1ST SOURCE CORP — Interim / Quarterly Report 2007

Oct 25, 2007

10-Q 1 form10-q.htm 1ST SOURCE CORPORATION FORM 10Q 9/30/07 form10-q.htm Licensed to: 1st Source Document Created using EDGARizer 4.0.1.0 Copyright 2007 EDGARfilings, Ltd., an IEC company. All rights reserved EDGARfilings.com

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

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 |
| --- |
| (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.

Yes X No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer Accelerated filer X Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes No X

Number of shares of common stock outstanding as of October 25, 2007 – 24,172,983 shares

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Table of Contents

TABLE OF CONTENTS

| PART
I. FINANCIAL INFORMATION | | |
| --- | --- | --- |
| | | Page |
| Item
1. | Financial
Statements (Unaudited) | |
| | Consolidated
statements of financial condition -- September
30, 2007, and December 31, 2006 | 3 |
| | Consolidated
statements of income -- three months and nine
months ended September 30, 2007 and 2006 | 4 |
| | Consolidated
statements of changes in shareholders’ equity --
nine months ended September 30, 2007 and 2006 | 5 |
| | Consolidated
statements of cash flows -- nine months ended
September 30, 2007 and 2006 | 6 |
| | Notes
to the Consolidated Financial
Statements | 7 |
| Item
2. | Management’s
Discussion and Analysis of Financial Condition
and Results of Operations | 12 |
| Item
3. | Quantitative
and Qualitative Disclosures About Market
Risk | 23 |
| Item
4. | Controls
and Procedures | 23 |
| PART
II. OTHER INFORMATION | | |
| Item
1. | Legal
Proceedings | 24 |
| Item
1A. | Risk
Factors | 24 |
| Item
2. | Unregistered
Sales of Equity Securities and Use of
Proceeds | 24 |
| Item
3. | Defaults
Upon Senior Securities | 24 |
| Item
4. | Submission
of Matters to a Vote of Security
Holders | 24 |
| Item
5. | Other
Information | 24 |
| Item
6. | Exhibits | 25 |
| SIGNATURES | | 26 |
| EXHIBITS | | |
| | Exhibit
31.1 | |
| | Exhibit
31.2 | |
| | Exhibit
32.1 | |
| | Exhibit
32.2 | |

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Table of Contents

1st SOURCE CORPORATION
CONSOLIDATED
STATEMENTS OF FINANCIAL
CONDITION
(Unaudited
- Dollars in thousands)
	September
30,	December
31,
	2007	2006
ASSETS
Cash
and due from banks	$ 117,564	$	118,131
Federal
funds sold and
interest
bearing deposits with other banks	3,754		64,979
Investment
securities available-for-sale
(amortized
cost of $807,441and $709,091
at
September 30, 2007 and December 31, 2006, respectively)	810,802		708,672
Mortgages
held for sale	25,074		50,159
Loans
and leases - net of unearned discount:
Commercial
and agricultural loans	585,842		478,310
Auto,
light truck and environmental equipment	330,967		317,604
Medium
and heavy duty truck	315,116		341,744
Aircraft
financing	583,533		498,914
Construction
equipment financing	377,069		305,976
Loans
secured by real estate	858,818		632,283
Consumer
loans	150,250		127,706
Total
loans and leases	3,201,595		2,702,537
Reserve
for loan and lease losses	(64,664	)	(58,802	)
Net
loans and leases	3,136,931		2,643,735
Equipment
owned under operating leases, net	78,041		76,310
Net
premises and equipment	49,272		37,326
Goodwill
and intangile assets	91,546		19,418
Accrued
income and other assets	99,667		88,585
Total
assets	$ 4,412,651	$	3,807,315
LIABILITIES
Deposits:
Noninterest
bearing	$ 389,099	$	339,866
Interest
bearing	3,026,070		2,708,418
Total
deposits	3,415,169		3,048,284
Federal
funds purchased and securities
sold
under agreements to repurchase	327,623		195,262
Other
short-term borrowings	24,611		27,456
Long-term
debt and mandatorily redeemable securities	44,303		43,761
Subordinated
notes	100,002		59,022
Accrued
expenses and other liabilities	73,748		64,626
Total
liabilities	3,985,456		3,438,411
SHAREHOLDERS'
EQUITY
Preferred
stock; no par value
Authorized
10,000,000 shares; none issued or outstanding	-		-
Common
stock; no par value
Authorized
40,000,000 shares; issued 25,918,510 at September 30, 2007
and
23,781,518 at December 31, 2006, less unearned shares
(275,004
at September 30, 2007 and 262,986 at December 31, 2006)	342,840		289,163
Retained
earnings	112,938		99,572
Cost
of common stock in treasury (1,470,523 shares at September 30,
2007,
and
1,022,435
shares at December 31, 2006)	(30,717	)	(19,571	)
Accumulated
other comprehensive income/(loss)	2,134		(260	)
Total
shareholders' equity	427,195		368,904
Total
liabilities and shareholders' equity	$ 4,412,651	$	3,807,315
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 | | | Nine
Months Ended | | | |
| | September
30, | | | September
30, | | | |
| | 2007 | 2006 | | 2007 | | 2006 | |
| Interest
income: | | | | | | | |
| Loans
and leases | $ 57,970 | $ | 47,468 | $ | 159,322 | $ 132,777 | |
| Investment
securities, taxable | 7,365 | | 5,298 | | 19,086 | 14,020 | |
| Investment
securities, tax-exempt | 2,213 | | 1,279 | | 5,351 | 3,838 | |
| Other | 782 | | 334 | | 2,856 | 921 | |
| Total
interest income | 68,330 | | 54,379 | | 186,615 | 151,556 | |
| Interest
expense: | | | | | | | |
| Deposits | 31,184 | | 22,399 | | 85,249 | 58,715 | |
| Short-term
borrowings | 2,978 | | 2,776 | | 8,240 | 8,358 | |
| Subordinated
notes | 1,846 | | 1,098 | | 4,236 | 3,228 | |
| Long-term
debt and mandatorily redeemable securities | 624 | | 655 | | 2,049 | 1,560 | |
| Total
interest expense | 36,632 | | 26,928 | | 99,774 | 71,861 | |
| Net
interest income | 31,698 | | 27,451 | | 86,841 | 79,695 | |
| Provision
for (recovery of provision for) loan and lease losses | 3,660 | | (667 | ) | 4,284 | (2,638 | ) |
| Net
interest income after provision for | | | | | | | |
| (recovery
of provision for) loan and lease losses | 28,038 | | 28,118 | | 82,557 | 82,333 | |
| Noninterest
income: | | | | | | | |
| Trust
fees | 3,853 | | 3,271 | | 11,367 | 10,320 | |
| Service
charges on deposit accounts | 5,278 | | 5,020 | | 15,074 | 14,323 | |
| Mortgage
banking income | 770 | | 4,971 | | 2,400 | 9,833 | |
| Insurance
commissions | 964 | | 1,012 | | 3,540 | 3,626 | |
| Equipment
rental income | 5,345 | | 5,032 | | 15,730 | 13,910 | |
| Other
income | 1,841 | | 1,740 | | 6,042 | 4,873 | |
| Investment
securities and other investment (losses) gains | (154 | ) | (223 | ) | 300 | 2,010 | |
| Total
noninterest income | 17,897 | | 20,823 | | 54,453 | 58,895 | |
| Noninterest
expense: | | | | | | | |
| Salaries
and employee benefits | 20,035 | | 17,433 | | 55,754 | 49,820 | |
| Net
occupancy expense | 2,467 | | 1,854 | | 6,552 | 5,581 | |
| Furniture
and equipment expense | 3,996 | | 2,936 | | 10,838 | 9,029 | |
| Depreciation
- leased equipment | 4,284 | | 4,031 | | 12,603 | 10,960 | |
| Supplies
and communication | 1,666 | | 1,358 | | 4,450 | 4,028 | |
| Other expense | 4,992 | | 4,212 | | 13,489 | 14,198 | |
| Total
noninterest expense | 37,440 | | 31,824 | | 103,686 | 93,616 | |
| Income
before income taxes | 8,495 | | 17,117 | | 33,324 | 47,612 | |
| Income
tax expense | 2,365 | | 6,153 | | 10,611 | 16,438 | |
| Net
income | $ 6,130 | $ | 10,964 | $ | 22,713 | $ 31,174 | |
| Per
common share: | | | | | | | |
| Basic
net income per common share | $ 0.25 | $ | 0.49 | $ | 0.97 | $ 1.38 | |
| Diluted
net income per common share | $ 0.25 | $ | 0.48 | $ | 0.96 | $ 1.36 | |
| Dividends
declared | $ 0.140 | $ | 0.140 | $ | 0.420 | $ 0.394 | |
| Basic
weighted average common shares outstanding | 24,275,794 | | 22,497,930 | | 23,309,281 | 22,549,914 | |
| Diluted
weighted average common shares outstanding | 24,567,404 | | 22,811,273 | | 23,603,676 | 22,843,785 | |
| The
accompanying notes are a part of the consolidated financial
statements. | | | | | | | |

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Table of Contents

| 1st SOURCE
CORPORATION | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY | | | | | | | | | |
| (Unaudited
- Dollars in thousands, except per share amounts) | | | | | | | | | |
| | | | | | | | | Net | |
| | | | | | | | | Unrealized | |
| | | | | | | | | Appreciation | |
| | | | | | Cost
of | | | (Depreciation) | |
| | | | | | Common | | | of
Securities | |
| | | Common | | Retained | Stock | | | Available- | |
| | Total | Stock | | Earnings | in
Treasury | | | For-Sale | |
| Balance
at January 1, 2006 | $ 345,576 | $ | 221,579 | $ 139,601 | $ | (12,364 | ) | $ (3,240 | ) |
| Comprehensive
Income, net of tax: | | | | | | | | | |
| Net
Income | 31,174 | | - | 31,174 | | - | | - | |
| Change
in unrealized appreciation | | | | | | | | | |
| of
available-for-sale securities, net of tax | 2,321 | | - | - | | - | | 2,321 | |
| Total
Comprehensive Income | 33,495 | | - | - | | - | | - | |
| Issuance
of 94,089 common shares | | | | | | | | | |
| under
stock based compensation awards, | | | | | | | | | |
| including
related tax effects | 709 | | - | 353 | | 356 | | - | |
| Cost
of 328,931 shares of common | | | | | | | | | |
| stock
acquired for treasury | (7,385 | ) | - | - | | (7,385 | ) | - | |
| Cash
dividend ($0.394 per share) | (8,937 | ) | - | (8,937 | ) | - | | - | |
| 10%
common stock dividend | | | | | | | | | |
| ($12
cash paid in lieu of fractional shares) | (12 | ) | 67,584 | (67,596 | ) | - | | - | |
| Balance
at September 30, 2006 | $ 363,446 | $ | 289,163 | $ 94,595 | $ | (19,393 | ) | $ (919 | ) |
| Balance
at January 1, 2007 | $ 368,904 | $ | 289,163 | $ 99,572 | $ | (19,571 | ) | $ (260 | ) |
| Comprehensive
Income, net of tax: | | | | | | | | | |
| Net
Income | 22,713 | | - | 22,713 | | - | | - | |
| Change
in unrealized appreciation | | | | | | | | | |
| of
available-for-sale securities, net of tax | 2,394 | | - | - | | - | | 2,394 | |
| Total
Comprehensive Income | 25,107 | | - | - | | - | | - | |
| Issuance
of 40,349 common shares | | | | | | | | | |
| under
stock based compensation awards, | | | | | | | | | |
| including
related tax effects | 544 | | - | 384 | | 160 | | - | |
| Cost
of 478,083 shares of common | | | | | | | | | |
| stock
acquired for treasury | (11,306 | ) | - | - | | (11,306 | ) | - | |
| Cash
dividend ($0.42 per share) | (9,731 | ) | - | (9,731 | ) | - | | - | |
| Issuance
of 2,124,974 shares of common | | | | | | | | | |
| stock
for FINA Bancorp purchase | 53,677 | | 53,677 | - | | - | | - | |
| Balance
at September 30, 2007 | $ 427,195 | $ | 342,840 | $ 112,938 | $ | (30,717 | ) | $ 2,134 | |
| 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) | | | | |
| | Nine
Months Ended September 30, | | | |
| | 2007 | 2006 | | |
| Operating
activities: | | | | |
| Net
income | $ 22,713 | $ | 31,174 | |
| Adjustments
to reconcile net income to net cash | | | | |
| from/(used
in) operating activities: | | | | |
| Provision
for (recovery of provision for) loan and lease losses | 4,284 | | (2,638 | ) |
| Depreciation
of premises and equipment | 3,905 | | 3,689 | |
| Depreciation
of equipment owned under operating leases | 12,603 | | 10,960 | |
| Amortization
of investment security premiums | | | | |
| and
accretion of discounts, net | (273 | ) | 159 | |
| Amortization
of mortgage servicing rights | 1,753 | | 3,930 | |
| Mortgage
servicing asset impairment recoveries | - | | (16 | ) |
| Change
in deferred income taxes | (3,226 | ) | (5,878 | ) |
| Realized
investment securities gains | (300 | ) | (2,010 | ) |
| Change
in mortgages held for sale | 25,085 | | 13,039 | |
| Change
in interest receivable | (3,538 | ) | (1,705 | ) |
| Change
in interest payable | 2,816 | | 5,104 | |
| Change
in other assets | (1,303 | ) | 577 | |
| Change
in other liabilities | (867 | ) | (67 | ) |
| Other | 1,328 | | 77 | |
| Net
change in operating activities | 64,980 | | 56,395 | |
| Investing
activities: | | | | |
| Cash
paid for acquisition, net of cash acquired | (55,977 | ) | - | |
| Proceeds
from sales of investment securities | 1,070 | | 64,623 | |
| Proceeds
from maturities of investment securities | 445,847 | | 216,996 | |
| Purchases
of investment securities | (360,199 | ) | (272,058 | ) |
| Net
change in short-term investments | 217,400 | | 10,836 | |
| Net
change in loans and leases | (261,770 | ) | (160,780 | ) |
| Net
change in equipment owned under operating leases | (14,333 | ) | (26,928 | ) |
| Purchases
of premises and equipment | (13,600 | ) | (3,010 | ) |
| Net
change in investing activities | (41,562 | ) | (170,321 | ) |
| Financing
activities: | | | | |
| Net
change in demand deposits, NOW | | | | |
| accounts
and savings accounts | (230,677 | ) | (320,060 | ) |
| Net
change in certificates of deposit | 75,420 | | 459,741 | |
| Net
change in short-term borrowings | 111,331 | | (68,259 | ) |
| Proceeds
from issuance of long-term debt | - | | 20,972 | |
| Proceeds
from issuance of subordinated notes | 58,764 | | - | |
| Payments
on subordinated notes | (17,784 | ) | - | |
| Payments
on long-term debt | (381 | ) | (337 | ) |
| Net
proceeds from issuance of treasury stock | 545 | | 709 | |
| Acquisition
of treasury stock | (11,306 | ) | (7,385 | ) |
| Cash
dividends | (9,897 | ) | (9,106 | ) |
| Net
change in financing activities | (23,985 | ) | 76,275 | |
| Net
change in cash and cash equivalents | (567 | ) | (37,651 | ) |
| Cash
and cash equivalents, beginning of year | 118,131 | | 124,817 | |
| Cash
and cash equivalents, end of period | $ 117,564 | $ | 87,166 | |
| Supplemental
non-cash activity: | | | | |
| Common
stock issued for purchase of FINA | $ 53,667 | $ | - | |
| 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)

Note1. Basis of Presentation

The accompanying unaudited consolidated financial statements reflect all adjustments (all of which are normal and recurring in nature) that are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, the results of operations, 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 have been omitted. The Notes to the Consolidated Financial Statements appearing in 1st Source Corporation’s Annual Report on Form 10-K for 2006 (2006 Annual Report), which include descriptions of significant accounting policies, should be read in conjunction with these interim financial statements. The balance sheet at December 31, 2006, has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by U. S. generally accepted accounting principles for complete financial statements. Certain amounts in the prior period consolidated financial statements have been reclassified to conform with the current year presentation.

Note 2. Acquisition Activity

FINA Bancorp

On May 31, 2007, we acquired FINA Bancorp (FINA), the parent company of First National Bank, Valparaiso (FNBV), for $133.80 million. FNBV is a full service bank with 26 banking facilities located in Porter, LaPorte and Starke Counties of Indiana. Pursuant to the definitive agreement, FINA shareholders were able to choose whether to receive 1st Source common stock and/or cash pursuant to the election procedures described in the definitive agreement. Under the terms of the transaction, FINA was acquired in exchange for 2,124,974 shares of 1st Source common stock valued at $53.68 million and $80.12 million in cash. The value of the common stock was $25.26. We believe that the purchase of FINA is a natural extension of our service area and is consistent with our growth and market expansion initiatives. We expect to merge FNBV and 1st Source Bank in early 2008.

The acquisition was accounted for under the purchase method of accounting, and accordingly, the purchase price has been allocated to the tangible and identified intangible assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition. There are refinements in the process of allocating the purchase price that have not been entirely completed. Identified intangible assets and purchase accounting fair value adjustments are being amortized under various methods over the expected lives of the corresponding assets and liabilities. Goodwill will not be amortized, but will be reviewed for impairment on an annual basis. Currently, identified intangible assets from the acquisition subject to amortization are $8.59 million and total goodwill from the acquisition is $63.21 million.

On the date of acquisition, unaudited financial statements of FINA reflected assets of $619.31 million, which included $240.13 million of loans and $184.47 million of investment securities, $523.04 million of deposits and year-to-date net income of $3.85 million. In conjunction with the $240.13 million of loans, FINA’s allowance for loan losses at the acquisition date was $2.42 million. We applied the guidance required under the American Institute of Certified Public Accountants Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3) and determined that certain loans acquired in the FINA acquisition had evidence of deterioration of credit quality since origination and it was probable that all contractual required payments would not be collected on these loans. We determined that two loans with book values totaling approximately $0.28 million and fair values of $0.07 million were within the guidelines set forth under SOP 03-3. We recorded these loans at their fair value and reduced the allowance for loan losses by $0.21 million. Accordingly, we recorded $2.21 million of reserve for loan losses on loans not subject to SOP 03-3.

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Table of Contents

Pro Forma Condensed Combined Financial Information

The following pro forma condensed combined financial information presents the results of operations had the acquisition been completed as of the beginning of the periods indicated.

| | Three
Months Ended September 30, — 2007 | 2006 | Nine
Months Ended September 30, — 2007 | 2006 |
| --- | --- | --- | --- | --- |
| Net
interest income after provision for (recovery of provision for) loan
and
lease losses | $ 28,038 | $ 32,759 | $ 89,946 | $ 96,388 |
| Noninterest
income | 17,897 | 17,936 | 61,704 | 57,167 |
| Noninterest
expense | 37,440 | 36,382 | 112,769 | 107,537 |
| Income
before income taxes | 8,495 | 14,313 | 38,881 | 46,018 |
| Income
tax expense | 2,365 | 5,018 | 12,670 | 15,541 |
| Net
income | $ 6,130 | $ 9,295 | $ 26,211 | $ 30,477 |
| Per
common share: | | | | |
| Basic
net income per common share | $ 0.25 | $ 0.38 | $ 1.07 | $ 1.24 |
| Diluted
net income per common share | $ 0.25 | $ 0.37 | $ 1.06 | $ 1.24 |
| Basic
weighted average common shares outstanding | 24,275,794 | 24,622,904 | 24,484,634 | 24,674,888 |
| Diluted
weighted average common shares outstanding | 24,567,404 | 24,936,247 | 24,781,991 | 24,968,759 |

Trustcorp Mortgage Company

On May 1, 2007, the business of Trustcorp Mortgage Company was merged with 1st Source Bank; both of which are wholly owned subsidiaries of 1st Source Corporation. We believe that this will allow us to focus our home mortgage efforts in 1st Source Bank’s retail footprint in Indiana and Michigan and provide a foundation for broadening direct relationships with our clients. Prior to the acquisition by 1st Source Bank, both 1st Source Bank and Trustcorp Mortgage Company held a strong mortgage origination market share within 1st Source Bank’s traditional 15 county market of Northern Indiana and Southwestern Michigan. This market will continue to be the focus of 1st Source Bank’s home mortgage business.

Note 3. Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 157, “ Fair Value Measurements ,” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, but it does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently in the process of evaluating the impact of SFAS No. 157 on our Consolidated Financial Statements.

In February 2007, the Financial Accounting Standards Board (FASB) issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB No. 115” (SFAS No. 159). This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option permits companies to choose to measure eligible items at fair value at specified election dates. Companies will report unrealized gains and losses on items for which the fair value option has been elected in earnings after adoption. SFAS No. 159 requires additional disclosures related to the fair value measurements included in the companies financial statements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. We will adopt SFAS No. 159 on January 1, 2008. We are evaluating the impact of SFAS No. 159 on the consolidated financial statements.

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Table of Contents

In July 2006, the FASB issued FASB Interpretation No. 48 (FIN No. 48), “ Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” which clarifies the accounting for uncertainty in tax positions. FIN No. 48 requires that we recognize in our financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN No. 48 are effective as of the beginning of our 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We adopted the provisions of FIN No. 48 on January 1, 2007. Details related to the adoption of FIN No. 48 and the impact on our financial statements are more fully discussed in Note 7 – Uncertainty in Income Taxes.

Note 4. Reserve for Loan and Lease Losses

The reserve for loan and lease losses is maintained at a level believed to be adequate by management to absorb probable losses inherent in the loan and lease portfolio. The determination of the reserve requires significant judgment reflecting management’s best estimate of probable loan and lease losses related to specifically identified loans and leases as well as probable losses in the remainder of the various loan and lease portfolios. The methodology for assessing the appropriateness of the reserve consists of several key elements, which include: specific reserves for identified special attention loans and leases (classified loans and leases and internal watch list credits), percentage allocations for special attention loans and leases without specific reserves, formula reserves for each business lending division portfolio, including a higher percentage reserve allocation for special attention loans and leases without a specific reserve, and reserves for pooled homogeneous loans and leases. Management’s evaluation is based upon a continuing review of these portfolios, estimates of future customer performance, collateral values and dispositions and forecasts of future economic and geopolitical events, all of which are subject to judgment and will change.

Note 5. Financial Instruments with Off-Balance-Sheet Risk

To meet the financing needs of our customers, 1st Source Corporation 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, purchase 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 consolidated statements of financial condition. Our 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. We use the same credit policies and collateral requirements in making commitments and conditional obligations as we do for on-balance-sheet instruments.

1st Source Bank and FNBV, subsidiaries of 1st Source Corporation, grant 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.

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We issue letters of credit that are conditional commitments that guarantee the performance of a customer to a third party. The credit risk involved and collateral obtained in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

As of September 30, 2007 and December 31, 2006, 1st Source Bank had commitments outstanding to originate and purchase mortgage loans aggregating $80.00 million and $113.25 million, respectively. Outstanding commitments to sell mortgage loans aggregated $39.38 million at September 30, 2007, and $73.87 million at December 31, 2006. Standby letters of credit totaled $62.03 million and $83.15 million at September 30, 2007, and December 31, 2006, respectively at 1st Source Bank. At September 30, 2007, standby letters of credit totaled $1.89 million at FNBV. Standby letters of credit have terms ranging from six months to one year.

Note 6. Stock-Based Compensation

As of September 30, 2007, we had five stock-based employee compensation plans, which are more fully described in Note K of the Consolidated Financial Statements in 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2006. These plans include two stock option plans, the Employee Stock Purchase Plan, the Executive Incentive Plan, and the Restricted Stock Award Plan.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), using the modified prospective transition method and, therefore, have not restated results for prior periods. Under this transition method, stock-based compensation expense for the first quarter of 2006 included compensation expense for all stock-based compensation awards granted prior to, but that remained unvested as of, January 1, 2006. Compensation expense was based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123.

Prior to January 1, 2006, we accounted for stock-based compensation under the recognition, measurement and pro forma disclosure provisions of APB No. 25, the original provisions of SFAS No. 123, and SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (SFAS 148). In accordance with APB No. 25, we generally would have recognized compensation expense for stock awards on the grant date and we generally would have recognized compensation expense for stock options only when we granted options with a discounted exercise price or modified the terms of previously issued options, and would have recognized the related compensation expense ratably over the associated service period, which was generally the option vesting term.

Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006, 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 we recognize 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 we use the related vesting term. We estimate forfeiture rates based on historical employee option exercise and employee termination experience. We have identified separate groups of awardees that exhibit similar option exercise behavior and employee termination experience and have considered them as separate groups in the valuation models and expense estimates.

As a result of our January 1, 2006, adoption of SFAS No.123(R), the impact to the Consolidated Financial Statements for the three month period ended September 30, 2006 on income before income taxes and on net income were additions of $0.27 million and $0.17 million, respectively; and for the nine month period ended

September 30, 2006 on income before income taxes and on net income were additions of $2.09 million and $1.29 million, respectively. The cumulative effect of the change in accounting was $0.66 million before income taxes and $0.40 million, after income taxes. The impact on both basic and diluted earnings per share for the three months ended September 30, 2006 was $0.01 per share. The impact on both basic and diluted earnings per share for the nine months ended September 30, 2006 was $0.05 per share. In addition, prior to the adoption of SFAS No. 123(R), we presented the tax benefit of stock option exercises as operating cash flows. Upon the adoption of SFAS No. 123(R), tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options are classified as financing cash flows.

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The stock-based compensation expense recognized in the condensed consolidated statement of operations for the nine months ended September 30, 2007 and 2006 was based on awards ultimately expected to vest, and accordingly has been adjusted by the amount of estimated forfeitures. SFAS No. 123(R) 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.

The aggregate intrinsic value in the table below represents the total pretax intrinsic value (the difference between 1st Source’s closing stock price on the last trading day of the third quarter of 2007 (September 30, 2007) and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2007. This amount changes based on the fair market value of 1st Source’s stock. Total intrinsic value of options exercised for the nine months ended September 30, 2007 was $267 thousand. Total fair value of options vested and expensed was $35 thousand, net of tax, for the nine months ended September 30, 2007.

			Average
		Weighted	Remaining		Total
		Average	Contractual		Intrinsic
Number
of		Grant-date	Term		Value
Shares		Fair
Value	(in
years)		(in
000's)
Options
outstanding, beginning of year	489,475	$	26.04
Granted	2,696		28.40
Exercised	(20,654	)	15.63
Forfeited	-		-
Options
outstanding, September 30, 2007	471,517	$	26.51	1.37	$ 400
Vested
and expected to vest at September 30, 2007	471,517			1.37	$ 400
Exercisable
at September 30, 2007	457,821			1.26	$ 281

The following weighted-average assumptions were used to estimate the fair value of options granted during the nine months ended September 30, 2007:

Risk-free interest rate 4.10%

Expected dividend yield 1.94%

Expected volatility factor 30.46%

Expected option life 4.67 years

No options were granted during the nine months ended September 30, 2006.

As of September 30, 2007, there was $1.79 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 5.16 years.

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The following table summarizes information about stock options outstanding at September 30, 2007:

		Weighted — Average	Weighted		Weighted
Range
of	Number	Remaining	Average	Number	Average
Exercise	of
shares	Contractual	Exercise	of
shares	Exercise
Prices	Outstanding	Life	Price	Exercisable	Price
$12.04
to $17.99	29,508	4.99	$13.38	18,508	$14.18
$18.00
to $26.99	55,587	3.08	21.06	55,587	21.06
$27.00
to $28.40	386,422	0.85	28.30	383,726	28.30

The fair value of each stock option was estimated on the date of grant using the Black-Scholes option-pricing model with the weighed average assumptions included in the table above.

Note 7. Uncertainty in Income Taxes

We adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. As a result of the implementation of FIN No. 48, we recognized no change in the liability for unrecognized tax benefits.

The total amount of unrecognized tax benefits at January 1, 2007, was $5.79 million. Of that amount, $3.33 million would affect the effective tax rate if recognized. We recognize interest and penalties through the income tax provision. The total amount of interest and penalties on the date of adoption was $0.87 million.

Tax years that remain open and subject to audit include federal 2003–2006 years and Indiana 2002–2006 years. Additionally, we have an open tax examination with the Indiana Department of Revenue for the tax years 2002-2004. Indiana is currently proposing adjustments for certain apportionment issues. We are appealing these adjustments.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except for historical information contained herein, the matters discussed in this document express “forward-looking statements.” Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will” and similar expressions indicate forward-looking 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 U. S. generally accepted accounting principles; 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 1st Source’s filings with the SEC, including its Annual Report on Form 10-K for 2006, which filings are available from the SEC. We undertake no obligation to publicly update or revise any forward-looking statements.

The following management’s discussion and analysis is presented to provide information concerning our condition as of September 30, 2007, as compared to December 31, 2006, and the results of operations for the three and nine months ended September 30, 2007 and 2006. 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 2006 Annual Report.

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IMPACT OF FIRST NATIONAL BANK, VALPARAISO ACQUISITION

The following disclosure is not determined in accordance with generally accepted accounting principles (GAAP) and is considered a non-GAAP disclosure. Management believes that this presentation, while not in accordance with GAAP, provides useful insight as to the impact of the acquisition of First National Bank, Valparaiso on the financial condition from the date of acquisition to September 30, 2007.

We acquired First National Bank, Valparaiso (FNBV) on May 31, 2007 (See Note 2 of the Notes to Consolidated Financial Statements for information concerning this acquisition). The following table shows (for selected balance sheet items at September 30, 2007) the consolidated balance sheet item, the total for the balance sheet item for FNBV, and the total for the balance sheet item without FNBV.

| Selected
- Balance Sheet
Items | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| (Unaudited
- Dollars in thousands) | | | | | | | | |
| | 1st
Source | | | 1st
Source | | 1st
Source | | |
| | Consolidated | FNBV | | Without
FNBV | | Consolidated | | |
| | September 30, | September
30, | | September 30, | | December
31, | | |
| | 2007 | 2007 | | 2007 | | 2006 | | |
| Investment
securities available-for-sale | $ 810,802 | $ | 93,007 | $ | 717,795 | $ | 708,672 | |
| Total
loans and leases | 3,201,595 | | 241,577 | | 2,960,018 | | 2,702,537 | |
| Reserve
for loan and lease losses | (64,664 | ) | (2,212 | ) | (62,452 | ) | (58,802 | ) |
| Net
loans and leases | 3,136,931 | | 239,365 | | 2,897,566 | | 2,643,735 | |
| Net
premises and equipment | 49,272 | | 20,998 | | 28,274 | | 37,326 | |
| Goodwill
and other intangible assets | 91,546 | | 71,559 | | 19,987 | | 19,418 | |
| Deposits: | | | | | | | | |
| Noninterest
bearing | 389,099 | | 47,815 | | 341,284 | | 339,866 | |
| Interest
bearing | 3,026,070 | | 464,157 | | 2,561,913 | | 2,708,418 | |
| Total
deposits | 3,415,169 | | 511,972 | | 2,903,197 | | 3,048,284 | |
| Federal
funds purchased and securities sold under agreements to
repurchase | 327,623 | | 16,932 | | 310,691 | | 195,262 | |
| Total
assets | 4,412,651 | | 669,326 | | 3,743,325 | | 3,807,315 | |

FINANCIAL CONDITION

Our total assets at September 30, 2007, were $4.41 billion, up $605.34 million or 15.90% from December 31, 2006. The increase in assets was due to the acquisition of FNBV which had assets, including goodwill, of $669.33 million at September 30, 2007.

Total loans and leases were $3.20 billion at September 30, 2007, an increase of $499.06 million or 18.47% from December 31, 2006. The acquisition of FNBV contributed $241.58 million toward the increase in total loans and leases at September 30, 2007.

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Total deposits at September 30, 2007, were $3.42 billion, up $366.89 million or 12.04% over the comparable figures at the end of 2006. The increase in deposits was due to the acquisition of FNBV which had total deposits of $511.97 million at September 30, 2007.

Nonperforming assets at September 30, 2007, were $17.13 million compared to $17.67 million at December 31, 2006. At September 30, 2007, nonperforming assets were 0.52% of net loans and leases compared to 0.64% at December 31, 2006.

Other assets were as follows:

| (Dollars
in Thousands) | September
30, | December
31, |
| --- | --- | --- |
| | 2007 | 2006 |
| Other
assets: | | |
| Bank
owned life insurance cash surrender value | $ 38,829 | $ 36,157 |
| Accrued
interest receivable | 21,534 | 17,997 |
| Mortgage
servicing assets | 7,617 | 7,572 |
| Other
real estate | 2,679 | 800 |
| Repossessions | 3,430 | 975 |
| All
other assets | 25,578 | 25,084 |
| Total
other assets | $ 99,667 | $ 88,585 |

CAPITAL

As of September 30, 2007, total shareholders' equity was $427.20 million, up $58.29 million or 15.80% from the $368.90 million at December 31, 2006. Common stock increased by $53.68 million due to the issuance of 2,124,974 1st Source common shares for the acquisition of FINA. Other significant changes in shareholders’ equity during the first nine months of 2007 included net income of $22.71 million, $11.31 million in treasury stock purchases, and $9.73 million of dividends paid. The accumulated other comprehensive income component of shareholders’ equity totaled $2.13 million at September 30, 2007, compared to an accumulated other comprehensive loss of $0.26 million at December 31, 2006. The increase in accumulated other comprehensive income was a result of changes in unrealized gain or loss on securities in the available-for-sale portfolio. Our equity-to-assets ratio was 9.68% as of September 30, 2007, compared to 9.69% at December 31, 2006. Book value per common share rose to $17.67 at September 30, 2007, up from $16.40 at December 31, 2006.

We declared and paid cash dividends per common share of $0.14 during the third quarter of 2007. The trailing four quarters dividend payout ratio, representing dividends per share divided by diluted earnings per share, was 42.42%. The dividend payout is continually reviewed by management and the Board of Directors.

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. The actual and required capital amounts and ratios of 1st Source Corporation, 1st Source Bank, and FNBV, as of September 30, 2007, are presented in the table below:

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| | | | | | To
Be Well | |
| --- | --- | --- | --- | --- | --- | --- |
| | | | | | Capitalized
Under | |
| | | | Minimum
Capital | | Prompt
Corrective | |
| | Actual | | Adequacy | | Action
Provisions | |
| (Dollars
in thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio |
| Total
Capital (To Risk-Weighted Assets): | | | | | | |
| 1st
Source Corporation | $ 478,081 | 13.07 % | $ 292,727 | 8.00 % | $ 365,909 | 10.00 % |
| 1st
Source Bank | 402,275 | 11.83 | 271,933 | 8.00 | 339,917 | 10.00 |
| FNBV | 63,626 | 22.94 | 22,193 | 8.00 | 27,741 | 10.00 |
| Tier
1 Capital (to Risk-Weighted Assets): | | | | | | |
| 1st
Source Corporation | 430,365 | 11.76 | 146,364 | 4.00 | 219,545 | 6.00 |
| 1st
Source Bank | 358,692 | 10.55 | 135,967 | 4.00 | 203,950 | 6.00 |
| FNBV | 61,414 | 22.14 | 11,096 | 4.00 | 16,645 | 6.00 |
| Tier
1 Capital (to Average Assets): | | | | | | |
| 1st
Source Corporation | 430,365 | 9.88 | 174,198 | 4.00 | 217,747 | 5.00 |
| 1st
Source Bank | 358,692 | 9.08 | 157,990 | 4.00 | 197,487 | 5.00 |
| FNBV | 61,414 | 9.82 | 25,022 | 4.00 | 31,277 | 5.00 |

LIQUIDITY AND INTEREST RATE SENSITIVITY

Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as the operating cash needs of 1st Source Corporation, are met. Funds are available from a number of sources, including the securities portfolio, the core deposit base, Federal Home Loan Bank borrowings, and the capability to package loans for sale. Our loan to asset ratio was 72.55% at September 30, 2007 compared to 70.98% at December 31, 2006 and 72.54% at September 30, 2006. Cash and cash equivalents totaled $117.56 million at September 30, 2007 compared to $118.13 million at December 31, 2006 and $87.17 million at September 30, 2006. At September 30, 2007, the consolidated statement of financial condition was rate sensitive by $947.36 million more liabilities than assets scheduled to reprice within one year, or approximately 0.72%. Management believes that the present funding sources provide adequate liquidity to meet our cash flow needs.

SUBORDINATED DEBT

During the second quarter of 2007, we completed the private placement issuance of $40 million of trust preferred securities through, 1st Source Master Trust, a newly formed subsidiary trust organized under Delaware law. The trust preferred securities were issued at $1,000.00 per share and bear a 7.2175 percent per annum fixed rate of interest, payable quarterly. The securities are redeemable after five years and are due in 2037. The net proceeds of the issuance were used to fund a portion of the purchase price for FINA. Additionally, during the second quarter of 2007, we provided notice to the trustee for the 690,000 shares of floating rate trust preferred securities issued by 1st Source Capital Trust II of our plans to redeem these securities on August 1, 2007.

During the third quarter of 2007, we completed private placement of $17 million of trust preferred securities through 1st Source Master Trust. The trust preferred securities were issued at $1,000.00 per share and bear a 7.095 percent per annum fixed rate of interest for the first ten years and a floating rate thereafter, payable quarterly. The securities are redeemable after five years and are due in 2037. The net proceeds of the trust preferred securities issuance were used to redeem $17.78 million in 7.03 percent floating-rate trust preferred securities issued by 1st Source Capital Trust II and $0.43 million of pre-tax capitalized debt issuance costs were written off. We will dissolve our unconsolidated subsidiary 1st Source Capital Trust II.

RESULTS OF OPERATIONS

Net income for the three- and nine-month periods ended September 30, 2007, was $6.13 million and $22.71 million respectively, compared to $10.96 million and $31.17 million for the same periods in 2006. Diluted net income per common share was $0.25 and $0.96 respectively, for the three- and nine-month periods ended September 30, 2007, compared to $0.48 and $1.36 for the same periods in 2006. Return on average common shareholders' equity was 7.58% for the nine months ended September 30, 2007, compared to 11.77% in 2006. The return on total average assets was 0.75% for the nine months ended September 30, 2007, compared to 1.19% in 2006.

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The decrease in net income for the nine months ended September 30, 2007, over the first nine months of 2006, was primarily attributable to an increase of $6.92 million in our provision for loan and lease losses, a decline of $4.44 million in noninterest income, and an increase of $10.07 million in noninterest expense, which were primarily offset by a $5.83 million reduction in income tax expense. Details of the changes in the various components of net income are further discussed below.

NET INTEREST INCOME

The taxable-equivalent net interest income for the three months ended September 30, 2007, was $32.74 million, up 16.64% from the comparable period in 2006. The taxable-equivalent net interest income for the nine months ended September 30, 2007, was $89.40 million, an increase of 9.56% from the same period in 2006.

The net interest margin on a fully taxable-equivalent basis was 3.16% for the three months ended September 30, 2007, compared to 3.34% for three months ended September 30, 2006. The net interest margin on a fully taxable-equivalent basis was 3.17% for the nine months ended September 30, 2007, compared to 3.36% for the nine months ended September 30, 2006.

Average earning assets increased $772.42 million or 23.19% and $521.36 million or 16.04%, respectively, for the three and nine month periods ended September 30, 2007, over the comparable periods in 2006. Average interest-bearing liabilities increased $773.40 million or 27.59% and $523.44 million or 19.30%, respectively, for the three and nine month periods ended September 30, 2007, over the comparable period one year ago. As of September 30, 2007, average earning assets at FNBV totaled $265.86 million and average interest-bearing liabilities totaled $229.74 million.

The yield on average earning assets increased 16 basis points to 6.71% for the third quarter of 2007 from 6.55% for the third quarter of 2006. The yield on average earning assets for the nine month period ended September 30, 2007, increased 40 basis points to 6.71% from 6.31% for the nine month period ended September 30, 2006. The rate earned on assets continued to experience positive impacts from the increases in short-term market interest rates from a year ago. Total cost of average interest-bearing liabilities increased 25 basis points to 4.06% for the third quarter of 2007 from 3.81% for the third quarter of 2006. Total cost of average interest-bearing liabilities increased 58 basis points to 4.12% for the nine month period ended September 30, 2007 from 3.54% for the nine month period ended September 30, 2006. The cost of interest-bearing liabilities was also affected by short-term market interest rates. The result to the net interest margin, or the difference between interest income on earning assets and expense on interest-bearing liabilities, was a decrease of 18 basis points and 19 basis points, respectively, for the three and nine month periods ended September 30, 2007 from September 30, 2006.

The largest contributor to the increase in the yield on average earning assets for the first nine months of 2007, on a volume-weighted basis, was the $391.52 million or 15.42% increase in higher yielding net loans and leases as compared to the first nine months of 2006. Average loans and leases grew by $564.49 million or 21.59% during the third quarter of 2007, compared to the third quarter of 2006. Average loans and leases outstanding increased across our entire portfolio, most notably in construction equipment financing, commercial loans, aircraft financing, loans secured by real estate, and medium and heavy duty truck financing for both the third quarter and year-to-date 2007 as compared to 2006. As of September 30, 2007, average loans and leases at FNBV totaled $107.56 million, the majority were loans secured by real estate.

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Total average investment securities increased 32.73% and 16.77%, respectively, for the three- and nine- month periods over one year ago. This increase was mainly due to an increase in mortgage-backed and municipal securities. Average mortgages held for sale decreased 62.22% and 43.78% respectively, for the three- and nine- month periods over the same periods one year ago. Production volume decreased approximately 59% and 48%, respectively, during the third quarter and year-to-date 2007 compared to the third quarter and year-to-date 2006, primarily due to a reduction of our mortgage purchase activity with the majority of our production affiliates. Other investments, which include federal funds sold, time deposits with other banks and commercial paper, increased 1.43 times for the three month period ended September 30, 2007 from same period one year ago, and 1.89 times for the first nine months of 2007 as compared to the first nine months of 2006 as excess funds were invested. As of September 30, 2007, the average investment securities portfolio at FNBV totaled $45.11 million, the majority of which was in federal agency and municipal securities.

Average interest-bearing deposits increased $690.34 million or 28.25% and $508.41 million or 21.69%, respectively, for the third quarter of 2007 and first nine months of 2007, over the same periods in 2006. The effective rate paid on average interest-bearing deposits increased 31 basis points to 3.95% for the third quarter of 2007 compared to 3.64% for the third quarter of 2006. The effective rate paid on average interest-bearing deposits increased 65 basis points to 4.00% for the first nine months of 2007 compared to 3.35% for the first nine months of 2006.The increase in the average cost of interest-bearing deposits during the third quarter and first nine months of 2007 as compared to the third quarter and first nine months of 2006 was primarily the result of increases in interest rates offered on deposit products due to increases in market interest rates and increased competition for deposits across all markets. As of September 30, 2007, average interest-bearing deposits at FNBV totaled $222.09 million.

Average short-term borrowings increased $37.29 million or 14.33% for the third quarter of 2007 as compared to the third quarter of 2006. Short-term borrowings decreased $11.52 million or 4.20% for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. Average trust preferred borrowings increased $41.07 million or 69.58% and $17.46 million or 29.59%, respectively, for the third quarter of 2007 and the first nine months of 2007, over the same periods in 2006. Interest paid on short-term and trust preferred borrowings decreased during the third quarter of 2007 as compared to the third quarter of 2006. Interest paid on short-term borrowings and trust preferred borrowings increased on a year-to-date basis for 2007 as compared to 2006 primarily due to the interest rate increase in adjustable rate borrowings. Average long-term debt increased $4.71 million or 11.92% during the third quarter of 2007 as compared to the third quarter of 2006. Average long-term debt increased $9.09 million or 26.19% during the first nine months of 2007 as compared to the first nine months of 2006. The majority of the increase in long-term debt was made up of Federal Home Loan Bank borrowings. Additionally, we issued $40.00 million of trust preferred securities on June 7, 2007, which were used to fund a portion of the purchase price for FNBV, and $17.00 million of trust preferred securities on August 1, 2007, which were used primarily to redeem trust preferred securities issued by 1st Source Capital Trust II.

Average demand deposits increased $9.35 million for the three-month period ended September 30, 2007 as compared to the three-month period of 2006. Average demand deposits decreased $19.75 million for the nine-month period ended September 30, 2007 as compared to the nine-month period ended September 30, 2006. Much of the decline on a year-to-date basis was due to the reclassification of some of our deposit products from noninterest bearing to interest bearing and a decrease in escrow deposit accounts concurrent with the reduction in our mortgage servicing portfolio. As of September 30, 2007, average demand deposits at FNBV were $20.04 million.

The following table provides an analysis of net interest income and illustrates the interest 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.

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| DISTRIBUTION
OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| INTEREST
RATES AND INTEREST DIFFERENTIAL | | | | | | | | | | | | |
| (Dollars
in thousands) | | | | | | | | | | | | |
| | Three
months ended September 30, | | | | | | Nine months
ended September 30, | | | | | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| | | Interest | | | Interest | | | Interest | | | Interest | |
| | Average | Income/ | Yield/ | Average | Income/ | Yield/ | Average | Income/ | Yield/ | Average | Income/ | Yield/ |
| | Balance | Expense | Rate | Balance | Expense | Rate | Balance | Expense | Rate | Balance | Expense | Rate |
| ASSETS: | | | | | | | | | | | | |
| Investment
securities: | | | | | | | | | | | | |
| Taxable | $ 586,111 | $ 7,365 | 4.99 % | $ 464,331 | $ 5,298 | 4.53 % | $ 521,943 | $ 19,086 | 4.89 % | $ 458,816 | $ 14,020 | 4.09 % |
| Tax
exempt | 255,200 | 3,150 | 4.90 % | 169,520 | 1,825 | 4.27 % | 215,656 | 7,619 | 4.72 % | 172,853 | 5,507 | 4.26 % |
| Mortgages
- held for sale | 21,722 | 393 | 7.18 % | 57,501 | 994 | 6.86 % | 30,850 | 1,525 | 6.61 % | 54,878 | 2,737 | 6.67 % |
| Net
loans and leases | 3,179,234 | 57,677 | 7.20 % | 2,614,743 | 46,541 | 7.06 % | 2,930,077 | 158,086 | 7.21 % | 2,538,558 | 130,270 | 6.86 % |
| Other
investments | 61,540 | 782 | 5.04 % | 25,288 | 334 | 5.24 % | 73,290 | 2,856 | 5.21 % | 25,349 | 921 | 4.86 % |
| Total
Earning Assets | 4,103,807 | 69,367 | 6.71 % | 3,331,383 | 54,992 | 6.55 % | 3,771,816 | 189,172 | 6.71 % | 3,250,454 | 153,455 | 6.31 % |
| Cash
and due from banks | 86,794 | | | 79,129 | | | 78,323 | | | 79,707 | | |
| Reserve
for loan and lease losses | (62,513 | ) | | (59,195 | ) | | (60,274 | ) | | (59,110 | ) | |
| Other
assets | 318,631 | | | 223,557 | | | 264,079 | | | 217,057 | | |
| Total | $ 4,446,719 | | | $ 3,574,874 | | | $ 4,053,944 | | | $ 3,488,108 | | |
| LIABILITIES
AND SHAREHOLDERS' EQUITY: | | | | | | | | | | | | |
| Interest-bearing
deposits | $ 3,134,368 | $ 31,184 | 3.95 % | $ 2,444,033 | $ 22,399 | 3.64 % | $ 2,852,381 | $ 85,249 | 4.00 % | $ 2,343,973 | $ 58,715 | 3.35 % |
| Short-term
borrowings | 297,543 | 2,978 | 3.97 % | 260,249 | 2,776 | 4.23 % | 262,748 | 8,240 | 4.19 % | 274,263 | 8,358 | 4.07 % |
| Subordinated
notes | 100,089 | 1,846 | 7.32 % | 59,022 | 1,098 | 7.38 % | 76,486 | 4,236 | 7.40 % | 59,022 | 3,228 | 7.31 % |
| Long-term
debt and | | | | | | | | | | | | |
| mandatorily redeemable securities | 44,200 | 624 | 5.60 % | 39,493 | 655 | 6.58 % | 43,777 | 2,049 | 6.26 % | 34,691 | 1,560 | 6.01 % |
| Total
Interest-Bearing Liabilities | 3,576,200 | 36,632 | 4.06 % | 2,802,797 | 26,928 | 3.81 % | 3,235,392 | 99,774 | 4.12 % | 2,711,949 | 71,861 | 3.54 % |
| Noninterest
bearing deposits | 355,825 | | | 346,473 | | | 340,758 | | | 360,505 | | |
| Other
liabilities | 83,984 | | | 65,205 | | | 77,228 | | | 61,663 | | |
| Shareholders'
equity | 430,710 | | | 360,399 | | | 400,566 | | | 353,991 | | |
| Total | $ 4,446,719 | | | $ 3,574,874 | | | $ 4,053,944 | | | $ 3,488,108 | | |
| Net
Interest Income | | $ 32,735 | | | $ 28,064 | | | $ 89,398 | | | $ 81,594 | |
| Net
Yield on Earning Assets on
a Taxable Equivalent | | | | | | | | | | | | |
| Basis | | | 3.16 % | | | 3.34 % | | | 3.17 % | | | 3.36 % |

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PROVISION AND RESERVE FOR LOAN AND LEASE LOSSES

Our provision for loan and lease losses for the three-month and nine-month periods ended September 30, 2007 was $3.66 million and $4.28 million, respectively, compared to a recovery of provision for loan and lease losses of $0.67 million and $2.64 million for the three-month and nine-month periods ended September 30, 2006, respectively. Net charge-offs of $1.68 million were recorded for the third quarter 2007, compared to net recoveries of $0.47 million for the same quarter a year ago. Year-to-date net charge-offs of $0.64 million have been recorded in 2007, compared to net recoveries of $2.94 million through September 2006.

In the third quarter 2007, loan and lease delinquencies were 0.42% as compared to 0.26% on September 30, 2006, and 0.17% at the end of 2006. The reserve for loan and lease losses as a percentage of loans and leases outstanding at September 30, 2007 was 2.02% as compared to 2.25% one year ago and 2.18% at December 31, 2006. A summary of loan and lease loss experience during the three- and nine-month periods ended September 30, 2007 and 2006 is provided below.

| | Summary
of Reserve for Loan and Lease Losses | | | | | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | (Dollars
in Thousands) | | | | | | | |
| | Three
Months Ended | | | Nine
Months Ended | | | | |
| | September
30, | | | September
30, | | | | |
| | 2007 | 2006 | | 2007 | | 2006 | | |
| Reserve
for loan and lease losses - beginning balance | $ 62,682 | $ | 59,197 | $ | 58,802 | $ | 58,697 | |
| Acquired
reserves from acquisitions | - | | - | | 2,214 | | - | |
| Charge-offs | (2,579 | ) | (932 | ) | (5,009 | ) | (2,303 | ) |
| Recoveries | 901 | | 1,404 | | 4,373 | | 5,246 | |
| Net
(charge-offs)/recoveries | (1,678 | ) | 472 | | (636 | ) | 2,943 | |
| Provision
for (recovery of provision for) loan and lease losses | 3,660 | | (667 | ) | 4,284 | | (2,638 | ) |
| Reserve
for loan and lease losses - ending balance | $ 64,664 | $ | 59,002 | $ | 64,664 | $ | 59,002 | |
| Loans
and leases outstanding at end of period | $ 3,201,595 | $ | 2,627,153 | $ | 3,201,595 | $ | 2,627,153 | |
| Average
loans and leases outstanding during period | 3,179,234 | | 2,614,743 | | 2,930,077 | | 2,538,558 | |
| Reserve
for loan and lease losses as a percentage of | | | | | | | | |
| loans
and leases outstanding at end of period | 2.02 | % | 2.25 | % | 2.02 | % | 2.25 | % |
| Ratio
of net recoveries/(charge-offs) during period to | | | | | | | | |
| average
loans and leases outstanding | (0.23 | )% | 0.07 | % | (0.04 | )% | 0.16 | % |

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NONPERFORMING ASSETS

Nonperforming assets were as follows:

| (Dollars
in thousands) | September
30, | December
31, | September
30, |
| --- | --- | --- | --- |
| | 2007 | 2006 | 2006 |
| Loans
and leases past due 90 days or more | $ 693 | $ 116 | $ 264 |
| Nonaccrual
and restructured loans and leases | 10,211 | 15,575 | 11,248 |
| Other
real estate | 2,679 | 800 | 759 |
| Repossessions | 3,430 | 975 | 2,356 |
| Equipment
owned under operating leases | 114 | 201 | 66 |
| Total
nonperforming assets | $ 17,127 | $ 17,667 | $ 14,693 |

Nonperforming assets totaled $17.13 million at September 30, 2007, an improvement of 3.06% from the $17.67 million reported at December 31, 2006, and a 16.57% increase over the $14.69 million reported at September 30, 2006. Nonperforming assets as a percentage of total loans and leases improved to 0.52% at September 30, 2007, from 0.64% at December 31, 2006 and 0.54% at September 30, 2006.

As of September 30, 2007, repossessions primarily consisted of automobiles, light trucks, medium and heavy duty trucks, aircraft, and construction equipment. At the time of repossession, unless the equipment is in the process of immediate sale, the recorded amount of the loan or lease is written down, if necessary, to the estimated value of the equipment or vehicle by a charge to the reserve for loan and lease losses. Any subsequent write-downs are included in noninterest expense.

Supplemental Loan and Lease Information as of September 30, 2007

| (Dollars
in thousands) | | Nonaccrual | Other
real estate | Year-to-date | |
| --- | --- | --- | --- | --- | --- |
| | Loans
and leases | and | owned
and | net
credit losses/ | |
| | outstanding | restructured
loans | repossessions | (recoveries) | |
| Commercial
and agricultural loans | $ 585,842 | $ 715 | $ - | $ (875 | ) |
| Auto,
light truck and environmental equipment | 330,967 | 674 | 1,520 | 1,477 | |
| Medium
and heavy duty truck | 315,116 | 583 | 141 | 413 | |
| Aircraft
financing | 583,533 | 759 | 1,350 | (1,325 | ) |
| Construction
equipment financing | 377,069 | 488 | 367 | 535 | |
| Loans
secured by real estate | 858,818 | 5,621 | 824 | 16 | |
| Consumer
loans | 150,250 | 255 | 52 | 298 | |
| Total | $ 3,201,595 | $ 9,095 | $ 4,254 | $ 539 | |

For financial statements purposes, nonaccrual loans and leases are included in loan and lease outstandings, whereas repossessions and other real estate are included in other assets. Net credit losses include net charge-offs on loans and leases and valuation adjustments and gains and losses on disposition of repossessions and defaulted operating leases.

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NONINTEREST INCOME

Noninterest income for the three month periods ended September 30, 2007 and 2006 was $17.90 million and $20.82 million, respectively, and $54.45 million and $58.90 million for the nine month periods ended September 30, 2007 and 2006, respectively. Details of noninterest income follow:

| (Dollars
in thousands) | Three
Months Ended | | | | | |
| --- | --- | --- | --- | --- | --- | --- |
| | September
30, | | | September
30, | | |
| | 2007 | 2006 | | 2007 | | 2006 |
| Noninterest
income: | | | | | | |
| Trust
fees | $ 3,853 | $ | 3,271 | $ | 11,367 | $ 10,320 |
| Service
charges on deposit accounts | 5,278 | | 5,020 | | 15,074 | 14,323 |
| Mortgage
banking income | 770 | | 4,971 | | 2,400 | 9,833 |
| Insurance
commissions | 964 | | 1,012 | | 3,540 | 3,626 |
| Equipment
rental income | 5,345 | | 5,032 | | 15,730 | 13,910 |
| Other
income | 1,841 | | 1,740 | | 6,042 | 4,873 |
| Investment
securities and other investment (losses) gains | (154 | ) | (223 | ) | 300 | 2,010 |
| Total
noninterest income | $ 17,897 | $ | 20,823 | $ | 54,453 | $ 58,895 |

Declines in mortgage banking income of $4.20 million and $7.43 million, respectively, for the three and nine month periods ended September 30, 2007 as compared to the same periods of 2006, was the primary factor in the overall decline in noninterest income. During the third quarter of 2006, mortgage banking income benefited from a $3.20 million, pre-tax, gain on the bulk sale of mortgage servicing rights which did not recur during the third quarter of 2007. The third quarter 2006 bulk sale of mortgage servicing rights combined with the second quarter 2006, $1.25 million gain on the bulk sale of mortgage servicing rights, resulted in a total 2006 year-to-date gain of $4.45 million, pre-tax. Additionally, a decline in production volume for the three and nine month periods ending September 30, 2007, resulted in lower gains on sales of mortgage servicing assets and a decline in loan servicing fee income occurred due to a reduction in the portfolio from the servicing sales in the second and third quarters of 2006.

Other factors contributing to decreased noninterest income for the third quarter 2007 and year-to-date 2007 compared to the third quarter 2006 and year-to-date 2006 were lower insurance commissions and gains on investment securities which include venture partnerships. Insurance commissions fell $0.05 million and $0.09 million, respectively, over the three and nine month periods ending September 30, 2007 as compared to the same periods in 2006, mainly due to lower contingent commissions. Gains on venture partnerships totaled $0.03 million for the first nine months of 2007 compared to gains of $1.85 million for the first nine months of 2006.

Equipment rental income increased during the third quarter 2007 and the first nine months of 2007 compared to the third quarter of 2006 and first nine months of 2006 in conjunction with an increase in the operating lease portfolio. Other income increased over the three- and nine- month periods ended September 30, 2007 compared to the same periods of 2006, primarily due to income from interest rate swaps. Trust fees grew over the course of both the three and nine month periods ended September 30, 2007 compared to the same periods one year ago, as a result of growth of assets under management and favorable market conditions. Additionally, service charges on deposit accounts, which include overdraft and NSF fees, increased during the third quarter and year-to-date 2007 compared to the third quarter and year-to-date 2006.

FNBV contributed $0.67 million to noninterest income during the third quarter of 2007 and a total of $1.05 million since the date of acquisition on May 31, 2007.

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NONINTEREST EXPENSE

Noninterest expense for the three month periods ended September 30, 2007 and 2006 was $37.44 million and $31.82 million, respectively, and $103.69 million and $93.62 million for the nine month periods ended September 30, 2007 and 2006, respectively. Details of noninterest expense follow:

| (Dollars
in thousands) | Three
Months Ended — September
30, | | Nine
Months Ended — September
30, | |
| --- | --- | --- | --- | --- |
| | 2007 | 2006 | 2007 | 2006 |
| Noninterest
expense: | | | | |
| Salaries
and employee benefits | $ 20,035 | $ 17,433 | $ 55,754 | $ 49,820 |
| Net
occupancy expense | 2,467 | 1,854 | 6,552 | 5,581 |
| Furniture
and equipment expense | 3,996 | 2,936 | 10,838 | 9,029 |
| Depreciation
- leased equipment | 4,284 | 4,031 | 12,603 | 10,960 |
| Professional
fees | 921 | 939 | 3,089 | 2,928 |
| Supplies
and communication | 1,666 | 1,358 | 4,450 | 4,028 |
| Business
development and marketing expense | 1,028 | 879 | 3,302 | 2,568 |
| Intangible
asset amortization | 287 | 417 | 524 | 1,742 |
| Loan
and lease collection and repossession expense | 345 | 58 | 670 | 333 |
| Other
expense | 2,411 | 1,919 | 5,904 | 6,627 |
| Total
noninterest expense | $ 37,440 | $ 31,824 | $ 103,686 | $ 93,616 |

Salaries and employee benefits increased $2.60 million and $5.93 million, respectively, for the third quarter and year-to-date of 2007 compared to the third quarter and year-to-date of 2006. The majority of this increase was due to the acquisition of FNBV which added $2.49 million to salaries and employee benefit expense for the third quarter of 2007, and $3.28 million since the date of acquisition on May 31, 2007. Additionally, during the first quarter of 2006 we benefited from the reversal of previously recognized stock-based compensation expense under historical accounting methods related to the estimated forfeiture of stock awards. This one-time reversal, combined with the adoption of SFAS No. 123(R) estimated forfeiture accounting requirements, resulted in a reduction in stock-based compensation, during the first quarter of 2006, of $2.07 million, pre-tax.

Furniture and equipment expense increased during the third quarter of 2007 and on a year-to-date 2007 basis as compared to the same periods of 2006 primarily due to expenses related to the core system conversion project and other processing charges. Leased equipment depreciation increased for the quarter and year-to-date ended September 30, 2007 compared quarter and year-to-date ended September 30, 2006, primarily due to the increase in the operating lease portfolio. As of September 30, 2007, business development and marketing expense increased on a year-over-year and quarter-over-quarter basis mainly due to strong marketing across our entire footprint area.

Supplies and communication expense rose during the third quarter of 2007 and year-to-date 2007 as compared the third quarter of 2006 and year-to-date 2006, primarily due to increased expense associated with data communications. Loan and lease collection and repossession expense increased during the third quarter of 2007 and on a year-over-year mainly due to higher repossession expense. Professional fees remained comparable to 2006 levels.

Other expenses were lower at September 30, 2007, as compared to one year ago primarily due to a significant reduction in forgery and miscellaneous losses. Other expenses increased during the third quarter of 2007 compared to the third quarter of 2006, mainly due to the write-off of issuance costs associated with the redemption of trust preferred securities. Intangible asset amortization decreased during the third quarter of 2007 as intangible assets associated with 2001 acquisitions became fully amortized.

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In addition to the increased salaries and employee benefit expense mentioned above, FNBV increased noninterest expense by $2.16 million for the quarter ended September 30, 2007, and by $2.85 million since the date of acquisition on May 31, 2007.

INCOME TAXES

The provisions for income taxes for the three and nine month periods ended September 30, 2007, were $2.37 million and $10.61 million, respectively, compared to $6.15 million and $16.44 million, respectively, for the same periods in 2006. The effective tax rates were 27.84% for the quarter ended September 30, 2007 and 31.84% for the nine month period ended September 30, 2007, compared to 35.95% and 34.52% for the three and nine month periods ended September 30, 2006, respectively. The effective tax rate decreased due to a decrease in pre-tax income and an increase in tax-exempt income. The provision for income taxes for the three and nine month periods ended September 30, 2007 and 2006, are at a rate which management believes approximates the effective rate for the year.

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, 2006. For information regarding our market risk, refer to our Annual Report on Form 10-K for the year ended December 31, 2006.

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-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, at September 30, 2007, our disclosure controls and procedures were effective in accumulating and communicating to management (including such officers) the information relating to 1st Source (including its consolidated subsidiaries) required to be included in our periodic SEC filings.

During the quarter ended September 30, 2007, we converted to a new core operating system. Due to the nature of a conversion of this magnitude, a number of critical internal controls were affected. However, management believes that the conversion went well and appropriate internal controls were maintained or implemented during the process. There were no other changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the third fiscal quarter of 2007 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting, except that this report and assessment excludes First National Bank, Valparaiso (FNBV) which we acquired as of May 31, 2007. See Note 2 to the condensed consolidated financial statements included in Item 1 for discussion of the acquisition and related financial data. We are in the process of integrating FNBV operations and will be incorporating these operations as part of our assessment of our internal controls.

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PART II. OTHER INFORMATION

IT EM 1. Legal Proceedings.

1st Source and its subsidiaries are involved in various legal proceedings incidental to the conduct of their businesses. Management does not expect that the outcome of any such proceedings will have a material adverse effect on 1st Source’s consolidated financial position or results of operations.

ITEM 1A. Risk Factors.

There have been no material changes in risks faced by 1st Source since the filing of our Annual Report on Form 10-K for the year ended December 31, 2006, except for risk associated with the conversion of our core systems, the majority of which was completed in July 2007. We can provide no assurance that the amount expended on this investment will not exceed our expectations and result in materially increased levels of expense or asset impairment charges. There is no assurance that the conversion of our core systems will achieve the expected cost savings or result in a positive return on our investment. Additionally, if our new core system does not operate as intended, there could be disruptions in our business which could adversely affect our financial condition and results of operations.

For information regarding our other risk factors, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2006.

IT EM 2. Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES

| | Total
number | Average | Total
number of — shares
purchased | Maximum
number (or approximate — dollar
value) of shares |
| --- | --- | --- | --- | --- |
| | of
shares | price
paid per | as
part of publicly announced | that
may yet be purchased under |
| Period | purchased | share | plans
or programs (1) | the
plans or programs |
| July
01 - 31, 2007 | 39,808 | $21.44 | 39,808 | 1,732,790 |
| August
01 - 31, 2007 | 204,469 | $21.22 | 204,469 | 1,528,321 |
| September
01 - 30, 2007 | - | - | - | 1,528,321 |
| (1) 1st
Source
maintains a stock repurchase plan that was authorized by the Board
of
Directors on April 26, 2007. | | | | |
| Under
the terms of the plan, 1st Source may repurchase up to 2,000,000
shares of
its common stock when | | | | |
| favorable
conditions exist on the open market or through private transactions
at
various prices from time to time. | | | | |
| Since
the inception of the plan, 1st Source has repurchased a total of
471,679
shares. | | | | |

ITE M 3. Defaults Upon Senior Securities.

None

IT EM 4. Submission of Matters to a Vote of Security Holders.

None

IT EM 5. Other Information.

None

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IT EM 6. Exhibits

The following exhibits are filed with this report:

1. Exhibit 31.1 Certification of Chief Executive Officer required by Rule 13a-14(a).

2. Exhibit 31.2 Certification of Chief Financial Officer required by Rule 13a-14(a).

3. Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 of Chief Executive Officer.

4. Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 of Chief Financial Officer.

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SI GNATURES

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 October
25, 2007 | /s/CHRISTOPHER
J. MURPHY III |
| | Christopher
J. Murphy III |
| | Chairman
of the Board, President and CEO |
| DATE October
25, 2007 | /s/LARRY
E. LENTYCH |
| | Larry
E. Lentych |
| | Treasurer
and Chief Financial Officer |
| | Principal
Accounting Officer |

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