely affected the values of used aircraft, trucks and autos and increased the time it takes to liquidate recovered assets in those categories. With increased staffing and reassignment of personnel to the collection and recovery process, 1st Source is actively marketing the recovered assets and continuing to work with its customers to reduce their debts to 1st Source and their overall exposure to the weakening economy. A summary of loan loss experience during the three-month and nine-month periods ended September 30, 2002 and 2001 is provided below. It is management's opinion that the reserve for loan losses is adequate to absorb losses inherent in the loan portfolio as of September 30, 2002. <TABLE> <CAPTION> Summary of Reserve for Loan Losses ------------------------------------ Three Months Ended Nine Months Ended September 30 September 30 2002 2001 2002 2001 --------- --------- --------- --------- (Dollars in Thousands) <S> <C> <C> <C> <C> Reserve for loan losses - beginning balance $ 57,420 $ 50,901 $ 57,624 $ 44,644 Charge-offs (7,910) (6,068) (32,345) (10,734) Recoveries 671 186 2,343 783 --------- --------- --------- --------- Net charge-offs (7,239) (5,882) (30,002) (9,951) Provision for loan losses 9,750 9,807 34,416 21,566 Recaptured reserve due to loan securitizations (985) (331) (3,092) (1,764) Acquired reserves from acquisitions -- 596 -- 596 --------- --------- --------- --------- Reserve for loan losses - ending balance $ 58,946 $ 55,091 $ 58,946 $ 55,091 ========= ========= ========= ========= Loans outstanding at end of period 2,391,418 2,530,023 2,391,418 2,530,023 Average loans outstanding during period 2,438,976 2,512,027 2,482,704 2,449,950 12
Reserve for loan losses as a percentage of loans outstanding at end of period 2.46% 2.18% 2.46% 2.18% Ratio of net charge-offs during period to average loans outstanding 1.18% 0.93% 1.62% 0.54% Nonperforming assets as a percentage of loans and leases at end of period 3.26% 1.35% 3.26% 1.35% Loans past due 90 days or more 309 615 Non-accrual loans 54,685 26,503 Other real estate owned 4,873 2,991 Repossessions 19,536 5,207 Other nonperforming assets 1,888 183 -------- -------- Nonperforming assets at end of period 81,291 35,499 </TABLE> <TABLE> <CAPTION> Supplemental Loan Information as of September 30, 2002 - ------------------------------------------------------ Year-to-date losses and growth in non-performing assets, as well as write downs of other real estate owned or assets owned, have come primarily from aircraft and auto and truck financings. The effect of the slowing economy in mid-2001 was exacerbated by the events of 9/11. Collateral value of aircraft and autos dropped considerably and the continuing economic slowdown has raised questions as to the ability to ever recover those losses. Other real estate Loan owned and Year-to-date outstandings Non-accrual repossessions net charge-offs <S> <C> <C> <C> <C> Commercial and Agricultural 431,766 1,727 -- 1,045 Loans Secured by Real Estate 721,371 2,049 4,873 118 Comsumer Loans 114,761 4,330 40 558 Aircraft Financing 352,206 25,931 18,417 22,600 Auto and Truck Financing 446,492 11,587 864 4,897 Construction Equipment Financing 324,822 9,061 215 784 ------- ------- ------- ------- Total 2,391,418 54,685 24,409 30,002 ========= ======== ======== ======== </TABLE> For financial statements purposes, non-accrual loans are included in loan outstandings and repossessions and other real estate owned are included in other assets. NONINTEREST INCOME Noninterest income for the three-month periods ended September 30, 2002, and 2001 was $17.4 million and $20.0 million respectively, and was $57.8 million and $70.3 million for the nine-month periods ended September 30, 2002 and 2001, respectively. Loan servicing and sale income for the three-month and nine-month 13
periods ended September 30, 2002 decreased $3.7 million and $16.9 million, respectively. The decrease in loan servicing and sale income for the three-month period is due to the $4.1 million non-cash valuation adjustment for impairment of the carrying value of the mortgage servicing portfolio held by Trustcorp Mortgage (see following paragraph), whereas the decrease for the nine- month period is attributed to the $1.0 billion sale of mortgage servicing rights in the first quarter of 2001 which resulted in an $11.1 million gain partially offset by a $5.3 million valuation reserve on the mortgage servicing rights portfolio in 2002. For the nine-month period ending September 30, 2002, $1.1 million of venture capital losses were recorded, compared to the $1.0 million of venture capital gains in 2001. Service charges on deposit accounts increased $2.7 million and equipment rental income increased $2.9 million. The increase in service charges on deposits is mainly due to increases in business service fees, overdraft fees and debit card fees. Equipment rental income increased due to the growth in operating leases. As evidenced by the decrease in loan servicing and sale income, the continuing decline in mortgage interest rates during 2002 has adversely impacted 1st Source's servicing income and the market value of its mortgage servicing rights. The lower interest rate environment led to a higher level of refinancing, which, in turn, also increased mortgage loan prepayment rates and lowered the estimated value of existing mortgage servicing assets. The value of mortgage servicing assets is sensitive to changes in interest rates. In a declining rate environment, as experienced in 2002, mortgages 1st Source made recently, and on which the servicing was retained, are themselves being refinanced much earlier than 1st Source, or the market, had anticipated. Therefore, the value of the servicing rights associated with those mortgages is less than what was originally estimated. The third quarter charge is a non-cash re-valuation of these retained servicing rights due to impairment caused by the current market for mortgage refinancing. NONINTEREST EXPENSE Noninterest expense for the three-month periods ended September 30, 2002 and 2001 was $33.5 million and $30.3 million, respectively, an increase of 10.48%, and was $99.4 million and $88.4 million for nine-month periods ended September 30, 2002 and 2001, respectively, an increase of 12.45%. For the nine-month period ending September 30, 2002, salaries and employee benefits increased $3.3 million, net occupancy expense increased $0.6 million, furniture and equipment expense increased $1.0 million, and supplies and communications expense increased $0.6 million. The increases were, in general, the result of the acquisition of 17 branches in late 2001. Depreciation on leased equipment increased $2.7 million, business development and marketing expense decreased $1.2 million and other expense increased $4.2 million. The increase in other expense is attributed primarily to repossession and collection expenses, write-downs on repossessed assets, and the amortization of the core deposit premium and other intangible assets relating to the branch acquisitions in late 2001. INCOME TAXES The provision for income taxes for the nine months ended September 30, 2002, was $2.9 million, compared to $16.1 million for the comparable period in 2001. The provision for income taxes for the nine months ended September 30, 2002, and 2001, is at a rate which management believes approximates the effective rate for the year. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes in market risk exposures that affect the "Quantitative and Qualitative Disclosures" presented in 1st Source's annual report on Form 10-K for the year ended December 31, 2001. See the discussion of interest rate sensitivity beginning on page 6 of 1st Source's 2001 Annual Report and page 9 of this Form 10-Q. 14
ITEM 4. CONTROLS AND PROCEDURES Within the 90 days prior to the date of this report, 1st Source Corporation carried out an evaluation, under the supervision and with the participation of 1st Source's management, including 1st Source's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of 1st Source's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that 1st Source's disclosure controls and procedures are effective in timely alerting them to material information relating to 1st Source Corporation (including its consolidated subsidiaries) required to be included in 1st Source's periodic SEC filings. 15
PART II. OTHER INFORMATION ITEM 1. Legal Proceedings. None ITEM 2. Changes in Securities. None ITEM 3. Defaults Upon Senior Securities. None ITEM 4. Submission of Matters to a Vote of Security Holders None ITEM 5. Other Information. None ITEM 6(a).Exhibits Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. ITEM 6(b).Reports on Form 8-K. None 16
SIGNATURES Pursuant to the requirements 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 ------------------- DATE 11/12/02 /s/ Christopher J. Murphy III ---------- ---------------------------------------- (Signature) Christopher J. Murphy III Chairman of the Board, President and CEO DATE 11/12/02 /s/ Larry E. Lentych ---------- ---------------------------------------- (Signature) Larry E. Lentych Treasurer and Chief Financial Officer Principal Accounting Officer 17
I, Christopher J. Murphy III, Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of 1st Source Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 -- /s/ Christopher J. Murphy III - ----------------------------- Christopher J. Murphy III Chief Executive Officer 18
I, Larry E. Lentych, Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of 1st Source Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 -- /s/ Larry E. Lentych - -------------------- Larry E. Lentych Chief Financial Officer 19
EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of 1st Source Corporation (the "Company") on Form 10-Q for the quarterly period ended September 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Christopher J. Murphy III, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities and Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: /s/ Christopher J. Murphy III - ----------------------------- Christopher J. Murphy III Chief Executive Officer November 12, 2002 --
EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of 1st Source Corporation (the "Company") on Form 10-Q for the quarterly period ended September 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Larry E. Lentych, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities and Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: /s/ Larry E. Lentych - -------------------- Larry E. Lentych Chief Financial Officer November 12, 2002 --