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

 
$

 
$
1,766

Ending balance, collectively evaluated for impairment
 
14,250

 
9,582

 
4,511

 
33,106

 
7,462

 
13,835

 
3,232

 
1,552

 
87,530

Total reserve for loan and lease losses
 
$
14,735

 
$
9,582

 
$
4,511

 
$
34,240

 
$
7,462

 
$
13,835

 
$
3,379

 
$
1,552

 
$
89,296

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment in loans
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance, individually evaluated for impairment
 
$
3,649

 
$

 
$

 
$
4,018

 
$
536

 
$
8,519

 
$
365

 
$

 
$
17,087

Ending balance, collectively evaluated for impairment
 
745,375

 
428,455

 
272,917

 
779,826

 
467,246

 
708,091

 
466,085

 
146,893

 
4,014,888

Total recorded investment in loans
 
$
749,024

 
$
428,455

 
$
272,917

 
$
783,844

 
$
467,782

 
$
716,610

 
$
466,450

 
$
146,893

 
$
4,031,975

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Reserve for loan and lease losses
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance, individually evaluated for impairment
 
$
649

 
$

 
$

 
$

 
$

 
$

 
$
148

 
$

 
$
797

Ending balance, collectively evaluated for impairment
 
14,807

 
9,269

 
4,699

 
32,373

 
7,592

 
13,762

 
3,234

 
1,579

 
87,315

Total reserve for loan and lease losses
 
$
15,456

 
$
9,269

 
$
4,699

 
$
32,373

 
$
7,592

 
$
13,762

 
$
3,382

 
$
1,579

 
$
88,112

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recorded investment in loans
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance, individually evaluated for impairment
 
$
3,900

 
$

 
$

 
$
4,384

 
$
539

 
$
8,494

 
$
366

 
$

 
$
17,683

Ending balance, collectively evaluated for impairment
 
740,849

 
425,236

 
278,254

 
773,628

 
455,026

 
691,774

 
463,763

 
148,479

 
3,977,009

Total recorded investment in loans
 
$
744,749

 
$
425,236

 
$
278,254

 
$
778,012

 
$
455,565

 
$
700,268

 
$
464,129

 
$
148,479

 
$
3,994,692

Note 6.       Mortgage Servicing Rights
The Company recognizes the rights to service residential mortgage loans for others as separate assets, whether the servicing rights are acquired through a separate purchase or through the sale of originated loans with servicing rights retained. The Company allocates a portion of the total proceeds of a mortgage loan to servicing rights based on the relative fair value. The unpaid principal balance of residential mortgage loans serviced for third parties was $788.59 million and $798.51 million at March 31, 2016 and December 31, 2015, respectively.
Mortgage servicing rights (MSRs) are evaluated for impairment at each reporting date. For purposes of impairment measurement, MSRs are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. If temporary impairment exists within a tranche, a valuation allowance is established through a charge to income equal to the amount by which the carrying value exceeds the fair value. If it is later determined all or a portion of the temporary impairment no longer exists for a particular tranche, the valuation allowance is reduced through a recovery of income.

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Table of Contents

The following table shows changes in the carrying value of MSRs and the associated valuation allowance.
 
 
Three Months Ended 
 March 31,
(Dollars in thousands)
 
2016
 
2015
Mortgage servicing rights:
 
 

 
 

Balance at beginning of period
 
$
4,608

 
$
4,733

Additions
 
205

 
250

Amortization
 
(332
)
 
(393
)
Sales
 

 

Carrying value before valuation allowance at end of period
 
4,481

 
4,590

Valuation allowance:
 
 

 
 

Balance at beginning of period
 

 

Impairment recoveries
 

 

Balance at end of period
 
$

 
$

Net carrying value of mortgage servicing rights at end of period
 
$
4,481

 
$
4,590

Fair value of mortgage servicing rights at end of period
 
$
6,353

 
$
6,654

 
At March 31, 2016 and 2015, the fair value of MSRs exceeded the carrying value reported in the Statements of Financial Condition by $1.87 million and $2.06 million, respectively. This difference represents increases in the fair value of certain MSRs that could not be recorded above cost basis.
Mortgage loan contractual servicing fees, including late fees and ancillary income, were $0.70 million and $0.72 million for the three months ended March 31, 2016 and 2015, respectively. Mortgage loan contractual servicing fees are included in Mortgage Banking Income on the Statements of Income.
Note 7.       Commitments and Financial Instruments with Off-Balance-Sheet Risk
1st Source and its subsidiaries are parties to financial instruments with off-balance-sheet risk in the normal course of business. These off-balance-sheet financial instruments include commitments to originate and sell loans and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Statements of Financial Condition. The exposure to credit loss in the event of nonperformance by the other party to the financial instruments for loan commitments and standby letters of credit is represented by the dollar amount of those instruments. The Company uses the same credit policies and collateral requirements in making commitments and conditional obligations as it does for on-balance-sheet instruments.
The following table shows financial instruments whose contract amounts represent credit risk.
(Dollars in thousands)
 
March 31, 2016
 
December 31, 2015
Amounts of commitments:
 
 
 
 
Loan commitments to extend credit
 
$
853,202

 
$
829,509

Standby letters of credit
 
$
39,563

 
$
37,984

Commercial and similar letters of credit
 
$
611

 
$
741

1st Source Bank (Bank), a subsidiary of 1st Source Corporation, grants mortgage loan commitments to borrowers, subject to normal loan underwriting standards. The interest rate risk associated with these loan commitments is managed by entering into contracts for future deliveries of loans. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The Bank issues standby letters of credit which are conditional commitments that guarantee the performance of a client to a third party. The credit risk involved in and collateral obtained when issuing standby letters of credit is essentially the same as that involved in extending loan commitments to clients. Standby letters of credit generally have terms ranging from six months to one year.
Commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and the third party. Commercial letters of credit generally have terms ranging from three months to six months.

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Table of Contents

The Bank has made investments directly in low income housing tax credit (LIHTC) operating partnerships formed by third parties. As a limited partner in these operating partnerships, we are allocated credits and deductions associated with the underlying properties. The Bank has determined that it is not the primary beneficiary of these investments because the general partners have the power to direct the activities that most significantly influence the economic performance of their respective partnerships. At March 31, 2016 and December 31, 2015, investment balances, including all legally binding commitments to fund future investments totaled $9.45 million and $9.62 million, respectively. In addition, the Bank had a liability for all legally binding unfunded commitments of $3.64 million at March 31, 2016 and December 31, 2015.
Note 8.       Derivative Financial Instruments
Commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans are considered derivative instruments. See Note 7 for further information.
The Company has certain interest rate derivative positions that are not designated as hedging instruments. Derivative assets and liabilities are recorded at fair value on the balance sheet and do take into account the effects of master netting agreements. Master netting agreements allow the Company to settle all derivative contracts held with a single counterparty on a net basis, and to offset net derivative positions with related collateral, where applicable. These derivative positions relate to transactions in which the Company enters into an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each transaction, the Company agrees to pay interest to the client on a notional amount at a variable interest rate and receive interest from the client on the same notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the client to effectively convert a variable rate loan to a fixed rate. Because the terms of the swaps with the customers and the other financial institutions offset each other, with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not significantly impact the Company’s results of operations.
The following table shows the amounts of non-hedging derivative financial instruments.
 
 
 
 
Asset derivatives
 
Liability derivatives
(Dollars in thousands)
 
Notional or contractual amount
 
Statement of Financial Condition classification
 
Fair value
 
Statement of Financial Condition classification
 
Fair value
March 31, 2016
 
 

 
 
 
 

 
 
 
 

Interest rate swap contracts
 
$
565,265

 
Other assets
 
$
14,766

 
Other liabilities
 
$
15,045

Loan commitments
 
11,941

 
Mortgages held for sale
 
95

 
N/A
 

Forward contracts - mortgage loan
 
17,450

 
N/A
 

 
Mortgages held for sale
 
132

Total
 
$
594,656

 
 
 
$
14,861

 
 
 
$
15,177

 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 
 
 

 
 
 
 

Interest rate swap contracts
 
$
554,083

 
Other assets
 
$
9,859

 
Other liabilities
 
$
10,044

Loan commitments
 
12,440

 
Mortgages held for sale
 
47

 
N/A
 

Forward contracts - mortgage loan
 
16,416

 
Mortgages held for sale
 
13

 
N/A
 

Total
 
$
582,939

 
 
 
$
9,919

 
 
 
$
10,044

The following table shows the amounts included in the Statements of Income for non-hedging derivative financial instruments.
 
 
 
 
Gain (loss)
 
 
 
 
Three Months Ended 
 March 31,
(Dollars in thousands)
 
Statement of Income classification
 
2016
 
2015
Interest rate swap contracts
 
Other expense
 
$
(93
)
 
$
(19
)
Interest rate swap contracts
 
Other income
 
204

 
76

Loan commitments
 
Mortgage banking income
 
48

 
139

Forward contracts - mortgage loan
 
Mortgage banking income
 
(145
)
 
(26
)
Total
 
 
 
$
14

 
$
170

 

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Table of Contents

The following table shows the offsetting of financial assets and derivative assets.
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Statement of Financial Condition
 
 
(Dollars in thousands)
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Statement of Financial Condition
 
Net Amounts of Assets Presented in the Statement of Financial Condition
 
Financial Instruments
 
Cash Collateral Received
 
Net Amount
March 31, 2016
 
 

 
 

 
 

 
 

 
 

 
 

Interest rate swaps
 
$
14,981

 
$
215

 
$
14,766

 
$

 
$

 
$
14,766

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

Interest rate swaps
 
$
10,016

 
$
157

 
$
9,859

 
$

 
$

 
$
9,859

 
The following table shows the offsetting of financial liabilities and derivative liabilities.
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Statement of Financial Condition
 
 
(Dollars in thousands)
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset in the Statement of Financial Condition
 
Net Amounts of Liabilities Presented in the Statement of Financial Condition
 
Financial Instruments
 
Cash Collateral Pledged
 
Net Amount
March 31, 2016
 
 

 
 

 
 

 
 

 
 

 
 

Interest rate swaps
 
$
15,260

 
$
215

 
$
15,045

 
$

 
$
14,299

 
$
746

Repurchase agreements
 
169,820

 

 
169,820

 
169,820

 

 

Total
 
$
185,080

 
$
215

 
$
184,865

 
$
169,820

 
$
14,299

 
$
746

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

 
 

 
 

Interest rate swaps
 
$
10,201

 
$
157

 
$
10,044

 
$

 
$
9,833

 
$
211

Repurchase agreements
 
130,662

 

 
130,662

 
130,662

 

 

Total
 
$
140,863

 
$
157

 
$
140,706

 
$
130,662

 
$
9,833

 
$
211

 
If a default in performance of any obligation of a repurchase agreement occurs, each party will set-off property held in respect of transactions against obligations owing in respect of any other transactions. At March 31, 2016 and December 31, 2015, repurchase agreements had a remaining contractual maturity of $168.04 million and $128.88 million in overnight, $1.48 million and $1.78 million in up to 30 days and $0.30 million and $0.00 million in greater than 90 days, respectively and were collateralized by U.S. Treasury and Federal agencies securities.
Note 9.       Earnings Per Share
Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include non-vested restricted stock awards. Non-vested restricted stock awards are considered participating securities to the extent the holders of these securities receive non-forfeitable dividends at the same rate as holders of common stock. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock compensation using the treasury stock method.
Stock options, where the exercise price was greater than the average market price of the common shares, were excluded from the computation of diluted earnings per common share because the result would have been antidilutive. There were no stock options outstanding as of March 31, 2016 and 2015.

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Table of Contents

The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share.
 
 
Three Months Ended 
 March 31,
(Dollars in thousands - except per share amounts)
 
2016
 
2015
Distributed earnings allocated to common stock
 
$
4,686

 
$
4,296

Undistributed earnings allocated to common stock
 
9,017

 
9,063

Net earnings allocated to common stock
 
13,703

 
13,359

Net earnings allocated to participating securities
 
115

 
152

Net income allocated to common stock and participating securities
 
$
13,818

 
$
13,511

 
 
 
 
 
Weighted average shares outstanding for basic earnings per common share*
 
25,923,530

 
26,258,273

Dilutive effect of stock compensation
 

 

Weighted average shares outstanding for diluted earnings per common share*
 
25,923,530

 
26,258,273

 
 
 
 
 
Basic earnings per common share*
 
$
0.53

 
$
0.51

Diluted earnings per common share*
 
$
0.53

 
$
0.51

 
*Three months ended March 31, 2015 outstanding shares and per common share figures have been adjusted for 10% stock dividend declared July 22, 2015 and issued on August 14, 2015.
Note 10.     Stock Based Compensation
As of March 31, 2016, the Company had four active stock-based employee compensation plans, which are more fully described in Note 16 of the Consolidated Financial Statements in 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2015. These plans include three executive stock award plans, the Executive Incentive Plan, the Restricted Stock Award Plan, the Strategic Deployment Incentive Plan; and the Employee Stock Purchase Plan. The 2011 Stock Option Plan was approved by the shareholders on April 21, 2011 but the Company had not made any grants through March 31, 2016.
Stock-based compensation expense for all stock-based compensation awards granted is based on the grant-date fair value. For all awards except stock option awards, the grant date fair value is either the fair market value per share or book value per share (corresponding to the type of stock awarded) as of the grant date. For stock option awards, the grant date fair value is estimated using the Black-Scholes option pricing model. For all awards the Company recognizes these compensation costs only for those shares expected to vest on a straight-line basis over the requisite service period of the award, for which the Company uses the related vesting term. The Company estimates forfeiture rates based on historical employee option exercise and employee termination experience. The Company has identified separate groups of award recipients that exhibit similar option exercise behavior and employee termination experience and have considered them as separate groups in the valuation models and expense estimates.
The stock-based compensation expense recognized in the Statements of Income for the three months ended March 31, 2016 and 2015 was based on awards ultimately expected to vest, and accordingly has been adjusted by the amount of estimated forfeitures. GAAP requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based partially on historical experience.
Total fair value of options vested and expensed was zero for the three months ended March 31, 2016 and 2015. As of March 31, 2016 and 2015 there were no outstanding stock options. There were no stock options exercised during the three months ended March 31, 2016 and 2015. All shares issued in connection with stock option exercises are issued from available treasury stock.
As of March 31, 2016, there was $6.06 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 3.51 years.

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Table of Contents

Note 11.     Accumulated Other Comprehensive Income
The following table presents reclassifications out of accumulated other comprehensive income related to unrealized gains and losses on available-for-sale securities.
 
 
Three Months Ended 
 March 31,
 
Affected Line Item in the Statements of Income
(Dollars in thousands)
 
2016
 
2015
 
Realized gains included in net income
 
$
10

 
$

 
Gains on investment securities available-for-sale
 
 
10

 

 
Income before income taxes
Tax effect
 
(4
)
 

 
Income tax expense
Net of tax
 
$
6

 
$

 
Net income
 
Note 12.     Income Taxes
The total amount of unrecognized tax benefits that would affect the effective tax rate if recognized was $0.32 million at March 31, 2016 and $0.25 million at December 31, 2015. Interest and penalties were recognized through the income tax provision. For the three months ended March 31, 2016 and 2015, the Company recognized no interest or penalties, respectively. There were no accrued interest and penalties at March 31, 2016 and December 31, 2015, respectively.
Tax years that remain open and subject to audit include the federal 2012-2015 years and the Indiana 2013-2015 years. The Company does not anticipate a significant change in the amount of uncertain tax positions within the next 12 months.
Note 13.     Fair Value Measurements
The Company records certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are also utilized to determine the initial value of certain assets and liabilities, to perform impairment assessments, and for disclosure purposes. The Company uses quoted market prices and observable inputs to the maximum extent possible when measuring fair value. In the absence of quoted market prices, various valuation techniques are utilized to measure fair value. When possible, observable market data for identical or similar financial instruments is used in the valuation. When market data is not available, fair value is determined using valuation models that incorporate management’s estimates of the assumptions a market participant would use in pricing the asset or liability.
Fair value measurements are classified within one of three levels based on the observability of the inputs used to determine fair value, as follows:
Level 1 — The valuation is based on quoted prices in active markets for identical instruments.
Level 2 — The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3 — The valuation is based on unobservable inputs that are supported by minimal or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques that incorporate management’s own estimates of assumptions that market participants would use in pricing the instrument, or valuations that require significant management judgment or estimation.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The Company elected fair value accounting for mortgages held for sale. The Company believes the election for mortgages held for sale (which are economically hedged with free standing derivatives) will reduce certain timing differences and better match changes in the value of these assets with changes in the value of derivatives used as economic hedges for these assets. At March 31, 2016 and December 31, 2015, all mortgages held for sale were carried at fair value.

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Table of Contents

The following table shows the differences between the fair value carrying amount of mortgages held for sale measured at fair value and the aggregate unpaid principal amount the Company is contractually entitled to receive at maturity.
(Dollars in thousands)
 
Fair value carrying
amount
 
Aggregate
unpaid principal
 
Excess of fair value carrying amount over (under) unpaid principal
 
 
March 31, 2016
 
 

 
 

 
 

 
 
Mortgages held for sale reported at fair value
 
$
11,999

 
$
11,826

 
$
173

 
(1)
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 
Mortgages held for sale reported at fair value
 
$
9,825

 
$
9,691

 
$
134

 
(1)
 
(1)
The excess of fair value carrying amount over (under) unpaid principal is included in mortgage banking income and includes changes in fair value at and subsequent to funding and gains and losses on the related loan commitment prior to funding.
Financial Instruments on Recurring Basis:
The following is a description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis:
Investment securities available for sale are valued primarily by a third party pricing agent. Prices supplied by the independent pricing agent, as well as their pricing methodologies and assumptions, are reviewed by the Company for reasonableness and to ensure such prices are aligned with market levels. In general, the Company’s investment securities do not possess a complex structure that could introduce greater valuation risk. The portfolio mainly consists of traditional investments including U.S. Treasury and Federal agencies securities, federal agency mortgage pass-through securities, and general obligation and revenue municipal bonds. Pricing for such instruments is fairly generic and is easily obtained. On a quarterly basis, prices supplied by the pricing agent are validated by comparison to prices obtained from other third party sources for a material portion of the portfolio.
The valuation policy and procedures for Level 3 fair value measurements of available for sale debt securities are decided through collaboration between management of the Corporate Accounting and Funds Management departments. The changes in fair value measurement for Level 3 securities are analyzed on a periodic basis under a collaborative framework with the aforementioned departments. The methodology and variables used for input are derived from the combination of observable and unobservable inputs. The unobservable inputs are determined through internal assumptions that may vary from period to period due to external factors, such as market movement and credit rating adjustments.
Both the market and income valuation approaches are implemented using the following types of inputs:
U.S. treasuries are priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.
Government-sponsored agency debt securities and corporate bonds are primarily priced using available market information through processes such as benchmark curves, market valuations of like securities, sector groupings and matrix pricing.
Other government-sponsored agency securities, mortgage-backed securities and some of the actively traded REMICs and CMOs, are primarily priced using available market information including benchmark yields, prepayment speeds, spreads and volatility of similar securities.
Other inactive government-sponsored agency securities are primarily priced using consensus pricing and dealer quotes.
State and political subdivisions are largely grouped by characteristics, i.e., geographical data and source of revenue in trade dissemination systems. Since some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities. Local direct placement municipal securities, with very little market activity, are priced using an appropriate market yield curve, which includes a credit spread assumption.
Marketable equity (common) securities are primarily priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.
Mortgages held for sale and the related loan commitments and forward contracts (hedges) are valued using a market value approach and utilizing an appropriate current market yield and a loan commitment closing rate based on historical analysis.

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Table of Contents

Interest rate swap positions, both assets and liabilities, are valued by a third party pricing agent using an income approach and utilizing models that use as their basis readily observable market parameters. This valuation process considers various factors including interest rate yield curves, time value and volatility factors. Validation of third party agent valuations is accomplished by comparing those values to the Company’s swap counterparty valuations. Management believes an adjustment is required to “mid-market” valuations for derivatives tied to its performing loan portfolio to recognize the imprecision and related exposure inherent in the process of estimating expected credit losses as well as velocity of deterioration evident with systemic risks embedded in these portfolios.
The following table shows the balance of assets and liabilities measured at fair value on a recurring basis.
(Dollars in thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
March 31, 2016
 
 

 
 

 
 

 
 

Assets:
 
 

 
 

 
 

 
 

Investment securities available-for-sale:
 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
19,998

 
$
374,072

 
$

 
$
394,070

U.S. States and political subdivisions securities
 

 
119,499

 
4,810

 
124,309

Mortgage-backed securities — Federal agencies
 

 
240,923

 

 
240,923

Corporate debt securities
 

 
34,575

 

 
34,575

Foreign government and other securities
 

 

 
809

 
809

Total debt securities
 
19,998

 
769,069

 
5,619

 
794,686

Marketable equity securities
 
7,264

 

 

 
7,264

Total investment securities available-for-sale
 
27,262

 
769,069

 
5,619

 
801,950

Mortgages held for sale
 

 
11,999

 

 
11,999

Accrued income and other assets (interest rate swap agreements)
 

 
14,766

 

 
14,766

Total
 
$
27,262

 
$
795,834

 
$
5,619

 
$
828,715

 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

Accrued expenses and other liabilities (interest rate swap agreements)
 
$

 
$
15,045

 
$

 
$
15,045

Total
 
$

 
$
15,045

 
$

 
$
15,045

 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

Assets:
 
 

 
 

 
 

 
 

Investment securities available-for-sale:
 
 

 
 

 
 

 
 

U.S. Treasury and Federal agencies securities
 
$
19,879

 
$
369,790

 
$

 
$
389,669

U.S. States and political subdivisions securities
 

 
118,462

 
4,528

 
122,990

Mortgage-backed securities — Federal agencies
 

 
236,297

 

 
236,297

Corporate debt securities
 

 
34,383

 

 
34,383

Foreign government and other securities
 

 

 
809

 
809

Total debt securities
 
19,879

 
758,932

 
5,337

 
784,148

Marketable equity securities
 
7,579

 

 

 
7,579

Total investment securities available-for-sale
 
27,458

 
758,932

 
5,337

 
791,727

Mortgages held for sale
 

 
9,825

 

 
9,825

Accrued income and other assets (interest rate swap agreements)
 

 
9,859

 

 
9,859

Total
 
$
27,458

 
$
778,616

 
$
5,337

 
$
811,411

 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

Accrued expenses and other liabilities (interest rate swap agreements)
 
$

 
$
10,044

 
$

 
$
10,044

Total
 
$

 
$
10,044

 
$

 
$
10,044


23

Table of Contents

The following table shows changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter ended March 31, 2016 and 2015.
(Dollars in thousands)
 
U.S. States and
political
subdivisions
securities
 
Foreign government and other securities
 
Investment securities available-for-sale
Beginning balance January 1, 2016
 
$
4,528

 
$
809

 
$
5,337

Total gains or losses (realized/unrealized):
 
 

 
 
 
 
Included in earnings
 

 

 

Included in other comprehensive income
 
35

 

 
35

Purchases
 
1,100

 

 
1,100

Issuances
 

 

 

Sales
 

 

 

Settlements
 

 

 

Maturities
 
(853
)
 

 
(853
)
Transfers into Level 3
 

 

 

Transfers out of Level 3
 

 

 

Ending balance March 31, 2016
 
$
4,810

 
$
809

 
$
5,619

 
 
 
 
 
 
 
Beginning balance January 1, 2015
 
$
6,466

 
$
811

 
$
7,277

Total gains or losses (realized/unrealized):
 
 

 
 
 
 
Included in earnings
 

 

 

Included in other comprehensive income
 
(7
)
 
(3
)
 
(10
)
Purchases
 

 

 

Issuances
 

 

 

Sales
 

 

 

Settlements
 

 

 

Maturities
 
(827
)
 

 
(827
)
Transfers into Level 3
 

 

 

Transfers out of Level 3
 

 

 

Ending balance March 31, 2015
 
$
5,632

 
$
808

 
$
6,440

 
There were no gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at March 31, 2016 or 2015. No transfers between levels occurred during the three months ended March 31, 2016 or 2015.
The following table shows the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a recurring basis.
(Dollars in thousands)
 
Fair Value
 
Valuation Methodology
 
Unobservable Inputs
 
Range of Inputs
March 31, 2016
 
 

 
 
 
 
 
 
Investment securities available-for sale
 
 

 
 
 
 
 
 
Direct placement municipal securities
 
$
4,810

 
Discounted cash flows
 
Credit spread assumption
 
0.72% - 1.60%
 
 
 
 
 
 
 
 
 
Foreign government
 
$
809

 
Discounted cash flows
 
Market yield assumption
 
0.71% - 1.91%
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 
 
 
 
 
Investment securities available-for sale
 
 

 
 
 
 
 
 
Direct placement municipal securities
 
$
4,528

 
Discounted cash flows
 
Credit spread assumption
 
1.27% - 2.03%
 
 
 
 
 
 
 
 
 
Foreign government
 
$
809

 
Discounted cash flows
 
Market yield assumption
 
0.88% - 2.00%
 
The sensitivity to changes in the unobservable inputs and their impact on the fair value measurement can be significant. The significant unobservable input for direct placement municipal securities are the credit spread assumptions used to determine the fair value measure. An increase (decrease) in the estimated spread assumption of the market will decrease (increase) the fair value measure of the securities. The significant unobservable input for foreign government securities are the market yield assumptions. The market yield assumption is negatively correlated to the fair value measure. An increase (decrease) in the determined market yield assumption will decrease (increase) the fair value measurement.

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Table of Contents

Financial Instruments on Non-recurring Basis:
The Company may be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower of cost or market accounting or impairment charges of individual assets.
The Credit Policy Committee (CPC), a management committee, is responsible for overseeing the valuation processes and procedures for Level 3 measurements of impaired loans, other real estate and repossessions. The CPC reviews these assets on a quarterly basis to determine the accuracy of the observable inputs, generally third party appraisals, auction values, values derived from trade publications and data submitted by the borrower, and the appropriateness of the unobservable inputs, generally discounts due to current market conditions and collection issues. The CPC establishes discounts based on asset type and valuation source; deviations from the standard are documented. The discounts are reviewed periodically, annually at a minimum, to determine they remain appropriate. Consideration is given to current trends in market values for the asset categories and gains and losses on sales of similar assets. The Loan and Funds Management Committee of the Board of Directors is responsible for overseeing the CPC.
Discounts vary depending on the nature of the assets and the source of value. Aircraft are generally valued using quarterly trade publications adjusted for engine time, condition, maintenance programs, discounted by 10%. Likewise, autos are valued using current auction values, discounted by 10%; medium and heavy duty trucks are valued using trade publications and auction values, discounted by 15%. Construction equipment is generally valued using trade publications and auction values, discounted by 20%. Real estate is valued based on appraisals or evaluations, discounted by 20% with higher discounts for property in poor condition or property with characteristics which may make it more difficult to market. Commercial loans subject to borrowing base certificates are generally discounted by 20% for receivables and 40% - 75% for inventory with higher discounts when monthly borrowing base certificates are not required or received.
Impaired loans and related write-downs are based on the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are reviewed quarterly and estimated using customized discounting criteria, appraisals and dealer and trade magazine quotes which are used in a market valuation approach. In accordance with fair value measurements, only impaired loans for which a reserve for loan loss has been established based on the fair value of collateral require classification in the fair value hierarchy. As a result, only a portion of the Company’s impaired loans are classified in the fair value hierarchy.
Partnership investments and the adjustments to fair value primarily result from application of lower of cost or fair value accounting. The partnership investments are priced using financial statements provided by the partnerships. Quantitative unobservable inputs are not reasonably available for reporting purposes.
The Company has established MSRs valuation policies and procedures based on industry standards and to ensure valuation methodologies are consistent and verifiable. MSRs and related adjustments to fair value result from application of lower of cost or fair value accounting. For purposes of impairment, MSRs are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. The fair value of each tranche of the servicing portfolio is estimated by calculating the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors. Prepayment rates and discount rates are derived through a third party pricing agent. Changes in the most significant inputs, including prepayment rates and discount rates, are compared to the changes in the fair value measurements and appropriate resolution is made. A fair value analysis is also obtained from an independent third party agent and compared to the internal valuation for reasonableness. MSRs do not trade in an active, open market with readily observable prices and though sales of MSRs do occur, precise terms and conditions typically are not readily available and the characteristics of the Company’s servicing portfolio may differ from those of any servicing portfolios that do trade.
Other real estate is based on the lower of cost or fair value of the underlying collateral less expected selling costs. Collateral values are estimated primarily using appraisals and reflect a market value approach. Fair values are reviewed quarterly and new appraisals are obtained annually. Repossessions are similarly valued.
For assets measured at fair value on a nonrecurring basis the following represents impairment charges (recoveries) recognized on these assets during the quarter ended March 31, 2016: impaired loans - $0.00 million; partnership investments - $0.00 million; mortgage servicing rights - $0.00 million; repossessions - $0.29 million; and other real estate - $0.00 million.

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The following table shows the carrying value of assets measured at fair value on a non-recurring basis.
(Dollars in thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
March 31, 2016
 
 

 
 

 
 

 
 

Impaired loans - collateral based
 
$

 
$

 
$
720

 
$
720

Accrued income and other assets (partnership investments)
 

 

 
512

 
512

Accrued income and other assets (mortgage servicing rights)
 

 

 
4,481

 
4,481

Accrued income and other assets (repossessions)
 

 

 
7,201

 
7,201

Accrued income and other assets (other real estate)
 

 

 
330

 
330

Total
 
$

 
$

 
$
13,244

 
$
13,244

 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

Impaired loans - collateral based
 
$

 
$

 
$
220

 
$
220

Accrued income and other assets (partnership investments)
 

 

 
1,000

 
1,000

Accrued income and other assets (mortgage servicing rights)
 

 

 
4,608

 
4,608

Accrued income and other assets (repossessions)
 

 

 
6,927

 
6,927

Accrued income and other assets (other real estate)
 

 

 
736

 
736

Total
 
$

 
$

 
$
13,491

 
$
13,491

The following table below shows the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a non-recurring basis.
(Dollars in thousands)
 
Carrying Value
 
Fair Value
 
Valuation Methodology
 
Unobservable Inputs
 
Range of Inputs
March 31, 2016
 
 

 
 

 
 
 
 
 
 
Impaired loans
 
$
720

 
$
720

 
Collateral based measurements including appraisals, trade publications, and auction values
 
Discount for lack of marketability and current conditions
 
20% - 70%
 
 
 
 
 
 
 
 
 
 
 
Mortgage servicing rights
 
4,481

 
6,353

 
Discounted cash flows
 
Constant prepayment rate (CPR)
 
12.1% - 17.0%
 
 
 

 
 

 
 
 
Discount rate
 
9.4% - 12.2%
 
 
 
 
 
 
 
 
 
 
 
Repossessions
 
7,201

 
7,378

 
Appraisals, trade publications and auction values
 
Discount for lack of marketability
 
2% - 3%
 
 
 
 
 
 
 
 
 
 
 
Other real estate
 
330

 
373

 
Appraisals
 
Discount for lack of marketability
 
0% - 20%
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 
 
 
 
 
Impaired loans
 
$
220

 
$
220

 
Collateral based measurements including appraisals, trade publications, and auction values
 
Discount for lack of marketability and current conditions
 
20%
 
 
 
 
 
 
 
 
 
 
 
Mortgage servicing rights
 
4,608

 
7,246

 
Discounted cash flows
 
Constant prepayment rate (CPR)
 
9.4% - 15.0%
 
 
 

 
 

 
 
 
Discount rate
 
9.8% - 13.3%
 
 
 
 
 
 
 
 
 
 
 
Repossessions
 
6,927

 
7,104

 
Appraisals, trade publications and auction values
 
Discount for lack of marketability
 
2% - 3%
 
 
 
 
 
 
 
 
 
 
 
Other real estate
 
736

 
851

 
Appraisals
 
Discount for lack of marketability
 
8% - 35%
 
GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring or non-recurring basis.

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The following table shows the fair values of the Company’s financial instruments.
(Dollars in thousands)
 
Carrying or Contract Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
March 31, 2016
 
 

 
 

 
 

 
 

 
 

Assets:
 
 

 
 

 
 

 
 

 
 

Cash and due from banks
 
$
52,373

 
$
52,373

 
$
52,373

 
$

 
$

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

 
32,854

 
32,854

 

 

Investment securities, available-for-sale
 
801,950

 
801,950

 
27,262

 
769,069

 
5,619

Other investments
 
21,973

 
21,973

 
21,973

 

 

Mortgages held for sale
 
11,999

 
11,999

 

 
11,999

 

Loans and leases, net of reserve for loan and lease losses
 
3,942,679

 
3,964,867

 

 

 
3,964,867

Mortgage servicing rights
 
4,481

 
6,353

 

 

 
6,353

Interest rate swaps
 
14,766

 
14,766

 

 
14,766

 

Liabilities:
 
 

 
 

 
 

 
 

 
 

Deposits
 
$
4,225,148

 
$
4,231,877

 
$
3,016,933

 
$
1,214,944

 
$

Short-term borrowings
 
181,914

 
181,914

 
171,495

 
10,419

 

Long-term debt and mandatorily redeemable securities
 
68,837

 
68,662

 

 
68,662

 

Subordinated notes
 
58,764

 
49,377

 

 
49,377

 

Interest rate swaps
 
15,045

 
15,045

 

 
15,045

 

Off-balance-sheet instruments *
 

 
388

 

 
388

 

 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 

 
 

 
 

 
 

 
 

Assets:
 
 

 
 

 
 

 
 

 
 

Cash and due from banks
 
$
65,171

 
$
65,171

 
$
65,171

 
$

 
$

Federal funds sold and interest bearing deposits with other banks
 
14,550

 
14,550

 
14,550

 

 

Investment securities, available-for-sale
 
791,727

 
791,727

 
27,458

 
758,932

 
5,337

Other investments
 
21,973

 
21,973

 
21,973

 

 

Mortgages held for sale
 
9,825

 
9,825

 

 
9,825

 

Loans and leases, net of reserve for loan and lease losses
 
3,906,580

 
3,927,967

 

 

 
3,927,967

Mortgage servicing rights
 
4,608

 
7,246

 

 

 
7,246

Interest rate swaps
 
9,859

 
9,859

 

 
9,859

 

Liabilities:
 
 

 
 

 
 

 
 

 
 

Deposits
 
$
4,139,186

 
$
4,139,649

 
$
2,998,443

 
$
1,141,206

 
$

Short-term borrowings
 
233,229

 
233,229

 
134,156

 
99,073

 

Long-term debt and mandatorily redeemable securities
 
57,379

 
57,193

 

 
57,193

 

Subordinated notes
 
58,764

 
48,304

 

 
48,304

 

Interest rate swaps
 
10,044

 
10,044

 

 
10,044

 

Off-balance-sheet instruments *
 

 
375

 

 
375

 

 
* Represents estimated cash outflows required to currently settle the obligations at current market rates.
The methodologies for estimating fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The estimated fair value approximates carrying value for cash and due from banks, federal funds sold and interest bearing deposits with other banks and other investments. The methodologies for other financial assets and financial liabilities are discussed below:
Loans and Leases — For variable rate loans and leases that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values of other loans and leases are estimated using discounted cash flow analyses which use interest rates currently being offered for loans and leases with similar terms to borrowers of similar credit quality.
Deposits — The fair values for all deposits other than time deposits are equal to the amounts payable on demand (the carrying value). Fair values of variable rate time deposits are equal to their carrying values. Fair values for fixed rate time deposits are estimated using discounted cash flow analyses using interest rates currently being offered for deposits with similar remaining maturities.

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Table of Contents

Short-Term Borrowings — The carrying values of Federal funds purchased, securities sold under repurchase agreements, and other short-term borrowings, including the liability related to mortgage loans available for repurchase under GNMA optional repurchase programs, approximate their fair values.
Long-Term Debt and Mandatorily Redeemable Securities — The fair values of long-term debt are estimated using discounted cash flow analyses, based on the current estimated incremental borrowing rates for similar types of borrowing arrangements. The carrying values of mandatorily redeemable securities are based on the current estimated cost of redeeming these securities which approximate their fair values.
Subordinated Notes — Fair values are estimated based on calculated market prices of comparable securities.
Off-Balance-Sheet Instruments — Contract and fair values for certain off-balance-sheet financial instruments (guarantees) are estimated based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.
Limitations — Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. Because no market exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other such factors.
These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. These estimates are subjective in nature and require considerable judgment to interpret market data. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange, nor are they intended to represent the fair value of the Company as a whole. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management as of the respective balance sheet date. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.
Other significant assets, such as premises and equipment, other assets, and liabilities not defined as financial instruments, are not included in the above disclosures. Also, the fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following management’s discussion and analysis is presented to provide information concerning 1st Source Corporation and its subsidiaries’ (collectively referred to as “the Company”, “we”, and “our”) financial condition as of March 31, 2016, as compared to December 31, 2015, and the results of operations for the three months ended March 31, 2016 and 2015. This discussion and analysis should be read in conjunction with our consolidated financial statements and the financial and statistical data appearing elsewhere in this report and our 2015 Annual Report.
Except for historical information contained herein, the matters discussed in this document express “forward-looking statements.” Generally, the words “believe,” “contemplate,” “seek,” “plan,” “possible,” “assume,” “expect,” “intend,” “targeted,” “continue,” “remain,” “estimate,” “anticipate,” “project,” “will,” “should,” “indicate,” “would,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Those statements, including statements, projections, estimates or assumptions concerning future events or performance, and other statements that are other than statements of historical fact, are subject to material risks and uncertainties. We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. We may make other written or oral forward-looking statements from time to time. Readers are advised that various important factors could cause our actual results or circumstances for future periods to differ materially from those anticipated or projected in such forward-looking statements. Such factors include, but are not limited to, changes in law, regulations or GAAP; our competitive position within the markets we serve; increasing consolidation within the banking industry; unforeseen changes in interest rates; unforeseen changes in loan prepayment assumptions; unforeseen downturns in or major events affecting the local, regional or national economies or the industries in which we have credit concentrations; and other matters discussed in our filings with the SEC, including our Annual Report on Form 10-K  for 2015, which filings are available from the SEC. We undertake no obligation to publicly update or revise any forward-looking statements.

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FINANCIAL CONDITION
Our total assets at March 31, 2016 were $5.25 billion, an increase of $57.69 million or 1.11% from December 31, 2015. Total loans and leases were $4.03 billion, an increase of $37.28 million or 0.93% from December 31, 2015. Total investment securities, available for sale were $801.95 million which represented an increase of $10.22 million and total deposits were $4.23 billion, an increase of $85.96 million or 2.08% over the comparable figures at the end of 2015. Short-term borrowings were $181.91 million, a decrease of $51.32 million or 22.00% from December 31, 2015.
Nonperforming assets at March 31, 2016 were $21.35 million, an increase of $0.73 million or 3.54% from the $20.62 million reported at December 31, 2015. At March 31, 2016 and December 31, 2015, nonperforming assets were 0.51% and 0.50%, respectively of net loans and leases.
The following table shows accrued income and other assets.
(Dollars in thousands)
 
March 31,
2016
 
December 31,
2015
Accrued income and other assets:
 
 

 
 

Bank owned life insurance cash surrender value
 
$
62,540

 
$
61,992

Accrued interest receivable
 
14,353

 
13,689

Mortgage servicing rights
 
4,481

 
4,608

Other real estate
 
330

 
736

Repossessions
 
7,201

 
6,927

All other assets
 
43,796

 
41,900

Total accrued income and other assets
 
$
132,701

 
$
129,852

 
CAPITAL
As of March 31, 2016, total shareholders’ equity was $649.97 million, up $5.92 million or 0.92% from the $644.05 million at December 31, 2015. In addition to net income of $13.82 million, other significant changes in shareholders’ equity during the first three months of 2016 included $8.01 million of common stock acquired for treasury and $4.71 million of dividends paid. The accumulated other comprehensive income/(loss) component of shareholders’ equity totaled $9.30 million at March 31, 2016, compared to $6.56 million at December 31, 2015. The increase in accumulated other comprehensive income/(loss) during 2016 was the result of changes in unrealized gain/(loss) on securities in the available-for-sale portfolio. Our equity-to-assets ratio was 12.39% as of March 31, 2016, compared to 12.41% at December 31, 2015. Book value per common share rose to $25.14 at March 31, 2016, from $24.75 at December 31, 2015.
We distributed a 10% stock dividend to shareholders of record on August 4, 2015, issuing 2,591,995 shares on August 14, 2015. All share and per share information in this report has been adjusted to reflect the stock dividend, unless otherwise noted.
We declared and paid cash dividends per common share of $0.18 during the first quarter of 2016. The trailing four quarters dividend payout ratio, representing cash dividends per common share divided by diluted earnings per common share, was 31.32%. The dividend payout is continually reviewed by management and the Board of Directors subject to the Company’s capital and dividend policy. 
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. In addition, banking regulators have established risk-based capital guidelines for U.S. banking organizations.
Under the final capital rules that became effective on January 1, 2015, there was a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement is being phased in over three years beginning in 2016. We have included the 0.625% increase for 2016 in our minimum capital adequacy ratios in the table below. The capital buffer requirement effectively raises the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. Management believes that, as of March 31, 2016, 1st Source and the Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis as if all such requirements were currently in effect.

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The actual capital amounts and ratios of 1st Source Corporation and 1st Source Bank as of March 31, 2016, are presented in the table below.
 
 
Actual
 
Minimum Capital Adequacy
 
Minimum Capital Adequacy with Capital Buffer
 
To Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
Total Capital (to Risk-Weighted Assets):
 
 

 
 

 
 

 
 

 
 
 
 
 
 

 
 

1st Source Corporation
 
$
679,462

 
14.94
%
 
$
363,855

 
8.00
%
 
$
392,281

 
8.625
%
 
$
454,818

 
10.00
%
1st Source Bank
 
641,992

 
14.15

 
363,008

 
8.00

 
391,369

 
8.625

 
453,761

 
10.00

Tier 1 Capital (to Risk-Weighted Assets):
 
 

 
 

 
 

 
 

 
 
 
 
 
 

 
 

1st Source Corporation
 
619,759

 
13.63

 
272,891

 
6.00

 
301,317

 
6.625

 
363,855

 
8.00

1st Source Bank
 
584,816

 
12.89

 
272,256

 
6.00

 
300,616

 
6.625

 
363,008

 
8.00

Common Equity Tier 1 Capital (to Risk-Weighted Assets):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1st Source Corporation
 
562,759

 
12.37

 
204,668

 
4.50

 
233,094

 
5.125

 
295,632

 
6.50

1st Source Bank
 
584,816

 
12.89

 
204,192

 
4.50

 
232,552

 
5.125

 
294,944

 
6.50

Tier 1 Capital (to Average Assets):
 
 

 
 

 
 

 
 

 
 
 
 
 
 

 
 

1st Source Corporation
 
619,759

 
12.10

 
204,909

 
4.00

 
N/A

 
N/A

 
256,136

 
5.00

1st Source Bank
 
584,816

 
11.43

 
204,692

 
4.00

 
N/A

 
N/A

 
255,865

 
5.00

LIQUIDITY AND INTEREST RATE SENSITIVITY
Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as our operating cash needs are met. Funds are available from a number of sources, including the securities portfolio, the core deposit base, Federal Home Loan Bank (FHLB) borrowings, Federal Reserve Bank (FRB) borrowings, and the capability to package loans for sale.
We have borrowing sources available to supplement deposits and meet our funding needs. 1st Source Bank has established relationships with several banks to provide short term borrowings in the form of federal funds purchased. At March 31, 2016, we had no outstandings and could borrow approximately $265.00 million for a short time from these banks on a collective basis. As of March 31, 2016, we had $47.89 million outstanding in FHLB advances and could borrow an additional $185.42 million. We also had $415.92 million available to borrow from the FRB with no amounts outstanding as of March 31, 2016.
Our loan to asset ratio was 76.86% at March 31, 2016 compared to 77.00% at December 31, 2015 and 76.12% at March 31, 2015. Cash and cash equivalents totaled $85.23 million at March 31, 2016 compared to $79.72 million at December 31, 2015 and $69.26 million at March 31, 2015. At March 31, 2016, the Statement of Financial Condition was rate sensitive by $700.70 million more assets than liabilities scheduled to reprice within one year, or approximately 1.37%. Management believes that the present funding sources provide adequate liquidity to meet our cash flow needs.
Under Indiana law governing the collateralization of public fund deposits, the Indiana Board of Depositories determines which financial institutions are required to pledge collateral based on the strength of their financial ratings. We have been informed that no collateral is required for our public fund deposits. However, the Board of Depositories could alter this requirement in the future and adversely impact our liquidity. Our potential liquidity exposure if we must pledge collateral is approximately $498 million.
RESULTS OF OPERATIONS
Net income for the three month period ended March 31, 2016 was $13.82 million, compared to $13.51 million for the same period in 2015. Diluted net income per common share was $0.53 for the three month period ended March 31, 2016, compared to $0.51 for the same period in 2015. Return on average common shareholders’ equity was 8.56% for the three months ended March 31, 2016, compared to 8.79% in 2015. The return on total average assets was 1.07% for the three months ended March 31, 2016, compared to 1.14% in 2015.
Net income increased for the three months ended March 31, 2016 compared to the first three months of 2015. Net interest income and noninterest income increased offset by an increase in provision for loan and lease losses, noninterest expense and income tax expense. Details of the changes in the various components of net income are discussed further below.
NET INTEREST INCOME
Quarter Ended March 31, 2016 compared to the Quarter Ended December 31, 2015
The taxable equivalent net interest income for the three months ended March 31, 2016 was $41.75 million, a decrease of 4.39% over the three months ended December 31, 2015. The net interest margin on a fully taxable equivalent basis was 3.45% for the three months ended March 31, 2016, compared to 3.61% for the three months ended December 31, 2015.

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During the three month period ended March 31, 2016, average earning assets increased $71.22 million or 1.49% over the three months ended December 31, 2015. Average interest-bearing liabilities increased $74.38 million or 2.11% for the three month period ended March 31, 2016 over the three months ended December 31, 2015. The yield on average earning assets decreased 10 basis points to 3.91% for the first quarter of 2016 from 4.01% for the fourth quarter of 2015. Total cost of average interest-bearing liabilities increased 7 basis points to 0.61% for the first quarter of 2016 from 0.54% for the fourth quarter 2015. The result to the net interest margin, or the ratio of net interest income to average earning assets, was a decrease of 16 basis points for the three month period ended March 31, 2016 from December 31, 2015.
The largest contributor to the decrease in the yield on average earning assets for the three months ended March 31, 2016, compared to the three months ended December 31, 2015, was a reduction in yields on net loans and leases of 12 basis points. The reduction in yields on net loans and leases was primarily the result of fourth quarter net interest recoveries being higher by $1.66 million, which related to one commercial loan relationship. Average net loans and leases increased $48.97 million or 1.24% for the first quarter of 2016 from the fourth quarter of 2015. Total average investment securities increased $8.95 million or 1.14% for the first quarter over the fourth quarter of 2015. Average mortgages held for sale increased $0.75 million or 8.88% for the three month period ended March 31, 2016, over the fourth quarter of 2015. Average other investments, which include federal funds sold, time deposits with other banks, Federal Reserve Bank excess balances, Federal Reserve Bank and Federal Home Loan Bank stock and commercial paper, increased $12.56 million or 32.39% for the three month period ended March 31, 2016, over the fourth quarter of 2015
Average interest-bearing deposits increased $61.02 million or 1.91% for the first quarter of 2016 over the fourth quarter of 2015. The effective rate paid on average interest-bearing deposits increased 7 basis points to 0.47% for the first quarter 2016 compared to 0.40% for the fourth quarter 2015. The increase in the average cost of interest-bearing deposits during the first three months of 2016 as compared to the fourth quarter of 2015 was primarily the result of higher rates on certificates of deposit and accelerated discount amortization from called brokered certificates of deposit during the first quarter of 2016.
Average short-term borrowings increased $8.28 million or 3.71% for the first quarter of 2016 compared to the three months ended December 31, 2015. Interest paid on short-term borrowings increased 10 basis points for the first quarter of 2016. The increase in short-term borrowings during the first quarter of 2016 as compared to the three months ended December 31, 2015 was primarily the result of changes in borrowings with the Federal Home Loan Bank (FHLB). Average long-term debt and mandatorily redeemable securities increased $5.09 million or 8.87% during the first quarter of 2016 as compared to the fourth quarter of 2015. Interest paid on long-term debt and mandatorily redeemable securities increased 40 basis points for the first quarter compared to the fourth quarter of 2015. The increase during the first quarter of 2016 as compared to the fourth quarter of 2015 was due to higher rates on mandatorily redeemable securities.
Quarter Ended March 31, 2016 compared to the Quarter Ended March 31, 2015
The taxable equivalent net interest income for the three months ended March 31, 2016 was $41.75 million, an increase of 4.76% over the same period in 2015. The net interest margin on a fully taxable equivalent basis was 3.45% for the three months ended March 31, 2016, compared to 3.58% for the three months ended March 31, 2015.
During the three month period ended March 31, 2016, average earning assets increased $352.31 million or 7.81% over the comparable period in 2015. Average interest-bearing liabilities increased $242.39 million or 7.20% for the three month period ended March 31, 2016 over the comparable period one year ago. The yield on average earning assets decreased 5 basis points to 3.91% for the first quarter of 2016 from 3.96% for the first quarter of 2015. Total cost of average interest-bearing liabilities increased 10 basis points to 0.61% for the first quarter of 2016 from 0.51% for the first quarter 2015. The result to the net interest margin, or the ratio of net interest income to average earning assets, was a decrease of 13 basis points for the three month period ended March 31, 2016 from March 31, 2015.
The largest contributor to the decrease in the yield on average earning assets for the three months ended March 31, 2016, compared to the three months ended March 31, 2015, was a reduction in yields on net loans and leases of 7 basis points due to market conditions. Average net loans and leases increased $334.35 million or 9.10% for the first quarter of 2016 from the first quarter of 2015. Total average investment securities increased $6.29 million or 0.80% for the first quarter over one year ago. Average mortgages held for sale decreased $3.87 million or 29.75% for the three month period ended March 31, 2016, over the comparable period a year ago. Average other investments, which include federal funds sold, time deposits with other banks, Federal Reserve Bank excess balances, Federal Reserve Bank and Federal Home Loan Bank stock and commercial paper, increased $15.54 million or 43.38% for the three month period ended March 31, 2016, over the comparable period a year ago. 
Average interest-bearing deposits increased $225.08 million or 7.43% for the first quarter of 2016 over the same period in 2015. The effective rate paid on average interest-bearing deposits increased 13 basis points to 0.47% for the first quarter 2016 compared to 0.34% for the first quarter 2015. The increase in the average cost of interest-bearing deposits during the first three months of 2016 as compared to the first three months of 2015 was primarily the result of higher rates on certificates of deposit and accelerated discount amortization on called brokered certificates of deposit during the first quarter of 2016.

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Average short-term borrowings increased $11.53 million or 5.24% for the first quarter of 2016 compared to the same period in 2015. Interest paid on short-term borrowings increased 9 basis points for the first quarter of 2016. The increase in short-term borrowings during the first quarter of 2016 as compared to the same period in 2015 was primarily the result of changes in borrowings with the Federal Home Loan Bank (FHLB). Average long-term debt and mandatorily redeemable securities increased $5.78 million or 10.18% during the first quarter of 2016 as compared to the first quarter of 2015. Interest paid on long-term debt and mandatorily redeemable securities decreased 5 basis points for the first quarter compared to the first quarter of 2015. The decrease during the first quarter of 2016 as compared to the same period in 2015 was due to lower rates on mandatorily redeemable securities.
The following table provides an analysis of net interest income and illustrates the interest income earned and interest expense charged for each major component of interest earning assets and interest bearing liabilities. Yields/rates are computed on a tax-equivalent basis, using a 35% rate. Nonaccrual loans and leases are included in the average loan and lease balance outstanding. 
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
 
Three Months Ended
 
Three Months Ended
 
Three Months Ended
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
(Dollars in thousands)
Average
Balance
 
Interest Income/Expense
 
Yield/
Rate
 
Average
Balance
 
Interest Income/Expense
 
Yield/
Rate
 
Average
Balance
 
Interest Income/Expense
 
Yield/
Rate
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
$
671,989

 
$
3,080

 
1.84
%
 
$
663,569

 
$
3,000

 
1.79
%
 
$
665,577

 
$
3,004

 
1.83
%
Tax exempt
122,860

 
1,013

 
3.32
%
 
122,334

 
1,074

 
3.48
%
 
122,984

 
1,134

 
3.74
%
Mortgages held for sale
9,137

 
95

 
4.18
%
 
8,392

 
88

 
4.16
%
 
13,007

 
126

 
3.93
%
Net loans and leases
4,008,435

 
42,781

 
4.29
%
 
3,959,468

 
44,045

 
4.41
%
 
3,674,082

 
39,531

 
4.36
%
Other investments
51,353

 
291

 
2.28
%
 
38,790

 
267

 
2.73
%
 
35,817

 
255

 
2.89
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total earning assets
4,863,774

 
47,260

 
3.91
%
 
4,792,553

 
48,474

 
4.01
%
 
4,511,467

 
44,050

 
3.96
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
58,851

 
 
 
 
 
62,446

 
 
 
 

 
61,544

 
 

 
 

Reserve for loan and lease losses
(88,845
)
 
 
 
 
 
(89,841
)
 
 
 
 

 
(85,791
)
 
 

 
 

Other assets
375,985

 
 
 
 
 
369,436

 
 
 
 

 
333,233

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
5,209,765

 
 
 
 
 
$
5,134,594

 
 
 
 

 
$
4,820,453

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 

 
 
 
 

 
 

 
 

 
 

Interest-bearing deposits
$
3,254,262

 
$
3,771

 
0.47
%
 
$
3,193,247

 
$
3,218

 
0.40
%
 
$
3,029,179

 
$
2,559

 
0.34
%
Short-term borrowings
231,477

 
161

 
0.28
%
 
223,202

 
103

 
0.18
%
 
219,950

 
103

 
0.19
%
Subordinated notes
58,764

 
1,055

 
7.22
%
 
58,764

 
1,055

 
7.12
%
 
58,764

 
1,055

 
7.28
%
Long-term debt and mandatorily redeemable securities
62,505

 
523

 
3.37
%
 
57,414

 
430

 
2.97
%
 
56,730

 
479

 
3.42
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest bearing liabilities
3,607,008

 
5,510

 
0.61
%
 
3,532,627

 
4,806

 
0.54
%
 
3,364,623

 
4,196

 
0.51
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing deposits
899,011

 
 

 
 

 
907,666

 
 

 
 

 
787,776

 
 

 
 

Other liabilities
54,149

 
 

 
 

 
47,274

 
 

 
 

 
44,657

 
 

 
 

Shareholders’ equity
649,597

 
 

 
 

 
647,027

 
 

 
 

 
623,397

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders’ equity
$
5,209,765

 
 

 
 

 
$
5,134,594

 
 

 
 

 
$
4,820,453

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 

 
$
41,750

 
 

 
 

 
$
43,668

 
 

 
 

 
$
39,854

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin on a tax equivalent basis
 

 
 

 
3.45
%
 
 

 
 

 
3.61
%
 
 

 
 

 
3.58
%
PROVISION AND RESERVE FOR LOAN AND LEASE LOSSES 
The provision for loan and lease losses for the three month period ended March 31, 2016 was $0.98 million compared to a provision for loan and lease losses in the three month period ended March 31, 2015 of $0.36 million. Net recoveries of $0.21 million were recorded for the first quarter 2016, compared to net charge-offs of $0.33 million for the same quarter a year ago.

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Weaknesses negatively impacting the U.S. recovery, are geopolitical events. Current concerns include the unrelenting decline in oil prices, the continued slowdown in China, the weak EU economies, the recessionary pressures in Japan and Brazil (with the resultant decline in the value of the real), and the heightened concerns of terrorist attacks. We include a factor in our loss ratios for the global risk, as we are increasingly aware of the threat that global concerns may affect our customers. While we are unable to determine with any precision the impact of global economic and political issues on our loan portfolios, we feel the risks are real and significant. We believe there is a risk of negative consequences for our borrowers that would affect their ability to repay their financial obligations. Therefore, we continue to include a factor for global risk in our analysis for the first quarter of 2016.
Another area of concern continues to be our aircraft portfolio where we have collateral concentration and $209 million in foreign exposure. The aircraft industry was among the sectors affected most by the sluggish economy. We have seen some evidence that depressed private jet markets have stabilized. As the U.S. economy slowly improves, the industry is likely to benefit and we should see a decrease in the fleet of unsold pre-owned aircraft which will result in further strengthening of values. Nevertheless, we remain concerned about the prolonged low prices for several models. We also have some foreign exposure in this portfolio, particularly in Mexico and Brazil. Brazil is suffering from their worst recession in twenty-five years. We continue to monitor individual customer performance and assess risks in the portfolio as a whole. We do not see a clear trend of improvement or deterioration. We have assessed our reserve ratios, which were established based on the higher and more volatile loss histories and believe our reserve ratios remain appropriate.
On March 31, 2016, 30 day and over loan and lease delinquencies were 0.28% compared to 0.40% on March 31, 2015. The decrease in delinquencies is largely attributable to the aircraft portfolio. The reserve for loan and lease losses as a percentage of loans and leases outstanding at the end of the period was 2.21% as compared to 2.30% one year ago. A summary of loan and lease loss experience during the three months ended March 31, 2016 and 2015 is located in Note 5 of the Consolidated Financial Statements. 
A loan or lease is considered impaired, based on current information and events, if it is probable that we 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. We evaluate loans and leases exceeding $100,000 for impairment and establish 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. A summary of impaired loans as of March 31, 2016 and December 31, 2015 is reflected in Note 4 of the Consolidated Financial Statements. 
NONPERFORMING ASSETS 
The following table shows nonperforming assets.
(Dollars in thousands)
 
March 31,
2016
 
December 31,
2015
 
March 31,
2015
Loans and leases past due 90 days or more
 
$
728

 
$
122

 
$
190

Nonaccrual loans and leases
 
12,982

 
12,718

 
21,359

Other real estate
 
330

 
736

 
892

Former bank premises held for sale
 

 

 
626

Repossessions
 
7,201

 
6,927

 
4,607

Equipment owned under operating leases
 
113

 
121

 
36

Total nonperforming assets
 
$
21,354

 
$
20,624

 
$
27,710

 
Nonperforming assets as a percentage of total loans and leases were 0.51% at March 31, 2016, 0.50% at December 31, 2015, and 0.73% at March 31, 2015. Nonperforming assets totaled $21.35 million at March 31, 2016, an increase of 3.54% from the $20.62 million reported at December 31, 2015, and a 22.94% decrease from the $27.71 million reported at March 31, 2015. The increase in nonperforming assets during the first three months of 2016 was related to an increase in loans and leases past due 90 days or more, nonaccrual loans and leases and repossessions offset by sales of other real estate. The decrease in nonperforming assets at March 31, 2016 from March 31, 2015 occurred primarily in nonaccrual loans and leases and the sale of other real estate.
The increase in loans past due 90 days or more at March 31, 2016 from December 31, 2015 primarily occurred in the residential real estate and home equity portfolio. The increase in nonaccrual loans and leases at March 31, 2016 from December 31, 2015 occurred primarily in the commercial real estate and consumer portfolios. The decrease in nonaccrual loans and leases at March 31, 2016 from March 31, 2015 occurred primarily in the aircraft, commercial and commercial real estate portfolios. A summary of nonaccrual loans and leases and past due aging for the period ended March 31, 2016 and December 31, 2015 is located in Note 4 of the Consolidated Financial Statements.
Other real estate is the result of foreclosing on real estate in the local market for which we have a current appraisal and are well secured. Other real estate decreased over the past year due to current sales of existing properties outpacing current foreclosures.

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Repossessions consisted mainly of aircraft financing. At the time of repossession, the recorded amount of the loan or lease is written down to the fair value of the equipment or vehicle by a charge to the reserve for loan and lease losses or other income, if a positive adjustment, unless the equipment is in the process of immediate sale. Any subsequent fair value write-downs or write-ups, to the extent of previous write-downs, are included in noninterest expense.
The following table shows a summary of other real estate and repossessions.
(Dollars in thousands)
 
March 31,
2016
 
December 31,
2015
 
March 31,
2015
Commercial and agricultural
 
$
30

 
$
564

 
$

Auto and light truck
 

 
10

 
40

Medium and heavy duty truck
 

 

 

Aircraft financing
 
6,828

 
6,916

 
4,543

Construction equipment financing
 
360

 

 

Commercial real estate
 
120

 

 
465

Residential real estate and home equity
 
154

 
159

 
141

Consumer
 
39

 
14

 
310

Total
 
$
7,531

 
$
7,663

 
$
5,499

 
For financial statement purposes, nonaccrual loans and leases are included in loan and lease outstandings, whereas repossessions and other real estate are included in other assets.
Foreign Outstandings — Our foreign loan and lease outstandings, all denominated in U.S. dollars were $208.70 million and $205.83 million as of March 31, 2016 and December 31, 2015, respectively. Foreign loans and leases are in aircraft financing. Loan and lease outstandings to borrowers in Brazil and Mexico were $81.64 million and $115.09 million as of March 31, 2016, respectively, compared to $76.79 million and $116.73 million as of December 31, 2015, respectively. As of March 31, 2016 and December 31, 2015 there was not a significant concentration in any other country.
NONINTEREST INCOME 
The following table shows the details of noninterest income. 
 
 
Three Months Ended 
 March 31,
(Dollars in thousands)
 
2016
 
2015
 
$ Change
 
% Change
Noninterest income:
 
 

 
 

 
 
 
 
Trust fees
 
$
4,623

 
$
4,557

 
66

 
1.45
 %
Service charges on deposit accounts
 
2,107

 
2,197

 
(90
)
 
(4.10
)%
Debit card income
 
2,599

 
2,399

 
200

 
8.34
 %
Mortgage banking income
 
1,046

 
1,251

 
(205
)
 
(16.39
)%
Insurance commissions
 
1,563

 
1,305

 
258

 
19.77
 %
Equipment rental income
 
6,073

 
5,079

 
994

 
19.57
 %
Gains on investment securities available-for-sale
 
10

 

 
10

 
NM

Other income
 
3,606

 
2,963

 
643

 
21.70
 %
Total noninterest income
 
$
21,627

 
$
19,751

 
1,876

 
9.50
 %
 
NM = Not Meaningful
Trust fees increased slightly for the three months ended March 31, 2016 over the same period a year ago. Trust fees are largely based on the number and size of client relationships and the market value of assets under management. The market value of trust assets under management at March 31, 2016 and December 31, 2015 was $3.89 billion and $3.78 billion, respectively.
Service charges on deposit accounts declined for the three months ended March 31, 2016 over the comparable period one year ago. The decrease in service charges on deposit accounts primarily reflects a lower volume of nonsufficient fund transactions and a decrease in paper statement fees as clients continue to move to online access for account statements.
Debit card income increased in the three months ended March 31, 2016 over the same period a year ago. The improvement in debit card income was mainly the result of an increased volume of debit card transactions in 2016.

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Mortgage banking income decreased in the first quarter of 2016 as compared to the first quarter of 2015. This variance was primarily caused by decreased gains on loan sales and lower secondary market loan production offset by a reduction in MSR amortization expense.
Insurance commissions increased during the three months ended March 31, 2016 compared to the same period in 2015. The increase in insurance commissions was primarily due to higher contingency commissions received during the first quarter of 2016 compared to the same period a year ago.
Equipment rental income grew for the three months ended March 31, 2016 over the comparable period one year ago. The increase was the result of the average equipment rental portfolio increasing 34.42% over the same period a year ago due to improving market conditions for equipment finance mainly in construction equipment, auto and light trucks and medium and heavy duty trucks. The increase in equipment rental income was offset by a similar increase in depreciation on equipment owned under operating leases.
Gains on investment securities available-for-sale were flat during the first quarter of 2016 compared to the first quarter of 2015.
Other income increased for the three months ended March 31, 2016 over the same period a year ago. The higher income during the first three months of 2016 compared to the same period a year ago was mainly due to gains on partnership investments, increased customer swap fees and higher mutual fund income offset by lower monogram fund income.
NONINTEREST EXPENSE 
The following table shows the details of noninterest expense. 
 
 
Three Months Ended 
 March 31,
(Dollars in thousands)
 
2016
 
2015
 
$ Change
 
% Change
Noninterest expense:
 
 

 
 

 
 
 
 
Salaries and employee benefits
 
$
21,351

 
$
20,925

 
426

 
2.04
 %
Net occupancy expense
 
2,501

 
2,461

 
40

 
1.63
 %
Furniture and equipment expense
 
4,790

 
4,336

 
454

 
10.47
 %
Depreciation - leased equipment
 
5,101

 
4,088

 
1,013

 
24.78
 %
Professional fees
 
1,219

 
870

 
349

 
40.11
 %
Supplies and communication
 
1,508

 
1,406

 
102

 
7.25
 %
FDIC and other insurance
 
879

 
849

 
30

 
3.53
 %
Business development and marketing expense
 
980

 
1,049

 
(69
)
 
(6.58
)%
Loan and lease collection and repossession expense
 
427

 
363

 
64

 
17.63
 %
Other expense
 
1,949

 
1,714

 
235

 
13.71
 %
Total noninterest expense
 
$
40,705

 
$
38,061

 
2,644

 
6.95
 %
 
Salaries and employee benefits increased for the three months ended March 31, 2016 compared to the same period in 2015. The increase for the first quarter 2016 was mainly due to higher base salary expense offset by lower group insurance costs. Higher base salary expense was primarily due to more full-time equivalent employees as a result of opening a new banking center in June 2015, filling other open positions and normal performance raises. Group insurance costs decreased as a result of lower health insurance claims experience.
Net occupancy expense increased slightly during the first quarter of 2016 compared to the same period in 2015.
Furniture and equipment expense, including depreciation, increased during the first quarter of 2016 compared to the same period in 2015. Furniture and equipment expense was higher in 2016 mainly due to increased computer processing charges, software and equipment maintenance costs and depreciation.
During the first quarter of 2016, depreciation on leased equipment increased in conjunction with the increase in equipment rental income as compared to the same period one year ago.
Professional fees grew during the first quarter of 2016 compared to the same period a year ago. Professional fees increased in 2016 primarily due to higher legal fees and increased utilization of consulting services offset by lower audit fees.
Supplies and communication expense increased for the three months ended March 31, 2016 compared to the same period in 2015. The increase in 2016 was mainly the result of continuing to replace debit cards with the new embedded EMV chip technology.
FDIC and other insurance increased slightly during the first quarter of 2016 compared to the same period a year ago.

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Table of Contents

Business development and marketing expense decreased for the three months ended March 31, 2016 versus the three months ended March 31, 2015. The lower expense in 2016 was primarily the result of decreased marketing promotions.
Loan and lease collection and repossession expense increased for the three months ended March 31, 2016 compared to the same period in 2015 primarily due to fewer gains on the sale of other real estate and repossessions offset by decreased valuation adjustments and lower collection and repossession expenses.
Other expenses were higher during the first quarter of 2016 as compared to the same period in 2015. The increase during the first quarter of 2016 over a year ago primarily related to higher provision on unfunded loan commitments and swap valuation adjustments offset by lower expenses related to a previously reported proceeding that involved the Bank as trustee and reduced intangible asset amortization as items fully amortize.
INCOME TAXES 
The provision for income taxes for the three month period ended March 31, 2016 was $7.42 million compared to $7.26 million for the same period in 2015. The effective tax rates were 34.93% and 34.95% for the first quarter ended March 31, 2016 and 2015, respectively.
ITEM 3. 
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 
There have been no material changes in market risks faced by 1st Source since December 31, 2015. For information regarding our market risk, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2015.
ITEM 4. 
CONTROLS AND PROCEDURES 
As of the end of the period covered by this report an evaluation was carried out, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, at March 31, 2016, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by 1st Source in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are designed to ensure that information required to be disclosed in those reports is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure. 
In addition, there were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the first fiscal quarter of 2016 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. 



PART II.  OTHER INFORMATION 
ITEM 1.         Legal Proceedings. 
1st Source and its subsidiaries are involved in various legal proceedings incidental to the conduct of our businesses. Management does not expect that the outcome of any such proceedings will have a material adverse effect on our consolidated financial position or results of operations. 
ITEM 1A.      Risk Factors. 
There have been no material changes in risks faced by 1st Source since December 31, 2015. For information regarding our risk factors, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2015

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Table of Contents

ITEM 2.         Unregistered Sales of Equity Securities and Use of Proceeds 
ISSUER PURCHASES OF EQUITY SECURITIES 
Period
 
Total Number of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs*
 
Maximum Number (or Approximate Dollar Value) of Shares that may yet be Purchased Under the Plans or Programs
January 01 - 31, 2016
 
46,052

 
$
28.96

 
46,052

 
1,611,400

February 01 - 29, 2016
 
223,615

 
29.84

 
223,615

 
1,387,785

March 01 - 31, 2016
 

 

 

 
1,387,785

 
* 1st Source maintains a stock repurchase plan that was authorized by the Board of Directors on July 24, 2014. Under the terms of the plan, 1st Source may repurchase up to 2,000,000** shares of its common stock from time to time to mitigate the potential dilutive effects of stock-based incentive plans and other potential uses of common stock for corporate purposes. Since the inception of the plan, 1st Source has repurchased a total of 612,215** shares.
**Unadjusted for 10% stock dividend declared July 22, 2015 and issued on August 14, 2015.
ITEM 3.         Defaults Upon Senior Securities. 
None 
ITEM 4.         Mine Safety Disclosures. 
None 
ITEM 5.         Other Information. 
None 
ITEM 6.         Exhibits 
The following exhibits are filed with this report: 
31.1
 
Certification of Chief Executive Officer required by Rule 13a-14(a).
 
 
 
31.2
 
Certification of Chief Financial Officer required by Rule 13a-14(a).
 
 
 
32.1
 
Certification pursuant to 18 U.S.C. Section 1350 of Chief Executive Officer.
 
 
 
32.2
 
Certification pursuant to 18 U.S.C. Section 1350 of Chief Financial Officer.
 
 
 
101.INS
 
XBRL Instance Document
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.LAB
 
XBRL Taxonomy Extension Labels Linkbase Document
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document

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Table of Contents

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
April 21, 2016
 
/s/ CHRISTOPHER J. MURPHY III
 
 
Christopher J. Murphy III
Chairman of the Board and CEO
 
 
 
 
 
 
DATE
April 21, 2016
 
/s/ ANDREA G. SHORT
 
 
Andrea G. Short
Treasurer and Chief Financial Officer
Principal Accounting Officer


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