SRCE-2014.3.31-10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM 10-Q 
(Mark One)
 
x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2014
 
OR

o         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
 
(Exact name of registrant as specified in its charter) 
INDIANA
 
35-1068133
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
100 North Michigan Street
 
 
South Bend, IN
 
46601
(Address of principal executive offices)
 
(Zip Code)
 
(574) 235-2000
(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.  x  Yes  o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  x Yes  o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
Large accelerated filer o
 
Accelerated filer x
 
 
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  x No
 
Number of shares of common stock outstanding as of April 18, 201424,334,787 shares
 


Table of Contents

TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CERTIFICATIONS
 
 
 
 
 


2

Table of Contents



1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited - Dollars in thousands)
 
March 31,
2014
 
December 31,
2013
ASSETS
 

 
 

Cash and due from banks
$
92,465

 
$
77,568

Federal funds sold and interest bearing deposits with other banks
1,362

 
2,484

Investment securities available-for-sale (amortized cost of $826,007 and $822,163 at March 31, 2014
and December 31, 2013, respectively)
839,597

 
832,700

Other investments
22,400

 
22,400

Trading account securities
192

 
192

Mortgages held for sale
10,961

 
6,079

Loans and leases, net of unearned discount:
 

 
 

Commercial and agricultural loans
698,246

 
679,492

Auto and light truck
388,665

 
391,649

Medium and heavy duty truck
237,906

 
237,854

Aircraft financing
730,803

 
738,133

Construction equipment financing
352,796

 
333,088

Commercial real estate
588,629

 
583,997

Residential real estate
455,678

 
460,981

Consumer loans
124,845

 
124,130

Total loans and leases
3,577,568

 
3,549,324

Reserve for loan and lease losses
(85,010
)
 
(83,505
)
Net loans and leases
3,492,558

 
3,465,819

Equipment owned under operating leases, net
58,468

 
60,967

Net premises and equipment
45,856

 
46,630

Goodwill and intangible assets
86,057

 
86,343

Accrued income and other assets
123,277

 
121,644

Total assets
$
4,773,193

 
$
4,722,826

 
 
 
 
LIABILITIES
 

 
 

Deposits:
 

 
 

Noninterest bearing
$
750,662

 
$
735,212

Interest bearing
2,957,761

 
2,918,438

Total deposits
3,708,423

 
3,653,650

Short-term borrowings:
 

 
 

Federal funds purchased and securities sold under agreements to repurchase
168,339

 
181,120

Other short-term borrowings
129,308

 
133,011

Total short-term borrowings
297,647

 
314,131

Long-term debt and mandatorily redeemable securities
59,555

 
58,335

Subordinated notes
58,764

 
58,764

Accrued expenses and other liabilities
52,218

 
52,568

Total liabilities
4,176,607

 
4,137,448

 
 
 
 
SHAREHOLDERS’ EQUITY
 

 
 

Preferred stock; no par value
 

 
 

Authorized 10,000,000 shares; none issued or outstanding

 

Common stock; no par value
 

 
 

Authorized 40,000,000 shares; issued 25,641,887 at March 31, 2014 and December 31, 2013
346,535

 
346,535

Retained earnings
270,848

 
261,626

Cost of common stock in treasury (1,306,006 shares at March 31, 2014 and 1,319,377 shares at December 31, 2013)
(29,285
)
 
(29,364
)
Accumulated other comprehensive income
8,488

 
6,581

Total shareholders’ equity
596,586

 
585,378

Total liabilities and shareholders’ equity
$
4,773,193

 
$
4,722,826

The accompanying notes are a part of the consolidated financial statements.

3

Table of Contents

1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited - Dollars in thousands, except per share amounts) 
 
Three Months Ended 
 March 31,
 
2014
 
2013
Interest income:
 

 
 

Loans and leases
$
38,914

 
$
39,170

Investment securities, taxable
3,345

 
3,695

Investment securities, tax-exempt
819

 
771

Other
277

 
242

Total interest income
43,355

 
43,878

 
 
 
 
Interest expense:
 

 
 

Deposits
2,971

 
4,542

Short-term borrowings
136

 
32

Subordinated notes
1,055

 
1,055

Long-term debt and mandatorily redeemable securities
575

 
495

Total interest expense
4,737

 
6,124

 
 
 
 
Net interest income
38,618

 
37,754

Provision for loan and lease losses
804

 
757

Net interest income after provision for loan and lease losses
37,814

 
36,997

 
 
 
 
Noninterest income:
 

 
 

Trust fees
4,476

 
4,101

Service charges on deposit accounts
2,066

 
2,239

Debit card income
2,232

 
2,065

Mortgage banking income
1,334

 
1,628

Insurance commissions
1,563

 
1,446

Equipment rental income
4,082

 
4,012

Gains on investment securities available-for-sale
963

 

Other income
2,682

 
3,457

Total noninterest income
19,398

 
18,948

 
 
 
 
Noninterest expense:
 

 
 

Salaries and employee benefits
19,482

 
19,936

Net occupancy expense
2,437

 
2,207

Furniture and equipment expense
4,237

 
3,899

Depreciation - leased equipment
3,249

 
3,225

Professional fees
1,128

 
1,355

Supplies and communication
1,392

 
1,536

FDIC and other insurance
864

 
878

Business development and marketing expense
1,684

 
773

Loan and lease collection and repossession expense
(494
)
 
757

Other expense
1,994

 
1,984

Total noninterest expense
35,973

 
36,550

 
 
 
 
Income before income taxes
21,239

 
19,395

Income tax expense
7,607

 
6,991

 
 
 
 
Net income
$
13,632

 
$
12,404

 
 
 
 
Per common share:
 

 
 

Basic net income per common share
$
0.55

 
$
0.50

Diluted net income per common share
$
0.55

 
$
0.50

Dividends
$
0.17

 
$
0.17

Basic weighted average common shares outstanding
24,317,446

 
24,321,985

Diluted weighted average common shares outstanding
24,317,446

 
24,324,328

The accompanying notes are a part of the consolidated financial statements.

4

Table of Contents

1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited - Dollars in thousands)
 
Three Months Ended 
 March 31,
 
2014
 
2013
 
 
 
 
Net income
$
13,632

 
$
12,404

 
 
 
 
Other comprehensive income (loss):
 

 
 

Change in unrealized appreciation (depreciation) of available-for-sale securities
4,016

 
(1,931
)
Reclassification adjustment for realized (gains) losses included in net income
(963
)
 

Income tax effect
(1,146
)
 
725

Other comprehensive income (loss), net of tax
1,907

 
(1,206
)
 
 
 
 
Comprehensive income
$
15,539

 
$
11,198

The accompanying notes are a part of the consolidated financial statements.

1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited - Dollars in thousands, except per share amounts)
 
Preferred
Stock
 
Common
Stock
 
Retained
Earnings
 
Cost of
Common
Stock
in Treasury
 
Accumulated
Other
Comprehensive
Income (Loss), Net
 
Total
Balance at January 1, 2013
$

 
$
346,535

 
$
223,715

 
$
(31,134
)
 
$
19,539

 
$
558,655

Net income

 

 
12,404

 

 

 
12,404

Other comprehensive loss

 

 

 

 
(1,206
)
 
(1,206
)
Issuance of 148,627 common shares under stock based compensation awards, including related tax effects

 

 
(281
)
 
3,530

 

 
3,249

Cost of 24,800 shares of common stock acquired for treasury

 

 

 
(566
)
 

 
(566
)
Common stock dividend ($0.17 per share)

 

 
(4,174
)
 

 

 
(4,174
)
Balance at March 31, 2013
$

 
$
346,535

 
$
231,664

 
$
(28,170
)
 
$
18,333

 
$
568,362

 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2014
$

 
$
346,535

 
$
261,626

 
$
(29,364
)
 
$
6,581

 
$
585,378

Net income

 

 
13,632

 

 

 
13,632

Other comprehensive income

 

 

 

 
1,907

 
1,907

Issuance of 61,978 common shares under stock based compensation awards, including related tax effects

 

 
(243
)
 
1,480

 

 
1,237

Cost of 48,607 shares of common stock acquired for treasury

 

 

 
(1,401
)
 

 
(1,401
)
Common stock dividend ($0.17 per share)

 

 
(4,167
)
 

 

 
(4,167
)
Balance at March 31, 2014
$

 
$
346,535

 
$
270,848

 
$
(29,285
)
 
$
8,488

 
$
596,586

The accompanying notes are a part of the consolidated financial statements.


5

Table of Contents

1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited - Dollars in thousands)
 
Three Months Ended March 31,
 
2014
 
2013
Operating activities:
 

 
 

Net income
$
13,632

 
$
12,404

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Provision for loan and lease losses
804

 
757

Depreciation of premises and equipment
1,189

 
1,148

Depreciation of equipment owned and leased to others
3,249

 
3,225

Amortization of investment security premiums and accretion of discounts, net
1,044

 
942

Amortization of mortgage servicing rights
286

 
480

Deferred income taxes
(905
)
 
433

Gains on investment securities available-for-sale
(963
)
 

Originations of loans held for sale, net of principal collected
(22,470
)
 
(26,885
)
Proceeds from the sales of loans held for sale
18,373

 
28,308

Net gain on sale of loans held for sale
(785
)
 
(1,178
)
Change in trading account securities

 
(16
)
Change in interest receivable
(714
)
 
(1,339
)
Change in interest payable
100

 
856

Change in other assets
3,433

 
865

Change in other liabilities
905

 
(728
)
Other
1,271

 
112

Net change in operating activities
18,449

 
19,384

 
 
 
 
Investing activities:
 

 
 

Proceeds from sales of investment securities
1,236

 

Proceeds from maturities of investment securities
64,251

 
65,273

Purchases of investment securities
(69,412
)
 
(47,367
)
Loans sold or participated to others
689

 
8,109

Net change in loans and leases
(33,676
)
 
(54,653
)
Net change in equipment owned under operating leases
(750
)
 
(4,509
)
Purchases of premises and equipment
(421
)
 
(1,761
)
Net change in investing activities
(38,083
)
 
(34,908
)
 
 
 
 
Financing activities:
 

 
 

Net change in demand deposits, NOW accounts and savings accounts
(6,167
)
 
(33,078
)
Net change in certificates of deposit
60,940

 
89,297

Net change in short-term borrowings
(16,484
)
 
(54,311
)
Proceeds from issuance of long-term debt
5,647

 
4,912

Payments on long-term debt
(6,096
)
 
(9,189
)
Net proceeds from issuance of treasury stock
1,237

 
3,249

Acquisition of treasury stock
(1,401
)
 
(566
)
Cash dividends paid on common stock
(4,267
)
 
(4,267
)
Net change in financing activities
33,409

 
(3,953
)
 
 
 
 
Net change in cash and cash equivalents
13,775

 
(19,477
)
 
 
 
 
Cash and cash equivalents, beginning of year
80,052

 
83,934

 
 
 
 
Cash and cash equivalents, end of period
$
93,827

 
$
64,457

 
 
 
 
Supplemental Information:
 

 
 

Non-cash transactions:
 

 
 

Loans transferred to other real estate and repossessed assets
$
5,444

 
$
822

Common stock matching contribution to Employee Stock Ownership and Profit Sharing Plan

 
2,801

The accompanying notes are a part of the consolidated financial statements.

6

Table of Contents

1ST SOURCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1.       Basis of Presentation
 
1st Source Corporation is a bank holding company headquartered in South Bend, Indiana that provides, through its subsidiaries (collectively referred to as “1st Source” or “the Company”), a broad array of financial products and services. 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, changes in comprehensive income, changes in shareholders’ equity, 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 (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been omitted.
 
The Notes to the Consolidated Financial Statements appearing in 1st Source Corporation’s Annual Report on Form 10-K (2013 Annual Report), which include descriptions of significant accounting policies, should be read in conjunction with these interim financial statements. The Consolidated Statement of Financial Condition at December 31, 2013 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. Certain amounts in the prior period consolidated financial statements have been reclassified to conform to the current year presentation.
 
Note 2.       Recent Accounting Pronouncements
 
Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure: In January 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-04 "Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40) - Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure." ASU 2014-04 clarifies when an in substance repossession or foreclosure occurs and requires interim and annual disclosures of the amount of foreclosed residential real estate property and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. ASU 2014-04 is effective either on a modified retrospective transition method or a prospective transition method for interim and annual periods beginning after December 15, 2014. Early adoption is permitted. The Company is assessing the impact of ASU 2014-04 on its disclosures.

Accounting for Investments in Qualified Affordable Housing Projects: In January 2014, the FASB issued ASU No. 2014-01 "Investments - Equity method and Joint Ventures (Topic 323) - Accounting for Investments in Qualified Affordable Housing Projects." ASU 2014-01 allows investors to use the proportional amortization method to account for investments in limited liability entities that manage or invest in affordable housing projects that qualify for low-income housing tax credits if certain conditions are met. ASU 2014-01 is effective retrospectively for interim and annual periods in fiscal years that begin after December 15, 2014. Early adoption is permitted. The Company is assessing the impact of ASU 2014-01 on its accounting for affordable housing projects.

Investment Companies: In June 2013, the FASB issued ASU No. 2013-08 “Financial Services-Investment Companies (Topic 946) — Amendments to the Scope, Measurement and Disclosure Requirements.” ASU 2013-08 changes the approach to the investment company assessment in Topic 946, clarifies the characteristics of an investment company and provides comprehensive guidance for assessing whether an entity is an investment company. ASU 2013-08 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013. Early application is prohibited. The Company determined that 1st Source Capital Corporation, a wholly-owned subsidiary of 1st Source Bank, is considered an investment company and is applying the guidance in Topic 946 in accordance with ASU 2013-08. 


7

Table of Contents

Note 3.       Investment Securities
 
The following table shows investment securities available-for-sale.
 
(Dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
March 31, 2014
 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
400,973

 
$
4,440

 
$
(4,023
)
 
$
401,390

U.S. States and political subdivisions securities
 
124,174

 
3,775

 
(555
)
 
127,394

Mortgage-backed securities — Federal agencies
 
266,392

 
5,395

 
(2,267
)
 
269,520

Corporate debt securities
 
31,875

 
308

 
(43
)
 
32,140

Foreign government and other securities
 
700

 
2

 

 
702

Total debt securities
 
824,114

 
13,920

 
(6,888
)
 
831,146

Marketable equity securities
 
1,893

 
6,560

 
(2
)
 
8,451

Total investment securities available-for-sale
 
$
826,007

 
$
20,480

 
$
(6,890
)
 
$
839,597

 
 
 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
394,558

 
$
5,008

 
$
(4,527
)
 
$
395,039

U.S. States and political subdivisions securities
 
120,416

 
3,670

 
(847
)
 
123,239

Mortgage-backed securities — Federal agencies
 
273,495

 
5,148

 
(3,563
)
 
275,080

Corporate debt securities
 
30,828

 
241

 
(4
)
 
31,065

Foreign government and other securities
 
700

 
9

 

 
709

Total debt securities
 
819,997

 
14,076

 
(8,941
)
 
825,132

Marketable equity securities
 
2,166

 
5,404

 
(2
)
 
7,568

Total investment securities available-for-sale
 
$
822,163

 
$
19,480

 
$
(8,943
)
 
$
832,700

 
At March 31, 2014 and December 31, 2013, the residential mortgage-backed securities held by the Company consisted primarily of GNMA, FNMA and FHLMC pass-through certificates which are guaranteed by those respective agencies of the United States government (Government Sponsored Enterprise, GSEs).
 
The following table shows the contractual maturities of investments in securities available-for-sale at March 31, 2014. Expected maturities will differ from contractual maturities, because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
(Dollars in thousands)
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
37,524

 
$
38,027

Due after one year through five years
 
400,315

 
404,908

Due after five years through ten years
 
117,501

 
116,329

Due after ten years
 
2,382

 
2,362

Mortgage-backed securities
 
266,392

 
269,520

Total debt securities available-for-sale
 
$
824,114

 
$
831,146


The following table shows the gross realized gains and losses on sale of securities from the securities available-for-sale portfolio, including marketable equity securities. Realized gains and losses on the sales of all securities are computed using the specific identification cost basis. The gross gains and losses for the three months ended March 31, 2014 reflect the sale of marketable equity securities.
 
 
 
Three Months Ended 
 March 31,
(Dollars in thousands)
 
2014
 
2013
Gross realized gains
 
$
963

 
$

Gross realized losses
 

 

Net realized gains (losses)
 
$
963

 
$

 

8

Table of Contents

The following table summarizes gross unrealized losses and fair value by investment category and age.
 
 
 
Less than 12 Months
 
12 months or Longer
 
Total
(Dollars in thousands) 
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
March 31, 2014
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
210,143

 
$
(3,876
)
 
$
15,044

 
$
(147
)
 
$
225,187

 
$
(4,023
)
U.S. States and political subdivisions securities
 
34,278

 
(528
)
 
915

 
(27
)
 
35,193

 
(555
)
Mortgage-backed securities - Federal agencies
 
72,185

 
(1,438
)
 
14,813

 
(829
)
 
86,998

 
(2,267
)
Corporate debt securities
 
6,066

 
(43
)
 

 

 
6,066

 
(43
)
Foreign government and other securities
 
100

 

 

 

 
100

 

Total debt securities
 
322,772

 
(5,885
)
 
30,772

 
(1,003
)
 
353,544

 
(6,888
)
Marketable equity securities
 

 

 
4

 
(2
)
 
4

 
(2
)
Total investment securities available-for-sale
 
$
322,772

 
$
(5,885
)
 
$
30,776

 
$
(1,005
)
 
$
353,548

 
$
(6,890
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
153,868

 
$
(4,404
)
 
$
15,085

 
$
(123
)
 
$
168,953

 
$
(4,527
)
U.S. States and political subdivisions securities
 
37,115

 
(814
)
 
1,419

 
(33
)
 
38,534

 
(847
)
Mortgage-backed securities - Federal agencies
 
99,488

 
(3,099
)
 
5,352

 
(464
)
 
104,840

 
(3,563
)
Corporate debt securities
 
6,332

 
(4
)
 

 

 
6,332

 
(4
)
Foreign government and other securities
 

 

 

 

 

 

Total debt securities
 
296,803

 
(8,321
)
 
21,856

 
(620
)
 
318,659

 
(8,941
)
Marketable equity securities
 

 

 
4

 
(2
)
 
4

 
(2
)
Total investment securities available-for-sale
 
$
296,803

 
$
(8,321
)
 
$
21,860

 
$
(622
)
 
$
318,663

 
$
(8,943
)
 
The initial indication of OTTI for both debt and equity securities is a decline in fair value below amortized cost. Quarterly, the impaired securities are analyzed on a qualitative and quantitative basis in determining OTTI. Declines in the fair value of available-for-sale debt securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of impairment related to other factors is recognized in other comprehensive income. In estimating OTTI impairment losses, the Company considers among other things, (i) the length of time and the extent to which fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) whether it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.
 
There were no other-than-temporary-impairment (OTTI) write-downs in 2014 or 2013.

At March 31, 2014, the Company does not have the intent to sell any of the available-for-sale securities in the table above and believes that it is more likely than not, that it will not have to sell any such securities before an anticipated recovery of cost. Primarily the unrealized losses on debt securities are due to increases in market rates over the yields available at the time the underlying securities were purchased and market illiquidity on auction rate securities which are reflected in U.S. States and political subdivisions. The fair value is expected to recover on all debt securities as they approach their maturity date or re-pricing date or if market yields for such investments decline. The Company does not believe any of the securities are impaired due to reasons of credit quality.

At March 31, 2014 and December 31, 2013, investment securities with carrying values of $248.11 million and $237.42 million, respectively, were pledged as collateral for security repurchase agreements and for other purposes.
 
Note 4.       Loan and Lease Financings
 
The Company evaluates loans and leases for credit quality at least annually but more frequently if certain circumstances occur (such as material new information which becomes available and indicates a potential change in credit risk). The Company uses two methods to assess credit risk: loan or lease credit quality grades and credit risk classifications. The purpose of the loan or lease credit quality grade is to document the degree of risk associated with individual credits as well as inform management of the degree of risk in the portfolio taken as a whole. Credit risk classifications are used to categorize loans by degree of risk and to designate individual or committee approval authorities for higher risk credits at the time of origination. Credit risk classifications include categories for: Acceptable, Marginal, Special Attention, Special Risk, Restricted by Policy, Regulated and Prohibited by Law.
 

9

Table of Contents

All loans and leases, except residential real estate loans and consumer loans, are assigned credit quality grades on a scale from 1 to 12 with grade 1 representing superior credit quality. The criteria used to assign grades to extensions of credit that exhibit potential problems or well-defined weaknesses are primarily based upon the degree of risk and the likelihood of orderly repayment, and their effect on the Company’s safety and soundness. Loans or leases graded 7 or weaker are considered “special attention” credits and, as such, relationships in excess of $100,000 are reviewed quarterly as part of management’s evaluation of the appropriateness of the reserve for loan and lease losses. Grade 7 credits are defined as “watch” and contain greater than average credit risk and are monitored to limit the exposure to increased risk; grade 8 credits are “special mention” and, following regulatory guidelines, are defined as having potential weaknesses that deserve management’s close attention. Credits that exhibit well-defined weaknesses and a distinct possibility of loss are considered “classified” and are graded 9 through 12 corresponding to the regulatory definitions of “substandard” (grades 9 and 10) and the more severe “doubtful” (grade 11) and “loss” (grade 12).
 
The following table shows the credit quality grades of the recorded investment in loans and leases, segregated by class.
 
 
 
Credit Quality Grades
(Dollars in thousands) 
 
1-6
 
7-12
 
Total
March 31, 2014
 
 

 
 

 
 

Commercial and agricultural loans
 
$
671,796

 
$
26,450

 
$
698,246

Auto and light truck
 
379,015

 
9,650

 
388,665

Medium and heavy duty truck
 
233,505

 
4,401

 
237,906

Aircraft financing
 
697,505

 
33,298

 
730,803

Construction equipment financing
 
345,542

 
7,254

 
352,796

Commercial real estate
 
564,365

 
24,264

 
588,629

Total
 
$
2,891,728

 
$
105,317

 
$
2,997,045

 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

Commercial and agricultural loans
 
$
652,620

 
$
26,872

 
$
679,492

Auto and light truck
 
378,392

 
13,257

 
391,649

Medium and heavy duty truck
 
235,465

 
2,389

 
237,854

Aircraft financing
 
704,997

 
33,136

 
738,133

Construction equipment financing
 
325,849

 
7,239

 
333,088

Commercial real estate
 
557,692

 
26,305

 
583,997

Total
 
$
2,855,015

 
$
109,198

 
$
2,964,213


For residential real estate and consumer loans, credit quality is based on the aging status of the loan and by payment activity. The following table shows the recorded investment in residential real estate and consumer loans by performing or nonperforming status. Nonperforming loans are those loans which are on nonaccrual status or are 90 days or more past due.
 
(Dollars in thousands) 
 
Performing
 
Nonperforming
 
Total
March 31, 2014
 
 

 
 

 
 

Residential real estate
 
$
453,025

 
$
2,653

 
$
455,678

Consumer
 
124,402

 
443

 
124,845

Total
 
$
577,427

 
$
3,096

 
$
580,523

 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

Residential real estate
 
$
458,385

 
$
2,596

 
$
460,981

Consumer
 
123,663

 
467

 
124,130

Total
 
$
582,048

 
$
3,063

 
$
585,111

 

10

Table of Contents

The following table shows the recorded investment of loans and leases, segregated by class, with delinquency aging and nonaccrual status.
 
(Dollars in thousands) 
 
Current
 
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days or More Past Due and Accruing
 
Total Accruing Loans
 
Nonaccrual
 
Total Financing Receivables
March 31, 2014
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and agricultural loans
 
$
686,536

 
$
200

 
$
1

 
$

 
$
686,737

 
$
11,509

 
$
698,246

Auto and light truck
 
388,074

 
241

 
2

 

 
388,317

 
348

 
388,665

Medium and heavy duty truck
 
237,762

 
12

 

 

 
237,774

 
132

 
237,906

Aircraft financing
 
716,622

 
7,072

 
3,528

 

 
727,222

 
3,581

 
730,803

Construction equipment financing
 
351,206

 
424

 

 

 
351,630

 
1,166

 
352,796

Commercial real estate
 
583,474

 

 

 

 
583,474

 
5,155

 
588,629

Residential real estate
 
452,365

 
459

 
201

 
274

 
453,299

 
2,379

 
455,678

Consumer
 
123,669

 
598

 
135

 
33

 
124,435

 
410

 
124,845

Total
 
$
3,539,708

 
$
9,006

 
$
3,867

 
$
307

 
$
3,552,888

 
$
24,680

 
$
3,577,568

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and agricultural loans
 
$
667,462

 
$
263

 
$
2

 
$

 
$
667,727

 
$
11,765

 
$
679,492

Auto and light truck
 
387,881

 
222

 
36

 

 
388,139

 
3,510

 
391,649

Medium and heavy duty truck
 
237,645

 
20

 

 

 
237,665

 
189

 
237,854

Aircraft financing
 
713,832

 
10,309

 
3,627

 

 
727,768

 
10,365

 
738,133

Construction equipment financing
 
331,083

 
973

 

 

 
332,056

 
1,032

 
333,088

Commercial real estate
 
576,933

 

 

 

 
576,933

 
7,064

 
583,997

Residential real estate
 
456,782

 
1,334

 
269

 
197

 
458,582

 
2,399

 
460,981

Consumer
 
122,657

 
786

 
220

 
84

 
123,747

 
383

 
124,130

Total
 
$
3,494,275

 
$
13,907

 
$
4,154

 
$
281

 
$
3,512,617

 
$
36,707

 
$
3,549,324



11

Table of Contents

The following table shows impaired loans and leases, segregated by class, and the corresponding reserve for impaired loan and lease losses.
 
(Dollars in thousands) 
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
March 31, 2014
 
 

 
 

 
 

With no related reserve recorded:
 
 

 
 

 
 

Commercial and agricultural loans
 
$
11,146

 
$
11,146

 
$

Auto and light truck
 
266

 
266

 

Medium and heavy duty truck
 

 

 

Aircraft financing
 
3,650

 
3,652

 

Construction equipment financing
 
784

 
784

 

Commercial real estate
 
12,789

 
12,789

 

Residential real estate
 

 

 

Consumer loans
 

 

 

Total with no related reserve recorded
 
28,635

 
28,637

 

With a reserve recorded:
 
 

 
 

 
 

Commercial and agricultural loans
 

 

 

Auto and light truck
 

 

 

Medium and heavy duty truck
 

 

 

Aircraft financing
 
497

 
497

 
57

Construction equipment financing
 
345

 
345

 
9

Commercial real estate
 

 

 

Residential real estate
 
377

 
380

 
160

Consumer loans
 

 

 

Total with a reserve recorded
 
1,219

 
1,222

 
226

Total impaired loans
 
$
29,854

 
$
29,859

 
$
226

 
 
 
 
 
 
 
December 31, 2013
 
 

 
 

 
 

With no related reserve recorded:
 
 

 
 

 
 

Commercial and agricultural loans
 
$
11,231

 
$
11,230

 
$

Auto and light truck
 
3,499

 
3,499

 

Medium and heavy duty truck
 

 

 

Aircraft financing
 
9,764

 
9,764

 

Construction equipment financing
 
938

 
938

 

Commercial real estate
 
14,897

 
14,897

 

Residential real estate
 

 

 

Consumer loans
 

 

 

Total with no related reserve recorded
 
40,329

 
40,328

 

With an allowance recorded:
 
 

 
 

 
 

Commercial and agricultural loans
 

 

 

Auto and light truck
 

 

 

Medium and heavy duty truck
 

 

 

Aircraft financing
 
563

 
563

 
113

Construction equipment financing
 

 

 

Commercial real estate
 

 

 

Residential real estate
 
381

 
381

 
161

Consumer loans
 

 

 

Total with a reserve recorded
 
944

 
944

 
274

Total impaired loans
 
$
41,273

 
$
41,272

 
$
274



12

Table of Contents

The following table shows average recorded investment and interest income recognized on impaired loans and leases, segregated by class.
 
 
 
Three Months Ended March 31,
 
 
2014
 
2013
(Dollars in thousands) 
 
Average
Recorded
Investment
 
Interest
Income
 
Average
Recorded
Investment
 
Interest
Income
Commercial and agricultural loans
 
$
11,255

 
$
16

 
$
8,319

 
$
3

Auto and light truck
 
1,627

 

 

 

Medium and heavy duty truck
 

 

 
466

 

Aircraft financing
 
6,976

 
9

 
8,268

 

Construction equipment financing
 
949

 

 
4,705

 
2

Commercial real estate
 
13,666

 
147

 
20,545

 
152

Residential real estate
 
378

 
4

 

 

Consumer
 

 

 

 

Total
 
$
34,851

 
$
176

 
$
42,303

 
$
157

 
The following table shows the number of loans and leases classified as troubled debt restructuring (TDR) during the three months ended March 31, 2014 and 2013, segregated by class, as well as the recorded investment as of March 31. The classification between nonperforming and performing is shown at the time of modification. During 2014 and 2013, modification programs focused on extending maturity dates or modifying payment patterns with most TDRs experiencing a combination of concessions. The modifications did not result in the contractual forgiveness of principal or interest or interest rate reductions below market rates. Consequently, the financial impact of the modifications is immaterial.
 
 
 
Three Months Ended March 31,
 
 
2014
 
2013
(Dollars in thousands)
 
Number of Modifications
 
Recorded Investment
 
Number of Modifications
 
Recorded Investment
Performing TDRs:
 
 

 
 

 
 

 
 

Commercial and agricultural loans
 

 
$

 

 
$

Auto and light truck
 

 

 

 

Medium and heavy duty truck
 

 

 

 

Aircraft financing
 
1

 
596

 

 

Construction equipment financing
 

 

 

 

Commercial real estate
 

 

 

 

Residential real estate
 

 

 

 

Consumer
 

 

 

 

Total performing TDR modifications
 
1

 
$
596

 

 
$

 
 
 
 
 
 
 
 
 
Nonperforming TDRs:
 
 

 
 

 
 

 
 

Commercial and agricultural loans
 

 
$

 
1

 
$
25

Auto and light truck
 

 

 

 

Medium and heavy duty truck
 

 

 

 

Aircraft financing
 

 

 

 

Construction equipment financing
 

 

 

 

Commercial real estate
 

 

 

 

Residential real estate
 

 

 

 

Consumer
 

 

 

 

Total nonperforming TDR modifications
 

 
$

 
1

 
$
25

Total TDR modifications
 
1

 
$
596

 
1

 
$
25

 
There were no TDRs which had payment defaults within the twelve months following modification during the three months ended March 31, 2014 and 2013. Default occurs when a loan or lease is 90 days or more past due under the modified terms or transferred to nonaccrual.
 

13

Table of Contents

The following table shows the recorded investment of loans and leases classified as troubled debt restructurings as of March 31, 2014 and December 31, 2013.
 
(Dollars in thousands)
 
March 31,
2014
 
December 31,
2013
Performing TDRs
 
$
9,331

 
$
8,786

Nonperforming TDRs
 
9,434

 
11,824

Total TDRs
 
$
18,765

 
$
20,610

 
Note 5.       Reserve for Loan and Lease Losses
 
The reserve for loan and lease loss methodology has been consistently applied for several years, with enhancements instituted periodically. Reserve ratios are reviewed quarterly and revised periodically to reflect recent loss history and to incorporate current risks and trends which may not be recognized in historical data. As the historical charge-off analysis is updated, the Company reviews the look-back periods for each business loan portfolio. Furthermore, a thorough analysis of charge-offs, non-performing asset levels, special attention outstandings and delinquency is performed in order to review portfolio trends and other factors, including specific industry risks and economic conditions, which may have an impact on the reserves and reserve ratios applied to various portfolios. The Company adjusts the calculated historical based ratio as a result of the analysis of environmental factors, principally economic risk and concentration risk. Key economic factors affecting the portfolios are growth in gross domestic product, unemployment rates, housing market trends, commodity prices, inflation and global economic and political issues. Concentration risk is impacted primarily by geographic concentration in Northern Indiana and Southwestern Lower Michigan in the business banking and commercial real estate portfolios and by collateral concentration in the specialty finance portfolios and exposure to foreign markets by geographic risk.
 
The reserve for loan and lease losses is maintained at a level believed to be appropriate by the Company to absorb probable losses inherent in the loan and lease portfolio. The determination of the reserve requires significant judgment reflecting the Company’s best estimate of probable loan and lease losses related to specifically identified impaired loans and leases as well as probable losses in the remainder of the various loan and lease portfolios. For purposes of determining the reserve, the Company has segmented loans and leases into classes based on the associated risk within these segments. The Company has determined that eight classes exist within the loan and lease portfolio. The methodology for assessing the appropriateness of the reserve consists of several key elements, which include: specific reserves for impaired loans, formula reserves for each business lending division portfolio including percentage allocations for special attention loans and leases not deemed impaired, and reserves for pooled homogeneous loans and leases. The Company’s evaluation is based upon a continuing review of these portfolios, estimates of customer performance, collateral values and dispositions, and assessments of economic and geopolitical events, all of which are subject to judgment and will change.


14

Table of Contents

The following table shows the changes in the reserve for loan and lease losses, segregated by class, for the three months ended March 31, 2014 and 2013.
 
(Dollars in thousands)
 
Commercial and
agricultural loans
 
Auto and
light truck
 
Medium and
heavy duty truck
 
Aircraft
financing
 
Construction
equipment
financing
 
Commercial
real estate
 
Residential
real estate
 
Consumer
loans
 
Total
March 31, 2014
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Reserve for loan and lease losses
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
 
$
11,515

 
$
9,657

 
$
4,212

 
$
34,037

 
$
5,972

 
$
12,406

 
$
4,093

 
$
1,613

 
$
83,505

Charge-offs
 
15

 
11

 

 

 
2

 
1

 
16

 
258

 
303

Recoveries
 
379

 
234

 
37

 
57

 
166

 
39

 
5

 
87

 
1,004

Net charge-offs (recoveries)
 
(364
)
 
(223
)
 
(37
)
 
(57
)
 
(164
)
 
(38
)
 
11

 
171

 
(701
)
Provision (recovery of provision)
 
(60
)
 
(224
)
 
162

 
415

 
178

 
165

 
(20
)
 
188

 
804

Balance, end of period
 
$
11,819

 
$
9,656

 
$
4,411

 
$
34,509

 
$
6,314

 
$
12,609

 
$
4,062

 
$
1,630

 
$
85,010

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance, individually evaluated for impairment
 
$

 
$

 
$

 
$
57

 
$
9

 
$

 
$
160

 
$

 
$
226

Ending balance, collectively evaluated for impairment
 
11,819

 
9,656

 
4,411

 
34,452

 
6,305

 
12,609

 
3,902

 
1,630

 
84,784

Total reserve for loan and lease losses
 
$
11,819

 
$
9,656

 
$
4,411

 
$
34,509

 
$
6,314

 
$
12,609

 
$
4,062

 
$
1,630

 
$
85,010