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 MARCH 31, 1996 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 0-5907 1ST SOURCE CORPORATION (Exact name of registrant as specified in its charter) INDIANA 35-1068133 (State or 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) (219) 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 March 31, 1996 - 12,524,418 shares. PART I. FINANCIAL INFORMATION Item 1. Financial Statements a) Consolidated statements of financial condition -- March 31, 1996 and December 31, 1995 b) Consolidated statements of income -- three months ended March 31, 1996 and 1995 c) Consolidated statements of cash flows -- three months ended March 31, 1996 and 1995 -2- <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION 1st Source Corporation and Subsidiaries (Dollars in thousands) March 31, December 31, <S> 1996 1995 ASSETS <C> <C> Cash and due from banks $76,197 $94,517 Interest bearing deposits with other banks 2,790 2,946 Investment securities: Securities available-for-sale, at fair value (amortized cost of $274,667 and $270,621 at March 31, 1996 and December 31, 1995) 272,631 270,290 Securities held-to-maturity, at amortized cost (fair value of $130,669 and $132,383 at March 31, 1996 and December 31, 1995) 125,459 126,085 Total Investment Securities 398,090 396,375 Loans - net of unearned discount 1,314,900 1,259,415 Reserve for loan losses (27,570) (27,470) Net Loans 1,287,330 1,231,945 Premises and equipment 24,327 23,383 Other assets 53,676 50,091 Total Assets $1,842,410 $1,799,257 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest bearing $187,290 $190,045 Interest bearing 1,290,531 1,251,704 Total Deposits 1,477,821 1,441,749 Federal funds purchased and securities sold under agreements to repurchase 92,159 101,166 Other short-term borrowings 62,440 51,813 Other liabilities 32,695 30,109 Long-term debt 20,178 21,819 Total Liabilities 1,685,293 1,646,656 Shareholders' equity: Common stock-no par value 5,700 5,429 Capital surplus 69,947 56,337 Retained earnings 87,671 96,952 Less cost of common stock in treasury (5,564) (6,497) Unrealized depreciation of investment securities, net (637) 380 Total Shareholders' Equity 157,117 152,601 Total Liabilities and Shareholders' Equity $1,842,410 $1,799,257 </TABLE> -3- <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF INCOME 1st Source Corporation and Subsidiaries (Dollars in thousands, except per share amounts) Three Months Ended March 31, <S> 1996 1995 Interest Income: <C> <C> Loans, including fees $29,495 $25,726 Investment securities: Taxable 3,478 3,480 Tax-exempt 1,973 1,765 Other 285 391 Total Interest Income 35,231 31,362 Interest Expense: Deposits 15,246 12,706 Short-term borrowings 1,803 1,073 Long-term debt 346 529 Total Interest Expense 17,395 14,308 Net Interest Income 17,836 17,054 Provision for Loan Losses 1,209 960 Net Interest Income After Provision for Loan Losses 16,627 16,094 Other Income: Trust fees 1,623 1,664 Service charges on deposit accounts 1,176 1,198 Mortgage servicing fees, commission income and other 2,609 1,950 Investment securities and other gains 38 (153) Total Other Income 5,446 4,659 Other Expense: Salaries and employee benefits 8,652 8,090 Net occupancy expense 1,154 870 Furniture and equipment expense 1,295 1,438 Insurance expense 121 856 Other 2,646 2,113 Total Other Expense 13,868 13,367 Income Before Income Taxes 8,205 7,386 Income taxes 2,839 2,532 Net Income $5,366 $4,854 Per Common Share: <F1> Net Income $0.42 $0.38 Dividends $0.080 $0.070 Weighted Average Common Shares Outstanding 12,777,155 12,793,028 <FN> <F1> The computation of per share data gives retroactive recognition to a 3:2 stock split declared on July 18, 1995, and a 5 percent stock dividend declared on January 22, 1996. </FN> </TABLE> -4- <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF CASH FLOWS 1st Source Corporation and Subsidiaries (Dollars in thousands) Three Months Ended March 31, 1996 1995 <S> <C> <C> Operating Activities: Net income $5,366 $4,854 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,209 960 Depreciation of premises and equipment 785 609 Amortization of investment security premiums and accretion of discounts, net 131 212 Deferred income taxes 0 974 Realized investment securities (gains) losses (38) 153 Increase in interest receivable (791) (32) Increase in interest payable 1,590 3,297 Other 294 270 Net Cash Provided by Operating Activities 8,546 11,297 Investing Activities: Proceeds from sales and maturities of investment securities 34,329 28,244 Purchases of investment securities (37,839) (38,223) Net increase in short-term investments 156 294 Loans sold or participated to others 27,620 39,806 Net increase in loans made to customers and principal collections on loans (82,732) (79,356) Principal payments received under lease 1,066 850 Purchase of assets to be leased (2,556) (1,169) Purchases of premises and equipment (1,526) (681) Other (203) (94) Net Cash Used in Investing Activities (61,685) (50,329) Financing Activities: Net decrease in demand deposits, NOW accounts and savings accounts (11,346) (41,697) Net increase in certificates of deposit 47,418 65,648 Net increase in short-term borrowings 1,620 13,715 Payments on long-term debt (1,642) (5,429) Acquisition of treasury stock (220) (140) Cash dividends (999) (879) Other (12) (12) Net Cash Provided by Financing Activities 34,819 31,206 Decrease in Cash and Cash Equivalents (18,320) (7,826) Cash and cash equivalents, beginning of year 94,517 79,226 Cash and Cash Equivalents, End of Period $76,197 $71,400 </TABLE> -5- PART I. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The unaudited consolidated condensed financial statements have been prepared in accordance with the instructions for Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. The information furnished herein reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods for which this report is submitted. This discussion and analysis should be read in conjunction with the Company's consolidated condensed financial statements and the financial and statistical data appearing elsewhere in this report. The amounts shown in this analysis have been adjusted to reflect tax-exempt income on a tax equivalent basis using a 40.525% rate. On September 30, 1994, 1st Source Corporation purchased the remaining shares of the outstanding common stock of Mortgage Acquisition Company the parent company of Trustcorp Mortgage Company, a South Bend based full service mortgage banker (collectively "Trustcorp Mortgage Company" or "Trustcorp"). 1st Source previously owned 30% of the outstanding common stock of Trustcorp. The purchase price consisted of approximately $2.6 million in cash, $500,000 in guaranteed notes maturing in one to two years and 91,504 shares of 1st Source Corporation common stock with a market value of approximately $2.4 million. The acquired net assets of Trustcorp consisted of $17 million of mortgage loans held for sale, $5.2 million of mortgage servicing rights, and $1.9 million of other assets. Liabilities assumed consisted of $20.5 million of borrowings and $1.1 million of other liabilities. A premium in excess of book value of $3.6 million was paid in the transaction and allocated to purchased mortgage servicing rights ($2.2 million) and goodwill ($1.4 million). At the date of its acquisition, Trustcorp had a mortgage loan servicing portfolio in excess of $1.0 billion. During the third quarter of 1994, 1st Source Bank completed the securitization of $60 million of aircraft loans originated by its Transportation and Equipment Financing Group. 1st Source Bank will continue to service the loans for a fee. A total of $1.45 million was expensed in connection with this transaction. Due to reduced loan outstandings, a similar amount was released from the reserve for loan losses which made the transaction income neutral in the third quarter of 1994. -6- 1st Source adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" (SFAS No. 114) on January 1, 1995. Under the new standard, a loan is considered impaired, based on current information and events, if it is probable that the Corporation will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral- dependent loans are measured for impairment based on the fair value of the collateral. The adoption of SFAS No. 114 had no impact on the provision for loan losses as reported. The provision for loan losses charged to expense is based upon the actual net loan losses incurred as determined on a basis consistent with SFAS No. 114, plus an amount for such other factors which, in management's judgment, deserve recognition in estimating possible loan losses. Loans are charged against the reserve for loan losses when deemed uncollectible. 1st Source adopted Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights" (SFAS No. 122) on January 1, 1996. The new standard requires mortgage banking enterprises to recognize as separate assets the rights to service mortgage loans for others, however those mortgage servicing rights are acquired. SFAS 122 also requires that mortgage banking enterprises assess capitalized mortgage servicing rights based on the fair value of those rights on a disaggregated basis. As of March 31, 1996, 1st Source has capitalized $369,000 of originated mortgage servicing rights. The adoption of SFAS No. 122 has had no material impact on the financial statements. 1st Source has entered into two off-balance sheet amortizing interest rate swaps as part of its interest rate risk management strategy. The swaps are being used to hedge against the company's prime floating rate loans. The notional amount of the first swap as of March 31, 1996 is $29 million. It has a maturity date of January, 2002, and has a current fair value of $(555,000). The second swap has a notional amount of $30 million as of March 31, 1996. It has a maturity date of March, 2001, and has a fair value of $(272,000). The company pays a variable interest rate (one month LIBOR) on each swap and receives a fixed rate. The interest rate swaps are the most efficient means of protecting the bank net interest rate margin in a declining interest rate environment. Conversely, if interest rates increase, the increased contribution to net interest income from on- balance sheet assets will substantially offset any negative impact on net interest income from these swap transactions. -7- 1st Source adopted Statement of Financial Accounting Standards No. 123 "Accounting for Stock-based Compensation" (SFAS No. 123) on January 1, 1996. This Statement requires the fair value of stock options and other stock-based compensation issued to employees to either be included as compensation expense in the statement of income, or the pro forma effect on net income and earnings per share of such compensation expense to be disclosed in the footnotes to the financial statements. 1st Source adopted SFAS No. 123 on a disclosure basis only and, accordingly, the adoption of this Statement will not have a material impact on the company's financial position. There have been no stock options granted during the first quarter of 1996. -8- COMPARISON OF THREE MONTH PERIODS ENDED MARCH 31, 1996 AND 1995 Net income for the three month period ended March 31, 1996 was $5,366,000 compared to $4,854,000 for the equivalent period in 1995. The primary reasons for the increase were an increase in net interest income and a strong increase in other income offset by an increase in the provision for loan losses and only a modest increase in other expense. Net income per share increased to $0.42 for the three month period ended March 31, 1996 from $0.38 in 1995. Return on average equity was 13.98% for the three months ended March 31, 1996 compared to 14.09% in 1995. This ratio is based on shareholders' equity before the market value adjustment for securities designated as "available for sale" as required by SFAS No. 115. The ratio after the market value adjustment was 13.93% for the three months ended March 31, 1996 compared to 14.81% for the same period in 1995. The return on total average assets was 1.20% for the three months ended March 31, 1996 compared to 1.24% in 1995. NET INTEREST INCOME The taxable equivalent net interest income for the three month period ended March 31, 1996 was $18,780,000, an increase of 4.39% over the same period in 1995, resulting in a net yield of 4.51% compared to 4.95% in 1995. Total average earning assets increased 13.53% for the period ended March 31, 1996 compared to the period ended March 31, 1995. Total average investment securities increased 8.25% from one year ago, and a 15.27% increase in average loans occurred primarily in transportation and equipment loans. The taxable equivalent yields on total average earning assets were 8.69% and 8.89% for the periods ended March 31, 1996 and 1995, respectively. Average deposits increased 9.86% from the first quarter of 1995 to the first quarter of 1996. The cost rate on average interest bearing funds was 4.89% for the period ended March 31, 1996 compared to 4.59% for the three months ended March 31, 1995. The majority of the growth in deposits from last year has occurred in time deposits of $100 thousand and over and time deposits less than one year. The following table sets forth consolidated information regarding average balances and rates. -9- <TABLE> <CAPTION> DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY INTEREST RATES AND INTEREST DIFFERENTIAL (Dollars in thousands) Three months ended March 31, 1996 1995 Interest Interest Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate <S> <C> <C> <C> <C> <C> <C> ASSETS: Interest bearing deposits $2,774 $34 4.98% $999 $6 2.56% Investment securities: Taxable 249,379 3,717 6.00% 241,924 3,762 6.31% Tax exempt <F1> 141,882 2,879 8.16% 114,801 2,651 9.37% Net loans <F2><F3> 1,278,685 29,533 9.29% 1,109,321 25,777 9.42% Other investments 811 12 5.73% 7,044 103 5.91% Total Earning Assets 1,673,531 36,175 8.69% 1,474,089 32,299 8.89% Cash and due from banks 72,251 70,383 Reserve for loan losses (27,566) (24,157) Other assets 73,394 69,161 Total $1,791,610 $1,589,476 LIABILITIES AND SHAREHOLDERS' EQUITY: Interest bearing deposits $1,266,349 15,245 4.84% $1,144,237 12,706 4.50% Short-term borrowings 144,566 1,804 5.02% 94,176 1,073 4.62% Long-term debt 20,840 346 6.68% 26,811 529 8.00% Total Interest Bearing Liabilities 1,431,755 17,395 4.89% 1,265,224 14,308 4.59% Noninterest bearing deposits 172,550 165,468 Other liabilities 32,340 25,827 Shareholders' equity 154,965 132,957 Total $1,791,610 $1,589,476 Net Interest Income $18,780 $17,991 Net Yield on Earning Assets on a Taxable Equivalent Basis 4.51% 4.95% <FN> <F1> Interest income includes the effects of taxable equivalent adjustments, using a 40.525% rate for 1996 and 1995. Tax equivalent adjustments were $906 in 1996 and $886 in 1995. <F2> Loan income includes fees on loans of $756 in 1996 and $761 in 1995. Loan income also includes the effects of taxable equivalent adjustments, using a 40.525% rate for 1996 and 1995. The tax equivalent adjustments were $38 in 1996 and $51 in 1995. <F3> For purposes of this computation, nonaccruing loans are included in the daily average loan amounts outstanding. </FN> </TABLE> -10- PROVISION FOR LOAN LOSSES The provision for loan losses for the three month period ended March 31, 1996 and 1995 was $1,209,000 and $960,000, respectively. Year-to-date Net Charge-offs of $1,109,000 have been recorded in 1996, compared to $229,000 of Net Recoveries in the same period in 1995. The reserve for loan losses was $27,570,000 or 2.10% of net loans at March 31, 1996 compared to $27,470,000 or 2.18% of net loans at December 31, 1995. Nonperforming assets at March 31, 1996 were $7,867,000 compared to $6,584,000 at December 31, 1995, an increase of 19.47%. At March 31, 1996, nonperforming assets were .60% of net loans compared to .52% at December 31, 1995. It is management's opinion that the reserve for loan losses is adequate to absorb anticipated losses in the loan portfolio as of March 31, 1996. OTHER INCOME Other income for the three month periods ended March 31, 1996 and 1995 was $5,446,000 and $4,659,000, respectively. Trust fees decreased 2.46%, service charges on deposit accounts decreased 1.84% and other mortgage servicing fees, commission income and other income increased 46.82% over the same period in 1995. The significant increases in the last category were attributed primarily to increases in mortgage servicing, salable loan fees and equipment rental income. Investment securities and other gains were $38,000 in 1996 compared to $153,000 in losses in 1995. The net gains in 1996 and the net losses in 1995 were primarily due to adjustments made to the carrying value of certain partnership investments. OTHER EXPENSE Other expense for the three month period ended March 31, 1996 was $13,868,000, an increase of 3.75% over the same period in 1995. For the three month period ended March 31, 1996, salaries and employee benefits increased 6.95%, furniture and equipment costs decreased 9.94%, net occupancy expense increased 32.65%, insurance expense decreased 85.86%, business development and marketing expense increased 38.53% and miscellaneous other expenses increased 22.67% over the same period in 1995. The increase in net occupancy expense is due to the loss of a major tenant in our corporate headquarters building. The decrease in insurance expense reflects an FDIC assessment factor of 0% for 1996. The Business development and marketing expense has increased due to new branches being opened in 1996. The increase in miscellaneous expense is due to depreciation of leased equipment. -11- INCOME TAXES The provision for income taxes for the three months ended March 31, 1996 was $2,839,000 compared to $2,532,000 for the comparable period in 1995. The increase was due to increased taxable income in 1996. CAPITAL RESOURCES 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 8.57% at March 31, 1996. The Federal Reserve Board has also approved final 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 1996 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 risked-based capital ratio on March 31, 1996 was 11.41% and the total risk-based capital ratio was 12.99%. 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 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 sensitivity gaps and interest spreads. Maturities of rate sensitive assets are carefully maintained relative to the maturities of rate sensitive liabilities and interest rate forecasts. At March 31, 1996, the consolidated statement of financial condition was rate sensitive by $37,471,000 more assets than liabilities scheduled to reprice within one year or 104.25%. Management adjusts the composition of its assets and liabilities to manage the interest rate sensitivity gap based upon its expectations of interest rate fluctuations. -12- PART II. OTHER INFORMATION Item l. 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. Exhibits and Reports on Form 8-K. None -13- 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 (Registrant) DATE May 15, 1996 Christopher J. Murphy III /s/ (Signature) Christopher J. Murphy III, President DATE May 15, 1996 Larry E. Lentych /s/ (Signature) Larry E. Lentych, Treasurer (Chief Accounting and Financial Officer) -14-