10-Q
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, 2016
 
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 15, 2016 — 25,849,257 shares
 


Table of Contents

TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
EXHIBITS
 
 
 
 
 
 
 
 
 


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Table of Contents



1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited - Dollars in thousands)
 
March 31,
2016
 
December 31,
2015
ASSETS
 

 
 

Cash and due from banks
$
52,373

 
$
65,171

Federal funds sold and interest bearing deposits with other banks
32,854

 
14,550

Investment securities available-for-sale (amortized cost of $787,062 and $781,232 at March 31, 2016
and December 31, 2015, respectively)
801,950

 
791,727

Other investments
21,973

 
21,973

Mortgages held for sale
11,999

 
9,825

Loans and leases, net of unearned discount:
 

 
 

Commercial and agricultural
749,024

 
744,749

Auto and light truck
428,455

 
425,236

Medium and heavy duty truck
272,917

 
278,254

Aircraft financing
783,844

 
778,012

Construction equipment financing
467,782

 
455,565

Commercial real estate
716,610

 
700,268

Residential real estate and home equity
466,450

 
464,129

Consumer
146,893

 
148,479

Total loans and leases
4,031,975

 
3,994,692

Reserve for loan and lease losses
(89,296
)
 
(88,112
)
Net loans and leases
3,942,679

 
3,906,580

Equipment owned under operating leases, net
110,412

 
110,371

Net premises and equipment
54,139

 
53,191

Goodwill and intangible assets
84,530

 
84,676

Accrued income and other assets
132,701

 
129,852

Total assets
$
5,245,610

 
$
5,187,916

 
 
 
 
LIABILITIES
 

 
 

Deposits:
 

 
 

Noninterest bearing
$
926,379

 
$
902,364

Interest bearing
3,298,769

 
3,236,822

Total deposits
4,225,148

 
4,139,186

Short-term borrowings:
 

 
 

Federal funds purchased and securities sold under agreements to repurchase
169,820

 
130,662

Other short-term borrowings
12,094

 
102,567

Total short-term borrowings
181,914

 
233,229

Long-term debt and mandatorily redeemable securities
68,837

 
57,379

Subordinated notes
58,764

 
58,764

Accrued expenses and other liabilities
60,974

 
55,305

Total liabilities
4,595,637

 
4,543,863

 
 
 
 
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 28,205,674 at March 31, 2016 and December 31, 2015
436,538

 
436,538

Retained earnings
260,813

 
251,812

Cost of common stock in treasury (2,356,417 shares at March 31, 2016 and 2,178,090 shares at December 31, 2015)
(56,677
)
 
(50,852
)
Accumulated other comprehensive income
9,299

 
6,555

Total shareholders’ equity
649,973

 
644,053

Total liabilities and shareholders’ equity
$
5,245,610

 
$
5,187,916

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

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Table of Contents

1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited - Dollars in thousands, except per share amounts) 
 
 
Three Months Ended 
 March 31,
 
 
2016
 
2015
Interest income:
 
 

 
 

Loans and leases
 
$
42,736

 
$
39,604

Investment securities, taxable
 
3,080

 
3,004

Investment securities, tax-exempt
 
692

 
769

Other
 
291

 
255

Total interest income
 
46,799

 
43,632

 
 
 
 
 
Interest expense:
 
 

 
 

Deposits
 
3,771

 
2,559

Short-term borrowings
 
161

 
103

Subordinated notes
 
1,055

 
1,055

Long-term debt and mandatorily redeemable securities
 
523

 
479

Total interest expense
 
5,510

 
4,196

 
 
 
 
 
Net interest income
 
41,289

 
39,436

Provision for loan and lease losses
 
975

 
357

Net interest income after provision for loan and lease losses
 
40,314

 
39,079

 
 
 
 
 
Noninterest income:
 
 

 
 

Trust fees
 
4,623

 
4,557

Service charges on deposit accounts
 
2,107

 
2,197

Debit card income
 
2,599

 
2,399

Mortgage banking income
 
1,046

 
1,251

Insurance commissions
 
1,563

 
1,305

Equipment rental income
 
6,073

 
5,079

Gains on investment securities available-for-sale
 
10

 

Other income
 
3,606

 
2,963

Total noninterest income
 
21,627

 
19,751

 
 
 
 
 
Noninterest expense:
 
 

 
 

Salaries and employee benefits
 
21,351

 
20,925

Net occupancy expense
 
2,501

 
2,461

Furniture and equipment expense
 
4,790

 
4,336

Depreciation - leased equipment
 
5,101

 
4,088

Professional fees
 
1,219

 
870

Supplies and communication
 
1,508

 
1,406

FDIC and other insurance
 
879

 
849

Business development and marketing expense
 
980

 
1,049

Loan and lease collection and repossession expense
 
427

 
363

Other expense
 
1,949

 
1,714

Total noninterest expense
 
40,705

 
38,061

 
 
 
 
 
Income before income taxes
 
21,236

 
20,769

Income tax expense
 
7,418

 
7,258

 
 
 
 
 
Net income
 
$
13,818

 
$
13,511

 
 
 
 
 
Per common share*:
 
 

 
 

Basic net income per common share
 
$
0.53

 
$
0.51

Diluted net income per common share
 
$
0.53

 
$
0.51

Cash dividends
 
$
0.180

 
$
0.164

Basic weighted average common shares outstanding*
 
25,923,530

 
26,258,273

Diluted weighted average common shares outstanding*
 
25,923,530

 
26,258,273

*The computation of three months ended March 31, 2015 per common share data and shares outstanding gives retrospective recognition to a 10% stock dividend declared on July 22, 2015 and issued on August 14, 2015.
The accompanying notes are a part of the consolidated financial statements.

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1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited - Dollars in thousands)
 
 
Three Months Ended 
 March 31,
 
 
2016
 
2015
 
 
 
 
 
Net income
 
$
13,818

 
$
13,511

 
 
 
 
 
Other comprehensive income (loss):
 
 

 
 

Change in unrealized appreciation (depreciation) of available-for-sale securities
 
4,403

 
2,946

Reclassification adjustment for realized (gains) losses included in net income
 
(10
)
 

Income tax effect
 
(1,649
)
 
(1,106
)
Other comprehensive income (loss), net of tax
 
2,744

 
1,840

 
 
 
 
 
Comprehensive income
 
$
16,562

 
$
15,351

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, 2015
$

 
$
346,535

 
$
302,242

 
$
(43,711
)
 
$
9,407

 
$
614,473

Net income

 

 
13,511

 

 

 
13,511

Other comprehensive income

 

 

 

 
1,840

 
1,840

Issuance of 94,361 common shares under stock based compensation awards, including related tax effects*

 

 
(221
)
 
2,191

 

 
1,970

Cost of 104,661 shares of common stock acquired for treasury*

 

 

 
(2,964
)
 

 
(2,964
)
Common stock cash dividend ($0.164 per share)*

 

 
(4,325
)
 

 

 
(4,325
)
Balance at March 31, 2015
$

 
$
346,535

 
$
311,207

 
$
(44,484
)
 
$
11,247

 
$
624,505

 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2016
$

 
$
436,538

 
$
251,812

 
$
(50,852
)
 
$
6,555

 
$
644,053

Net income

 

 
13,818

 

 

 
13,818

Other comprehensive income

 

 

 

 
2,744

 
2,744

Issuance of 91,340 common shares under stock based compensation awards, including related tax effects

 

 
(111
)
 
2,180

 

 
2,069

Cost of 269,667 shares of common stock acquired for treasury

 

 

 
(8,005
)
 

 
(8,005
)
Common stock cash dividend ($0.180 per share)

 

 
(4,706
)
 

 

 
(4,706
)
Balance at March 31, 2016
$

 
$
436,538

 
$
260,813

 
$
(56,677
)
 
$
9,299

 
$
649,973

*Share and per share data gives retrospective recognition to a 10% stock dividend declared on July 22, 2015 and issued on August 14, 2015.
The accompanying notes are a part of the consolidated financial statements.


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Table of Contents

1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited - Dollars in thousands)
 
Three Months Ended March 31,
 
2016
 
2015
Operating activities:
 

 
 

Net income
$
13,818

 
$
13,511

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

 
 

Provision for loan and lease losses
975

 
357

Depreciation of premises and equipment
1,283

 
1,148

Depreciation of equipment owned and leased to others
5,101

 
4,088

Stock-based compensation
784

 
1,239

Amortization of investment securities premiums and accretion of discounts, net
1,257

 
1,111

Amortization of mortgage servicing rights
332

 
393

Deferred income taxes
611

 
(139
)
Gains on investment securities available-for-sale
(10
)
 

Originations of loans held for sale, net of principal collected
(23,007
)
 
(34,517
)
Proceeds from the sales of loans held for sale
21,502

 
26,347

Net gain on sale of loans held for sale
(669
)
 
(1,046
)
Net gain on sale of other real estate and repossessions
(140
)
 
(564
)
Change in trading account securities

 
(3
)
Change in interest receivable
(664
)
 
(224
)
Change in interest payable
273

 
(250
)
Change in other assets
(1,230
)
 
167

Change in other liabilities
6,029

 
5,851

Other
(517
)
 
230

Net change in operating activities
25,728

 
17,699

Investing activities:
 

 
 

Proceeds from sales of investment securities available-for-sale
511

 

Proceeds from maturities and paydowns of investment securities available-for-sale
44,416

 
19,807

Purchases of investment securities available-for-sale
(52,003
)
 
(23,458
)
Net change in other investments

 
240

Loans sold or participated to others

 
1,373

Net change in loans and leases
(37,666
)
 
(19,203
)
Net change in equipment owned under operating leases
(5,142
)
 
(12,585
)
Purchases of premises and equipment
(2,298
)
 
(520
)
Proceeds from sales of other real estate and repossessions
573

 
5,654

Net change in investing activities
(51,609
)
 
(28,692
)
Financing activities:
 

 
 

Net change in demand deposits and savings accounts
18,491

 
37,774

Net change in time deposits
67,471

 
29,826

Net change in short-term borrowings
(51,315
)
 
(45,676
)
Proceeds from issuance of long-term debt
10,000

 

Payments on long-term debt
(387
)
 
(459
)
Acquisition of treasury stock
(8,005
)
 
(2,964
)
Cash dividends paid on common stock
(4,868
)
 
(4,434
)
Net change in financing activities
31,387

 
14,067

 
 
 
 
Net change in cash and cash equivalents
5,506

 
3,074

Cash and cash equivalents, beginning of year
79,721

 
66,190

Cash and cash equivalents, end of period
$
85,227

 
$
69,264

Supplemental Information:
 

 
 

Non-cash transactions:
 

 
 

Loans transferred to other real estate and repossessed assets
$
592

 
$
4,945

Common stock matching contribution to Employee Stock Ownership and Profit Sharing Plan
800

 
500

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

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Table of Contents

1ST SOURCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) 
Note 1.       Accounting Policies 
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.
Basis of Presentation – The accompanying unaudited consolidated financial statements reflect all adjustments (all of which are normal and recurring in nature) which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, the results of operations, 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 (2015 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, 2015 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.
Use of Estimates in the Preparation of Financial Statements – Financial statements prepared in accordance with GAAP require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the reporting period. Actual results could differ from those estimates.
Loans and Leases – Loans are stated at the principal amount outstanding, net of unamortized deferred loan origination fees and costs and net of unearned income. Interest income is accrued as earned based on unpaid principal balances. Origination fees and direct loan and lease origination costs are deferred and the net amount amortized to interest income over the estimated life of the related loan or lease. Loan commitment fees are deferred and amortized into other income over the commitment period.
Direct financing leases are carried at the aggregate of lease payments plus estimated residual value of the leased property, net of unamortized deferred lease origination fees and costs and unearned income. Interest income on direct financing leases is recognized over the term of the lease to achieve a constant periodic rate of return on the outstanding investment.
The accrual of interest on loans and leases is discontinued when a loan or lease becomes contractually delinquent for 90 days, or when an individual analysis of a borrower’s credit worthiness indicates a credit should be placed on nonperforming status, except for residential mortgage loans and consumer loans that are well secured and in the process of collection. Residential mortgage loans are placed on nonaccrual at the time the loan is placed in foreclosure. When interest accruals are discontinued, interest credited to income in the current year is reversed and interest accrued in the prior year is charged to the reserve for loan and lease losses. However, in some cases, the Company may elect to continue the accrual of interest when the net realizable value of collateral is sufficient to cover the principal and accrued interest. When a loan or lease is classified as nonaccrual and the future collectibility of the recorded loan or lease balance is doubtful, collections on interest and principal are applied as a reduction to principal outstanding. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured, which is typically evidenced by a sustained repayment performance of at least six months.
A loan or lease is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Interest on impaired loans and leases, which are not classified as nonaccrual, is recognized on the accrual basis. The Company evaluates loans and leases exceeding $100,000 for impairment and establishes a specific reserve as a component of the reserve for loan and lease losses when it is probable all amounts due will not be collected pursuant to the contractual terms of the loan or lease and the recorded investment in the loan or lease exceeds its fair value.
Loans and leases that have been modified and economic concessions have been granted to borrowers who have experienced financial difficulties are considered a troubled debt restructuring (TDR) and, by definition, are deemed an impaired loan. These concessions typically result from the Company’s loss mitigation activities and may include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructuring and typically are returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period of at least six months.

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When the Company modifies loans and leases in a TDR, it evaluates any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or uses the current fair value of the collateral, less selling costs for collateral dependent loans. If the Company determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a reserve for loan and lease losses estimate or a charge-off to the reserve for loan and lease losses. In periods subsequent to modification, the Company evaluates all TDRs, including those that have payment defaults, for possible impairment and recognizes impairment through the reserve for loan and lease losses.
Note 2.       Recent Accounting Pronouncements
Share Based Payment Accounting: In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-09 “Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting.” ASU 2016-09 requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also allows an employer to repurchase more of an employee’s shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election for forfeitures as they occur. The guidance is effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those years. Early adoption is permitted. The Company is assessing the impact of ASU 2016-09 on its accounting and disclosures.
Leases: In February 2016, the FASB issued ASU No. 2016-02 “Leases (Topic 842).” ASU 2016-02 establishes a right of use model that requires a lessee to record a right of use asset and a lease liability for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. A lease will be treated as sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years for public business entities. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, with certain practical expedients available. Early adoption is permitted. The Company is assessing the impact of ASU 2016-02 on its accounting and disclosures.
Recognition and Measurement of Financial Instruments: In January 2016, the FASB issued ASU No. 2016-01 “Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 is intended to improve the recognition and measurement of financial instruments by requiring equity investments to be measured at fair value with changes in fair value recognized in net income; requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured and amortized at cost on the balance sheet; and requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. ASU 2016-01 is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2017. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. The Company is assessing the impact of ASU 2016-01 on its accounting and disclosures.
Short Duration Contracts: In May 2015, the FASB issued ASU No. 2015-09 “Financial Services - Insurance (Topic 944) - Disclosures about Short Duration Contracts.” ASU 2015-09 includes amendments that require insurance entities to disclose for annual reporting periods information about the liability for unpaid claims and claim adjustment expenses as well as significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses. In addition, the amendments require a roll-forward of the liability for unpaid claims and claim adjustment expenses on an annual and interim basis. The amendments are effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016 and should be applied retrospectively. Early adoption is permitted. The Company is assessing the impact of ASU 2015-09 on its disclosures.

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Consolidations: In February 2015, the FASB issued ASU No. 2015-02 “Consolidation (Topic 810) - Amendments to the Consolidation Analysis.” ASU 2015-02 includes amendments that are intended to improve targeted areas of consolidation for legal entities including reducing the number of consolidation models from four to two and simplifying the FASB Accounting Standards Codification. ASU 2015-02 is effective for annual and interim periods within those annual periods, beginning after December 15, 2015. The amendments may be applied retrospectively in previously issued financial statements for one or more years with a cumulative effect adjustment to retained earnings as of the beginning of the first year restated. Early adoption is permitted, including adoption in an interim period. The Company adopted ASU 2015-02 on January 1, 2016 and it did not have an impact on its accounting and disclosures.
Revenue from Contracts with Customers: In May 2014, the FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers (Topic 606).” The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. On July 9, 2015, the FASB approved amendments deferring the effective date by one year. ASU 2014-09 is now effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. In March 2016, the FASB issued final amendments (ASU No. 2016-08 and ASU No. 2016-10) to clarify the implementation guidance for principal versus agent considerations, identifying performance obligations and the accounting for licenses of intellectual property. The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this Update recognized at the date of initial application. Early application is permitted but not before the original public entity effective date, i.e., annual periods beginning after December 15, 2016. The Company continues to assess the impact of ASU 2014-09 on its accounting and disclosures.
Note 3.       Investment Securities Available-For-Sale
The following table shows investment securities available-for-sale.
(Dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
March 31, 2016
 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
391,488

 
$
2,624

 
$
(42
)
 
$
394,070

U.S. States and political subdivisions securities
 
121,464

 
2,968

 
(123
)
 
124,309

Mortgage-backed securities — Federal agencies
 
237,234

 
4,153

 
(464
)
 
240,923

Corporate debt securities
 
34,183

 
393

 
(1
)
 
34,575

Foreign government and other securities
 
800

 
9

 

 
809

Total debt securities
 
785,169

 
10,147

 
(630
)
 
794,686

Marketable equity securities
 
1,893

 
5,670

 
(299
)
 
7,264

Total investment securities available-for-sale
 
$
787,062

 
$
15,817

 
$
(929
)
 
$
801,950

 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
389,457

 
$
1,718

 
$
(1,506
)
 
$
389,669

U.S. States and political subdivisions securities
 
120,441

 
2,692

 
(143
)
 
122,990

Mortgage-backed securities — Federal agencies
 
234,400

 
3,430

 
(1,533
)
 
236,297

Corporate debt securities
 
34,241

 
199

 
(57
)
 
34,383

Foreign government and other securities
 
800

 
10

 
(1
)
 
809

Total debt securities
 
779,339

 
8,049

 
(3,240
)
 
784,148

Marketable equity securities
 
1,893

 
5,906

 
(220
)
 
7,579

Total investment securities available-for-sale
 
$
781,232

 
$
13,955

 
$
(3,460
)
 
$
791,727

 
At March 31, 2016 and December 31, 2015, 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).

9

Table of Contents

The following table shows the contractual maturities of investments in debt securities available-for-sale at March 31, 2016. 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
 
$
144,949

 
$
145,669

Due after one year through five years
 
384,483

 
389,225

Due after five years through ten years
 
18,503

 
18,869

Due after ten years
 

 

Mortgage-backed securities
 
237,234

 
240,923

Total debt securities available-for-sale
 
$
785,169

 
$
794,686

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.
 
 
Three Months Ended 
 March 31,
(Dollars in thousands)
 
2016
 
2015
Gross realized gains
 
$
10

 
$

Gross realized losses
 

 

Net realized gains (losses)
 
$
10

 
$

 
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, 2016
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
36,933

 
$
(42
)
 
$

 
$

 
$
36,933

 
$
(42
)
U.S. States and political subdivisions securities
 
12,169

 
(73
)
 
4,332

 
(50
)
 
16,501

 
(123
)
Mortgage-backed securities - Federal agencies
 
27,283

 
(111
)
 
19,467

 
(353
)
 
46,750

 
(464
)
Corporate debt securities
 
1,753

 
(1
)
 

 

 
1,753

 
(1
)
Foreign government and other securities
 
100

 

 

 

 
100

 

Total debt securities
 
78,238

 
(227
)
 
23,799

 
(403
)
 
102,037

 
(630
)
Marketable equity securities
 
347

 
(297
)
 
3

 
(2
)
 
350

 
(299
)
Total investment securities available-for-sale
 
$
78,585

 
$
(524
)
 
$
23,802

 
$
(405
)
 
$
102,387

 
$
(929
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
151,581

 
$
(928
)
 
$
43,372

 
$
(578
)
 
$
194,953

 
$
(1,506
)
U.S. States and political subdivisions securities
 
17,040

 
(79
)
 
3,795

 
(64
)
 
20,835

 
(143
)
Mortgage-backed securities - Federal agencies
 
78,731

 
(777
)
 
20,592

 
(756
)
 
99,323

 
(1,533
)
Corporate debt securities
 
9,340

 
(57
)
 

 

 
9,340

 
(57
)
Foreign government and other securities
 
99

 
(1
)
 

 

 
99

 
(1
)
Total debt securities
 
256,791

 
(1,842
)
 
67,759

 
(1,398
)
 
324,550

 
(3,240
)
Marketable equity securities
 
427

 
(218
)
 
3

 
(2
)
 
430

 
(220
)
Total investment securities available-for-sale
 
$
257,218

 
$
(2,060
)
 
$
67,762

 
$
(1,400
)
 
$
324,980

 
$
(3,460
)
 
The initial indication of other-than-temporary-impairment (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.

10

Table of Contents

There were no OTTI write-downs in 2016 or 2015.
At March 31, 2016, 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. 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, 2016 and December 31, 2015, investment securities available-for-sale with carrying values of $284.11 million and $233.14 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.
All loans and leases, except residential real estate and home equity 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, 2016
 
 

 
 

 
 

Commercial and agricultural
 
$
719,127

 
$
29,897

 
$
749,024

Auto and light truck
 
414,418

 
14,037

 
428,455

Medium and heavy duty truck
 
270,829

 
2,088

 
272,917

Aircraft financing
 
751,761

 
32,083

 
783,844

Construction equipment financing
 
463,858

 
3,924

 
467,782

Commercial real estate
 
697,789

 
18,821

 
716,610

Total
 
$
3,317,782

 
$
100,850

 
$
3,418,632

 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

Commercial and agricultural
 
$
710,030

 
$
34,719

 
$
744,749

Auto and light truck
 
413,836

 
11,400

 
425,236

Medium and heavy duty truck
 
275,367

 
2,887

 
278,254

Aircraft financing
 
750,264

 
27,748

 
778,012

Construction equipment financing
 
448,683

 
6,882

 
455,565

Commercial real estate
 
680,304

 
19,964

 
700,268

Total
 
$
3,278,484

 
$
103,600

 
$
3,382,084


11

Table of Contents

For residential real estate and home equity 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 home equity 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, 2016
 
 

 
 

 
 

Residential real estate and home equity
 
$
463,905

 
$
2,545

 
$
466,450

Consumer
 
146,138

 
755

 
146,893

Total
 
$
610,043

 
$
3,300

 
$
613,343

 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

Residential real estate and home equity
 
$
462,236

 
$
1,893

 
$
464,129

Consumer
 
148,180

 
299

 
148,479

Total
 
$
610,416

 
$
2,192

 
$
612,608

 
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, 2016
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and agricultural
 
$
744,858

 
$
131

 
$
41

 
$

 
$
745,030

 
$
3,994

 
$
749,024

Auto and light truck
 
428,216

 
173

 
14

 

 
428,403

 
52

 
428,455

Medium and heavy duty truck
 
272,917

 

 

 

 
272,917

 

 
272,917

Aircraft financing
 
772,547

 
5,894

 
1,385

 

 
779,826

 
4,018

 
783,844

Construction equipment financing
 
466,239

 
655

 
352

 

 
467,246

 
536

 
467,782

Commercial real estate
 
714,408

 
391

 

 

 
714,799

 
1,811

 
716,610

Residential real estate and home equity
 
463,015

 
758

 
132

 
702

 
464,607

 
1,843

 
466,450

Consumer
 
145,623

 
442

 
73

 
27

 
146,165

 
728

 
146,893

Total
 
$
4,007,823

 
$
8,444

 
$
1,997

 
$
729

 
$
4,018,993

 
$
12,982

 
$
4,031,975

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and agricultural
 
$
740,335

 
$
52

 
$
79

 
$

 
$
740,466

 
$
4,283

 
$
744,749

Auto and light truck
 
424,997

 
170

 
23

 

 
425,190

 
46

 
425,236

Medium and heavy duty truck
 
278,254

 

 

 

 
278,254

 

 
278,254

Aircraft financing
 
764,074

 
9,442

 
108

 

 
773,624

 
4,388

 
778,012

Construction equipment financing
 
454,993

 
33

 

 

 
455,026

 
539

 
455,565

Commercial real estate
 
698,514

 
362

 

 

 
698,876

 
1,392

 
700,268

Residential real estate and home equity
 
460,771

 
1,038

 
427

 
71

 
462,307

 
1,822

 
464,129

Consumer
 
147,419

 
552

 
209

 
51

 
148,231

 
248

 
148,479

Total
 
$
3,969,357

 
$
11,649

 
$
846

 
$
122

 
$
3,981,974

 
$
12,718

 
$
3,994,692


12

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 Reserve
March 31, 2016
 
 

 
 

 
 

With no related reserve recorded:
 
 

 
 

 
 

Commercial and agricultural
 
$
941

 
$
941

 
$

Auto and light truck
 

 

 

Medium and heavy duty truck
 

 

 

Aircraft financing
 
2,884

 
2,884

 

Construction equipment financing
 
536

 
536

 

Commercial real estate
 
8,192

 
8,192

 

Residential real estate and home equity
 

 

 

Consumer
 

 

 

Total with no related reserve recorded
 
12,553

 
12,553

 

With a reserve recorded:
 
 

 
 

 
 

Commercial and agricultural
 
2,708

 
2,708

 
485

Auto and light truck
 

 

 

Medium and heavy duty truck
 

 

 

Aircraft financing
 
1,134

 
1,134

 
1,134

Construction equipment financing
 

 

 

Commercial real estate
 
327

 
327

 

Residential real estate and home equity
 
365

 
367

 
147

Consumer
 

 

 

Total with a reserve recorded
 
4,534

 
4,536

 
1,766

Total impaired loans
 
$
17,087

 
$
17,089

 
$
1,766

 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

With no related reserve recorded:
 
 

 
 

 
 

Commercial and agricultural
 
$
1,016

 
$
1,016

 
$

Auto and light truck
 

 

 

Medium and heavy duty truck
 

 

 

Aircraft financing
 
4,384

 
4,384

 

Construction equipment financing
 
539

 
539

 

Commercial real estate
 
8,494

 
8,494

 

Residential real estate and home equity
 

 

 

Consumer
 

 

 

Total with no related reserve recorded
 
14,433

 
14,433

 

With a reserve recorded:
 
 

 
 

 
 

Commercial and agricultural
 
2,884

 
2,884

 
649

Auto and light truck
 

 

 

Medium and heavy duty truck
 

 

 

Aircraft financing
 

 

 

Construction equipment financing
 

 

 

Commercial real estate
 

 

 

Residential real estate and home equity
 
366

 
368

 
148

Consumer
 

 

 

Total with a reserve recorded
 
3,250

 
3,252

 
797

Total impaired loans
 
$
17,683

 
$
17,685

 
$
797


13

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,
 
 
2016
 
2015
(Dollars in thousands) 
 
Average
Recorded
Investment
 
Interest
Income
 
Average
Recorded
Investment
 
Interest
Income
Commercial and agricultural
 
$
3,709

 
$
4

 
$
9,808

 
$
10

Auto and light truck
 

 

 

 

Medium and heavy duty truck
 

 

 

 

Aircraft financing
 
4,028

 

 
9,144

 
6

Construction equipment financing
 
880

 

 
739

 

Commercial real estate
 
8,402

 
123

 
11,904

 
142

Residential real estate and home equity
 
365

 
4

 
373

 
4

Consumer
 

 

 

 

Total
 
$
17,384

 
$
131

 
$
31,968

 
$
162

 
There were no loan and lease modifications classified as troubled debt restructurings (TDR) during the three months ended March 31, 2016 and 2015. The classification between nonperforming and performing is determined at the time of modification. Modification programs focus on extending maturity dates or modifying payment patterns with most TDRs experiencing a combination of concessions. Modifications do not result in the contractual forgiveness of principal or interest.
There were no TDRs which had payment defaults within the twelve months following modification during the three months ended March 31, 2016 and 2015. Default occurs when a loan or lease is 90 days or more past due under the modified terms or transferred to nonaccrual.
The following table shows the recorded investment of loans and leases classified as troubled debt restructurings as of March 31, 2016 and December 31, 2015.
(Dollars in thousands)
 
March 31,
2016
 
December 31,
2015
Performing TDRs
 
$
7,383

 
$
7,437

Nonperforming TDRs
 
1,882

 
1,926

Total TDRs
 
$
9,265

 
$
9,363

 
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.

14

Table of Contents

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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The following table shows the changes in the reserve for loan and lease losses, segregated by class, for the three months ended March 31, 2016 and 2015.
(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
and home
equity
 
Consumer
loans
 
Total
March 31, 2016
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
 
$
15,456

 
$
9,269

 
$
4,699

 
$
32,373

 
$
7,592

 
$
13,762

 
$
3,382

 
$
1,579

 
$
88,112

Charge-offs
 
200

 
3

 

 

 
92

 
1

 
23

 
245

 
564

Recoveries
 
91

 
62

 
8

 
138

 
78

 
305

 
2

 
89

 
773

Net charge-offs (recoveries)
 
109

 
(59
)
 
(8
)
 
(138
)
 
14

 
(304
)
 
21

 
156

 
(209
)
Provision (recovery of provision)
 
(612
)
 
254

 
(196
)
 
1,729

 
(116
)
 
(231
)
 
18

 
129

 
975

Balance, end of period
 
$
14,735

 
$
9,582

 
$
4,511

 
$
34,240

 
$
7,462

 
$
13,835

 
$
3,379

 
$
1,552

 
$
89,296

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance, beginning of period
 
$
11,760

 
$
10,326

 
$
4,500

 
$
32,234

 
$
7,008

 
$
13,270

 
$
4,102

 
$
1,868

 
$
85,068

Charge-offs
 
943

 
22

 

 
49

 

 

 
40

 
147

 
1,201

Recoveries
 
478

 
60

 
3

 
44

 
122

 
97

 
2

 
68

 
874

Net charge-offs (recoveries)
 
465

 
(38
)
 
(3
)
 
5

 
(122
)
 
(97
)
 
38

 
79

 
327

Provision (recovery of provision)
 
325

 
429

 
(139
)
 
(928
)
 
610

 
(181
)
 
51

 
190

 
357

Balance, end of period
 
$
11,620

 
$
10,793

 
$
4,364

 
$
31,301

 
$
7,740

 
$
13,186

 
$
4,115

 
$
1,979

 
$
85,098


15

Table of Contents

The following table shows the reserve for loan and lease losses and recorded investment in loans and leases, segregated by class, separated between individually and collectively evaluated for impairment as of March 31, 2016 and December 31, 2015.
(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
and home
equity
 
Consumer
loans
 
Total
March 31, 2016
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Reserve for loan and lease losses
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance, individually evaluated for impairment
 
$
485

 
$

 
$

 
$
1,134

 
$

 
$

 
$
147

 
$