1st Source (SRCE) 10-Q 2011 Q1 Quarterly report

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, 2011
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	46614
(Address of principle 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.                       xYes        oNo
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).    oYes        oNo
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, 2011 – 24,303,656 shares

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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements (Unaudited)
	Consolidated statements of financial condition – March 31, 2011 and December 31, 2010	3
	Consolidated statements of income – three months ended March 31, 2011 and 2010	4
	Consolidated statements of shareholders’ equity – three months ended March 31, 2011 and 2010	5
	Consolidated statements of cash flows – three months ended March 31, 2011 and 2010	6
	Notes to the Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	34
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35
Item 3.	Defaults Upon Senior Securities	35
Item 4.	(Removed and reserved)	35
Item 5.	Other Information	35
Item 6.	Exhibits	35
SIGNATURES		36
CERTIFICATIONS
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

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1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited - Dollars in thousands)
	March 31,			December 31,
	2011			2010
ASSETS
Cash and due from banks	$	57,271		$	62,313
Federal funds sold and
interest bearing deposits with other banks		81,661			34,559
Investment securities available-for-sale
(amortized cost of $927,522 and $952,101
at March 31, 2011 and December 31, 2010, respectively)		942,221			969,018
Other investments		20,503			21,343
Trading account securities		146			138
Mortgages held for sale		5,467			32,599
Loans and leases - net of unearned discount
Commercial and agricultural loans		547,381			530,228
Auto, light truck and environmental equipment		416,957			396,500
Medium and heavy duty truck		156,022			162,824
Aircraft financing		601,480			614,357
Construction equipment financing		271,490			285,634
Commercial real estate		578,648			594,729
Residential real estate		386,290			390,951
Consumer loans		93,450			95,400
Total loans and leases		3,051,718			3,070,623
Reserve for loan and lease losses		(86,160	)		(86,874	)
Net loans and leases		2,965,558			2,983,749
Equipment owned under operating leases, net		81,304			78,138
Net premises and equipment		36,024			33,881
Goodwill and intangible assets		88,650			88,955
Accrued income and other assets		133,571			140,588
Total assets		4,412,376			4,445,281
LIABILITIES
Deposits:
Noninterest bearing	$	513,315		$	524,564
Interest bearing		3,095,692			3,098,181
Total deposits		3,609,007			3,622,745
Short-term borrowings:
Federal funds purchased and securities
sold under agreements to repurchase		112,914			136,028
Other short-term borrowings		19,239			19,961
Total short-term borrowings		132,153			155,989
Long-term debt and mandatorily redeemable securities		26,717			24,816
Subordinated notes		89,692			89,692
Accrued expenses and other liabilities		64,340			65,656
Total liabilities		3,921,909			3,958,898
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 25,643,506 at March 31, 2011
and December 31, 2010		346,535			350,282
Retained earnings		164,455			157,875
Cost of common stock in treasury (1,339,860 shares at March 31, 2011 and
1,470,696 shares at December 31, 2010)		(29,655	)		(32,284	)
Accumulated other comprehensive income		9,132			10,510
Total shareholders' equity		490,467			486,383
Total liabilities and shareholders' equity	$	4,412,376		$	4,445,281
The accompanying notes are a part of the consolidated financial statements.

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1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited - Dollars in thousands, except per share amounts)
	Three Months Ended
	March 31,
	2011		2010
Interest income:
Loans and leases	$	41,299	$	42,270
Investment securities, taxable		4,482		5,401
Investment securities, tax-exempt		1,186		1,467
Other		243		274
Total interest income		47,210		49,412
Interest expense:
Deposits		8,355		12,405
Short-term borrowings		89		188
Subordinated notes		1,647		1,647
Long-term debt and mandatorily redeemable securities		259		270
Total interest expense		10,350		14,510
Net interest income		36,860		34,902
Provision for loan and lease losses		2,198		4,388
Net interest income after provision for
loan and lease losses		34,662		30,514
Noninterest income:
Trust fees		3,992		3,745
Service charges on deposit accounts		4,236		4,620
Mortgage banking income		444		777
Insurance commissions		1,142		1,465
Equipment rental income		6,038		6,745
Other income		2,971		2,689
Investment securities and other investment gains		130		881
Total noninterest income		18,953		20,922
Noninterest expense:
Salaries and employee benefits		18,638		18,810
Net occupancy expense		2,320		2,487
Furniture and equipment expense		3,349		2,800
Depreciation - leased equipment		4,805		5,364
Professional fees		1,096		1,514
Supplies and communication		1,394		1,369
FDIC and other insurance		1,676		1,674
Business development and marketing expense		622		567
Loan and lease collection and repossession expense		1,324		1,106
Other expense		3,252		1,419
Total noninterest expense		38,476		37,110
Income before income taxes		15,139		14,326
Income tax expense		4,531		4,647
Net income		10,608		9,679
Preferred stock dividends and discount accretion		-		(1,711	)
Net income available to common shareholders	$	10,608	$	7,968
Per common share
Basic net income per common share	$	0.43	$	0.33
Diluted net income per common share	$	0.43	$	0.33
Dividends	$	0.16	$	0.15
Basic weighted average common shares outstanding		24,271,366		24,210,242
Diluted weighted average common shares outstanding		24,279,517		24,215,506
The accompanying notes are a part of the consolidated financial statements.

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1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited - Dollars in thousands, except per share amounts)
												Cost of			Accumulated
												Common			Other
				Preferred		Common			Retained			Stock			Comprehensive
	Total			Stock		Stock			Earnings			in Treasury			Income (Loss), Net
Balance at January 1, 2010	$	570,320		$	104,930	$	350,269		$	142,407		$	(32,380	)	$	5,094
Comprehensive Income, net of tax:
Net Income		9,679			-		-			9,679			-			-
Change in unrealized appreciation
of available-for-sale securities, net of tax		1,578			-		-			-			-			1,578
Reclassification adjustment for gains
included in net income, net of tax		(174	)		-		-			-			-			(174	)
Total Comprehensive Income		11,083			-		-			-			-			-
Issuance of 182,934 common shares
under stock based compensation awards,
including related tax effects		2,778			-		-			632			2,146			-
Cost of 7,269 shares of common
stock acquired for treasury		(114	)		-		-			-			(114	)		-
Preferred stock discount accretion		-			324		-			(324	)		-			-
Preferred stock dividend (paid and/or accrued)		(1,387	)		-		-			(1,387	)		-			-
Common stock dividend ($0.15 per share)		(3,626	)		-		-			(3,626	)		-			-
Stock based compensation		3			-		3			-			-			-
Balance at March 31, 2010	$	579,057		$	105,254	$	350,272		$	147,381		$	(30,348	)	$	6,498
Balance at January 1, 2011	$	486,383		$	-	$	350,282		$	157,875		$	(32,284	)	$	10,510
Comprehensive Income, net of tax:
Net Income		10,608			-		-			10,608			-			-
Change in unrealized appreciation
of available-for-sale securities, net of tax		(1,250	)		-		-			-			-			(1,250	)
Reclassification adjustment for gains
included in net income, net of tax		(128	)		-		-			-			-			(128	)
Total Comprehensive Income		9,230			-		-			-			-			-
Issuance of 139,736 common shares
under stock based compensation awards,
including related tax effects		2,666			-		-			(126	)		2,792			-
Cost of 8,900 shares of common
stock acquired for treasury		(163	)		-		-			-			(163	)		-
Repurchase of common stock warrant		(3,750	)		-		(3,750	)		-			-			-
Common stock dividend ($0.16 per share)		(3,902	)		-		-			(3,902	)		-			-
Stock based compensation		3			-		3			-			-			-
Balance at March 31, 2011	$	490,467		$	-	$	346,535		$	164,455		$	(29,655	)	$	9,132
The accompanying notes are a part of the consolidated financial statements.

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1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited - Dollars in thousands)
	Three Months Ended March 31,
	2011			2010
Operating activities:
Net income	$	10,608		$	9,679
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Provision for loan and lease losses		2,198			4,388
Depreciation of premises and equipment		873			1,182
Depreciation of equipment owned and leased to others		4,805			5,364
Amortization of investment security premiums
and accretion of discounts, net		485			668
Amortization of mortgage servicing rights		734			761
Mortgage servicing asset impairment (recovery)		5			(1	)
Deferred income taxes		(297	)		948
Investment securities and other investment gains		(130	)		(881	)
Originations/purchases of loans held for sale, net of principal collected		(25,343	)		(50,208	)
Proceeds from the sales of loans held for sale		52,560			54,303
Net gain on sale of loans held for sale		(85	)		(512	)
Change in trading account securities		(8	)		(5	)
Change in interest receivable		(116	)		75
Change in interest payable		1,905			1,110
Change in other assets		6,701			(1,337	)
Change in other liabilities		(2,083	)		8,573
Other		1,696			15
Net change in operating activities		54,508			34,122
Investing activities:
Proceeds from sales of investment securities		66,989			71,579
Proceeds from maturities of investment securities		67,756			123,734
Purchases of investment securities		(110,522	)		(180,063	)
Net change in other investments		840			1,403
Loans sold or participated to others		4,010			4,586
Net change in loans and leases		11,983			(22,348	)
Net change in equipment owned under operating leases		(7,971	)		(586	)
Purchases of premises and equipment		(3,047	)		(857	)
Net change in investing activities		30,038			(2,552	)
Financing activities:
Net change in demand deposits, NOW
accounts and savings accounts		(33,730	)		(69,419	)
Net change in certificates of deposit		19,992			(43,915	)
Net change in short-term borrowings		(23,836	)		(8,964	)
Proceeds from issuance of long-term debt		417			5,303
Payments on long-term debt		(114	)		(139	)
Net proceeds from issuance of treasury stock		2,666			2,778
Acquisition of treasury stock		(163	)		(114	)
Repurchase of common stock warrant		(3,750	)		-
Cash dividends paid on preferred stock		-			(1,387	)
Cash dividends paid on common stock		(3,968	)		(3,690	)
Net change in financing activities		(42,486	)		(119,547	)
Net change in cash and cash equivalents		42,060			(87,977	)
Cash and cash equivalents, beginning of year		96,872			210,102
Cash and cash equivalents, end of period	$	138,932		$	122,125
Non-cash transactions:
Loans transferred to other real estate and repossessed assets	$	3,931		$	4,242
Common stock matching contribution to KSOP plan		2,420			2,545
The accompanying notes are a part of the consolidated financial statements.

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1ST SOURCE CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.              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 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 (2010 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, 2010 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.

Cash Flow – For purposes of the consolidated statements of cash flow, we consider cash and due from banks, federal funds sold and interest bearing deposits with other banks with original maturities of three months or less as cash and cash equivalents.

Note 2.              Recent Accounting Pronouncements

Receivables:  In April 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-02 “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.”  ASU 2011-02 clarifies whether loan modifications constitute troubled debt restructuring.  In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties.  ASU 2011-02 is effective for the first interim and annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption.  We are assessing the impact of ASU 2011-02 on our financial condition, results of operations, and disclosures.

Business Combinations:In December 2010, the FASB issued ASU No. 2010-29 "Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations."  If a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.  ASU 2010-29 also expands the supplementary pro forma disclosures.  ASU 2010-29 was effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  ASU 2010-29 will only affect us if there are future business combinations.

Intangibles - Goodwill and Other:  In December 2010, the FASB issued ASU No. 2010-28 "Intangibles - Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts."  ASU 2010-28 affects all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative.  ASU 2010-28 was effective for fiscal years and interim periods within those years, beginning after December 15, 2010.  ASU 2010-28 did not have an impact on our financial condition, results of operations, or disclosures.

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Note 3.              Investment Securities

Investment securities available-for-sale were as follows:

(Dollars in thousands)	Amortized		Gross		Gross
	Cost		Unrealized Gains		Unrealized Losses			Fair Value
March 31, 2011
U.S. Treasury and Federal agencies securities	$	434,510	$	4,461	$	(1,328	)	$	437,643
U.S. States and political subdivisions securities		120,814		4,153		(1,103	)		123,864
Mortgage-backed securities – Federal agencies		327,458		6,741		(441	)		333,758
Corporate debt securities		35,677		167		(249	)		35,595
Foreign government and other securities		6,717		23		(51	)		6,689
Total debt securities		925,176		15,545		(3,172	)		937,549
Marketable equity securities		2,346		2,329		(3	)		4,672
Total investment securities available-for-sale	$	927,522	$	17,874	$	(3,175	)	$	942,221
December 31, 2010
U.S. Treasury and Federal agencies securities	$	442,612	$	5,546	$	(849	)	$	447,309
U.S. States and political subdivisions securities		147,679		4,381		(1,753	)		150,307
Mortgage-backed securities – Federal agencies		309,046		7,854		(232	)		316,668
Corporate debt securities		45,778		182		(345	)		45,615
Foreign government and other securities		5,732		18		(34	)		5,716
Total debt securities		950,847		17,981		(3,213	)		965,615
Marketable equity securities		1,254		2,152		(3	)		3,403
Total investment securities available-for-sale	$	952,101	$	20,133	$	(3,216	)	$	969,018

At March 31, 2011, the residential mortgage-backed securities we held consisted primarily of GNMA, FNMA and FHLMC pass-through certificates which are guaranteed by those respective agencies of the United States government (or Government Sponsored Enterprise, GSEs).

The contractual maturities of debt securities available-for-sale at March 31, 2011 are shown below.  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	$	40,341	$	40,737
Due after one year through five years		437,823		442,361
Due after five years through ten years		108,324		110,481
Due after ten years		11,230		10,212
Mortgage-backed securities		327,458		333,758
Total debt securities available-for-sale	$	925,176	$	937,549

The following table shows the gross realized gains and losses on sale of securities from the securities available-for-sale portfolio, including marketable equity securities.  Realized gains and losses on the sales of all securities are computed using the specific identification cost basis.  The gross gains and losses in the first three months of 2011 primarily reflect the sale of municipal, FHLB and FFCB debt securities.  The sale of municipal securities was to reduce credit risk exposure in certain states.  The action to sell agency securities was to improve future yield. There was no impact to other than temporary impairment (OTTI) as a result of the first quarter 2011 sales. The gross gains and losses in the first three months of 2010 reflect the disposition of FNMA and FHLMC debt securities.  There were no OTTI write-downs in 2011.

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(Dollars in thousands)	Three Months Ended
	March 31,
	2011			2010
Gross realized gains	$	445		$	292
Gross realized losses		(238	)		(12	)
Net realized gains (losses)	$	207		$	280

There were net gains of $8 thousand for the three months ended March 31, 2011 and net gains of $5 thousand recorded for the three months ended March 31, 2010 on $0.15 million in trading securities outstanding at March 31, 2011 and $0.14 million at December 31, 2010.

The following tables summarize our gross unrealized losses and fair value by investment category and age:

	Less than 12 Months					12 months or Longer					Total
(Dollars in thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
March 31, 2011
U.S. Treasury and Federal agencies securities	$	156,626	$	(1,328	)	$	-	$	-		$	156,626	$	(1,328	)
U.S. States and political subdivisions securities		7,447		(132	)		9,591		(971	)		17,038		(1,103	)
Mortgage-backed securities - Federal agencies		36,872		(408	)		4,450		(33	)		41,322		(441	)
Corporate debt securities		26,398		(249	)		-		-			26,398		(249	)
Foreign government and other securities		2,962		(51	)		-		-			2,962		(51	)
Total debt securities		230,305		(2,168	)		14,041		(1,004	)		244,346		(3,172	)
Marketable equity securities		-		-			5		(3	)		5		(3	)
Total investment securities available-for-sale	$	230,305	$	(2,168	)	$	14,046	$	(1,007	)	$	244,351	$	(3,175	)
December 31, 2010
U.S. Treasury and Federal agencies securities	$	158,497	$	(849	)	$	-	$	-		$	158,497	$	(849	)
U.S. States and political subdivisions securities		9,226		(246	)		9,055		(1,507	)		18,281		(1,753	)
Mortgage-backed securities - Federal agencies		23,351		(213	)		4,887		(19	)		28,238		(232	)
Corporate debt securities		26,407		(345	)		-		-			26,407		(345	)
Foreign government and other securities		3,015		(34	)		-		-			3,015		(34	)
Total debt securities		220,496		(1,687	)		13,942		(1,526	)		234,438		(3,213	)
Marketable equity securities		-		-			5		(3	)		5		(3	)
Total investment securities available-for-sale	$	220,496	$	(1,687	)	$	13,947	$	(1,529	)	$	234,443	$	(3,216	)

The initial indication of OTTI for both debt and equity securities is a decline in fair value below amortized cost.  Quarterly, the impaired securities are analyzed on a qualitative and quantitative basis in determining OTTI.  Declines in the fair value of available-for-sale debt securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses.  The amount of impairment related to other factors is recognized in other comprehensive income.  In estimating OTTI impairment losses, we consider 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 we will not have to sell any such securities before a recovery of cost.

At March 31, 2011, we do not have the intent to sell any of the available-for-sale securities in the table above and believe that it is more likely than not that we will not have to sell any such securities before an anticipated recovery of cost.  The unrealized losses are due to increases in market interest rates over the yields available at the time the underlying securities were purchased and market illiquidity on auction rate securities which are reflected in U.S. States and Political subdivisions securities.  The fair value is expected to recover on all debt securities as they approach their maturity date or repricing date or if market yields for such investments decline.  

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We do not believe any of the securities are impaired due to reasons of credit quality.  Accordingly, as of March 31, 2011, we believe the impairments detailed in the table above are temporary and no impairment loss has been realized in our consolidated statements of income.

At March 31, 2011 and December 31, 2010, investment securities with carrying values of $256.64 million and $299.88 million, respectively, were pledged as collateral to secure government deposits, security repurchase agreements, and for other purposes.

Note 4.              Loan and Lease Financings

We evaluate loans and leases for credit quality on a monthly basis.  All loans and leases, except residential real estate loans and consumer loans, are assigned credit quality ratings on a scale from 1 to 12 with grade 1 representing superior credit quality.  The criteria used to assign quality ratings 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 Bank's safety and soundness.  Loans 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 adequacy of the reserve for loan and lease losses.  Grade 7 credits are defined as "watch" and contain greater than average credit risk and thus warrant timely follow-up to limit the Bank's 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 table below presents the credit quality category of the recorded investment in loans and leases, segregated by class.

(Dollars in thousands)	Grade:
		1-6		7-12	Total
March 31, 2011
Commercial and agricultural loans	$	504,137	$	43,244	$	547,381
Auto, light truck,
and environmental equipment		412,155		4,802		416,957
Medium and heavy duty truck		135,750		20,272		156,022
Aircraft financing		546,740		54,740		601,480
Construction equipment financing		240,214		31,276		271,490
Commercial real estate		518,801		59,847		578,648
Total	$	2,357,797	$	214,181	$	2,571,978
December 31, 2010
Commercial and agricultural loans	$	483,603	$	46,625	$	530,228
Auto, light truck,
and environmental equipment		389,774		6,726		396,500
Medium and heavy duty truck		143,431		19,393		162,824
Aircraft financing		555,106		59,251		614,357
Construction equipment financing		246,644		38,990		285,634
Commercial real estate		532,581		62,148		594,729
Total	$	2,351,139	$	233,133	$	2,584,272

- 10 -

The table below presents the recorded investment in residential real estate and consumer loans by performing or non-performing status.  Non-performing 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, 2011
Residential real estate	$	380,796	$	5,494	$	386,290
Consumer		92,882		568		93,450
Total	$	473,678	$	6,062	$	479,740
December 31, 2010
Residential real estate	$	385,729	$	5,222	$	390,951
Consumer		94,973		427		95,400
Total	$	480,702	$	5,649	$	486,351

The table below presents the recorded investment of loans and leases, segregated by class, with delinquency aging and nonaccrual status.

															Recorded
					90 Days								Total		Investment
(Dollars in thousands)	30-59 Days		60-89 Days		or More		Total Past						Financing		> 90 Days
	Past Due		Past Due		Past Due		Due		Nonaccrual		Current		Receivables		and Accruing
March 31, 2011
Commercial and agricultural loans	$	498	$	202	$	-	$	700	$	7,987	$	538,694	$	547,381	$	-
Auto, light truck and
environmental equipment		726		216		-		942		2,825		413,190		416,957		-
Medium and heavy duty truck		51		-		-		51		4,662		151,309		156,022		-
Aircraft financing		5,297		713		-		6,010		15,945		579,525		601,480		-
Construction equipment financing		3,463		29		-		3,492		8,077		259,921		271,490		-
Commercial real estate		328		943		-		1,271		28,995		548,382		578,648		-
Residential real estate		2,477		595		434		3,506		5,060		377,724		386,290		434
Consumer		859		341		81		1,281		487		91,682		93,450		81
Total	$	13,699	$	3,039	$	515	$	17,253	$	74,038	$	2,960,427	$	3,051,718	$	515
December 31, 2010
Commercial and agricultural loans	$	760	$	22	$	-	$	782	$	8,083	$	521,363	$	530,228	$	-
Auto, light truck and
environmental equipment		528		715		-		1,243		3,332		391,925		396,500		-
Medium and heavy duty truck		33		-		-		33		5,068		157,723		162,824		-
Aircraft financing		16,097		188		-		16,285		17,898		580,174		614,357		-
Construction equipment financing		1,254		601		-		1,855		8,575		275,204		285,634		-
Commercial real estate		759		94		-		853		26,622		567,254		594,729		-
Residential real estate		3,781		580		264		4,625		4,958		381,368		390,951		264
Consumer		1,152		531		98		1,781		329		93,290		95,400		98
Total	$	24,364	$	2,731	$	362	$	27,457	$	74,865	$	2,968,301	$	3,070,623	$	362

As of March 31, 2011 and December 31, 2010, we had $7.36 million and $7.31 million, respectively of performing loans classified as troubled debt restructuring.

- 11 -

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 we update our historical charge-off analysis, we review the look-back periods for each business loan portfolio. Furthermore, we perform a thorough analysis of charge-offs, non-performing asset levels, special attention outstandings and delinquency 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. We adjust the calculated historical based ratio as a result of our analysis of environmental factors, principally economic risk and concentration risk. Key economic factors affecting our portfolios are growth in gross domestic product, unemployment rates, housing market trends, commodity prices and inflation. Concentration risk is impacted primarily by geographic concentration in Northern Indiana and Southwestern Lower Michigan in our business banking and commercial real estate portfolios and by collateral concentration in our specialty finance portfolios.

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.  For purposes of determining the reserve, we have segmented our loans and leases into classes based on the associated risks within these segments.  We have determined that eight classes exist within our 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, percentage allocations for special attention loans and leases (classified loans and leases and internal watch list credits) without specific reserves, formula reserves for each business lending division portfolio, and reserves for pooled homogeneous loans and leases.  Management’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.

- 12 -

Changes in the reserve for loan and lease losses, segregated by class, for the three months ended March 31, 2011 and 2010 are shown below.

	Commercial			Auto, light			Medium
	and			truck and			and						Construction
(Dollars in thousands)	agricultural			environmental			heavy duty			Aircraft			equipment			Commercial		Residential		Consumer
	loans			equipment			truck			financing			financing			real estate		real estate		loans			Total
March 31, 2011
Reserve for loan and lease losses
Balance, beginning of period	$	20,544		$	7,542		$	5,768		$	29,811		$	8,439		$	11,177	$	2,518	$	1,075		$	86,874
Charge-offs		422			68			-			1,098			585			1,231		34		595			4,033
Recoveries		124			45			1			674			35			105		3		134			1,121
Net charge-offs (recoveries)		298			23			(1	)		424			550			1,126		31		461			2,912
Provision (recovery of provision)		(3,941	)		405			(704	)		1,516			(1,091	)		5,484		55		474			2,198
Balance, end of period	$	16,305		$	7,924		$	5,065		$	30,903		$	6,798		$	15,535	$	2,542	$	1,088		$	86,160
Ending balance: individually
evaluated for impairment	$	4,025		$	308		$	171		$	2,174		$	47		$	1,348	$	-	$	-		$	8,073
Ending balance: collectively
evaluated for impairment	$	12,280		$	7,616		$	4,894		$	28,729		$	6,751		$	14,187	$	2,542	$	1,088		$	78,087
Financing receivables:
Ending balance	$	547,381		$	416,957		$	156,022		$	601,480		$	271,490		$	578,648	$	386,290	$	93,450		$	3,051,718
Ending balance: individually
evaluated for impairment	$	12,769		$	1,993		$	4,692		$	16,462		$	8,065		$	31,489	$	-	$	-		$	75,470
Ending balance: collectively
evaluated for impairment	$	534,612		$	414,964		$	151,330		$	585,018		$	263,425		$	547,159	$	386,290	$	93,450		$	2,976,248
March 31, 2010
Reserve for loan and lease losses
Balance, beginning of period	$	24,017		$	9,630		$	6,186		$	24,807		$	8,875		$	10,453	$	880	$	3,388		$	88,236
Charge-offs		348			472			601			2,567			509			340		165		377			5,379
Recoveries		245			34			39			72			42			-		1		149			582
Net charge-offs (recoveries)		103			438			562			2,495			467			340		164		228			4,797
Provision (recovery of provision)		(2,798	)		(28	)		1,745			(615	)		982			4,649		1,834		(1,381	)		4,388
Balance, end of period	$	21,116		$	9,164		$	7,369		$	21,697		$	9,390		$	14,762	$	2,550	$	1,779		$	87,827
Ending balance: individually
evaluated for impairment	$	1,357		$	543		$	2,134		$	75		$	1,731		$	4,232	$	-	$	-		$	10,072
Ending balance: collectively
evaluated for impairment	$	19,759		$	8,621		$	5,235		$	21,622		$	7,659		$	10,530	$	2,550	$	1,779		$	77,755
Financing receivables:
Ending balance	$	546,826		$	364,445		$	200,228		$	608,643		$	303,866		$	584,756	$	392,911	$	104,440		$	3,106,115
Ending balance: individually
evaluated for impairment	$	8,274		$	3,935		$	15,310		$	2,786		$	11,617		$	31,699	$	-	$	-		$	73,621
Ending balance: collectively
evaluated for impairment	$	538,552		$	360,510		$	184,918		$	605,857		$	292,249		$	553,057	$	392,911	$	104,440		$	3,032,494

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The table below presents impaired loans and leases, segregated by class, and the corresponding reserve for impaired loan and lease losses.

			Unpaid				Average
(Dollars in thousands)	Recorded		Principal		Related		Recorded
	Investment		Balance		Allowance		Investment
March 31, 2011
With no related allowance recorded:
Commercial and agricultural loans	$	4,737	$	4,737	$	-	$	5,010
Auto, light truck and environmental equipment		1,099		1,099		-		1,378
Medium and heavy duty truck		1,596		1,596		-		1,657
Aircraft financing		5,743		5,743		-		7,506
Construction equipment financing		7,251		7,250		-		7,558
Commercial real estate		22,437		22,437		-		22,354
Total with no related allowance recorded		42,863		42,862		-		45,463
With an allowance recorded:
Commercial and agricultural loans		8,032		8,031		4,025		7,960
Auto, light truck and environmental equipment		894		894		308		859
Medium and heavy duty truck		3,096		3,096		171		3,153
Aircraft financing		10,719		10,718		2,174		8,771
Construction equipment financing		814		814		47		753
Commercial real estate		9,052		9,057		1,348		7,509
Total with an allowance recorded		32,607		32,610		8,073		29,005
Total:
Commercial and agricultural loans		12,769		12,768		4,025		12,970
Auto, light truck and environmental equipment		1,993		1,993		308		2,237
Medium and heavy duty truck		4,692		4,692		171		4,810
Aircraft financing		16,462		16,461		2,174		16,277
Construction equipment financing		8,065		8,064		47		8,311
Commercial real estate		31,489		31,494		1,348		29,863
Total impaired loans	$	75,470	$	75,472	$	8,073	$	74,468
December 31, 2010
With no related allowance recorded:
Commercial and agricultural loans	$	4,930	$	4,930	$	-	$	4,848
Auto, light truck and environmental equipment		1,596		1,597		-		1,632
Medium and heavy duty truck		1,748		1,748		-		2,922
Aircraft financing		4,509		4,509		-		3,315
Construction equipment financing		5,534		5,535		-		5,107
Commercial real estate		21,071		21,071		-		20,301
Total with no related allowance recorded		39,388		39,390		-		38,125
With an allowance recorded:
Commercial and agricultural loans		8,282		8,281		4,190		11,210
Auto, light truck and environmental equipment		1,136		1,136		377		1,714
Medium and heavy duty truck		3,347		3,347		1,049		5,591
Aircraft financing		13,913		13,913		2,050		8,626
Construction equipment financing		3,374		3,379		648		5,485
Commercial real estate		8,625		8,630		893		9,489
Total with an allowance recorded		38,677		38,686		9,207		42,115
Total:
Commercial and agricultural loans		13,212		13,211		4,190		16,058
Auto, light truck and environmental equipment		2,732		2,733		377		3,346
Medium and heavy duty truck		5,095		5,095		1,049		8,513
Aircraft financing		18,422		18,422		2,050		11,941
Construction equipment financing		8,908		8,914		648		10,592
Commercial real estate		29,696		29,701		893		29,790
Total impaired loans	$	78,065	$	78,076	$	9,207	$	80,240

- 14 -

(Dollars in thousands)	Three Months Ended
	March 31,
	2011		2010
Commercial and agricultural loans	$	116	$	25
Auto, light truck and environmental equipment		1		-
Medium and heavy duty truck		1		2
Aircraft financing		9		-
Construction equipment financing		9		88
Commercial real estate		65		24
Total impaired loans	$	201	$	139

Note 6.              Mortgage Servicing Assets

We recognize 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.  We allocate a portion of the total proceeds of a mortgage loan to servicing rights based on the fair value.

Mortgage servicing assets are evaluated for impairment.  For purposes of impairment measurement, mortgage servicing assets are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type and interest rate.  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.

Changes in the carrying value of mortgage servicing assets and the associated valuation allowance follow:

	Three Months Ended
(Dollars in thousands)	March 31,
	2011			2010
Mortgage servicing assets:
Balance at beginning of period	$	7,556		$	8,749
Additions		146			571
Amortization		(734	)		(761	)
Sales		-			(443	)
Carrying value before valuation allowance at end of period		6,968			8,116
Valuation allowance:
Balance at beginning of period		-			(1	)
Impairment (charges) recoveries		(5	)		1
Balance at end of period	$	(5	)	$	-
Net carrying value of mortgage servicing assets at end of period	$	6,963		$	8,116
Fair value of mortgage servicing assets at end of period	$	10,194		$	10,575

During the three months ended March 31, 2011 and 2010, management determined that it was not necessary to permanently write-down any previously established valuation allowance.  At March 31, 2011, the fair value of mortgage servicing assets exceeded the carrying value reported in the consolidated statement of financial condition by $3.23 million.  This difference represents increases in the fair value of certain mortgage servicing assets that could not be recorded above cost basis.

- 15 -

The key economic assumptions used to estimate the fair value of the mortgage servicing rights follow:

	March 31,
	2011		2010
Expected weighted-average life (in years)	3.46		3.55
Weighted-average constant prepayment rate (CPR)	18.00	%	17.64	%
Weighted-average discount rate	9.56	%	8.48	%

Mortgage loan contractual servicing fees, including late fees and ancillary income, were $1.02 million for both the three months ended March 31, 2011 and 2010.  Mortgage loan contractual servicing fees are included in mortgage banking income in the consolidated statements of income.

Note 7.              Financial Instruments with Off-Balance-Sheet Risk and Derivative Transactions

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.

We have certain interest rate derivative positions that are not designated as hedging instruments.  These derivative positions relate to transactions in which we enter 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, we agree 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, we agree 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 our client to effectively convert a variable rate loan to a fixed rate.  Because the terms of the swaps with our customers and the other financial institution 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 our results of operations.

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.  Commitments to originate or purchase residential mortgage loans held for sale and forward commitments to sell residential mortgage loans are considered derivative instruments.

- 16 -

At March 31, 2011 and December 31, 2010, the amounts of non-hedging derivative financial instruments are shown in the chart below:

(Dollars in thousands)			Asset derivatives			Liability derivatives
	Notional or		Statement of			Statement of
	contractual		Financial Condition	Fair		Financial Condition	Fair
	amount		location	value		location	value
March 31, 2011
Interest rate swap contracts	$	436,745	Other assets	$	12,391	Other liabilities	$	12,781
Loan commitments		13,263	Mortgages held for sale		71	N/A		-
Forward contracts		9,500	N/A		-	Mortgages held for sale		42
Total	$	459,508		$	12,462		$	12,823
December 31, 2010
Interest rate swap contracts	$	446,224	Other assets	$	14,959	Other liabilities	$	15,384
Loan commitments		28,666	Mortgages held for sale		30	N/A		-
Forward contracts		40,320	Mortgages held for sale		451	N/A		-
Total	$	515,210		$	15,440		$	15,384

For the three months ended March 31, 2011 and 2010, the amounts included in the consolidated statements of income for non-hedging derivative financial instruments are shown in the chart below:

		Gain (loss)
		Three Months Ended
	Statement of	March 31,
(Dollars in thousands)	Income location	2011			2010
Interest rate swap contracts	Other expense	$	2		$	(35	)
Interest rate swap contracts	Other income		27			77
Loan commitments	Mortgage banking income		41			107
Forward contracts	Mortgage banking income		(493	)		(325	)
Total		$	(423	)	$	(176	)

We issue letters of credit which 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.  Standby letters of credit totaled $17.80 million and $17.84 million at March 31, 2011 and December 31, 2010, respectively.  Standby letters of credit generally have terms ranging from six months to one year.

Note 8.              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.  Stock options of 33,000 and 49,763 were considered antidilutive as of March 31, 2011 and 2010.  Stock warrants of 837,947 were considered antidilutive as of March 31, 2010.  No stock warrants were outstanding as of March 31, 2011.

- 17 -

The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share for the three months ended March 31, 2011 and 2010.

	Three Months Ended
(Dollars in thousands - except per share amounts)	March 31,
	2011		2010
Distributed earnings allocated to common stock	$	3,888	$	3,616
Undistributed earnings allocated to common stock		6,612		4,278
Net earnings allocated to common stock		10,500		7,894
Net earnings allocated to participating securities		108		74
Net income allocated to common stock and participating securities	$	10,608	$	7,968
Weighted average shares outstanding for basic earnings per common share		24,271,366		24,210,242
Dilutive effect of stock compensation		8,151		5,264
Weighted average shares outstanding for diluted earnings per common share		24,279,517		24,215,506
Basic earnings per common share	$	0.43	$	0.33
Diluted earnings per common share	$	0.43	$	0.33

Note 9.              Stock-Based Compensation

As of March 31, 2011, we 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, 2010.  These plans include the 2001 Stock Option Plan, the Employee Stock Purchase Plan, the Executive Incentive Plan, and the Restricted Stock Award Plan.

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 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.

The stock-based compensation expense recognized in the condensed consolidated statement of income for the three months ended March 31, 2011 and 2010 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.

- 18 -

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 first quarter of 2011 (March 31, 2011) 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 March 31, 2011.  This amount changes based on the fair market value of 1st Source’s stock.  Total fair value of options vested and expensed was $3 thousand, net of tax, for both the three months ended March 31, 2011 and 2010.

						Average
				Weighted		Remaining		Total
				Average		Contractual		Intrinsic
	Number of			Exercise		Term		Value
	Shares			Price		(in years)		(in 000's)
Options outstanding, beginning of year		62,508		$	17.18
Granted		-			-
Exercised		-			-
Forfeited		(7,508	)		17.31
Options outstanding, March 31, 2011		55,000		$	17.16		1.01	$	181
Vested and expected to vest at March 31, 2011		55,000		$	17.16		1.01	$	181
Exercisable at March 31, 2011		52,250		$	17.43		0.95	$	159

No options were granted during the three months ended March 31, 2011.

As of March 31, 2011, there was $5.00 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 3.72 years.

The following table summarizes information about stock options outstanding at March 31, 2011:

		Options Outstanding				Options Exercisable
			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	22,000	2.06	$	12.04	19,250	$	12.04
$	18.00 to $26.99	33,000	0.31		20.58	33,000		20.58

The fair value of each stock option was estimated on the date of grant using the Black-Scholes option-pricing model.

Note 10.            Income Taxes

The total amount of unrecognized tax benefits that would affect the effective tax rate if recognized was $1.04 million at March 31, 2011 and $1.52 million at December 31, 2010.  Interest and penalties were recognized through the income tax provision.  For the three months ending March 31, 2011 and the twelve months ending December 31, 2010, we recognized approximately $(0.12) million and $0.05 million in interest, net of tax effect, and penalties, respectively.  Interest and penalties of approximately $0.48 million and $0.60 million were accrued at March 31, 2011 and December 31, 2010, respectively.

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Tax years that remain open and subject to audit include the federal 2007-2010 years and the Indiana 2007-2010 years.  Additionally, during the first quarter of 2011 we reached a state tax settlement for the 2008 year and as a result recorded a reduction of unrecognized tax benefits in the amount of $0.84 million that affected the effective tax rate and increased earnings in the amount of $0.47 million. We do not anticipate a significant change in the amount of uncertain tax positions within the next 12 months.

Note 11.            Fair Value Measurements

We record 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.  We use 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 are 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.

We elected fair value accounting for mortgages held for sale.  We believe the election for mortgages held for sale (which are hedged with free-standing derivatives [economic hedges]) 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, 2011 and December 31, 2010, all mortgages held for sale are carried at fair value.

The following table reflects the differences between fair value carrying amount of mortgages held for sale measured at fair value and the aggregate unpaid principal amount we are contractually entitled to receive at maturity on March 31, 2011:

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(Dollars in thousands)	Fair value carrying amount		Aggregate unpaid principal		Excess of fair value carrrying amount over (under) unpaid principal
Mortgages held for sale reported at fair value:
Total loans	$	5,467	$	5,307	$	160	(1	)
Nonaccrual loans		-		-		-
Loans 90 days or more past due and still accruing		-		-		-

(1) The excess of fair value carrying amount over unpaid principal is included in mortgage banking income and includes changes in fair value at and subsequent to funding, gains and losses on the related loan commitment prior to funding, and premiums on acquired loans.

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 and 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 tax anticipation warrants, with very little market activity, are priced using an appropriate market yield curve.

■      Marketable equity (common) securities are primarily priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.

Trading account securitiesare 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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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.  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 credit losses as well as velocity of deterioration evident with systemic risks imbedded in these portfolios.

The table below presents the balance of assets and liabilities at March 31, 2011, measured at fair value on a recurring basis:

(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment securities available-for-sale:
U.S. Treasury and Federal agencies securities	$	20,159	$	417,484	$	-	$	437,643
U.S. States and political subdivisions securities		-		107,326		16,538		123,864
Mortgage-backed securities – Federal agencies		-		333,758		-		333,758
Corporate debt securities		-		35,595		-		35,595
Foreign government and other securities	��	-		6,014		675		6,689
Total debt securities		20,159		900,177		17,213		937,549
Marketable equity securities		4,672		-		-		4,672
Total investment securities available-for-sale		24,831		900,177		17,213		942,221
Trading account securities		146		-		-		146
Mortgages held for sale		-		5,467		-		5,467
Accrued income and other assets (Interest rate swap agreements)		-		12,391		-		12,391
Total	$	24,977	$	918,035	$	17,213	$	960,225
Liabilities
Accrued expenses and other liabilities (Interest rate swap agreements)	$	-	$	12,781	$	-	$	12,781
Total	$	-	$	12,781	$	-	$	12,781

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter ended March 31, 2011 are summarized as follows:

(Dollars in thousands)	U.S. States and political subdivisions securities			Corporate debt securities			Foreign government and other securities		Investment securities available-for-sale
Beginning balance January 1, 2011	$	16,306		$	9,992		$	675	$	26,973
Total gains or losses (realized/unrealized):
Included in earnings		-			-			-		-
Included in other comprehensive income		577			-			-		577
Purchases		350			-			-		350
Issuances		-			-			-		-
Settlements		-			-			-		-
Maturities		(695	)		(9,992	)		-		(10,687	)
Transfers into Level 3		-			-			-		-
Transfers out of Level 3		-			-			-		-
Ending balance March 31, 2011	$	16,538		$	-		$	675	$	17,213

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, 2011.

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Financial Instruments on Non-recurring Basis:

We may be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring 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.

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.

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.

Mortgage servicing rights (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 and interest rate.  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.  A fair value analysis is also obtained from an independent third party agent.  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 our 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.  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, 2011:  impaired loans - $0.50 million; partnership investments – $(0.12) million; mortgage servicing rights - $0.00 million; repossessions - $0.18 million, and other real estate - $0.08 million.

The table below presents the carrying value of assets at March 31, 2011, measured at fair value on a non-recurring basis:

(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Loans	$	-	$	-	$	75,472	$	75,472
Accrued income and other assets (partnership investments)		-		-		2,006		2,006
Accrued income and other assets (mortgage servicing rights)		-		-		6,963		6,963
Accrued income and other assets (repossessions)		-		-		5,482		5,482
Accrued income and other assets (other real estate)		-		-		8,013		8,013
	$	-	$	-	$	97,936	$	97,936

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 fair values of our financial instruments as of March 31, 2011, and December 31, 2010, are summarized in the table below.

	March 31, 2011				December 31, 2010
	Carrying or				Carrying or
(Dollars in thousands)	Contract Value		Fair Value		Contract Value		Fair Value
Assets:
Cash and due from banks	$	57,271	$	57,271	$	62,313	$	62,313
Federal funds sold and interest bearing deposits with other banks		81,661		81,661		34,559		34,559
Investment securities, available-for-sale		942,221		942,221		969,018		969,018
Other investments and trading account securities		20,649		20,649		21,481		21,481
Mortgages held for sale		5,467		5,467		32,599		32,599
Loans and leases, net of reserve for loan and lease losses		2,965,558		3,076,930		2,983,749		3,040,895
Cash surrender value of life insurance policies		53,599		53,599		54,182		54,182
Mortgage servicing rights		6,963		10,194		7,556		8,785
Interest rate swaps		12,391		12,391		14,959		14,959
Liabilities:
Deposits	$	3,609,007	$	3,636,660	$	3,622,745	$	3,654,067
Short-term borrowings		132,153		132,153		155,989		155,989
Long-term debt and mandatorily redeemable securities		26,717		26,955		24,816		25,072
Subordinated notes		89,692		87,951		89,692		79,811
Interest rate swaps		12,781		12,781		15,384		15,384
Off-balance-sheet instruments *		-		146		-		134
* 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 cash surrender value of life insurance policies.  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.

Short-Term Borrowings — The carrying values of Federal funds purchased, securities sold under repurchase agreements, and other short-term borrowings, including our 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 our current estimated incremental borrowing rates for similar types of borrowing arrangements. The carrying values of mandatorily redeemable securities are based on approximate fair values.

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Subordinated Notes — Fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are estimated based on calculated market prices of comparable securities.

Off-Balance-Sheet Instruments — Contract and fair values for certain of our 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 our 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 our 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 we could realize in a current market exchange, nor are they intended to represent the fair value of 1st Source 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 management 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.

Note 12.            Subsequent Events

We have evaluated subsequent events through the date our financial statements were issued.  We do not believe any subsequent events have occurred that would require further disclosure or adjustment to our financial statements.

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,” “contemplate,” “seek,” “plan,” “possible,” “assume,” “expect,” “intend,” “targeted,” “continue,” “remain,” “estimate,” “anticipate,” “project,” “will,” “should,” “indicate,” “would,” “may” 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

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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 our filings with the SEC, including our Annual Report on Form 10-K  for 2010, 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 financial condition as of March 31, 2011, as compared to December 31, 2010, and the results of operations for the three months ended March 31, 2011 and 2010.  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 2010 Annual Report.

FINANCIAL CONDITION

Our total assets at March 31, 2011, were $4.41 billion, a decrease of $32.91 million or 0.74% from December 31, 2010.  Total loans and leases were $3.05 billion, a decrease of $18.91 million or 0.62% from December 31, 2010.  Fed funds sold and interest bearing deposits with other banks were $81.66 million, an increase of $47.10 million or 136.29% from December 31, 2010.  Total investment securities, available for sale were $942.22 million which represented a decrease of $26.80 million or 2.77% and total deposits were $3.61 billion, a decrease of $13.74 million or 0.38% over the comparable figures at the end of 2010.

Nonperforming assets at March 31, 2011, were $88.35 million, which was a decrease of $0.36 million or 0.41% from the $88.71 million reported at December 31, 2010.  At March 31, 2011 and December 31, 2010, nonperforming assets were 2.81% of net loans and leases.

Accrued income and other assets were as follows:

(Dollars in thousands)	March 31,		December 31,
	2011		2010
Accrued income and other assets:
Bank owned life insurance cash surrender value	$	53,599	$	54,182
Accrued interest receivable		14,334		14,218
Mortgage servicing assets		6,963		7,556
Other real estate		6,813		6,392
Former bank premises held for sale		1,200		1,200
Repossessions		5,482		5,670
All other assets		45,180		51,370
Total accrued income and other assets	$	133,571	$	140,588

CAPITAL

As of March 31, 2011, total shareholders' equity was $490.47 million, up $4.08 million or 0.84% from the $486.38 million at December 31, 2010.  In addition to net income of $10.61 million, other significant changes in shareholders’ equity during the first three months of 2011 included $3.90 million of dividends paid and $3.75 million of a common stock warrant repurchased.  The accumulated other comprehensive income/(loss) component of shareholders’ equity totaled $9.13 million at March 31, 2011, compared to $10.51 million at December 31, 2010.  The decrease in accumulated other comprehensive income/(loss) during 2011 was primarily a result of changes in unrealized gain/(loss) on securities in the available-for-sale portfolio.  Our equity-to-assets ratio was 11.12% as of March 31, 2011, compared to 10.94% at December 31, 2010.  Book value per common share rose to $20.18 at March 31, 2011, from $20.12 at December 31, 2010.

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We declared and paid dividends per common share of $0.16 during the first quarter of 2011.  The trailing four quarters dividend payout ratio, representing dividends per common share divided by diluted earnings per common share, was 47.33%.  The dividend payout is continually reviewed by management and the Board of Directors subject to the Corporation’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.  The actual capital amounts and ratios of 1st Source Corporation and 1st Source Bank as of March 31, 2011, are presented in the table below:

											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	$	522,933		15.68	%	$	266,750		8.00	%	$	333,438		10.00	%
1st Source Bank		516,652		15.55			265,845		8.00			332,306		10.00
Tier 1 Capital (to Risk-Weighted Assets):
1st Source Corporation		479,637		14.38			133,375		4.00			200,063		6.00
1st Source Bank		474,425		14.28			132,922		4.00			199,383		6.00
Tier 1 Capital (to Average Assets):
1st Source Corporation		479,637		11.07			173,272		4.00			216,589		5.00
1st Source Bank		474,425		10.99			172,682		4.00			215,852		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 (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. While at March 31, 2011 there were no amounts outstanding, management believes we could borrow approximately $255.00 million for a short time from these banks on a collective basis. As of March 31, 2011, the Bank had $15.93 million outstanding in FHLB advances and could borrow an additional $208.46 million. We also had $330.99 million available to borrow from the FRB with no amounts outstanding as of March 31, 2011.

Our loan to asset ratio was 69.16% at March 31, 2011 compared to 69.08% at December 31, 2010 and 69.88% at March 31, 2010.  Cash and cash equivalents totaled $57.27 million at March 31, 2011 compared to $62.31 million at December 31, 2010 and $53.52 million at March 31, 2010.  At March 31, 2011, the consolidated statement of financial condition was rate sensitive by $344.33 million more liabilities than assets scheduled to reprice within one year, or approximately 0.87%.  Management believes that the present funding sources provide adequate liquidity to meet our cash flow needs.

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In addition, the State of Indiana recently changed the law governing the collateralization of public fund deposits. Under the new law, the Indiana Board of Depositories will determine what financial institutions are required to pledge collateral. We have been informed that no collateral is necessary through March 31, 2011 for our Indiana public fund deposits.  However, pending legislation could alter this requirement in the future. Our potential liquidity exposure if we must pledge collateral is approximately $600.00 million.

RESULTS OF OPERATIONS

Net income for the three month period ended March 31, 2011 was $10.61 million, compared to $9.68 million for the same period in 2010.  Diluted net income per common share was $0.43 for the three month period ended March 31, 2011, compared to $0.33 for the same period in 2010.  Return on average common shareholders' equity was 8.73% for the three months ended March 31, 2011, compared to 6.82% in 2010.  The return on total average assets was 0.97% for the three months ended March 31, 2011, compared to 0.88% in 2010.

The increase in net income for the three months ended March 31, 2011, over the first three months of 2010, was primarily the result of a decrease in provision for loan and lease losses and an increase in net interest income.  This positive impact to net income was partially offset by an increase in noninterest expense and a decrease in noninterest income.  Details of the changes in the various components of net income are discussed further below.

NET INTEREST INCOME

The taxable equivalent net interest income for the three months ended March 31, 2011 was $37.57 million, an increase of 5.00% over the same period in 2010.  The net interest margin on a fully taxable equivalent basis was 3.71% for the three months ended March 31, 2011, compared to 3.50% for the three months ended March 31, 2010.

During the three month period ended March 31, 2011, average earning assets decreased $36.96 million or 0.89% over the comparable period in 2010.  Average interest-bearing liabilities decreased $48.06 million or 1.41% for the three month period ended March 31, 2011 over the comparable period one year ago.  The yield on average earning assets decreased 19 basis points to 4.73% for the first quarter of 2011 from 4.92% for the first quarter of 2010.  The rate earned on assets decreased due to the reduction in short-term market interest rates from a year ago.  Total cost of average interest-bearing liabilities decreased 48 basis points to 1.25% for the first quarter 2011 from 1.73% for the first quarter 2010.  The result to the net interest margin, or the difference between interest income on earning assets and interest expense on interest-bearing liabilities, was an increase of 21 basis points for the three month period ended March 31, 2011 from March 31, 2010.

The largest contributor to the decrease in the yield on average earning assets for the three months ended March 31, 2011, compared to the three months ended March 31, 2010, was a reduction in yields on taxable investment securities of 84 basis points.  Total average investment securities increased $63.96 million or 7.17% for the three month period over one year ago.  Average mortgages held for sale decreased $3.42 million or 16.58% for the three month period ended March 31, 2011, over the comparable periods a year ago due to the elimination of our wholesale broker activity.  Average net loans and leases decreased $46.13 million or 1.49% for the first quarter of 2011 from the first quarter of 2010.  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, decreased $51.37 million or 38.82% for the three month period ended March 31, 2011, over the comparable period a year ago.

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Average interest-bearing deposits decreased $41.49 million or 1.33%, for the first quarter of 2011 over the same period in 2010.  The effective rate paid on average interest-bearing deposits decreased 51 basis points to 1.10% for the first quarter 2011 compared to 1.61% for the first quarter 2010.  The decline in the average cost of interest-bearing deposits during the first quarter of 2011 as compared to the first quarter of 2010 was primarily the result of interest rate re-pricing on maturing certificates of deposit.

Average short-term borrowings decreased $11.92 million or 7.42% for the first quarter of 2011, compared to the same period in 2010.  The decrease in average short-term borrowings was primarily due to lower repurchase agreements and lower secured borrowings.  Interest paid on short-term borrowings decreased 23 basis points for the first quarter of 2011 due to the interest rate decrease on adjustable rate borrowings.  Average long-term debt increased $5.36 million or 26.69% during the first quarter of 2011 as compared to the first quarter of 2010.  The increase in long-term borrowings was the result of higher borrowings with the Federal Home Loan Bank offset by lower borrowings on a line of credit.  Interest paid on long-term borrowings decreased 133 basis points for the first quarter due to lower effective rates on new Federal Home Loan Bank borrowings.

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.

DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
(Dollars in thousands)
	Three months ended March 31,
	2011								2010
				Interest								Interest
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
ASSETS:
Investment securities:
Taxable	$	815,564		$	4,482		2.23	%	$	712,824		$	5,401		3.07	%
Tax exempt		141,004			1,734		4.99	%		179,782			2,145		4.84	%
Mortgages - held for sale		17,213			179		4.22	%		20,634			273		5.37	%
Net loans and leases		3,054,013			41,278		5.48	%		3,100,144			42,194		5.52	%
Other investments		80,949			243		1.22	%		132,323			274		0.84	%
Total Earning Assets		4,108,743			47,916		4.73	%		4,145,707			50,287		4.92	%
Cash and due from banks		58,710								57,891
Reserve for loan and lease losses		(88,263	)							(89,223	)
Other assets		340,974								371,019
Total	$	4,420,164							$	4,485,394
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing deposits	$	3,084,779		$	8,355		1.10	%	$	3,126,268		$	12,405		1.61	%
Short-term borrowings		148,729			89		0.24	%		160,652			188		0.47	%
Subordinated notes		89,692			1,647		7.45	%		89,692			1,647		7.45	%
Long-term debt and
mandatorily redeemable securities		25,426			259		4.13	%		20,070			270		5.46	%
Total Interest-Bearing Liabilities		3,348,626			10,350		1.25	%		3,396,682			14,510		1.73	%
Noninterest-bearing deposits		515,236								447,861
Other liabilities		63,629								62,239
Shareholders' equity		492,673								578,612
Total	$	4,420,164							$	4,485,394
Net Interest Income				$	37,566							$	35,777
Net Yield on Earning Assets on a Taxable
Equivalent Basis							3.71	%							3.50	%

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PROVISION AND RESERVE FOR LOAN AND LEASE LOSSES

The provision for loan and lease losses for the three month period ended March 31, 2011 was $2.20 million, compared to a provision for loan and lease losses in the three month period ended March 31, 2010 of $4.39 million.  Net charge-offs of $2.91million were recorded for the first quarter 2011, compared to $4.80 million for the same quarter a year ago.

On March 31, 2011, 30 day and over loan and lease delinquencies were 0.56% as compared to 0.84% on March 31, 2010.  The decrease in delinquencies was primarily in construction equipment, auto, light truck and environmental equipment and commercial loans.  The reserve for loan and lease losses as a percentage of loans and leases outstanding at the end of the period was 2.82% as compared to 2.83% one year ago.  A summary of loan and lease loss experience during the three months ended March 31, 2011 and 2010 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 an allowance 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 and lease and the recorded investment in the loan or lease exceeds its fair value.

NONPERFORMING ASSETS

Nonperforming assets were as follows:

(Dollars in thousands)
	March 31,		December 31,		March 31,
	2011		2010		2010
Loans and leases past due 90 days or more	$	515	$	361	$	272
Nonaccrual loans and leases		74,038		74,853		78,094
Other real estate		6,813		6,392		5,205
Former bank premises held for sale		1,200		1,200		2,363
Repossessions		5,482		5,670		9,886
Equipment owned under operating leases		300		236		150
Total nonperforming assets	$	88,348	$	88,712	$	95,970

Nonperforming assets as a percentage of total loans and leases were 2.81% at March 31, 2011 and December 31, 2010, and 2.98% at March 31, 2010.  Nonperforming assets totaled $88.35 million at March 31, 2011, a decrease of 0.41% from the $88.71 million reported at December 31, 2010, and a 7.94% decrease from the $95.97 million reported at March 31, 2010.  The decrease during the first three months of 2011 compared to the same period in 2010 was primarily related to decreases in nonaccrual loans and leases and repossessions as the economy slowly improves.

The decrease in nonaccrual loans and leases at March 31, 2011 from March 31, 2010 was spread among the various loan portfolios except for increases in aircraft.  The largest dollar decrease at March 31, 2011 from December 31, 2010 occurred in the aircraft portfolio, with notable decreases also occurring in the medium and heavy duty truck and construction equipment portfolios, and was offset by increases in commercial real estate loans.  A summary of nonaccrual loans and leases and past due aging for the period ended March 31, 2011 and December 31, 2010 is located in Note 4 of the Consolidated Financial Statements.

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As of March 31, 2011, the industry with the largest dollar exposure was with borrowers whose primary source of income was derived from commercial real estate.  These impaired loans totaled approximately $27.59 million which were comprised of $21.02 million secured by commercial real estate and included in loans secured by real estate and $6.57 million secured by aircraft and included in aircraft financing.  We have limited exposure to commercial real estate.  However, our borrowers with commercial real estate exposure, whether local real estate developers in our commercial portfolio or customers in our niche portfolios such as aircraft whose underlying business is dependent on developing, marketing and managing real estate properties, have suffered as a result of declining real estate values and minimal sales activity.  Furthermore, aircraft values declined during 2009 and 2010, increasing the risk in aircraft secured transactions.

The increase over the past year in other real estate is due to foreclosing on real estate in the local market for which we have a current appraisal and is well secured.

Repossessions consisted mainly of aircraft at March 31, 2011.  At the time of repossession, 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, unless the equipment is in the process of immediate sale.  Any subsequent write-downs are included in noninterest expense.

A summary of other real estate and repossessions as of March 31, 2011 and 2010 is shown in the table below:

	March 31,
(Dollars in thousands)	2011		2010
Commercial and agricultural loans	$	-	$	146
Auto, light truck and environmental equipment		261		325
Medium and heavy duty truck		60		315
Aircraft financing		4,946		8,858
Construction equipment financing		200		195
Commercial real estate		6,083		4,475
Residential real estate		730		730
Consumer loans		15		47
Total	$	12,295	$	15,091

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 $205.03 million and $201.03 million as of March 31, 2011 and December 31, 2010, respectively.  Foreign loans and leases are in aircraft financing. Loan and lease outstandings to borrowers in Brazil and Mexico were $145.09 million and $36.87 million as of March 31, 2011, respectively, compared to $134.34 million and $34.03 million as of December 31, 2010, respectively. Outstanding balances to borrowers in other countries were insignificant.

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NONINTEREST INCOME

Noninterest income for the three month period ended March 31, 2011 and 2010 was $18.95 million and $20.92 million, respectively.  Details of noninterest income follow:

(Dollars in thousands)	Three Months Ended
	March 31,
	2011		2010
Noninterest income:
Trust fees	$	3,992	$	3,745
Service charges on deposit accounts		4,236		4,620
Mortgage banking income		444		777
Insurance commissions		1,142		1,465
Equipment rental income		6,038		6,745
Other income		2,971		2,689
Investment securities and other investment gains		130		881
Total noninterest income	$	18,953	$	20,922

Noninterest income decreased in all categories for the first quarter 2011 as compared to the same period in 2010 except trust fees and other income.

Trust fees increased $0.25 million or 6.60% for the three month period ended March 31, 2011 over the three month period ended March 31, 2010.  The increase in trust fees was a result of an increase in market values of investment accounts.

Service charges on deposit accounts decreased $0.38 million or 8.31% for the three months ended March 31, 2011 over the comparable period one year ago.  The decline in service charges on deposit accounts reflects a lower volume of nonsufficient fund transactions.

Mortgage banking income decreased $0.33 million or 42.86% in the first quarter of 2011 as compared to the first quarter of 2010.  The first quarter decrease was due to lower gains on loan sales.

Insurance commissions decreased $0.32 million or 22.05% in the three months ended March 31, 2011 over the same period a year ago.  The decrease was due to reduced contingent commissions, primarily as a result of a high level of claims activity in our books of business. We also experienced a loss of commercial business premiums in the Fort Wayne market due to declines in business relationships.

Equipment rental income declined $0.71 million or 10.48% in the first quarter of 2011 compared to the first quarter 2010.  The average equipment rental portfolio decreased 9.65% in 2011 over the same period in 2010 resulting in lower rental income.

Other income increased $0.28 million or 10.49% for the three month period ended March 31, 2011 as compared to the same period in 2010, mainly due to higher earnout fees on the sale of assets of 1st Source Investment Advisors related to the management of the 1st Source Monogram Funds.

The decrease in investment securities and other investments gains of $0.75 million or 85.24% in the three months ended March 31, 2011 was due to a loss on a venture capital investment and lower partnership investment gains in 2011 compared to the same period a year earlier.

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NONINTEREST EXPENSE

Noninterest expense for the three month period ended March 31, 2011 and 2010 was $38.48 million and $37.11 million, respectively.  Details of noninterest expense follow:

(Dollars in thousands)	Three Months Ended
	March 31,
	2011		2010
Noninterest expense:
Salaries and employee benefits	$	18,638	$	18,810
Net occupancy expense		2,320		2,487
Furniture and equipment expense		3,349		2,800
Depreciation - leased equipment		4,805		5,364
Professional fees		1,096		1,514
Supplies and communication		1,394		1,369
Business development and marketing expense		622		567
Intangible asset amortization		325		330
Loan and lease collection and repossession expense		1,324		1,106
FDIC and other insurance		1,676		1,674
Other expense		2,927		1,089
Total noninterest expense	$	38,476	$	37,110

During the first quarter 2011, furniture and equipment expense increased $0.55 million or 19.61% compared to the first quarter 2010.  The higher expense was mainly due to computer processing charges.

Depreciation on leased equipment decreased $0.56 million or 10.42% in conjunction with the decrease in equipment rental income for the three months ended March 31, 2011 as compared to the same period one year ago.

Professional fees decreased $0.42 million or 27.61% for the three month period ended March 31, 2011 as compared to the three month period ended March 31, 2010.  The reduction in professional fees in 2011 was the result of lower consulting fees.

Loan and lease collection and repossession expense increased $0.22 million or 19.71% for the first quarter of 2011 as compared to the same period in 2010 mainly due to increased operating costs on other real estate owned and overall increased collection and repossession activity.

Other expenses increased $1.84 million or 168.78% in the three months ended March 31, 2011 as compared to the three months ended March 31, 2010.  The increase was primarily due to a charge of $1.68 million for provision on unfunded loan commitments.

Salaries and employee benefits, net occupancy, supplies and communication, business development and marketing, intangible asset amortization, and FDIC and other insurance expense all changed slightly in 2011 over the same period in 2010.

INCOME TAXES

The provision for income taxes for the three month period ended March 31, 2011 was $4.53 million, compared to $4.65 million for the same period in 2010.  The effective tax rates were 29.93% and 32.44% for the first quarter ended March 31, 2011 and 2010, respectively.  Additionally, during the first quarter of 2011 we reached a state tax settlement for the 2008 year and as a result recorded a reduction of unrecognized tax benefits in the amount of $0.84 million that affected the effective tax rate and increased earnings in the amount of $0.47 million.

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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, 2010.  For information regarding our market risk, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2010.

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, 2011, 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 2011 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.  Our 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.

We note that we received notice in April 2011 that the United States Department of Justice has initiated an investigation of 1st Source prompted by pricing practices of certain brokers from whom we purchased mortgages in prior years that were originated by them. The investigation is pursuant to the Equal Credit Opportunity Act and Fair Housing Act. As previously disclosed, we ended our relationships with third-party mortgage brokers in 2010. We are cooperating fully with the investigation and, based on our present understanding, do not expect an outcome that would have any 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, 2010.  For information regarding our risk factors, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2010.

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ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES

			Total number of	Maximum number (or approximate
	Total number	Average	shares purchased	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
January 01 - 31, 2011	-	$      -	-	1,238,372
February 01 - 28, 2011	1,900	18.50	1,900	1,236,472
March 01 - 31, 2011	7,000	18.35	7,000	1,229,472

(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 770,528 shares.

ITEM 3. Defaults Upon Senior Securities.

None

ITEM 4. (Removed and reserved).

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.

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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, 2011	/s/CHRISTOPHER J. MURPHY III
	Christopher J. Murphy III
	Chairman of the Board, President and CEO
DATE  April 21, 2011	/s/LARRY E. LENTYCH
	Larry E. Lentych
	Treasurer and Chief Financial Officer
	Principal Accounting Officer

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