FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-5907
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)
(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 September 30, 1998 -
17,210,100 shares.
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Page
Consolidated statements of financial condition -- 3
September 30, 1998, and December 31, 1997
Consolidated statements of income -- 4
three months and nine months ended September 30,
1998 and 1997
Consolidated statements of cash flows -- 5
nine months ended September 30, 1998 and 1997
Notes to the Consolidated Financial Statements
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
1st Source Corporation and Subsidiaries
(Dollars in thousands)
September 30, December 31,
1998 1997
<S> <C> <C>
ASSETS
Cash and due from banks $ 95,053 $ 90,864
Interest bearing deposits with other banks 821 1,677
Federal funds sold 48,500 10,000
Investment securities:
Securities available-for-sale, at fair value
(amortized cost of $368,782 and $298,438
at September 30, 1998 and December 31, 1997) 375,957 299,933
Securities held-to-maturity, at amortized cost
(fair value of $104,657 and $119,369 at
September 30, 1998 and December 31, 1997) 97,545 114,975
Total Investment Securities 473,502 414,908
Loans - net of unearned discount 1,781,895 1,796,781
Reserve for loan losses (40,289) (35,424)
Net Loans 1,741,606 1,761,357
Premises and equipment 30,896 30,782
Other assets 137,606 108,566
Total Assets $2,527,984 $2,418,154
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 243,544 $ 274,906
Interest bearing 1,751,068 1,616,885
Total Deposits 1,994,612 1,891,791
Federal funds purchased and securities
sold under agreements to repurchase 140,326 117,987
Other short-term borrowings 76,383 117,019
Other liabilities 48,452 34,998
Long-term debt 13,009 16,656
Total Liabilities 2,272,782 2,178,451
Guaranteed Preferred Beneficial Interests
in the Company's Subordinated Debentures 44,750 44,750
Shareholders' equity:
Common stock-no par value 6,270 5,700
Capital surplus 121,456 69,947
Retained earnings 90,606 124,394
Less cost of common stock in treasury (11,201) (6,978)
Unrealized appreciation of investment
securities, net 3,321 1,890
Total Shareholders' Equity 210,452 194,953
Total Liabilities and Shareholders' Equity $2,527,984 $2,418,154
The accompanying notes are a part of the consolidated financial statements.
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
1st Source Corporation and Subsidiaries
(Dollars in thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Interest Income:
Loans, including fees $ 42,459 $ 38,471 $ 127,184 $ 107,895
Investment securities:
Taxable 4,160 4,295 12,336 12,540
Tax-exempt 1,982 2,042 5,961 6,132
Other 754 34 1,084 179
Total Interest Income 49,355 44,842 146,565 126,746
Interest Expense:
Deposits 22,259 19,143 64,170 53,279
Short-term borrowings 3,352 3,330 11,340 9,154
Long-term debt 232 277 688 875
Total Interest Expense 25,843 22,750 76,198 63,308
Net Interest Income 23,512 22,092 70,367 63,438
Provision for Loan Losses 2,042 2,130 7,132 3,838
Net Interest Income After
Provision for Loan Losses 21,470 19,962 63,235 59,600
Noninterest Income:
Trust fees 2,191 1,999 6,351 5,491
Service charges on deposit accounts 1,482 1,433 4,320 3,969
Loan servicing sale income 4,070 1,768 10,106 4,708
Equipment rental income 3,602 1,955 8,885 4,617
Other income 2,578 1,811 7,405 4,679
Investment securities and other
gains (losses) 0 24 (706) (279)
Total Noninterest Income 13,923 8,990 36,361 23,185
Noninterest Expense:
Salaries and employee benefits 11,905 10,111 35,266 29,853
Net occupancy expense 1,250 1,143 3,695 3,337
Furniture and equipment expense 1,826 1,680 5,165 4,956
Depreciation - leased equipment 2,354 1,400 6,336 3,409
Business development and marketing expense 861 650 2,381 2,532
Other 4,064 2,935 9,758 8,081
Total Noninterest Expense 22,260 17,919 62,601 52,168
Income Before Income Taxes and
Subsidiary Trust Distributions 13,133 11,033 36,995 30,617
Income taxes 4,718 3,831 12,953 10,288
Distribution on Preferred Securities of
Subsidiary Trusts, Net of Tax 554 564 1,679 1,184
Net Income $ 7,861 $ 6,638 $22,363 $ 19,145
Other Comprehensive Income, Net of Tax:
Unrealized Gain on Securities $ 1,089 $ 1,012 $ 1,431 $ 987
Comprehensive Income $ 8,950 $ 7,650 $23,794 $ 20,132
Per Common Share: <F1>
Basic Net Income Per Common Share $ 0.45 $ 0.38 $ 1.29 $ 1.11
Diluted Net Income Per Common Share $ 0.45 $ 0.38 $ 1.27 $ 1.08
Dividends $ 0.080 $ 0.068 $ 0.226 $ 0.202
Basic Weighted Average Common Shares
Outstanding 17,221,825 17,203,187 17,292,866 17,210,937
Diluted Weighted Average Common Shares
Outstanding 17,557,160 17,788,839 17,642,616 17,758,348
<FN>
<F1> The computation of per share data gives retroactive recognition to a 10% stock
dividend declared on January 20, 1998, and a five-for-four stock split declared on
January 21, 1997.
</FN>
The accompanying notes are a part of the consolidated financial statements.
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
1st Source Corporation and Subsidiaries
(Dollars in thousands)
Nine Months Ended September 30
1998 1997
<S> <C> <C>
Operating Activities:
Net income $ 22,363 $ 19,145
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 7,132 3,838
Depreciation of premises and equipment 9,071 5,858
Amortization of investment security premiums
and accretion of discounts, net 711 656
Deferred income taxes 3,521 3,421
Realized investment securities (gains) losses 706 279
Increase in interest receivable (682) (1,343)
Increase in interest payable 6,880 9,330
Other (9,083) (36,250)
Net Cash Provided by Operating Activities 40,619 4,934
Investing Activities:
Proceeds from sales and maturities of
investment securities 148,977 104,016
Purchases of investment securities (206,304) (106,345)
Net decrease in short-term investments (37,644) (311)
Loans sold or participated to others 307,097 113,728
Net increase in loans made to customers
and principal collections on loans (294,754) (368,095)
Net increase in leased assets (16,112) (9,027)
Purchases of premises and equipment (2,380) (2,746)
Other (6,806) (4,703)
Net Cash Used in Investing Activities (107,926) (273,483)
Financing Activities:
Net increase (decrease) in demand deposits, NOW
accounts and savings accounts 12,416 (41,715)
Net increase in certificates of deposit 90,405 125,297
Net increase (decrease) in short-term borrowings (18,297) 94,842
New long-term debt 522 --
Payments on long-term debt (4,169) (3,091)
New issuance of trust preferred securities -- 44,750
Acquisition of treasury stock (5,474) (2,046)
Cash dividends (3,919) (3,473)
Other 12 (8)
Net Cash Provided by Financing Activities 71,496 214,556
Increase (Decrease) in Cash and Cash Equivalents 4,189 (53,993)
Cash and Cash Equivalents, Beginning of Year 90,864 137,588
Cash and Cash Equivalents, End of Period $ 95,053 $ 83,595
The accompanying notes are a part of the consolidated financial statements.
</TABLE>
Notes to the consolidated Financial Statements
1. 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 (all of which are normal and recurring in nature)
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. The 1997 1st Source Corporation Annual Report
on Form 10-K and quarterly report on Form 10-Q for the quarters
ended March 31, and June 30, 1998, should be read in conjunction
with these statements.
2. 1st Source has adopted Statement of Financial Accounting Standard
(SFAS) No. 130, "Reporting Comprehensive Income," as of March 31,
1998. SFAS No. 130 establishes standards for the reporting and
disclosure of comprehensive income and its components in a full set
of general purpose financial statements. Presently, the only
component of comprehensive income not included in net income is
unrealized gains or losses on available-for-sale investment
securities.
3. In June 1997, the Financial Accounting Standards Board (FASB)
issued SFAS No. 131 "Disclosure about Segments of an Enterprise and
Related Information." This Statement changes the manner in which
public companies report significant information in annual reports
and requires companies to report selected segment information in
interim financial reports. Companies are now required to report
financial and descriptive information about the company's operating
segments. In the year of adoption, companies are not required to
disclose interim period information. 1st Source will adopt the
Statement in 1998.
4. On June 15, 1998, the Financial Accounting Standards Board (FASB)
issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities. SFAS No. 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999
(January 1, 2000 for 1st Source). SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at their
fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction.
1st Source anticipates that, due to its limited use of derivative
instruments, the adoption of SFAS No. 133 will not have a
significant effect on the Company's results of operations or its
financial position.
5. On July 16, 1998, 1st Source entered into an agreement to
securitize up to $400 million in loans; $205 million for new
funding, $100 million for future growth, and $95 million for
replacement funding. The purpose of the securitization is to fund
the continued national growth of the 1st Source Bank Specialty
Finance Group. 1st Source Bank will continue to service the loans
for a fee.
PART I.
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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 and the 1997
1st Source Corporation Annual Report on Form 10-K and the quarterly report
on Form 10-Q for the quarters ended March 31, and June 30, 1998. The
amounts shown in this analysis have been adjusted to reflect tax-exempt
income on a tax equivalent basis using a 40.525% rate.
Except for historical information contained herein, the matters
discussed in this document, and other information contained in the
Company's SEC filings, may express "forward-looking statements." Those
"forward-looking statements" may involve risk and uncertainties, including
statements concerning future events or performance and assumptions and
other statements concerning future events or performance and assumptions
and other statements that are other than statements of historical facts.
The Company wishes to caution readers not to place undue reliance on any
forward-looking statements, which speak only as of the date made. Readers
are advised that various factors--including, but not limited to, changes
in laws, regulations or generally accepted accounting principles; the
Company's competitive position within the markets served of increasing
consolidation within the banking industry; certain customers and vendors
of critical systems or services failing to comply with Year 2000
programming issues; unforeseen changes in interest rates; any unforeseen
downturns in the local, regional or national economies--could cause the
Company's actual results or circumstances for future periods to differ
materially from those anticipated or projected.
1st Source does not undertake, and specifically disclaims any
obligation, to publicly release the result of any revisions that may be
made to any forward-looking statements to reflect the occurrence of
unanticipated events or circumstances after the date of such statements.
COMPARISON OF THREE-MONTH AND NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 1998 AND 1997
Net income for the three-month and nine-month periods ended
September 30, 1998, was $7,861,000 and $22,363,000 respectively, compared
to $6,638,000 and $19,145,000 for the equivalent periods in 1997. The
primary reasons for the increase were an increase in net interest income
and a strong increase in noninterest income offset by an increase in
noninterest expense.
Diluted net income per common share increased to $0.45 and $1.27,
respectively, for the three-month and nine-month periods ended
September 30, 1998, from $0.38 and $1.08 in 1997. Return on average
common shareholders' equity was 14.76% for the nine months ended
September 30, 1998, compared to 14.25% in 1997. The return on total
average assets was 1.19% for the nine months ended September 30, 1998,
compared to 1.19% in 1997.
NET INTEREST INCOME
The taxable equivalent net interest income for the three-month period
ended September 30, 1998, was $24,391,000, an increase of 5.94% over the
same period in 1997, resulting in a net yield of 4.15% compared to 4.35%
in 1997. The fully taxable equivalent net interest income for the
nine-month period ended September 30, 1998, was $73,066,000, an increase of
10.29% over 1997, resulting in a net yield of 4.23% compared to 4.42% in
1997.
Total average earning assets increased 10.90% and 15.24%, respectively,
for the three-month and nine-month periods ended September 30, 1998, over
the comparative amounts in 1997. Total average investment securities and
average other investments combined increased by 10.89% for the three-month
period and increased by 4.95% for the nine-month period, while a 10.91%
and 18.07% increase for the three-month and nine-month periods for average
loans occurred primarily in retail mortgages, commercial mortgages, and
transportation and equipment loans. The taxable equivalent yields on
total average earning assets were 8.55% and 8.64% for the three-month
period ended September 30, 1998, and 1997, and 8.65% for both the
nine-month periods ended September 30, 1998 and 1997.
Average deposits increased 15.78% and 17.92%, respectively, for the
three-month and nine-month periods over the same amounts from 1997. The
cost rate on average interest-bearing funds was 5.15% and 5.08% for the
three-months ended September 30, 1998, and 1997, and 5.16% and 5.00% for
the nine-month periods ended September 30, 1998, and 1997. The majority
of the growth in deposits from last year has occurred in time deposits of
$100 thousand and over and time deposits greater than one year.
The following table sets forth consolidated information regarding
average balances and rates.
<TABLE>
<CAPTION>
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
(Dollars in thousands)
Three Months Ended September 30
1998 1997
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
<S> <C> <C> <C> <C>
ASSETS:
Investment securities:
Taxable $ 282,635 $ 4,160 5.84% $ 283,097 $ 4,295 6.02%
Tax exempt (1) 151,086 2,809 7.38% 153,679 2,919 7.54%
Net loans (2 & 3) 1,842,592 42,512 9.15% 1,661,407 38,526 9.20%
Other investments 54,493 753 5.48% 3,497 33 3.74%
Total Earning Assets 2,330,806 50,234 8.55% 2,101,680 45,773 8.64%
Cash and due from banks 86,283 75,689
Reserve for loan losses (40,537) (32,326)
Other assets 161,745 114,290
Total $ 2,538,297 $ 2,259,333
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest bearing deposits $ 1,761,760 $ 22,259 5.01% $ 1,525,952 $ 19,144 4.97%
Short-term borrowings 214,418 3,352 6.20% 236,157 3,329 5.59%
Long-term debt 13,006 232 7.08% 15,505 277 7.09%
Total Interest Bearing Liabilities 1,989,184 25,843 5.15% 1,777,614 22,750 5.08%
Noninterest bearing deposits 252,015 213,338
Other liabilities 90,620 83,324
Shareholders' equity 206,478 185,057
Total $ 2,538,297 $ 2,259,333
Net Interest Income $ 24,391 $ 23,023
Net Yield on Earning Assets on a Taxable
Equivalent Basis 4.15% 4.35%
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
(Dollars in thousands)
Nine Months Ended September 30
1998 1997
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
<S> <C> <C> <C> <C>
ASSETS:
Investment securities:
Taxable $ 276,183 $ 12,336 5.97% $ 274,197 $ 12,540 6.11%
Tax exempt <F1> 150,437 8,504 7.56% 152,017 8,819 7.76%
Net loans <F2><F3> 1,854,384 127,341 9.18% 1,570,527 108,017 9.20%
Other investments 26,349 1,083 5.50% 5,402 179 4.44%
Total Earning Assets 2,307,353 149,264 8.65% 2,002,143 129,555 8.65%
Cash and due from banks 83,278 72,286
Reserve for loan losses (38,326) (31,126)
Other assets 153,054 103,147
Total $ 2,505,359 $ 2,146,450
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest bearing deposits $ 1,716,770 $ 64,170 5.00% $ 1,455,834 $ 53,279 4.89%
Short-term borrowings 244,567 11,340 6.20% 221,850 9,154 5.52%
Long-term debt 12,990 688 7.08% 16,750 875 6.98%
Total Interest Bearing
Liabilities 1,974,327 76,198 5.16% 1,694,434 63,308 5.00%
Noninterest bearing deposits 241,802 205,048
Other liabilities 86,647 67,295
Shareholders' equity 202,583 179,673
Total $ 2,505,359 $ 2,146,450
Net Interest Income $ 73,066 $ 66,247
Net Yield on Earning Assets on a
Taxable Equivalent Basis 4.23% 4.42%
<FN>
<FN1> Interest income includes the effects of taxable equivalent
adjustments, using a 40.525% rate for 1998 and 1997. Tax equivalent
adjustments for the three-month periods were $827 in 1998 and $876 in
1997 and for the nine-month periods were $2,543 in 1998 and $2,687 in
1997.
<FN2> Loan income includes fees on loans for the three-month periods of
$1,279 in 1998 and $876 in 1997 and for the nine-month periods of
$3,594 in 1998 and $2,912 in 1997. Loan income also includes the
effects of taxable equivalent adjustments, using a 40.525% rate for
1998 and 1997. The tax equivalent adjustments for the three-month
periods were $53 in 1998 and $54 in 1997 and for the nine-month
periods were $157 in 1998 and $121 in 1997.
<FN3> For purposes of this computation, non-accruing loans are included in
the daily average loan amounts outstanding.<PAGE>
PROVISION FOR LOAN LOSSES
</FN>
</TABLE>
PROVISION FOR LOAN LOSSES
The provision for loan losses for the three-month period ended
September 30, 1998, and 1997, was $2,042,000 and $2,130,000, respectively,
and was $7,132,000 and $3,838,000 for the nine-month periods ended
September 30, 1998 and 1997. Net Charge-offs of $1,462,000 have been
recorded for the three-month period ended September 30, 1998, compared to
$370,000 of Net Charge-offs for the same period in 1997. Year-to-date Net
Charge-offs of $2,267,000 have been recorded in 1998, compared to Net
Recoveries of $295,000 through September 1997. The reserve for loan
losses was $40,289,000 or 2.26% of net loans at September 30, 1998,
compared to $35,424,000 or 1.97% of net loans at December 31, 1997.
Non-performing assets at September 30, 1998, were $12,532,000 compared
to $11,436,000 at December 31, 1997, an increase of 9.58%. At
September 30, 1998, non-performing assets were .70% of net loans compared
to .64% at December 31, 1997. It is management's opinion that the reserve
for loan losses is adequate to absorb anticipated losses in the loan
portfolio as of September 30, 1998.
NONINTEREST INCOME
Noninterest income for the three-month periods ended September 30,
1998, and 1997 was $13,923,000 and $8,966,000, respectively, and for the
nine-month periods was $36,361,000 in 1998 and $23,185,000 in 1997. For
the nine-month period, trust fees increased 15.66%, service charges on
deposit accounts increased 8.84%, loan servicing and sale income increased
114.66%, equipment rental income increased 92.44% and other income
increased 58.26%. The increase in servicing and sale income is due to
increased loan securitization activity and income recognition required by
SFAS No. 125. The significant increase in equipment rental income was
primarily due to substantial growth in operating leases. Bank Owned Life
Insurance income was primarily the reason for the increase in the Other
Income category. Investment Security losses and other losses for the
nine-month period ended September 30, 1998, were $706,000 compared to net
losses of $279,000 in 1997. The net losses in 1998 and 1997 were
primarily attributed to certain partnership and venture capital
investments.
NONINTEREST EXPENSE
Noninterest expense for the three-month period ended September 30,
1998, was $22,260,000, an increase of 24.23% over the same period in 1997
and was $62,601,000 for the nine-month period ended September 30, 1998, an
increase of 20.00% over 1997. For the nine-month period ended
September 30, 1998, salaries and employee benefits increased 18.13%, net
occupancy expense increased 10.73%, furniture and equipment expense
increased 4.22%, depreciation on leased equipment increased 85.86%,
business development and marketing expense decreased 5.96%, and
miscellaneous other expenses increased 20.75% over the same period in
1997. The increase in salaries and employee benefits expense is primarily
attributed to a 10% increase in our employee base compared to 1997, and
additional expense provisions to fund our stock incentive reserves.
Business development and marketing expense decreased due to a $590,000
decrease in charitable contributions. The increase in depreciation of
leased equipment is due to a significant volume increase of operating
leases from the prior year as mentioned above. The increase in
miscellaneous other expenses is primarily due to expenses incurred for the
loan securitization during the third quarter.
INCOME TAXES
The provision for income taxes for the three-month and nine-month
periods ended September 30, 1998, was $4,718,000 and $12,953,000,
respectively, compared to $3,831,000 and $10,288,000 for the comparable
periods in 1997. The provision for income taxes for the nine months ended
September 30, 1998, and 1997, is at a rate which management believes
approximates the effective rate for the year.
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 9.82%
at September 30, 1998.
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 1998 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, 1998, was 12.67% and the total risk-based
capital ratio was 13.95%.
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 carefully
maintained relative to the maturities of rate sensitive liabilities and
interest rate forecasts. At September 30, 1998 the consolidated statement
of financial condition was rate sensitive by $297,544,000 more liabilities
than assets scheduled to reprice within one year or 81.82%.
Management adjusts the composition of its assets and liabilities to
manage the interest rate sensitivity gap based upon its expectations of
interest rate fluctuations.
1st Source has two off-balance sheet 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 September 30, 1998, is $17.7 million. It
has a maturity date of January, 2002, and has a current fair value of
$34,917. The second swap has a notional amount of $17.3 million as of
September 30, 1998. It has a maturity date of March, 2001, and has a
current fair value of $41,165.
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's 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.
YEAR 2000
The Year 2000 issue is the result of potential problems with computer
systems or any equipment with computer chips that store the year portion
of the date as just two digits (e.g., 98 for 1998). Systems using this
two-digit approach may not be able to determine whether "00" represents the
Year 2000 or 1900. The problem, if not corrected, may make those systems
fail altogether or, even worse, allow them to generate incorrect
calculations causing a disruption of normal operations.
In 1997, a project plan to address the Year 2000 issue as it relates
to the Company's operations was developed, approved by the Board of
Directors and implemented. The scope of the plan has five phases
including Awareness, Assessment, Renovation, Validation and Implementation
as defined by federal banking regulatory agencies. Two project teams were
assigned. The first consists of key members of the technology staff,
representatives of functional business units and senior management. The
second primarily consists of lenders and credit personnel. The first team
assessed our systems and equipment and vendors to ascertain their
readiness and to develop the overall plan to bring our systems into
compliance. The second team assessed the readiness of our customers and
determine what risk, if any, our key customers pose to the Company with
respect to their Year 2000 readiness. Additionally, the duties of the
Senior Vice President of Operations were realigned to serve as the Year
2000 Project Manager.
An assessment of the impact of the Year 2000 issue on the Company's
computer systems has been completed. The scope of the project also
includes other operational and environmental systems since they may be
impacted if embedded computer chips control the functionality of those
systems. From the assessment, the Company has identified and prioritized
those systems deemed to be mission critical or those that have a
significant impact on normal operations.
The Company relies on third-party vendors and service providers for
much of its data processing capabilities and to maintain its computer
systems. Formal communications with these providers were initiated in
1997 to assess the Year 2000 readiness of their products and services.
Their progress in meeting their targeted schedules is being monitored
continually for any indication that they may not be able to address the
problems in time. Thus far, all of the significant providers have advised
us that they have compliant versions available or are well into the
renovation and testing phases with completion scheduled for sometime in
1998. However, the Company can give no guarantee that the systems of
these service providers and vendors on which the Company's systems rely
will be timely renovated.
Additionally, the Company has implemented a plan to manage the
potential risk posed by the impact of the Year 2000 issue on its major
borrowing customers. Formal communications have been initiated, with an
assessment substantially completed on September 30, 1998. Loan losses
attributed to the Year 2000 issue are not anticipated to be material to
the Company. However, there can be no guarantee that any loss incurred
will be immaterial.
The project teams feel that the Company's Year 2000 readiness project
is on schedule. The following table provides a summary of the current
status of the five phases involved and a projected timetable for
completion.
Project Phase % Completed Estimated Completion
Awareness 100% - -
Assessment 100% - -
Renovation 85% December 32, 1998
Validation 35% March 31, 1999
Implementation 35% June 30, 1999
The Company's estimated total cost of the Year 2000 project is
estimated to be between $700,000 and $1,700,000. The total amount
expended on the project through September 30, 1998, was $352,000 of which
approximately $333,000 was related to the cost to repair or replace
software; approximately $9,000 to the cost of replacing equipment, and
approximately $10,000 to miscellaneous items such as training for
employees and communications with customers. Funds have been provided
from our normal operating budget and costs are expensed as they are
incurred. The total cost to the Company of these Year 2000 readiness
activities has not been, and is not anticipated to be, material to its
financial position or results of operations in any given year. No other
specific projects have been deferred due to this project. Much of the
work done within this project is an acceleration of work that would have
been done in the normal course of business.
The costs and timetable in which the Company plans to complete the
Year 2000 readiness activities are based on management's best estimates,
which were derived using numerous assumptions of future events including
the continued availability of certain resources, third-party readiness
plans and other factors. The Company can make no guarantee that these
estimates will be achieved and actual results could differ from such
plans.
Based upon current information related to the progress of its major
vendors and service providers, management believes that the Year 2000
issue will not pose significant operational problems for its computer
systems. This belief is based on the ability of those vendors and service
providers to renovate, in a timely manner, the products and services on
which the Company's systems rely. However, the Company can give no
guarantee that these systems will be renovated in a timely manner.
Realizing that some disruption may occur despite its best efforts, the
Company is in the process of developing contingency plans for each
critical system in the event that one or more of those systems fail.
While this is an ongoing process, the Company expects to have the plan
substantially documented by June 30, 1999.
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. Exhibits and Reports on Form 8-K.
None<PAGE>
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 11/11/98 /s/ Christopher J. Murphy III
(Signature)
Christopher J. Murphy III, President
DATE 11/11/98 /s/ Larry E. Lentych
(Signature)
Larry E. Lentych, Treasurer (Chief
Accounting and Financial Officer)
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