form10_q.htm



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, 2010

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, Indiana
46601
(Address of principal executive offices) (Zip Code)

(574) 235-2000
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     x Yes         o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   o Yes        o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
 
   Large accelerated filer     o  Accelerated filer                       x  
   Non-accelerated filer      o (Do not check if a smaller reporting company)  Smaller reporting company    o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes         x No

Number of shares of common stock outstanding as of April 16, 2010 – 24,286,688 shares

 
- 1 -

 


TABLE OF CONTENTS


PART I.  FINANCIAL INFORMATION
 
   
Page
Item 1.
Financial Statements (Unaudited)
 
 
3
 
4
 
5
 
6
 
7
Item 2.
21
Item 3.
 31 
Item 4.
 31 
     
PART II.  OTHER INFORMATION
 
     
Item 1.
31
Item 1A.
 31 
Item 2.
32
Item 3.
 32 
Item 4.
 32 
Item 5.
 32 
Item 6.
 32 
     
 33 
     
CERTIFICATIONS
 
   
Exhibit 31.1    
Exhibit 31.2    
Exhibit 32.1    
Exhibit 32.2    


           
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
           
(Unaudited - Dollars in thousands, except share amounts)
           
   
March 31,
   
December 31,
 
   
2010
   
2009
 
ASSETS
           
Cash and due from banks
  $ 53,518     $ 72,872  
Federal funds sold and
               
   interest bearing deposits with other banks
    71,139       141,166  
Investment securities available-for-sale
               
     (amortized cost of $878,403 and $893,439
               
     at March 31, 2010 and December 31, 2009, respectively)
    888,862       901,638  
Other investments
    21,012       21,012  
Trading account securities
    130       125  
Mortgages held for sale
    23,067       26,649  
Loans and leases - net of unearned discount
               
   Commercial and agricultural loans
    546,826       546,222  
   Auto, light truck and environmental equipment
    364,445       349,741  
   Medium and heavy duty truck
    200,228       204,545  
   Aircraft financing
    608,643       617,384  
   Construction equipment financing
    303,866       313,300  
   Loans secured by real estate
    977,667       952,223  
   Consumer loans
    104,440       109,735  
Total loans and leases
    3,106,115       3,093,150  
   Reserve for loan and lease losses
    (87,827 )     (88,236 )
Net loans and leases
    3,018,288       3,004,914  
Equipment owned under operating leases, net
    92,226       97,004  
Net premises and equipment
    37,556       37,907  
Goodwill and intangible assets
    89,949       90,222  
Accrued income and other assets
    149,365       148,591  
Total assets
  $ 4,445,112     $ 4,542,100  
                 
LIABILITIES
               
Deposits:
               
  Noninterest bearing
  $ 457,645     $ 450,608  
  Interest bearing
    3,081,485       3,201,856  
Total deposits
    3,539,130       3,652,464  
Federal funds purchased and securities
               
  sold under agreements to repurchase
    111,788       123,787  
Other short-term borrowings
    29,358       26,323  
Long-term debt and mandatorily redeemable securities
    24,847       19,761  
Subordinated notes
    89,692       89,692  
Accrued expenses and other liabilities
    71,240       59,753  
Total liabilities
    3,866,055       3,971,780  
                 
SHAREHOLDERS' EQUITY
               
Preferred stock; no par value
               
     Authorized 10,000,000 shares; issued 111,000 at March 31, 2010,
               
     and at December 31, 2009
    105,254       104,930  
Common stock; no par value
               
     Authorized 40,000,000 shares; issued 25,643,506 at March 31, 2010,
               
     and at December 31, 2009
    350,272       350,269  
Retained earnings
    147,381       142,407  
Cost of common stock in treasury (1,356,818 shares at March 31, 2010, and
               
     1,532,483 shares at December 31, 2009)
    (30,348 )     (32,380 )
Accumulated other comprehensive income
    6,498       5,094  
Total shareholders' equity
    579,057       570,320  
Total liabilities and shareholders' equity
  $ 4,445,112     $ 4,542,100  
                 
The accompanying notes are a part of the consolidated financial statements.
               



           
CONSOLIDATED STATEMENTS OF INCOME
           
(Unaudited - Dollars in thousands, except per share amounts)
           
   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Interest income:
           
Loans and leases
  $ 42,270     $ 44,597  
Investment securities, taxable
    5,401       4,036  
Investment securities, tax-exempt
    1,467       1,710  
Other
    274       333  
Total interest income
    49,412       50,676  
                 
Interest expense:
               
Deposits
    12,405       17,606  
Short-term borrowings
    188       349  
Subordinated notes
    1,647       1,647  
Long-term debt and mandatorily redeemable securities
    270       352  
Total interest expense
    14,510       19,954  
                 
Net interest income
    34,902       30,722  
Provision for loan and lease losses
    4,388       7,785  
Net interest income after provision for
               
loan and lease losses
    30,514       22,937  
                 
Noninterest income:
               
Trust fees
    3,745       3,804  
Service charges on deposit accounts
    4,620       4,746  
Mortgage banking income
    777       2,570  
Insurance commissions
    1,465       1,516  
Equipment rental income
    6,745       6,147  
Other income
    2,689       2,235  
Investment securities and other investment gains (losses)
    881       (469 )
Total noninterest income
    20,922       20,549  
                 
Noninterest expense:
               
Salaries and employee benefits
    18,810       20,086  
Net occupancy expense
    2,487       2,601  
Furniture and equipment expense
    2,800       3,481  
Depreciation - leased equipment
    5,364       4,956  
Professional fees
    1,514       1,062  
Supplies and communication
    1,369       1,567  
FDIC and other insurance
    1,674       1,550  
Business development and marketing expense
    567       485  
Loan and lease collection and repossession expense
    1,106       559  
Other expense
    1,419       2,293  
Total noninterest expense
    37,110       38,640  
                 
Income before income taxes
    14,326       4,846  
Income tax expense (benefit)
    4,647       (1,405 )
                 
Net income
    9,679       6,251  
Preferred stock dividends and discount accretion
    (1,711 )     (1,313 )
Net income available to common shareholders
  $ 7,968     $ 4,938  
                 
Per common share
               
Basic net income per common share
  $ 0.33     $ 0.20  
Diluted net income per common share
  $ 0.33     $ 0.20  
Dividends
  $ 0.15     $ 0.14  
Basic weighted average common shares outstanding
    24,210,242       24,150,200  
Diluted weighted average common shares outstanding
    24,215,506       24,191,610  
                 
The accompanying notes are a part of the consolidated financial statements.
               

 

                                   
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, 2009
  $ 453,664     $ 0     $ 342,982     $ 136,877     $ (32,019 )   $ 5,824  
Comprehensive Income, net of tax:
                                               
Net Income
    6,251       -       -       6,251       -       -  
Change in unrealized appreciation
                                               
of available-for-sale securities, net of tax
    (853 )     -       -       -       -       (853 )
Total Comprehensive Income
    5,398       -       -       -       -       -  
Issuance of 78,194 common shares
                                               
under stock based compensation awards,
                                               
including related tax effects
    1,566       -       -       687       879       -  
Issuance of preferred stock
    103,725       103,725       -       -       -       -  
Preferred stock discount accretion
    -       265       -       (265 )     -       -  
Issuance of warrants to purchase common stock
    7,275       -       7,275       -       -       -  
Preferred stock dividend (paid and/or accrued)
    (1,048 )     -       -       (1,048 )     -       -  
Common stock dividend ($0.14 per share)
    (3,381 )     -       -       (3,381 )     -       -  
Stock based compensation
    3       -       3       -       -       -  
Balance at March 31, 2009
  $ 567,202     $ 103,990     $ 350,260     $ 139,121     $ (31,140 )   $ 4,971  
                                                 
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
    1,404       -       -       -       -       1,404  
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  
                                                 
The accompanying notes are a part of the consolidated financial statements.
                         


           
CONSOLIDATED STATEMENTS OF CASH FLOWS
           
(Unaudited - Dollars in thousands)
           
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Operating activities:
           
Net income
  $ 9,679     $ 6,251  
Adjustments to reconcile net income to net cash
               
provided (used) by operating activities:
               
Provision for loan and lease losses
    4,388       7,785  
Depreciation of premises and equipment
    1,182       1,226  
Depreciation of equipment owned and leased to others
    5,364       4,956  
Amortization of investment security premiums
               
and accretion of discounts, net
    668       1,662  
Amortization of mortgage servicing rights
    761       724  
Mortgage servicing asset (recovery) impairment
    (1 )     565  
Deferred income taxes
    948       (1,944 )
Investment securities and other investment (gains) losses
    (881 )     469  
Originations/purchases of loans held for sale, net of principal collected
    (50,208 )     (195,322 )
Proceeds from the sales of loans held for sale
    54,303       117,411  
Net gain on sale of loans held for sale
    (512 )     (1,888 )
Change in trading account securities
    (5 )     1  
Change in interest receivable
    75       (1,002 )
Change in interest payable
    1,110       2,165  
Change in other assets
    (1,337 )     665  
Change in other liabilities
    8,573       (7,896 )
Other
    15       587  
Net change in operating activities
    34,122       (63,585 )
                 
Investing activities:
               
Proceeds from sales of investment securities
    71,579       98,945  
Proceeds from maturities of investment securities
    123,734       77,103  
Purchases of investment securities
    (180,063 )     (384,778 )
Net change in short-term investments
    70,026       (1,539 )
Loans sold or participated to others
    4,586       3,978  
Net change in loans and leases
    (22,348 )     76,305  
Net change in equipment owned under operating leases
    (586 )     (2,119 )
Purchases of premises and equipment
    (857 )     (542 )
Net change in investing activities
    66,071       (132,647 )
                 
Financing activities:
               
Net change in demand deposits, NOW
               
accounts and savings accounts
    (69,419 )     59,910  
Net change in certificates of deposit
    (43,915 )     (26,584 )
Net change in short-term borrowings
    (8,964 )     4,966  
Proceeds from issuance of long-term debt
    5,303       12  
Payments on long-term debt
    (139 )     (10,186 )
Net proceeds from issuance of treasury stock
    2,778       1,566  
Acquisition of treasury stock
    (114 )     -  
Net proceeds from issuance of preferred stock & common stock warrants
    -       111,000  
Cash dividends paid on preferred stock
    (1,387 )     (339 )
Cash dividends paid on common stock
    (3,690 )     (3,440 )
Net change in financing activities
    (119,547 )     136,905  
                 
Net change in cash and cash equivalents
    (19,354 )     (59,327 )
                 
Cash and cash equivalents, beginning of year
    72,872       119,771  
                 
Cash and cash equivalents, end of period
  $ 53,518     $ 60,444  
                 
The accompanying notes are a part of the consolidated financial statements.
               


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 (2009 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, 2009 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U. S. generally accepted accounting principles for complete financial statements. Certain amounts in the prior period consolidated financial statements have been reclassified to conform with the current year presentation.

Note 2.              Recent Accounting Pronouncements

Subsequent Events:  In February 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2010-09 “Subsequent Events (Topic 855) – Amendments to Certain Recognition and Disclosure Requirements.”  ASU 2010-09 amends the subsequent events disclosure guidance.  The amendments include a definition of an SEC filer, requires an SEC filer or conduit bond obligor to evaluate subsequent events through the date the financial statements are issued, and removes the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated.  ASU 2010-09 was effective upon issuance except for the use of the issued date for conduit debt obligors.  The impact of ASU 2010-09 on our disclosures is reflected in Note 11 - Subsequent Events.

Fair Value Measurements and Disclosures:  In January 2010, the FASB issued ASU No. 2010-06 “Fair Value Measurements and Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements.”  ASU 2010-06 amends the fair value disclosure guidance.  The amendments include new disclosures and changes to clarify existing disclosure requirements.  ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements of Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  The impact of ASU 2010-06 on our disclosures is reflected in Note 10 - Fair Value Measurements.

Consolidations:  In December 2009, the FASB issued ASU No. 2009-17 (formerly Statement No. 167), “Consolidations (Topic 810) – Improvements to Financial Reporting for Enterprises involved with Variable Interest Entities”. ASU 2009-17 amends the consolidation guidance applicable to variable interest entities. The amendments to the consolidation guidance affect all entities, as well as qualifying special-purpose entities (QSPEs) that are currently excluded from previous consolidation guidance. ASU 2009-17 was effective as of the beginning of the first annual reporting period that begins after November 15, 2009. ASU 2009-17 did not have an impact on our financial condition, results of operations, or disclosures.

 
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Accounting for Transfers of Financial Assets:  In December 2009, the FASB issued ASU No. 2009-16 (formerly Statement No. 166), “Transfers and Servicing (Topic 860) – Accounting for Transfers of Financial Assets”. ASU 2009-16 amends the derecognition accounting and disclosure guidance. ASU 2009-16 eliminates the exemption from consolidation for QSPEs and also requires a transferor to evaluate all existing QSPEs to determine whether they must be consolidated. ASU 2009-16 was effective as of the beginning of the first annual reporting period that begins after November 15, 2009. ASU 2009-16 did not have an impact on our financial condition, results of operations, or disclosures.

Note 3.              Investment Securities

Investment securities available-for-sale were as follows:
 
   
Amortized
   
Gross
   
Gross
       
(Dollars in thousands)
 
Cost
   
Unrealized Gains
   
Unrealized Losses
   
Fair Value
 
March 31, 2010
                       
U.S. Treasury and Federal agencies securities
  $ 355,055     $ 1,319     $ (547 )   $ 355,827  
U.S. States and political subdivisions securities
    173,425       5,265       (2,319 )     176,371  
Mortgage-backed securities - Federal agencies
    322,899       6,201       (1,256 )     327,844  
Corporate debt securities
    24,048       185       -       24,233  
Foreign government securities
    1,688       6       -       1,694  
Total debt securities
    877,115       12,976       (4,122 )     885,969  
Marketable equity securities
    1,288       1,632       (27 )     2,893  
Total investment securities available-for-sale
  $ 878,403     $ 14,608     $ (4,149 )   $ 888,862  
                                 
December 31, 2009
                               
U.S. Treasury and Federal agencies securities
  $ 390,189     $ 760     $ (1,780 )   $ 389,169  
U.S. States and political subdivisions securities
    188,706       5,450       (2,337 )     191,819  
Mortgage-backed securities - Federal agencies
    286,415       5,996       (1,434 )     290,977  
Corporate debt securities
    26,166       194       (38 )     26,322  
Foreign government and other securities
    675       -       -       675  
Total debt securities
    892,151       12,400       (5,589 )     898,962  
Marketable equity securities
    1,288       1,417       (29 )     2,676  
Total investment securities available-for-sale
  $ 893,439     $ 13,817     $ (5,618 )   $ 901,638  

At March 31, 2010, 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, 2010, 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
  $ 41,051     $ 41,462  
Due after one year through five years
    332,860       336,779  
Due after five years through ten years
    163,934       165,574  
Due after ten years
    16,371       14,310  
Mortgage-backed securities
    322,899       327,844  
Total debt securities available-for-sale
  $ 877,115     $ 885,969  

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 quarter of 2010 primarily reflect the disposition of FNMA and FHLMC debt securities.
 
 
- 8 -

 
The gross gains in the first quarter 2009 reflect gains on the sale of FHLB and FNMA debt securities.  The gross losses in the first quarter 2009 primarily reflect losses on the sale of preferred equities.  There have been no other than temporary impairment (OTTI) writedowns in 2010.  There were net gains (losses) of $5 thousand and $(1) thousand recorded for the three months ended March 31, 2010 and 2009 on $0.13 million and $0.13 million in trading securities outstanding at March 31, 2010, and December 31, 2009, respectively.
 
(Dollars in thousands)
 
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Gross realized gains
  $ 292     $ 594  
Gross realized losses
    (12 )     (707 )
Net realized gains (losses)
  $ 280     $ (113 )

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
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
(Dollars in thousands)
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
March 31, 2010
                                   
U.S. Treasury and Federal agencies securities
  $ 199,261     $ (547 )   $ -     $ -     $ 199,261     $ (547 )
U.S. States and political subdivisions securities
    7,697       (100 )     16,164       (2,219 )     23,861       (2,319 )
Mortgage-backed securities - Federal agencies
    70,567       (977 )     26,257       (279 )     96,824       (1,256 )
Corporate debt securities
    -       -       -       -       -       -  
Total debt securities
    277,525       (1,624 )     42,421       (2,498 )     319,946       (4,122 )
Marketable equity securities
    -       -       6       (27 )     6       (27 )
Total investment securities available-for-sale
  $ 277,525     $ (1,624 )   $ 42,427     $ (2,525 )   $ 319,952     $ (4,149 )
                                                 
December 31, 2009
                                               
U.S. Treasury and Federal agencies securities
  $ 245,921     $ (1,780 )   $ -     $ -     $ 245,921     $ (1,780 )
U.S. States and political subdivisions securities
    9,501       (178 )     16,718       (2,159 )     26,219       (2,337 )
Mortgage-backed securities - Federal agencies
    90,592       (1,137 )     22,330       (297 )     112,922       (1,434 )
Corporate debt securities
    7,149       (38 )     -       -       7,149       (38 )
Total debt securities
    353,163       (3,133 )     39,048       (2,456 )     392,211       (5,589 )
Marketable equity securities
    2       (2 )     4       (27 )     6       (29 )
Total investment securities available-for-sale
  $ 353,165     $ (3,135 )   $ 39,052     $ (2,483 )   $ 392,217     $ (5,618 )
 
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, 2010, 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 adjustable rate coupon securities which are reflected in U.S. States and Political subdivisions securities.  
 
 
- 9 -

 
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.  We do not believe any of the securities are impaired due to reasons of credit quality.  Accordingly, as of March 31, 2010, 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, 2010 and December 31, 2009, investment securities with carrying values of $333.59 million and $351.84 million, respectively, were pledged as collateral to secure government deposits, security repurchase agreements, and for other purposes.

Note 4.              Reserve for Loan and Lease Losses

The reserve for loan and lease losses is maintained at a level believed to be adequate by management to absorb probable losses inherent in the loan and lease portfolio.  The determination of the reserve requires significant judgment reflecting management’s best estimate of probable loan and lease losses related to specifically identified loans and leases as well as probable losses in the remainder of the various loan and lease portfolios.  The methodology for assessing the appropriateness of the reserve consists of several key elements, which include: specific reserves for 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.

Note 5.              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 cost 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.
 
 
- 10 -


Changes in the carrying value of mortgage servicing assets and the associated valuation allowance follow:
 
   
Three Months Ended
 
(Dollars in thousands)
 
March 31,
 
   
2010
   
2009
 
Mortgage servicing assets:
           
Balance at beginning of period
  $ 8,749     $ 6,708  
Additions
    571       2,496  
Amortization
    (761 )     (724 )
Sales
    (443 )     (623 )
Carrying value before valuation allowance at end of period
    8,116       7,857  
Valuation allowance:
               
Balance at beginning of period
    (1 )     (2,073 )
Impairment recoveries (charges)
    1       (565 )
Balance at end of period
  $ -     $ (2,638 )
Net carrying value of mortgage servicing assets at end of period
  $ 8,116     $ 5,219  
Fair value of mortgage servicing assets at end of period
  $ 10,575     $ 5,397  
 
During the three months ended March 31, 2010 and 2009, management determined that it was not necessary to permanently write-down any previously established valuation allowance.  At March 31, 2010, the fair value of mortgage servicing assets exceeded the carrying value reported in the consolidated statement of financial condition by $2.46 million.  This difference represents increases in the fair value of certain mortgage servicing assets that could not be recorded above cost basis.

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

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Expected weighted-average life (in years)
    3.55       3.21  
Weighted-average constant prepayment rate (CPR)
    17.64 %     38.34 %
Weighted-average discount rate
    8.48 %     8.34 %
 
Mortgage loan contractual servicing fees, including late fees and ancillary income, were $1.02 million and $0.86 million for the three months ended March 31, 2010 and 2009, respectively.  Mortgage loan contractual servicing fees are included in mortgage banking income in the consolidated statements of income.

Note 6.              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.
 
 
- 11 -


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.

At March 31, 2010 and December 31, 2009, 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, 2010
                         
Interest rate swap contracts
  $ 466,823  
Other assets
  $ 14,740    
Other liabilities
    $ 15,247  
Loan commitments
     44,641  
Mortgages held for sale
    184     N/A       -  
Forward contracts
    42,005  
Mortgages held for sale
    86     N/A       -  
                                 
Total
            $  15,010           $  15,247  
                                 
December 31, 2009
                               
Interest rate swap contracts
  $  412,717  
Other assets
  $ 13,516    
Other liabilities
    $ 13,988  
Loan commitments
    48,821  
Mortgages held for sale
    77     N/A       -  
Forward contracts
     38,940  
Mortgages held for sale
    411     N/A       -  
                                 
Total
            $ 14,004           $  13,988  

For the three months ended March 31, 2010 and 2009, the amounts included in the consolidated statements of income for non-hedging derivative financial instruments are shown in the chart below:
 
 
- 12 -


     
Gain (loss)
 
     
Three Months Ended
 
 
Statement of
 
March 31,
 
(Dollars in thousands)
Income location
 
2010
   
2009
 
               
Interest rate swap contracts
Other expense
  $ (35 )   $ 4  
Loan commitments
Mortgage banking income
    107       684  
Forward contracts
Mortgage banking income
    (325 )     (1,307 )
Total
    $ (253 )   $ (619 )
 
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 $22.66 million and $19.02 million at March 31, 2010 and December 31, 2009, respectively.  Standby letters of credit generally have terms ranging from six months to one year.

Note 7.              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 and warrants, 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 49,763 and 54,472 were considered antidilutive as of March 31, 2010 and 2009.  Stock warrants of 837,947 were considered antidilutive as of March 31, 2010 and 2009.

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, 2010 and 2009.
 
   
Three Months Ended
 
(Dollars in thousands - except per share amounts)
 
March 31,
 
   
2010
   
2009
 
Distributed earnings allocated to common stock
  $ 3,616     $ 3,375  
Undistributed earnings allocated to common stock
    4,278       1,534  
Net earnings allocated to common stock
    7,894       4,909  
Net earnings allocated to participating securities
    74       29  
Net income allocated to common stock and participating securities
  $ 7,968     $ 4,938  
                 
Weighted average shares outstanding for basic earnings per common share
    24,210,242       24,150,200  
Dilutive effect of stock compensation
    5,264       41,410  
Weighted average shares outstanding for diluted earnings per common share
    24,215,506       24,191,610  
                 
Basic earnings per common share
  $ 0.33     $ 0.20  
Diluted earnings per common share
  $ 0.33     $ 0.20  

 
- 13 -


Note 8.              Stock-Based Compensation

As of March 31, 2010, we had five 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, 2009.  These plans include two stock option plans, 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, 2010 and 2009 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.

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 2010 (March 31, 2010) 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, 2010.  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 and $3 thousand, net of tax, for the three months ended March 31, 2010 and 2009, respectively.
 
           
Average
   
       
Weighted
 
Remaining
 
Total
       
Average
 
Contractual
 
Intrinsic
   
Number of
 
Exercise
 
Term
 
Value
   
Shares
 
Price
 
(in years)
 
(in 000's)
                 
Options outstanding, beginning of year
 
71,763
 
$18.19
       
Granted
 
-
 
-
       
Exercised
 
-
 
-
       
Forfeited
 
-
 
-
       
Options outstanding, March 31, 2010
 
71,763
 
$18.19
 
1.83
 
$123
                 
                 
Vested and expected to vest at March 31, 2010
 
71,763
 
$18.19
 
1.83
 
$123
Exercisable at March 31, 2010
 
66,263
 
$18.70
 
1.72
 
$93
 
No options were granted during the three months ended March 31, 2010.
 
 
- 14 -

 
As of March 31, 2010, there was $3.75 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 3.74 years.
 
The following table summarizes information about stock options outstanding at March 31, 2010:
 
 
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
29,508
2.49
$13.38
 
24,008
$13.69
$18.00 to $26.99
36,700
1.33
  20.43
 
36,700
  20.43
$27.00 to $29.46
  5,555
1.57
  28.95
 
  5,555
  28.95
 
The fair value of each stock option was estimated on the date of grant using the Black-Scholes option-pricing model.

Note 9.              Income Taxes

The total amount of unrecognized tax benefits that would affect the effective tax rate if recognized was $1.42 million at March 31, 2010 and $1.30 million at December 31, 2009.  Interest and penalties were recognized through the income tax provision.  For the three months ending March 31, 2010 and the twelve months ending December 31, 2009, we recognized approximately $0.04 million and $(0.73) million in interest, net of tax effect, and penalties, respectively.  Interest and penalties of approximately $0.58 million and $0.55 million were accrued at March 31, 2010 and December 31, 2009, respectively.

Tax years that remain open and subject to audit include the federal 2006-2009 years and the Indiana 2006-2009 years.  Additionally, during the first quarter of 2009 we reached a resolution of audit examinations for the 2002-2007 years and as a result recorded a reduction of unrecognized tax benefits in the amount of $4.85 million that affected the effective tax rate and increased earnings in the amount of $2.60 million.  We do not anticipate a significant change in the amount of uncertain tax positions within the next 12 months.

Note 10.                            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.

 
- 15 -

 
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 new mortgages held for sale (MHFS) originations starting on January 1, 2008.  We believe the election for MHFS (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, 2010, all MHFS 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, 2010:

(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
  $ 23,067     $ 22,349     $ 718  (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.
                         

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.
 
 
- 16 -

 
·  
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.
 
·  
Marketable equity (preferred) securities are primarily priced using available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing.

Trading account securities are 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.

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.

The table below presents the balance of assets and liabilities at March 31, 2010, 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
  $ 20,117     $ 335,710     $ -     $ 355,827  
U.S. States and political subdivisions securities
    -       166,570       9,801       176,371  
Mortgage-backed securities - Federal agencies
    -       327,844       -       327,844  
Corporate debt securities
    -       25,252       -       25,252  
Foreign government securities
    -       -       675       675  
Total debt securities
    20,117       855,376       10,476       885,969  
Marketable equity securities
    2,884       -       9       2,893  
Total investment securities available-for-sale
    23,001       855,376       10,485       888,862  
Trading account securities
    130       -       -       130  
Mortgages held for sale
    -       23,067       -       23,067  
Accrued income and other assets (Interest rate swap agreements)
    -       14,740       -       14,740  
Total
  $ 23,131     $ 893,183     $ 10,485     $ 926,799  
                                 
Liabilities
                               
Accrued expenses and other liabilities (Interest rate swap agreements)
  $ -     $ 15,247     $ -     $ 15,247  
Total
  $ -     $ 15,247     $ -     $ 15,247  

 
- 17 -

 
The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the quarter ended March 31, 2010 are summarized as follows:

(Dollars in thousands)
 
U.S. States and political subdivisions securities
   
Foreign government securities
   
Marketable equity securities
   
Investment securities available-for-sale
 
Beginning balance January 1, 2010
  $ 18,310     $ 675     $ 9     $ 18,994  
Total gains or losses (realized/unrealized):
                               
Included in earnings
    -       -       -       -  
Included in other comprehensive income
    88       -       -       88  
Purchases
    988       -       -       988  
Issuances
    -       -       -       -  
Settlements
    -       -       -       -  
Expirations
    (9,585 )     -       -       (9,585 )
Transfers into Level 3
    -       -       -       -  
Transfers out of Level 3
    -       -       -       -  
Ending balance March 31, 2010
  $ 9,801     $ 675     $ 9     $ 10,485  

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, 2010.

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 other financial assets include loans measured for impairment, venture capital partnership investments, mortgage servicing rights, goodwill, repossessions and other real estate.

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 estimated using customized discounting criteria, appraisals and dealer and trade magazine quotes which are used in a market valuation approach.  Repossessions are similarly valued.

Venture capital 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.

Goodwill is reviewed for impairment at least annually, or on an interim basis if an event occurs or circumstances change that would more likely than not reduce the carrying amount.  Goodwill is allocated into two reporting units.  Fair value for each reporting unit is estimated using stock price multiples or revenue multiples.  We do not believe there is a reasonable possibility that either of our reporting units are at risk of failing a future Step 1 impairment test.
 
 
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Other real estate is based on the fair value of the underlying collateral less expected selling costs.  Collateral values are estimated primarily using appraisals and reflect a market value approach.

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, 2010:  impaired loans - $1.03 million; venture capital partnership investments - $(0.39) million; mortgage servicing rights - $0.00 million; goodwill - $0.00 million; repossessions - $0.60 million, and other real estate - $0.00 million.

For assets measured at fair value on a nonrecurring basis at March 31, 2010, the following table provides the level of valuation assumptions used to determine each valuation and the carrying value of the related assets:
 
(Dollars in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
                         
Loans
  $ -     $ -     $ 73,627     $ 73,627  
Accrued income and other assets (venture capital partnership investments)
    -       -       3,055       3,055  
Accrued income and other assets (mortgage servicing rights)
    -       -       8,116       8,116  
Goodwill and intangible assets (goodwill)
    -       83,329       -       83,329  
Accrued income and other assets (repossessions)
    -       -       9,886       9,886  
Accrued income and other assets (other real estate)
    -       -       7,568       7,568  
    $ -     $ 83,329     $ 102,252     $ 185,581  

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.

The fair values of our financial instruments as of March 31, 2010, and December 31, 2009, are summarized in the table below.
 
   
March 31, 2010
   
December 31, 2009
 
   
Carrying or
         
Carrying or
       
(Dollars in thousands)
 
Contract Value
   
Fair Value
   
Contract Value
   
Fair Value
 
Assets:
                       
Cash and due from banks
  $ 53,518     $ 53,518     $ 72,872     $ 72,872  
Federal funds sold and interest bearing deposits with other banks
    71,139       71,139       141,166       141,166  
Investment securities, available-for-sale
    888,862       888,862       901,638       901,638  
Other investments and trading account securities
    21,142       21,142       21,137       21,137  
Mortgages held for sale
    23,067       23,067       26,649       26,649  
Loans and leases, net of reserve for loan and lease losses
    3,018,288       3,064,686       3,004,914       3,042,251  
Cash surrender value of life insurance policies
    51,853       51,853       51,342       51,342  
Mortgage servicing rights
    8,116       10,575       8,748       10,180  
Interest rate swaps
    14,740       14,740       13,516       13,516  
Liabilities:
                               
Deposits
  $ 3,539,130     $ 3,574,454     $ 3,652,464     $ 3,692,203  
Short-term borrowings
    141,146       141,146       150,110       150,110  
Long-term debt and mandatorily redeemable securities
    24,847       24,956       19,761       19,831  
Subordinated notes
    89,692       74,410       89,692       81,118  
Interest rate swaps
    15,247       15,247       13,988       13,988  
Off-balance-sheet instruments *
    -       182       -       150  
* Represents estimated cash outflows required to currently settle the obligations at current market rates.
         
 
 
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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 cash equivalents 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 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.

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.