10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended   September 30, 2008

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.

Yes X 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 ___     Accelerated filer    X      Non-accelerated filer ___     Smaller reporting company ___

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

Yes No X

Number of shares of common stock outstanding as of October 22, 2008 - 24,110,930 shares

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TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements (Unaudited)
	Consolidated statements of financial condition – September 30, 2008, and December 31, 2007	3
	Consolidated statements of income -- three months and nine months ended September 30, 2008 and 2007	4
	Consolidated statements of changes in shareholders’ equity -- nine months ended September 30, 2008 and 2007	5
	Consolidated statements of cash flows -- nine months ended September 30, 2008 and 2007	6
	Notes to the Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4.	Controls and Procedures	24
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3.	Defaults Upon Senior Securities	26
Item 4.	Submission of Matters to a Vote of Security Holders	26
Item 5.	Other Information	26
Item 6.	Exhibits	26
SIGNATURES		27
Exhibits
Exhibit 31.1
Exhibit 31.2         0;
Exhibit 32.1
Exhibit 32.2
Exhibit 10(k)

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1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited - Dollars in thousands)
	September 30,			December 31,
	2008			2007
ASSETS
Cash and due from banks	$	75,704		$	153,137
Federal funds sold and
interest bearing deposits with other banks		59,090			25,817
Investment securities available-for-sale
(amortized cost of $656,294 and $775,922
at September 30, 2008 and December 31, 2007, respectively)		658,905			779,981
Other investments		18,612			14,937
Mortgages held for sale		38,700			25,921
Loans and leases - net of unearned discount:
Commercial and agricultural loans		671,019			593,806
Auto, light truck and environmental equipment		337,248			305,238
Medium and heavy duty truck		253,682			300,469
Aircraft financing		608,881			587,022
Construction equipment financing		383,446			377,785
Loans secured by real estate		924,313			881,646
Consumer loans		136,274			145,475
Total loans and leases		3,314,863			3,191,441
Reserve for loan and lease losses		(75,606	)		(66,602	)
Net loans and leases		3,239,257			3,124,839
Equipment owned under operating leases, net of accumulated depreciation		87,407			81,960
Net premises and equipment		41,194			45,048
Goodwill and intangible assets		92,185			93,567
Accrued income and other assets		98,565			101,897
Total assets	$	4,409,619		$	4,447,104
LIABILITIES
Deposits:
Noninterest bearing	$	374,290		$	418,529
Interest bearing		2,976,122			3,051,134
Total deposits		3,350,412			3,469,663
Federal funds purchased and securities
sold under agreements to repurchase		244,491			303,429
Other short-term borrowings		190,173			34,403
Long-term debt and mandatorily redeemable securities		34,861			34,702
Subordinated notes		89,692			100,002
Accrued expenses and other liabilities		58,980			74,401
Total liabilities		3,968,609			4,016,600
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 25,911,397 at September 30, 2008
and 25,927,510 at December 31, 2007, less unearned shares
(267,891 at September 30, 2008 and 284,004 at December 31, 2007)		342,979			342,840
Retained earnings		128,428			117,373
Cost of common stock in treasury (1,532,576 shares at September 30, 2008,
and 1,551,396 shares at December 31, 2007)		(32,019	)		(32,231	)
Accumulated other comprehensive income		1,622			2,522
Total shareholders' equity		441,010			430,504
Total liabilities and shareholders' equity	$	4,409,619		$	4,447,104
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				Nine Months Ended
			September 30,						September	30,
	2008			2007			2008				2007
Interest income:
Loans and leases	$	50,979		$	57,970		$	154,590			$	159,322
Investment securities, taxable		4,896			7,221			17,288				18,660
Investment securities, tax-exempt		1,873			2,213			5,904				5,351
Other		317			926			986				3,282
Total interest income		58,065			68,330			178,768				186,615
Interest expense:
Deposits		20,347			31,184			67,116				85,249
Short-term borrowings		2,255			2,978			6,434				8,240
Subordinated notes		1,648			1,846			5,067				4,236
Long-term debt and mandatorily redeemable securities		418			624			1,333				2,049
Total interest expense		24,668			36,632			79,950				99,774
Net interest income		33,397			31,698			98,818				86,841
Provision for loan and lease losses		3,571			3,660			9,603				4,284
Net interest income after
provision for loan and lease losses		29,826			28,038			89,215				82,557
Noninterest income:
Trust fees		4,939			3,853			14,155				11,367
Service charges on deposit accounts		5,761			5,278			16,633				15,074
Mortgage banking income		959			770			3,493				2,400
Insurance commissions		1,084			964			4,122				3,540
Equipment rental income		6,285			5,345			17,794				15,730
Other income		2,168			1,841			6,836				6,042
Investment securities and other investment (losses) gains		(8,816	)		(154	)		(9,259	)			300
Total noninterest income		12,380			17,897			53,774				54,453
Noninterest expense:
Salaries and employee benefits		19,297			20,035			58,996				55,754
Net occupancy expense		2,332			2,467			7,289				6,552
Furniture and equipment expense		3,694			3,996			11,555				10,838
Depreciation - leased equipment		5,041			4,284			14,266				12,603
Professional fees		2,773			922			6,453				3,089
Supplies and communication		1,812			1,666			5,163				4,450
Business development and marketing expense		881			1,027			2,524				3,302
Other  expense		2,487			3,043			8,367				7,098
Total noninterest expense		38,317			37,440			114,613				103,686
Income before income taxes		3,889			8,495			28,376				33,324
Income tax (benefit) expense		(583	)		2,365			7,305				10,611
Net income	$	4,472		$	6,130		$	21,071			$	22,713
Per common share:
Basic net income per common share	$	0.19		$	0.25		$	0.87			$	0.97
Diluted net income per common share	$	0.18		$	0.25		$	0.86			$	0.96
Dividends	$	0.14		$	0.14		$	0.43			$	0.42
Basic weighted average common shares outstanding		24,109,960			24,275,794			24,104,015				23,309,281
Diluted weighted average common shares outstanding		24,393,603			24,567,404			24,386,756				23,603,676
The accompanying notes are a part of the consolidated financial statements.

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1st SOURCE CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited - Dollars in thousands, except per share amounts)
												Accumulated
									Cost of			Other
									Common			Comprehensive
				Common		Retained			Stock			Income
	Total			Stock		Earnings			in Treasury			(Loss), Net
Balance at January 1, 2007	$	368,904		$	289,163	$	99,572		$	(19,571	)	$	(260	)
Comprehensive Income, net of tax:
Net Income		22,713			-		22,713			-			-
Change in unrealized appreciation
of available-for-sale securities, net of tax		2,394			-		-			-			2,394
Total Comprehensive Income		25,107			-		-			-			-
Issuance of 40,349 common shares
under stock-based compensation awards,
including related tax effects		544			-		384			160			-
Cost of 478,083 shares of common
stock acquired for treasury		(11,306	)		-		-			(11,306	)		-
Cash dividend ($0.42 per share)		(9,731	)		-		(9,731	)		-			-
Issuance of 2,124,974 shares of common
stock for FINA Bancorp purchase		53,677			53,677
Balance at September 30, 2007	$	427,195		$	342,840	$	112,938		$	(30,717	)	$	2,134
Balance at January 1, 2008	$	430,504		$	342,840	$	117,373		$	(32,231	)	$	2,522
Comprehensive Income, net of tax:
Net Income		21,071			-		21,071			-			-
Change in unrealized appreciation
of available-for-sale securities, net of tax		(900	)		-		-			-			(900	)
Total Comprehensive Income		20,171			-		-			-			-
Issuance of 18,820 common shares
under stock-based compensation awards,
including related tax effects		342			-		130			212			-
Stock-based compensation		139			139
Cash dividend ($0.42 per share)		(10,146	)		-		(10,146	)		-			-
Balance at September 30, 2008	$	441,010		$	342,979	$	128,428		$	(32,019	)	$	1,622
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)
	Nine Months Ended September 30,
	2008			2007
Operating activities:
Net income	$	21,071		$	22,713
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan and lease losses		9,603			4,284
Depreciation of premises and equipment		4,088			3,905
Depreciation of equipment owned and leased to others		14,266			12,603
Amortization of investment security premiums
and accretion of discounts, net		1,328			(273	)
Amortization of mortgage servicing rights		2,234			1,753
Mortgage servicing asset impairment		56			-
Deferred income taxes		(11,558	)		(3,226	)
Realized investment securities losses (gains)		9,259			(300	)
Change in mortgages held for sale		(12,779	)		25,085
Change in interest receivable		438			(3,538	)
Change in interest payable		(5,853	)		2,816
Change in other assets		1,984			(1,303	)
Change in other liabilities		2,539			(867	)
Other		2,988			1,328
Net change in operating activities		39,664			64,980
Investing activities:
Cash paid for acquisition, net		-			(55,977	)
Proceeds from sales of investment securities		8,237			1,070
Proceeds from maturities of investment securities		390,303			445,847
Purchases of investment securities		(289,498	)		(360,199	)
Net change in short-term investments		(36,948	)		217,400
Net change in loans and leases		(124,021	)		(261,770	)
Net change  in equipment owned under operating leases		(19,712	)		(14,333	)
Purchases of premises and equipment		(2,403	)		(13,600	)
Net change in investing activities		(74,042	)		(41,562	)
Financing activities:
Net change in demand deposits, NOW
accounts and savings accounts		(96,857	)		(230,677	)
Net change in certificates of deposit		(22,394	)		75,420
Net change in short-term borrowings		96,832			111,331
Proceeds from issuance of long-term debt		10,024			-
Proceeds from issuance of trust preferred securities		-			58,764
Payments on subordinated notes		(10,310	)		(17,784	)
Payments on long-term debt		(10,371	)		(381	)
Net proceeds from issuance of treasury stock		341			545
Acquisition of treasury stock		-			(11,306	)
Cash dividends		(10,320	)		(9,897	)
Net change in financing activities		(43,055	)		(23,985	)
Net change in cash and cash equivalents		(77,433	)		(567	)
Cash and cash equivalents, beginning of year		153,137			118,131
Cash and cash equivalents, end of period	$	75,704		$	117,564
Supplemental non-cash activity:
Common stock issued for purchase of FNBV	$	-		$	53,667
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) that are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, the results of operations, changes in shareholders’ equity, and cash flows for the periods presented. These unaudited consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with U. S. generally accepted accounting principles have been omitted. The Notes to the Consolidated Financial Statements appearing in 1st Source Corporation’s Annual Report on Form 10-K for 2007 (2007 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, 2007, 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.                      Other Activity

On June 7, 2008, First National Bank, Valparaiso (FNBV) was merged into 1st Source Bank; both of which were wholly owned subsidiaries of 1st Source Corporation.

On August 25, 2008, 1st Source Corporation Investment Advisors, Inc. (“1st Source Investment Advisors”), a wholly-owned subsidiary of 1st Source Bank and an affiliate of 1st Source Corporation, entered into a Purchase and Sale Agreement with WA Holdings, Inc. (“Buyer”) whereby 1st Source Investment Advisors agreed to sell certain assets to Buyer and to enter into a long-term strategic partnership with Buyer (the "Transaction").  Pursuant to the Purchase and Sale Agreement, Buyer and its wholly-owned subsidiary, Wasatch Advisors, Inc., investment advisor of the Wasatch Funds, Inc., will acquire assets of 1st Source Investment Advisors related to the management of the 1st Source Monogram Mutual Funds - the Income Equity Fund, the Long/Short Fund and the Income Fund. The 1st Source Monogram Mutual Funds will be reorganized into the Wasatch - 1st Source Income Equity Fund, the Wasatch - 1st Source Long/Short Fund, and the Wasatch - 1st Source Income Fund.  The closing of the Transaction is subject to the approval of the shareholders of each of the 1st Source Monogram Mutual Funds. Additionally, closing is subject to the completion of certain regulatory filings and subject to customary closing conditions. Assuming satisfaction of all requisite conditions, the Transaction is expected to close by the end of the year.

Note 3.                      Recent Accounting Pronouncements

FASB Clarifies Application of Fair Value Accounting: On October 10, 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.”   The FSP clarifies the application of FASB Statement No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The FSP is effective upon issuance, including prior periods for which financial statements have not been issued.  The provisions of FSP FAS 157-3 did not have an impact on our financial condition or results of operations.

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GAAP Hierarchy:  In May 2008, the FASB issued Statement No. 162, "The Hierarchy of Generally Accepted Accounting Principles" (SFAS No. 162).  This standard identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy).  The provisions of SFAS No. 162 did not have a material impact on our financial condition and results of operations.

Disclosures About Derivative Instruments and Hedging Activities:  In March 2008, the FASB issued Statement No. 161, “Disclosures About Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (SFAS No. 161).  SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements.  SFAS No. 161 is effective for fiscal years beginning after November 15, 2008.  We are assessing the potential disclosure effects of SFAS No. 161.

Business Combinations:  In December 2007, the FASB issued SFAS No. 141R, “Business Combinations.”  SFAS No. 141R broadens the guidance of SFAS No. 141, extending its applicability to all transactions and other events in which one entity obtains control over one or more other businesses.  It broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations.  SFAS No. 141R expands on required disclosures to improve the statement users’ abilities to evaluate the nature and financial effects of business combinations.  SFAS No. 141R is effective for the first annual reporting period beginning on or after December 15, 2008.  The provisions of SFAS No. 141R will only impact us if we are party to a business combination closing on or after January 1, 2009.

Written Loan Commitments Recorded at Fair Value Through Earnings:  In November 2007, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 109 (SAB 109), “Written Loan Commitments Recorded at Fair Value through Earnings,” an amendment of  SAB 105, “Application of Accounting Principles to Loan Commitments.”  Under SAB 109, the expected net future cash flows of associated loan servicing activities should be included in the measurement of written loan commitments accounted for at fair value through earnings.  The guidance in SAB 109 is applied on a prospective basis to derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007.  We adopted the provisions of SAB 109 on January 1, 2008.  Details related to the adoption of SAB 109 and the impact on our financial statements are more fully discussed in Note 7 – Fair Value.

Fair Value Option:  In February 2007, the Financial Accounting Standards Board (FASB) issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB No. 115” (SFAS No. 159).  The fair value option permits companies to choose to measure eligible items at fair value at specified election dates.  Companies will report unrealized gains and losses on items for which the fair value option has been elected in earnings after adoption.  SFAS No. 159 requires additional disclosures related to the fair value measurements included in the companies’ financial statements.  This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007.  We adopted the provisions of SFAS No. 159 on January 1, 2008.  Details related to the adoption of SFAS No. 159 and the impact on our financial statements are more fully discussed in Note 7 – Fair Value.

Fair Value Measurements:  In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”  This standard clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.  We adopted the provisions of SFAS No. 157 on January 1, 2008.  Details related to the adoption of SFAS No. 157 and the impact on our financial statements are more fully discussed in Note 7 – Fair Value.

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Note 4.  Reserve for Loan and Lease Losses

The reserve for loan and lease losses is maintained at a level believed to be adequate by management to absorb probable losses inherent in the loan and lease portfolio.  The determination of the reserve requires significant judgment reflecting management’s best estimate of probable loan and lease losses related to specifically identified loans and leases as well as probable losses in the remainder of the various loan and lease portfolios.  The methodology for assessing the appropriateness of the reserve consists of several key elements, which include: specific reserves for identified special attention loans and leases (classified loans and leases and internal watch list credits), percentage allocations for special attention loans and leases without specific reserves, formula reserves for each business lending division portfolio, 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.  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 we act as an intermediary for our client, changes in the fair value of the underlying derivative contracts essentially offset.  As of September 30, 2008, the notional amount of non-hedging interest rate swaps was $399.00 million.

1st Source 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.

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

As of September 30, 2008 and December 31, 2007, 1st Source Bank had commitments outstanding to originate and purchase mortgage loans aggregating $38.86 million and $29.53 million, respectively. Outstanding commitments to sell mortgage loans aggregated $58.00 million at September 30, 2008, and $45.53 million at December 31, 2007.  Standby letters of credit totaled $79.55 million and $61.79 million at September 30, 2008, and December 31, 2007, respectively.  Standby letters of credit have terms ranging from six months to one year.

Note 6.  Stock-Based Compensation

As of September 30, 2008, we had five stock-based employee compensation plans, which are more fully described in Note L of the Consolidated Financial Statements in 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2007.  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 operations for the nine months ended September 30, 2008 and 2007 was based on awards ultimately expected to vest, and accordingly has been adjusted by the amount of estimated forfeitures.  SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  Forfeitures were estimated based partially on historical experience.

The aggregate intrinsic value in the table below represents the total pretax intrinsic value (the difference between 1st Source’s closing stock price on the last trading day of the third quarter of 2008 (September 30, 2008) and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2008.  This amount changes based on the fair market value of 1st Source’s stock.  Total fair value of options vested and expensed was $12 thousand and $57 thousand, net of tax, for the nine months ended September 30, 2008 and 2007, respectively.

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table of contents
	September 30, 2008
						Average
				Weighted		Remaining		Total
				Average		Contractual		Intrinsic
	Number of			Grant-date		Term		Value
	Shares			Fair Value		(in years)		(in 000's)
Options outstanding, beginning of year		471,517		$	26.51
Granted		-			-
Exercised		-			-
Forfeited		(387,537	)		28.24
Options outstanding, September 30, 2008		83,980		$	18.53		3.02	$	447
Vested and expected to vest at September 30, 2008		83,980		$	18.53		3.02	$	447
Exercisable at September 30, 2008		75,730		$	19.24		2.85	$	353

No options were granted during the nine months ended September 30, 2008.

As of September 30, 2008, there was $2.52 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 4.24 years.

The following table summarizes information about stock options outstanding at September 30, 2008: 

		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		3.99	$	13.38		21,258	$	13.90
$	18.00 to $26.99		48,917		2.43		20.46		48,917		20.46
$	27.00 to $29.46		5,555		3.06		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 7.  Fair Value

As of January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements” and SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” including an amendment of SFAS No. 115.  SFAS No. 157 does not change existing guidance as to whether or not an asset or liability is carried at fair value.  It defines fair value 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, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  SFAS No. 159 generally permits the measurement of selected eligible financial instruments at fair value at specified election dates, subject to the conditions set forth in the standard.

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We also adopted the provisions of FASB Staff Position (FSP) No. 157-2, which defers until January 1, 2009, the application of SFAS 157 to nonfinancial assets and nonfinancial liabilities not recognized or disclosed at least annually at fair value.  Items affected by this deferral include goodwill, repossessions and other real estate, all for which any necessary impairment analyses are performed using fair value measurements.  We do not expect the adoption of FSP No. 157-2 will have a material impact on our financial condition, results of operations, or liquidity.

We elected to adopt SFAS No. 159 for mortgages held for sale (MHFS) at fair value prospectively for new MHFS originations starting on January 1, 2008.  We believe the election for MHFS (which are now 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.  There was no transition adjustment required upon adoption of SFAS No. 159 for MHFS because we continued to account for MHFS originated prior to January 1, 2008 at the lower of cost or fair value.  At September 30, 2008, MHFS carried at fair value totaled $38.70 million.  At September 30, 2008, there were no MHFS that were originated prior to January 1, 2008.

In accordance with SFAS No. 157, we group our financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.  These levels are:

§Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

§Level 2 – Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date.  The nature of these

assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the

parameters of which can be directly observed.

§Level 3 – Assets and liabilities that have little to no pricing observability as of the reported date.  These items do not have two-way markets and are measured using

management’s best estimate of fair value, where the inputs into the determination of fair value 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.

Certain assets and liabilities are measured at fair value on a recurring basis.  The following is a discussion of these assets and liabilities and valuation techniques applied to each for fair value measurement:

§   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 CMO’s, are primarily priced       using available market information including benchmark yields, prepayment speeds, spreads and volatility of similar securities.

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§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.

§Other non-marketable securities are primarily priced using cost or book values due to an absence of market activity and market data.

§   Mortgages held for sale and the related loan commitments and forward contracts (hedges) are valued using an income 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 September 30, 2008 measured at fair value on a recurring basis:

Assets and Liabilities Measured at Fair Value on a recurring basis:
							September 30, 2008
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Investment securities available for sale	$	73,265	$	564,886	$	20,754	$	658,905
Mortgages held for sale		-		38,700		-		38,700
Accrued income and other assets (Interest rate swap
agreements)		-		6,511		-		6,511
Total	$	73,265	$	610,097	$	20,754	$	704,116
Liabilities								-
Accrued expenses and other liabilities (Interest rate
swap agreements)	$	-	$	6,511	$	-	$	6,511
Total	$	-	$	6,511	$	-	$	6,511

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The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:

(Dollars in thousands)	Quarter ended September 30, 2008
	Investment securities available for sale
Beginning balance July 1, 2008	$	19,376
Total gains or losses (realized/unrealized):
Included in earnings		-
Included in other comprehensive income		(249	)
Purchases and issuances		1,411
Settlements		-
Maturities		(4,550	)
Transfers in and/or out of Level 3		4,766
Ending balance September 30, 2008	$	20,754
The amount of total 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 September 30, 2008.	$	-

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 under SFAS 114, venture capital partnership investments and mortgage servicing rights.  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.  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.  Fair value measurements for mortgage servicing rights are derived based on a variety of inputs including prepayment speeds, discount rates, scheduled servicing cash flows, delinquency rates and other assumptions.  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.  For assets measured at fair value on a nonrecurring basis the following represents impairment charges (recoveries) recognized on these assets during the quarter ended September 30, 2008:  impaired loans $0.04 million; venture capital partnership investments $(0.11) million; mortgage servicing rights $( 0.13) million.  For assets measured at fair value on a nonrecurring basis on hand at September 30, 2008, the following table provides the level of valuation assumptions used to determine each valuation and the fair value measurement of the related assets:

Assets and Liabilities Measured at Fair Value on a non-recurring basis:
	September 30, 2008
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Loans	$	-	$	-	$	19,275	$	19,275
Accrued income and other assets (venture capital partnership investments)		-		-		2,464		2,464
Accrued income and other assets (mortgage servicing rights)						10,775		10,775
	$	-	$	-	$	32,514	$	32,514

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Fair Value Option

The following table reflects the differences between fair value carrying amount of mortgages held for sale measured at fair value under SFAS No. 159 and the aggregate unpaid principal amount we are contractually entitled to receive at maturity on September 30, 2008:

(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	$	38,700	$	37,953	$	747	(1	)
Nonaccrual loans		-		-		-
Loans 90 days or more past due and still accruing		-		-		-
(1) The excess of fair value carrying amount over unpaid principal includes changes in fair value recorded at and
subsequent to funding, gains and losses on the related loan commitment prior to funding, and premiums on acquired loans.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except for historical information contained herein, the matters discussed in this document express “forward-looking statements.” Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will,” “should,” and similar expressions indicate forward-looking statements. Those statements, including statements, projections, estimates or assumptions concerning future events or performance, and other statements that are other than statements of historical fact, are subject to material risks and uncertainties. We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. We may make other written or oral forward-looking statements from time to time. Readers are advised that various important factors could cause our actual results or circumstances for future periods to differ materially from those anticipated or projected in such forward-looking statements. Such factors include, but are not limited to, changes in law, regulations or U. S. generally accepted accounting principles; our competitive position within the markets we serve; increasing consolidation within the banking industry; unforeseen changes in interest rates; unforeseen changes in loan prepayment assumptions; unforeseen downturns in or major events affecting the local, regional or national economies or the industries in which we have credit concentrations; and other matters discussed in our filings with the SEC, including our Annual Report on Form 10-K  for 2007, 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 September 30, 2008, as compared to December 31, 2007, and the results of operations for the three and nine month periods ended September 30, 2008 and 2007. 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 2007 Annual Report.

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FINANCIAL CONDITION

Our total assets at September 30, 2008, were $4.41 billion, relatively unchanged from December 31, 2007.  Total loans and leases were $3.31 billion at September 30, 2008, an increase of $123.42 million or 3.87% from December 31, 2007.  Total deposits at September 30, 2008, were $3.35 billion, down $119.25 million or 3.44% from the comparable figures at the end of 2007.  Total investment securities, available for sale were $658.91 million at September 30, 2008, a decrease of $121.08 million or 15.52% from December 31, 2007.

Nonperforming assets at September 30, 2008, were $30.00 million compared to $18.48 million at December 31, 2007, an increase of 62.34%.  The majority of the increase was in nonaccrual loans in the medium and heavy duty truck financing portfolio.  At September 30, 2008, nonperforming assets were 0.88% of net loans and leases compared to 0.56% at December 31, 2007.

Accrued income and other assets were as follows:

(Dollars in Thousands)
	September 30,		December 31,
	2008		2007
Accrued income and other assets:
Bank owned life insurance cash surrender value	$	38,453	$	38,871
Accrued interest receivable		18,855		19,293
Mortgage servicing assets		6,549		7,279
Other real estate		1,615		781
Former bank premises held for sale		3,821		4,040
Repossessions		234		2,291
All other assets		29,038		29,342
Total accrued income and other assets	$	98,565	$	101,897

CAPITAL

As of September 30, 2008, total shareholders' equity was $441.01 million, up $10.51 million or 2.44% from the $430.50 million at December 31, 2007.  In addition to net income of $21.07 million, other significant changes in shareholders’ equity during the first nine months of 2008 included $10.15 million of dividends paid.  The accumulated other comprehensive income component of shareholders’ equity totaled $1.62 million at September 30, 2008, compared to $2.52 million at December 31, 2007.  The decrease in accumulated other comprehensive income was a result of changes in unrealized gain or loss on securities in the available-for-sale portfolio.  Our equity-to-assets ratio was 10.00% as of September 30, 2008, compared to 9.68% at December 31, 2007. Book value per common share rose to $18.29 at September 30, 2008, up from $17.87 at December 31, 2007.  Tangible book value per common share was $14.47 at September 30, 2008, up from $13.99 at December 31, 2007.

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We declared and paid dividends per common share of $0.14 during the third quarter of 2008.  The trailing four quarters dividend payout ratio, representing dividends per share divided by diluted earnings per share, was 48.31%.  The dividend payout is continually reviewed by management and the Board of Directors.

The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1 or core capital as a percentage of average assets, to measure the soundness of a financial institution.  In addition, banking regulators have established risk-based capital guidelines for U. S. banking organizations.  The actual and required capital amounts and ratios of 1st Source Corporation and 1st Source Bank, as of September 30, 2008, 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	$	481,743		12.98	%	$	296,816		8.00	%	$	371,021		10.00	%
1st Source Bank		477,018		12.91			295,561		8.00			369,452		10.00
Tier 1 Capital (to Risk-Weighted Assets):
1st Source Corporation		434,049		11.70			148,408		4.00			222,612		6.00
1st Source Bank		430,472		11.65			147,781		4.00			221,671		6.00
Tier 1 Capital (to Average Assets):
1st Source Corporation		434,049		10.08			172,313		4.00			215,391		5.00
1st Source Bank		430,472		10.04			171,532		4.00			214,415		5.00

LIQUIDITY AND INTEREST RATE SENSITIVITY

Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as the operating cash needs of 1st Source Corporation, are met.  Funds are available from a number of sources, including the securities portfolio, the core deposit base, Federal Home Loan Bank borrowings, and the capability to package loans for sale.   Our loan to asset ratio was 75.17% at September 30, 2008 compared to 71.76% at December 31, 2007 and 72.55% at September 30, 2007.  Cash and cash equivalents totaled $75.70 million at September 30, 2008 compared to $153.14 million at December 31, 2007 and $117.56 million at September 30, 2007.  At September 30, 2008, the consolidated statement of financial condition was rate sensitive by $516.90 million more liabilities than assets scheduled to reprice within one year, or approximately 0.83%.  Management believes that the present funding sources provide adequate liquidity to meet our cash flow needs.

SUBORDINATED DEBT

  During the first quarter of 2008, we redeemed $10.31 million in floating-rate trust preferred securities issued by 1st Source Capital Trust III and $0.43 million of pre-tax capitalized debt issuance costs were written off.   1st Source Capital Trust III was dissolved during the third quarter of 2008.

RESULTS OF OPERATIONS

Net income for the three and nine month periods ended September 30, 2008, was $4.47 million and $21.07 million respectively, compared to $6.13 million and $22.71 million for the same periods in 2007.  Diluted net income per common share was $0.18 and $0.86 respectively, for the three and nine month periods ended September 30, 2008, compared to $0.25 and $0.96 for the same periods in 2007.  Return on average common shareholders' equity was 6.35% for the nine months ended September 30, 2008, compared to 7.58% in 2007. The return on total average assets was 0.64% for the nine months ended September 30, 2008, compared to 0.75% in 2007.

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The change in net income for the nine months ended September 30, 2008, over the first nine months of 2007, was primarily the result of an increase of $5.32 million to our provision for loan and lease losses, $10.26 million of other than temporary impairment on investment securities, and a $10.93 million increase in noninterest expense, which were offset by a $11.98 million increase in net interest income, a $9.58 million increase in noninterest income and a $3.31 million reduction in income tax expense.  Details of the changes in the various components of net income are further discussed below.

NET INTEREST INCOME

The taxable equivalent net interest income for the three months ended September 30, 2008, was $34.26 million, an increase of 4.65% over the same period in 2007. The net interest margin on a fully taxable equivalent basis was 3.34% for the three months ended September 30, 2008, compared to 3.16% for the three months ended September 30, 2007. The taxable equivalent net interest income for the nine month period ended September 30, 2008 was $101.51 million, an increase of 13.55% over 2007, resulting in a net yield of 3.35%, compared to a net yield of 3.17% for the same period in 2007.
 

Average earning assets decreased $28.27 million or 0.69% and increased $275.32 million or 7.30%, respectively, for the three and nine month periods ended September 30, 2008, over the comparable periods in 2007.  Average interest-bearing liabilities decreased $58.87 million or 1.65% and increased $257.62 million or 7.96%, respectively, for the three and nine month periods ended September 30, 2008, over the comparable period one year ago.  The yield on average earning assets decreased 96 basis points to 5.75% for the third quarter of 2008 from 6.71% for the third quarter of 2007.  The yield on average earning assets for the nine month period ended September 30, 2008, decreased 72 basis points to 5.99% from 6.71% for the nine month period ended September 30, 2007. The yield earned on assets continued to decrease due to the reduction in short-term market interest rates from a year ago.  Total cost of average interest-bearing liabilities decreased 127 basis points to 2.79% for the third quarter of 2008 from 4.06% for the third quarter of 2007. Total cost of average interest-bearing liabilities decreased 106 basis points to 3.06% for the nine month period ended September 30, 2008 from 4.12% for the nine month period ended September 30, 2007.  The cost of interest-bearing liabilities was also affected by the decline in short-term market interest rates.  The result to the net interest margin, or the difference between interest income on earning assets and expense on interest-bearing liabilities, was an increase of 18 basis points for both the three and the nine month periods ended September 30, 2008 from September 30, 2007.

Average loans and leases grew by $143.74 million or 4.52% during the third quarter of 2008, compared to the third quarter of 2007.  Average loans and leases outstanding increased most notably in commercial loans, construction equipment financing, aircraft financing, and loans secured by real estate for both the third quarter and year-to-date 2008 as compared to 2007.

Total average investment securities decreased 17.47%  for the three month period over one year ago, while they remained steady for the nine month period over one year ago.  Average mortgages held for sale increased 50.97% and 9.78% respectively, for the three and nine month periods over the same periods one year ago.  Average other investments, which include federal funds sold, time deposits with other banks, Federal Reserve Bank and Federal Home Loan Bank stock and commercial paper, decreased 50.57% for the three month period ended September 30, 2008 from same period one year ago, and 57.41% for the first nine months of 2008 as compared to the first nine months of 2007 as excess funds were used to fund loan and lease growth.

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       Average interest-bearing deposits decreased $169.45 million or 5.41% and increased $140.37 million or 4.92%, respectively, for the third quarter of 2008 and first nine months of 2008, over the same periods in 2007. The effective rate paid on average interest-bearing deposits decreased 122 basis points to 2.73% for the third quarter of 2008 compared to 3.95% for the third quarter of 2007.  The effective rate paid on average interest-bearing deposits decreased 100 basis points to 3.00% for the first nine months of 2008 compared to 4.00% for the first nine months of 2007.  The decline in the average cost of interest-bearing deposits during the third quarter and first nine months of 2008 as compared to the third quarter and first nine months of 2007 was primarily the result of decreases in interest rates offered on deposit products due to decreases in market interest rates.

Average short term borrowings increased $130.35 million or 43.81% and $111.50 million or 42.44%, respectively, for the third quarter of 2008 and the first nine months of 2008, compared to the same time periods in 2007.  Interest paid on short-term borrowings decreased due to the interest rate decrease in adjustable rate borrowings.  Average long-term debt decreased $9.38 million or 21.22% during the third quarter of 2008 as compared to the third quarter of 2007 and decreased $9.14 million or 20.88% during the first nine months of 2008 as compared to the first nine months of 2007.  The majority of the decrease in long-term debt was made up of Federal Home Loan Bank borrowings.

Average demand deposits increased 5.70% and 10.56%, respectively, for the three and nine month period ended September 30, 2008 as compared to the three and nine month periods of 2007.  Much of the change in demand deposits was due to the May 31, 2007 acquisition of FNBV.

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 September 30,																Nine months ended September 30,
				2008								2007								2008								2007
				Interest								Interest								Interest								Interest
	Average			Income/		Yield/			Average			Income/		Yield/			Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate			Balance			Expense		Rate			Balance			Expense		Rate
ASSETS:
Investment securities:
Taxable	$	461,448		$	4,896		4.22	%	$	571,174		$	7,221		5.02	%	$	498,066		$	17,288		4.64	%	$	509,619		$	18,660		4.90	%
Tax exempt		220,524			2,573		4.64	%		255,200			3,150		4.90	%		227,235			8,156		4.79	%		215,656			7,619		4.72	%
Mortgages - held for sale		32,794			523		6.34	%		21,722			393		7.18	%		33,868			1,544		6.09	%		30,850			1,525		6.61	%
Net loans and leases		3,322,970			50,617		6.06	%		3,179,234			57,677		7.20	%		3,251,499			153,484		6.31	%		2,930,077			158,086		7.21	%
Other investments		37,805			317		3.34	%		76,477			926		4.80	%		36,463			986		3.61	%		85,614			3,282		5.13	%
Total Earning Assets		4,075,541			58,926		5.75	%		4,103,807			69,367		6.71	%		4,047,131			181,458		5.99	%		3,771,816			189,172		6.71	%
Cash and due from banks		79,943								86,794								88,126								78,323
Reserve for loan and lease losses		(73,187	)							(62,513	)							(69,490	)							(60,274	)
Other assets		317,712								318,631								318,181								264,079
Total	$	4,400,009							$	4,446,719							$	4,383,948							$	4,053,944
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing deposits	$	2,964,923		$	20,347		2.73	%	$	3,134,368		$	31,184		3.95	%	$	2,992,747		$	67,116		3.00	%	$	2,852,381		$	85,249		4.00	%
Short-term borrowings		427,895			2,255		2.10	%		297,543			2,978		3.97	%		374,246			6,434		2.30	%		262,748			8,240		4.19	%
Subordinated notes		89,692			1,648		7.31	%		100,089			1,846		7.32	%		91,385			5,067		7.41	%		76,486			4,236		7.40	%
Long-term debt and
mandatorily redeemable securities		34,820			418		4.78	%		44,200			624		5.60	%		34,635			1,333		5.14	%		43,777			2,049		6.26	%
Total Interest-Bearing Liabilities		3,517,330			24,668		2.79	%		3,576,200			36,632		4.06	%		3,493,013			79,950		3.06	%		3,235,392			99,774		4.12	%
Noninterest-bearing  deposits		376,112								355,825								376,727								340,758
Other liabilities		62,348								83,984								71,046								77,228
Shareholders' equity		444,219								430,710								443,162								400,566
Total	$	4,400,009							$	4,446,719							$	4,383,948							$	4,053,944
Net Interest Income				$	34,258							$	32,735							$	101,508							$	89,398
Net Yield on Earning Assets on a Taxable Equivalent Basis							3.34	%							3.16	%							3.35	%							3.17	%

PROVISION AND RESERVE FOR LOAN AND LEASE LOSSES

The provision for loan and lease losses for the three and nine month periods ended September 30, 2008, was $3.57 million and $9.60 million, respectively, compared to the provision for loan and lease losses of $3.66 million and $4.28 million for the three and nine month periods ended September 30, 2007, respectively.  Net recoveries of $0.34million were recorded for the third quarter 2008, compared to net charge-offs of $1.84 million for the same quarter a year ago.  Year-to-date net charge-offs of $0.60 million have been recorded in 2008, compared to net charge-offs of $0.80 million through September 2007.

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In the third quarter 2008, over 30 day loan and lease delinquencies were 0.­­­83%, as compared to 0.42% for the thirdquarter 2007.  The reserve for loan and lease losses as a percentage of loans and leases outstanding at the end of the period was 2.28% as compared to 2.02% for the same period one year ago and 2.09% at December 31, 2007.  A summary of loan and lease loss experienced during the three- and nine- month periods ended September 30, 2008 and 2007 is provided below.

	Summary of Reserve for Loan and Lease Losses
	(Dollars in Thousands)
	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Reserve for loan and lease losses - beginning balance	$	71,698		$	62,682		$	66,602		$	58,802
Acquired reserves from acquisitions		-			165			-			2,379
Charge-offs		(1,006	)		(2,744	)		(3,921	)		(5,097	)
Recoveries		1,343			901			3,322			4,296
Net (charge-offs)/recoveries		337			(1,843	)		(599	)		(801	)
Provision for loan and lease losses		3,571			3,660			9,603			4,284
Reserve for loan and lease losses - ending balance	$	75,606		$	64,664		$	75,606		$	64,664
Loans and leases outstanding at end of period	$	3,314,863		$	3,201,595		$	3,314,863		$	3,201,595
Average loans and leases outstanding during period		3,322,970			3,179,234			3,251,499			2,930,077
Reserve for loan and lease losses as a percentage of
loans and leases outstanding at end of period		2.28	%		2.02	%		2.28	%		2.02	%
Ratio of net charge offs/(recoveries) during period to
average loans and leases outstanding		(0.03	) %		0.23	%		0.03	%		0.04	%

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NONPERFORMING ASSETS

Nonperforming assets were as follows:

(Dollars in thousands)
	September 30,		December 31,		September 30,
	2008		2007		2007
Loans and leases past due 90 days or more	$	1,476	$	1,105	$	693
Nonaccrual and restructured loans and leases		22,812		10,136		10,211
Other real estate		1,615		781		824
Former bank premises held for sale		3,821		4,040		1,855
Repossessions		234		2,291		3,430
Equipment owned under operating leases		40		126		114
Total nonperforming assets	$	29,998	$	18,479	$	17,127

Nonperforming assets totaled $30.00 million at September 30, 2008, an increase of 62.34% from $18.48 million at December 31, 2007 and an increase of 75.15% from $17.13 million at September 30, 2007. The increase during the first nine months of 2008 compared to December 31, 2007 and to September 30, 2007, was primarily related to an increase in nonaccrual loans and leases primarily in the medium and heavy duty truck finance portfolio.  The increase in medium and heavy duty truck nonaccrual loans was primarily the result of several customers continuing to experience cash flow difficulties as a result of high fuel prices and weakened demand for services due to overall economic conditions. Nonperforming assets as a percentage of total loans and leases increased to 0.88% at September 30, 2008, from 0.56% at December 31, 2007, and 0.52% at September 30, 2007.

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As of September 30, 2008, repossessions consisted of aircraft, automobiles, medium and heavy duty trucks, and construction equipment.  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.

Supplemental Loan Information as of September 30, 2008

(Dollars in thousands)			Nonaccrual		Other real estate		Year-to-date
	Loans and leases		and		owned and		net credit losses/
	outstanding		restructured loans		repossessions		(recoveries)
Commercial and agricultural loans	$	671,019	$	1,337	$	19	$	597
Auto, light truck and environmental equipment		337,248		606		143		(198	)
Medium and heavy duty truck		253,682		10,961		-		411
Aircraft financing		608,881		896		16		(1,784	)
Construction equipment financing		383,446		1,448		-		189
Loans secured by real estate		924,313		7,453		1,614		334
Consumer loans		136,274		111		57		523
Total	$	3,314,863	$	22,812	$	1,849	$	72

NONINTEREST INCOME

Noninterest income for the three month periods ended September 30, 2008 and 2007 was $12.38 million and $17.90 million, respectively, and $53.77 million and $54.45 million for the nine month periods ended September 30, 2008 and 2007, respectively.  Details of noninterest income follow:

(Dollars in thousands)	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Noninterest income:
Trust fees	$	4,939		$	3,853		$	14,155		$	11,367
Service charges on deposit accounts		5,761			5,278			16,633			15,074
Mortgage banking income		959			770			3,493			2,400
Insurance commissions		1,084			964			4,122			3,540
Equipment rental income		6,285			5,345			17,794			15,730
Other income		2,168			1,841			6,836			6,042
Investment securities and other investment (losses) gains		(8,816	)		(154	)		(9,259	)		300
Total noninterest income	$	12,380		$	17,897		$	53,774		$	54,453

Noninterest income increased in all categories for the third quarter and year-to-date 2008 as compared to the same periods in 2007 except for investment security loses which offset these increases.  Trust fees increased $1.09 million, or 28.17% during the third quarter of 2008 as compared to the third quarter of 2007, and $2.79 million, or 24.52% for the first nine months of 2008 as compared to the first nine months of 2007.  These increases were primarily due to an increase in assets under management and an increase in our investment advisory management fees received from the 1st Source Monogram Funds.  Service charges on deposit accounts increased for the three and nine month periods ended September 30, 2008 as compared to the same periods in 2007 due to growth in the number of deposit accounts and a higher volume of fee-generating transactions, primarily overdrafts, debit card and nonsufficient funds transactions.

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Mortgage banking income increased due to increased gains on the sales of mortgage loans.  Insurance commissions increased mainly due to an October 2007 acquisition of an insurance agency in the Fort Wayne area.  Equipment rental income increased during the third quarter of 2008 and the first nine months of 2008 primarily due to an increase in the operating lease portfolio.  Other noninterest income remained stable for the three and nine month periods ended September 30, 2008 as compared to the same periods in 2007.

Investment securities and other investment losses increased for the three and nine month periods ended September 30, 2008 as compared to the same periods in 2007 as we recorded $8.07 million and $9.00 million, respectively, in impairment charges on investments in the Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA) preferred stock .  In addition, other than temporary impairment charges of $0.93 million and $1.26 million, respectively, were recorded for the third quarter and year-to-date 2008 on other preferred equity holdings.  Due to the uncertainty of future market conditions and of financial performance of these entities, we were unable to determine when or if this impairment will be recovered and considered this to be an other than temporary impairment.  As of September 30, 2008, the carrying value of our investment in the FHLMC preferred stock was $0.58 million and the carrying value of our investment in the FNMA preferred stock was $0.07 million.

NONINTEREST EXPENSE

Noninterest expense for the three month periods ended September 30, 2008 and 2007 was $38.32 million and $37.44 million, respectively, and $114.61 million and $103.69 million for the nine month periods ended September 30, 2008 and 2007, respectively.   Details of noninterest expense follow:

(Dollars in thousands)	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2008			2007		2008		2007
Noninterest expense:
Salaries and employee benefits	$	19,297		$	20,035	$	58,996	$	55,754
Net occupancy expense		2,332			2,467		7,289		6,552
Furniture and equipment expense		3,694			3,996		11,555		10,838
Depreciation - leased equipment		5,041			4,284		14,266		12,603
Professional fees		2,773			922		6,453		3,089
Supplies and communication		1,812			1,666		5,163		4,450
Business development and marketing expense		881			1,027		2,524		3,302
Intangible asset amortization		351			287		1,052		524
Loan and lease collection and repossession expense		(130	)		345		672		670
Other expense		2,266			2,411		6,643		5,904
Total noninterest expense	$	38,317		$	37,440	$	114,613	$	103,686

For the third quarter of 2008 salaries and employee benefits expense was $19.30 million compared to $20.04 million for the third quarter of 2007. For the first nine months of 2008 salaries and employee benefits expense was $59.00 million compared to $55.75 million for the first nine months of 2007.  This increase was due to a larger work force following the acquisition of FNBV and increased executive incentive and group insurance provisions.

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The increases for the third quarter year-to-date 2008 as compared to 2007 in net occupancy expense, furniture and equipment expense, supplies and communication, and intangible asset amortization were primarily due to the added expenses of FNBV.  For the third quarter 2008, these expense categories all remained relatively stable with third quarter 2007 amounts.  Leased equipment depreciation expense increased in conjunction with the increase in equipment rental income from third quarter and year-to-date of 2007 to third quarter and year-to-date of 2008.  Professional fees increased in the third quarter and first nine months of 2008, as compared to the third quarter and first nine months of 2007 due to expenses recorded for a systems security breach that occurred in May 2008 and other consulting expenses.  Loan and lease collection and repossession expense remained comparable to 2007 levels.  Other expenses decreased for the third quarter and increased year-to-date 2008 as compared to 2007 due to increased FDIC Insurance premiums, correspondent banking fees, and debit card losses.

INCOME TAXES

The provision (benefit) for income taxes for the three and nine month periods ended September 30, 2008, was $(0.58) million and $7.31 million, respectively, compared to $2.37 million and $10.61 million, respectively, for the same periods in 2007.  The effective tax rates were 25.74% for the nine month period ended September 30, 2008, compared to 31.84% for the nine month period ended September 30, 2007. The decrease in the effective tax rate in 2008 was mainly due to an increase in tax-exempt interest in relation to taxable income.  Taxable income declined due to the other than temporary impairment charge on investment securities.  If these investment securities were sold, they would generate capital losses for income tax purposes.  Management believes that there will be adequate capital gains available in prior and subsequent tax periods to offset the capital loss which allows us to realize the full tax benefit of the potential capital loss. The provisions for income taxes for the three and nine month periods ended September 30, 2008 and 2007, are at a rate which management believes approximates the expected effective rate for the year.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in market risks faced by 1st Source since December 31, 2007.  For information regarding 1st Source’s market risk, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2007.

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 September 30, 2008, 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.

-24-

     In addition, there were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the third fiscal quarter of 2008 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 their businesses.  Management does not expect that the outcome of any such proceedings will have a material adverse effect on 1st Source’s consolidated financial position or results of operations.

ITEM 1A. Risk Factors.

Except for the addition of the risk factors detailed below, there have been no material changes in risks previously disclosed under item 1A. of 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2007.

        The soundness of other financial institutions could adversely affect us - Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due us. Any such losses could have a material adverse affect on our financial condition and results of operations.

          Current levels of market volatility are unprecedented - The capital and credit markets have been experiencing extreme volatility and disruption for more than 12 months. In recent weeks, the volatility and disruption have reached unprecedented levels. In some cases, the markets have exerted downward pressure on stock prices, security prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength.  If the current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience adverse effects, which may be material, on our ability to access capital and on our results of operations.

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

ISSUER PURCHASES OF EQUITY SECURITIES

						Maximum number (or approximate
				Total number of shares purchased		dollar value) of shares
				as part of publicly announced		that may yet be purchased under
Period	Total number of shares purchased	Average price paid per share		plans or programs (1)		the plans or programs
July 01 - 31, 2008			-		-		1,447,448
August 01 - 31, 2008			-		-		1,447,448
September 01 - 30, 2008			-		-		1,447,448
(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 552,552 shares.

-25-

ITEM 3.   Defaults Upon Senior Securities.

    None

ITEM 4.   Submission of Matters to a Vote of Security Holders.

    None

ITEM 5.   Other Information.

    None

ITEM 6.   Exhibits.

The following exhibits are filed with this report:

10(k)  Purchase and Sale Agreement with WA Holdings, Inc. dated August 25, 2008.

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.

-26-

    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   October 24 , 2008	/s/CHRISTOPHER J. MURPHY III
	Christopher J. Murphy III
	Chairman of the Board, President and CEO
DATE   October 24, 2008	/s/LARRY E. LENTYCH
	Larry E. Lentych
	Treasurer and Chief Financial Officer
	Principal Accounting Officer

-27-

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Christopher J. Murphy III, Chief Executive Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of 1st Source Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date:  October 24, 2008

/s/CHRISTOPHER J. MURPHY III               

Christopher J. Murphy III

Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Larry E. Lentych, Chief Financial Officer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of 1st Source Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date:   October 24, 2008

/s/LARRY E. LENTYCH

Larry E. Lentych

Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of 1st Source Corporation (1st Source) on Form 10-Q for the quarterly period ended September 30, 2008, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Christopher J. Murphy III, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

        (1)  The Report fully complies with the requirements of sections 13(a) or 15(d) of theSecurities and Exchange Act of 1934; and

        (2)  The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of 1st Source.

By:

/s/CHRISTOPHER J. MURPHY III

Christopher J. Murphy III

Chief Executive Officer

October 24, 2008

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of 1st Source Corporation (1st Source) on Form 10-Q for the quarterly period ended September 30, 2008, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Larry E. Lentych, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

       (1)  The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities and Exchange Act of 1934; and

       (2)  The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of 1st Source.

By:

/s/LARRY E. LENTYCH

Larry E. Lentych

Chief Financial Officer

October 24, 2008

EX-10.K

PURCHASE AND SALE AGREEMENT

This AGREEMENT is made as of this 25th day of August, 2008, by and between 1st Source Corporation Investment Advisors, Inc., an Indiana corporation with a principal place of business at 100 North Michigan Street, South Bend, Indiana 46601 (“Seller”) and WA Holdings, Inc., a Utah corporation with a principal place of business at 150 Social Hall Avenue, 4th Floor, Salt Lake City, Utah 84111 (“Buyer”).

WHEREAS, Seller acts as investment adviser and sponsor to the 1st Source Monogram Income Equity Fund (the “Current Income Equity Fund”), the 1st Source Monogram Long/Short Fund (the “Current Long/Short Fund”) and the 1st Source Monogram Income Fund (the “Current Income Fund”) (in such capacity to the Current Income Equity Fund, Current Long/Short Fund and Current Income Fund, the “Business”) (each of the Current Income Equity Fund, the Current Long/Short Fund and the Current Income Fund is a “Seller Fund” and, collectively, the “Seller Funds”), each a series of the Coventry Group (the “Trust”), a Massachusetts business trust that is registered with the Securities and Exchange Commission (the “SEC”) as an open-end investment company under the Investment Company Act of 1940, as amended (the “1940 Act”); and

WHEREAS, Wasatch Advisors, Inc. (“Wasatch”), a wholly-owned subsidiary of Buyer, acts as investment adviser and sponsor to the Wasatch Funds, Inc. (the “Wasatch Funds”), a Minnesota corporation that is registered with the SEC as an open-end investment company under the 1940 Act; and

WHEREAS, the parties intend to transfer the Business Assets to Buyer under the terms specified in this Agreement in the following manner:  The Wasatch Funds will establish three new funds and file an amendment (the “Amendment”) to its existing Registration Statement on Form N-1A (the “Registration Statement”) with the SEC for the purpose of registering shares of the three new funds (the “Shell Funds”) corresponding to the three Seller Funds (each such respective new fund, or any successor thereto, including by reorganization, asset transfer, merger or otherwise, the “New Income Equity Fund”, the “New Long/Short Fund” and the “New Income Fund” and, collectively following the Closing, the “New Funds”).  Wasatch Advisors will act as the investment adviser to the New Income Equity Fund, New Long/Short Fund and the New Income Fund, and Seller will act as the subadvisor to the New Income Fund.The Wasatch Funds, acting on behalf of the Shell Funds, and the Trust, acting on behalf of the Seller Funds, will enter intoan Agreement and Plan of Reorganization in the form and substance of Exhibit A hereto (the “Reorganization Agreement”) pursuant to which the respective Shell Funds will agree to acquire all of the assets and liabilities of their counterpart Seller Funds in exchange for Shell Fund shares, which in turn will be distributed pro rata to the former shareholders of the Seller Funds in a transaction intended to qualify as a “reorganization” as defined in Section 368(a) of the Internal Revenue Code of 1986, as amended (the “Reorganization”).  Shareholders of the Seller Funds will be solicited to approve the Reorganization by means of a prospectus/proxy statement (the “Prospectus/Proxy Statement”) of the New Funds filed with the SEC and mailed to the shareholders of the Seller Funds in connection with a special meeting to be held for such purpose; and

WHEREAS, on the date hereof and in connection herewith the following agreements ancillary hereto have been entered into:

1.Research and Consulting Agreement by and between Wasatch and Seller (the “Research and Consulting Agreement”);

2.Separation Agreement by and between Ralph C. Shive (“Shive”) and Seller (the “Shive Separation Agreement”);

3.Separation Agreement by and between Michael L. Shinnick (“Shinnick”) and Seller (the “Shinnick Separation Agreement”);

4.Employment Agreement by and between Shive and Buyer (the “Shive Employment Agreement”); and

5.Employment Agreement by and between Shinnick and Buyer (the “Shinnick Employment Agreement”).

NOW, THEREFORE, in consideration of the premises and mutual covenants contained herein and further good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows:

SECTION I.

OFFER AND SALE OF THE BUSINESS; CLOSING

A.Sale of Business Assets.  Subject to the terms and conditions contained in this Agreement, upon the Closing, Seller will assign, transfer and sell the Business Assets to Buyer and Buyer will purchase and accept the Business Assets from Seller in consideration of the purchase price set forth in subsection D below (the “Purchase Price”).  The term “Business Assets” means all right, title and interest that Seller possesses and has the right to transfer in and to (i) the goodwill of the Business and (ii) the performance record and related records of the Business.  Other than the Business Assets, Seller is not assigning, transferring or selling any assets of Seller to Buyer.

B.Liabilities.  Seller agrees to retain all pre-Closing liabilities associated with the Business.  Buyer is not assuming any liabilities from Seller as part of the transactions contemplated by this Agreement.

C.Closing Date and Place.  Subject to the terms and conditions of Section IV hereof (the “Closing Conditions”), the consummation of the transactions referred to in this Agreement (the “Closing”) shall take place promptly following the satisfaction or waiver of the condition precedents in Section IV below, or on such other date as may be agreed upon by the parties (the “Closing Date”), and in any event shall take place simultaneously with the closing of the transactions contemplated by the Reorganization Agreement.The Closing shall take place at the offices of Vedder Price P.C., 222 North LaSalle Street, Chicago, Illinois 60601-1003, or such other place as the parties mutually agree.  The parties agree that the Closing may occur by the electronic transmission or courier delivery of any documents required in connection with the

2

Closing and that neither party will be required to have a representative physically present at the Closing.

D.Purchase Price.  The Purchase Price shall equal the sum of all amounts due under the Initial Payment, Earn-Out Fees and Aggregate IE Value Earn-Out Fees as described in subsections 1, 2 and 3 below.

1.Thirteen Million Dollars ($13,000,000) to be paid at Closing (the “Initial Payment”).

2.Buyer shall pay Seller a purchase price earn-out fee (“Earn-Out Fee”) for each of the New Income Equity Fund and the New Long/Short Fund (calculated as set forth in (a) through (c) below) monthly for each month (or portion thereof) beginning with the month in which the Closing occurs and ending with the month during which falls the tenth anniversary of the Closing (the “Earn-Out Fee Term”).  Each Earn-Out Fee payment shall equal the sum of the Daily Earn-Out Fees for each Fund for each month (or portion thereof), and shall be paid within ten days following the end of the calendar month, with the first Earn-Out Fee payment due within ten days following the end of the calendar month in which the Closing occurs.  Exhibit B attached hereto sets forth an example of the calculation of the Earn-Out Fees using actual data for the time period set forth thereon.  Each Earn-Out Fee shall be calculated in accordance with the terms hereof, including as set forth on Exhibit B.  With each monthly Earn-Out Fee payment, Buyer shall provide Seller with a spreadsheet in the form of Exhibit B hereto showing its calculation of the amount due and then being paid and such spreadsheet shall be certified as true, accurate and correct by the Buyer’s chief financial officer.

(a).For each day in the period (the month or partial month), the Daily Earn-Out Fee for the New Income Equity Fund shall be an amount equal to (i) 0.0015/365, multiplied by (ii) an amount (“IE Net New Assets”) equal to the excess, if any, of (A) the total ending assets in the New Income Equity Fund as of the close of business (the “IE Aggregate Market Value”), over (B) (i) Six Hundred and Twenty-Seven Million Eight Hundred Sixty-Three Thousand Five Hundred Ninety-Six Dollars and Thirty-Two Cents ($627,863,596.32) multiplied by (ii) one plus the fund’s Cumulative Fund Return from June 15, 2008 through the day of the calculation (the “IE Adjusted Base Assets”).  The Daily Earn-Out Fee for each day that is not a business day shall equal the Daily Earn-Out Fee, if any, for the preceding business day.

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(b).For each day in the period (the month or partial month), the Daily Earn-Out Fee for the New Long/Short Fund shall be an amount equal to (i) 0.0015/365, multiplied by (ii) an amount (“LS Net New Assets”) equal to the excess, if any, of (A) the total ending assets in the New Long/Short Fund as of the close of business (the “LS Aggregate Market Value”), over (B) (i) Ninety-Nine Million Nine Hundred Thirty-Three Thousand Nine Hundred Ninety-Four Dollars and Forty-Four Cents ($99,933,994.44) multiplied by (ii) one plus the fund’s Cumulative Fund Return from June 15, 2008 through the day of the calculation (the “LS Adjusted Base Assets”).  The Daily Earn-Out Fee for each day that is not a business day shall equal the Daily Earn-Out Fee, if any, for the preceding business day.

(c).Definitions and special rules:

(i)“Base NAV” means, for the New Income Equity Fund, $14.920 per share, and for the New Long/Short Fund, $11.770 per share.

(ii)“Cumulative Fund Return” means, for each of the New Income Equity Fund and New Long/Short Fund, the quotient obtained by dividing (A) the sum of (i) the Daily NAV Changes (positive or negative) for such fund (or its predecessor) for each day beginning on [June 16, 2008] and continuing through the computation date, plus (ii) the cumulative per-share distributions expressed as a positive number (whether dividend, capital gains, or otherwise) made by such fund (or its predecessor) for all periods beginning on [June 16, 2008] and continuing through the computation date, by (B) the Base NAV with respect to such fund.

(iii)“Daily NAV Change” means, for each of the New Income Equity Fund and New Long/Short Fund, the per-share net asset value (NAV) as of the close of business on such day, minus the per-share NAV of such fund (or its predecessor) as of the close of business the prior business day, in each case computed in accordance with generally accepted accounting principals consistent with past practice of each such fund.

(iv)In the event of a split, combination, subdivision or other similar adjustment to the number of shares in the New Income Equity Fund or the New Long/Short Fund, the calculations of the amounts due shall be appropriately adjusted.

(d).Each Earn-Out Fee payment under this Section I.D.2. will be subject to a discount of ten percent (10%) (the “Earn-Out Fee Discount”) so long as each of the following conditions remain true and correct (the “Discount Conditions”):

(i)Shive and Shinnick are employed by Buyer or an affiliate of Buyer and Shive is acting as portfolio manager to the New Income Equity Fund and Shinnick is acting as portfolio manager to the New Long/Short Fund;

(ii)Buyer is not in breach of any of the terms of the Research and Consulting Agreement (including such provisions contained in such agreement with respect to Shive and Shinnick  performing the consulting services called for in such agreement in accordance with the terms thereof); and

(iii)Buyer is not in breach of any of the terms hereof, including, without limitation, Article VII hereof and Shive and Shinnick are not in violation of the restrictive covenants referenced in Section VII.B. hereof (assuming for the purposes hereof that Shive and Shinnick were in direct privity with Seller with respect to such restrictive covenants).

Upon any of the Discount Conditions becoming unsatisfied for any reason, the Earn-Out Fee Discount shall no longer be applicable to any Earn-Out Fee payment.

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3.In addition to the Earn-Out Fees set forth above, Buyer shall pay Seller an additional fee (“Aggregate IE Value Earn-Out Fee”) which shall accrue daily beginning the day after the Closing Date and continuing through the five (5) year anniversary of the Closing Date, in a daily amount equal to (i) the Incremental IE Management Fee divided by 365, multiplied by (ii) the IE Aggregate Market Value as of the close of business on each such day.  The “Incremental IE Management Fee” means 90% of the amount by which the gross investment management fee payable by the New Income Equity Fund exceeds eighty (80) basis points of assets annually; provided that the Incremental IE Management Fee shall not exceed nine (9) basis points.  The Aggregate IE Value Earn-Out Fee will be paid monthly for five years following Closing.  Each Aggregate IE Value Earn-Out Fee that is due will be paid within ten days of the end of the calendar month, with the first Aggregate IE Value Earn-Out Fee payment due within ten days of the end of the calendar month in which Closing occurs.  Exhibit B attached hereto sets forth an example of the calculations of the Aggregate IE Value Earn-Out Fee using actual data for the time period set forth thereon.  Each Aggregate IE Value Earn-Out Fee shall be calculated in accordance with the  terms hereof, including as set forth on Exhibit B.  With each monthly Aggregate IE Value Earn-Out Fee payment, Buyer shall provide Seller with a spreadsheet in the form of Exhibit B hereto showing its calculation of the amount then due and being paid and such spreadsheet shall be certified as true, accurate and correct by the chief financial officer of Buyer.

4.With respect to the determination of the Earn-Out Fee or the Aggregate IE Value Earn-Out Fee, Buyer and Seller hereby agree that:

(a).Buyer shall deliver or make available to Seller and/or its representatives promptly and, in any event, within two (2) business days after any written request, any and all work papers or other information of Buyer or any third party (including each transfer agent) related to monthly spreadsheet and the determination, preparation or calculation of the Earn-Out Fee and the Aggregate IE Value Earn-Out Fee, including, without limitation, the number of units outstanding and the aggregate value of each New Fund on a daily basis.If Seller does not object, or otherwise fails to respond, to the determination of the Earn-Out Fee or the Aggregate IE Value Earn-Out Fee as set forth by Buyer within thirty (30) days after delivery of such monthly spreadsheet to Seller (such period of time to be reasonably extended in the event that Buyer fails to promptly provide such work papers or other information in accordance with the immediately preceding sentence), then such determination of the Earn-Out Fee or the Aggregate IE Value Earn-Out Fee, as the case may be, specified therein shall automatically become final and conclusive.  In the event that Seller objects to the determination of the Earn-Out Fee or the Aggregate IE Value Earn-Out Fee as set forth by Buyer within such thirty (30) day period (as may be extended pursuant to the immediately preceding sentence), Seller and Buyer shall promptly meet and endeavor to reach agreement as to the determination of the Earn-Out Fee or the Aggregate IE Value Earn-Out Fee, as the case may be.  If Seller and Buyer agree on the determination of the Earn-Out Fee or the Aggregate IE Value Earn-Out Fee, as the case may be (as revised pursuant to any agreement between Buyer and Seller), then the specified determination therein shall become final and conclusive.  If Seller and Buyer are unable to reach agreement within twenty-one (21) days after the delivery of such objection to the determination of the Earn-Out Fee or the Aggregate IE Value Earn-Out Fee, as the case may be, then Grant Thornton LLP (the

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“Independent Accountants”) shall promptly be retained to undertake a determination of the Earn-Out Fee or the Aggregate IE Value Earn-Out Fee, as the case may be.  Only disputed item(s) shall be submitted to the Independent Accountants for review.  In resolving any disputed item, the Independent Accountants may not assign a value to such item greater than the greatest value for such item claimed by either party or less than the lowest value for such item claimed by either party, in each case as presented to the Independent Accountants.  The determination of the Independent Accountants as to any item in dispute shall be based solely on presentations by Seller and Buyer (i.e., not on independent review), and on the definitions set forth and other provisions contained in this Agreement.  Such determination of the Independent Accountants shall be final and binding on Seller and Buyer.

(b).Within five (5) business days of the final determination of the Earn-Out Fee or Aggregate IE Value Earn-Out Fee, pursuant to this Section 4, Buyer or Seller, as the case may be, shall pay or cause to be paid to the other an amount equal to (i) the amount by which the final Earn-Out Fee or Aggregate IE Value Earn-Out Fee is greater or less than the original Earn-Out Fee or Aggregate IE Value Earn-Out Fee set forth and paid by Buyer to Seller, and (ii) interest on such amount at a rate equal to the lower of (x) ten percent (10%) per annum or (y) the highest rate permitted by law thereon, from the date of such original payment of the Earn-Out Fee or Aggregate IE Value Earn-Out Fee to the date of payment of the final determined Earn-Out Fee or Aggregate IE Value Earn-Out Fee pursuant to this Section 4, as the case may be (such difference and interest thereon being the “Fee Reconciliation Amount”).  If the Fee Reconciliation Amount results in the payment of additional funds to Seller, Buyer shall promptly pay such Fee Reconciliation Amount to Seller and pay all expenses and fees of the Independent Accountants with respect to such final determination.  If the Fee Reconciliation Amount does not result in the payment of additional funds to Seller, Seller shall promptly pay or cause to be paid all expenses and fees of the Independent Accountants with respect to such final determination.  Final determination and payment of the Fee Reconciliation Amount shall be made without regard to any claims or offsets that either Seller or Buyer may have asserted against one another.

5.Any Earn-Out Fee or Aggregate IE Value Earn-Out Fee payment which is not paid when due shall accrue interest at a rate equal to the lower of (x) ten percent (10%) per annum or (y) the highest rate permitted by law, from the due date of such payment until the date such payment (including all accrued interest) is paid in full.

E.Income Fund.  Wasatch will promptly recommend to the Wasatch Funds Board of Directors (the “Wasatch Board”) that Seller become the investment subadvisor to the New Income Fund and the Investment Subadvisory Agreement with respect to such Income Fund shall be as set forth in Exhibit C hereto (the “New Investment Subadvisory Agreement”).  The investment management fee of the New Income Fund will continue at 0.55% of average daily net assets annually, and 0.52% of average daily net assets will be paid to Seller pursuant to the Income Fund New Investment Subadvisory Agreement.  Subject to its fiduciary duties, Buyer will use its reasonable best efforts to cause the Wasatch Board to not terminate or fail to renew Seller as the subadvisor to the New Income Fund on substantially the terms, and with respect to

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the subadvisory fees, on terms not less favorable than, as set forth in the New Investment Subadvisory Agreement.

F.Making of Payments.  Buyer shall make all payments of the Purchase Price in immediately available funds by wire transfer to the account or accounts designated by Seller.

G.Allocation of Purchase Price.  The Purchase Price shall be allocated among the Business Assets as mutually agreed between Buyer and Seller prior to the Closing Date.  The parties agree that such allocation shall be used by them and respected for all purposes, including income tax purposes, and that the parties shall follow such allocation for all reporting purposes.

H.Closing Deliveries.  At the Closing, (i) the Seller will execute and deliver the certificate referenced in Section IV.B.4.; (ii) the Buyer will execute and deliver the certificate referenced in Section IV.A.3; (iii) the Seller will execute and deliver to Buyer a bill of sale (the “Bill of Sale”); and (iv) Buyer will deliver to Seller the Initial Payment as specified in Section I.D.1.

SECTION II.

REPRESENTATIONS, WARRANTIES AND COVENANTS OF SELLER

Except as otherwise disclosed to Buyer in the Seller’s disclosure schedules to this Agreement (“Seller’s Disclosure Schedules”), Seller hereby represents and warrants to Buyer as of the date hereof the matters set forth in Sections II.A, B, C, D and E below and covenants with Buyer the matters set forth in Section II.F below as follows:

A.Authority to Execute and Perform Agreements; Enforceability.

1.Seller has the full legal right and power and all authority and approval required to enter into, execute and deliver this Agreement and to perform its obligations hereunder; and

2.This Agreement has been duly authorized, executed and delivered and is a valid and binding obligation of Seller, enforceable against Seller in accordance with its terms, subject only to qualifications relating to the enforcement of rights and remedies created under bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting the rights and remedies of creditors and general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law).

3.Subject to approval of the Reorganization Agreement by the Board of Trustees of the Trust, the Trust, on behalf of each of the Seller Funds, has the full legal right and power and all authority and approval required to enter into, execute and deliver the Reorganization Agreement and to perform its obligations thereunder; and

4.The Reorganization Agreement is fully enforceable against the Seller Funds in accordance with its terms, subject only to qualifications relating to the enforcement of rights and remedies created under bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting the rights and remedies of creditors and general principles

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of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law).

B.Non-Contravention; Compliance.

1.The execution, delivery and performance of this Agreement by Seller, and the consummation of the transactions contemplated hereby on the terms and conditions stated herein, will not violate any provision of Federal or state law, statute, ordinance or regulation or the rules of self-regulatory organizations (“Laws”) applicable to Seller and will not conflict with, or result in the breach or termination of any provision of, or constitute a default under, any material contract, other instrument or agreement by which Seller is bound;

2.Seller, and 1st Source Bank, and, to Seller’s knowledge, the Seller Funds have at all times conducted their respective businesses and all operations in material compliance with, and each of them is in material compliance with, all Laws applicable to each such entity and their respective businesses;

3.To the Seller’s knowledge, the execution, delivery and performance of the Reorganization Agreement by the Trust on behalf of the Seller Funds and the consummation of the transactions contemplated thereby on the terms and conditions stated therein, will not violate any provision of Law applicable to the Seller Funds or the Trust and will not conflict with, or result in the breach or termination of any provision of, or constitute a default under, any material contract, other instrument or agreement by which any of the Seller Funds or the Trust or their respective assets are bound; and

4.Seller is registered under the Investment Advisers Act of 1940, as amended (“Advisers Act”) as an investment adviser with the SEC.

C.Litigation.  There is no litigation, proceeding or, to Seller’s knowledge, investigation, pending or threatened before any court or governmental or regulatory agency against Seller or, to Seller’s knowledge, any of the Seller Funds that involves or could be reasonably expected to adversely affect, the Business, the Seller Funds, the transactions contemplated by this Agreement or the Reorganization Agreement, or the Business Assets to be acquired by Buyer pursuant to this Agreement.

D.Insolvency.  Seller is not insolvent, and no proceedings, in a court having jurisdiction, under any state or federal bankruptcy or insolvency law or under laws for relief of debtors, by or against Seller have been made.

E.Disclosure Matters.  All information supplied in writing to Buyer or its counsel by Seller for inclusion in the Prospectus/Proxy Statement, the Registration Statement and the Amendment relating to Seller, the Seller Funds, and their respective affiliates (as such term is defined under the 1940 Act) and their respective officers, directors, and trustees and to Seller’s knowledge, by service providers to the Seller Funds (excluding Seller) (collectively, “Seller Information”), will be true and correct in all material respects at the time indicated, as the case may be, and shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading to a

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shareholder of the Seller Funds evaluating the transactions described in the Prospectus/Proxy Statement.

F.Covenants Pending the Closing.  Except as otherwise provided herein, from and after the date hereof and until the Closing Date:

1.Seller will permit Buyer and its representatives (including its counsel and auditors), at reasonable times during normal business hours and in a manner which will not materially disrupt the Business, to have free and full access to examine and make copies of all Seller’s books and records pertaining to the Business, whether or not delivered to Buyer pursuant hereto (including, but not limited to, correspondence, corporate minutes and record books, memoranda, books of account, accountants’ work papers and the like), in order that Buyer may have full opportunity to make such investigation as it shall desire of the Business and the Seller Funds.  Such access shall be subject to any and all confidentiality obligations of Seller thereto and any attorney-client privilege of Seller thereto.Seller will use its reasonable best efforts to allow Buyer access to the books and records of the Seller Funds’ service providers and the books and records of the Seller Funds.  All information obtained by Buyer during such investigations shall be kept in confidence and shall be used and held as confidential and proprietary information pursuant to the terms and conditions of that certain Non-Disclosure & Non-Solicitation Agreement by and between Buyer and Seller, dated as of March 3, 2008.

2.Seller will continue to operate the Business in material compliance with applicable Laws and consistent with past practices and shall not take any action, or fail to take any action, which could be reasonably expected to have a material adverse effect on the Business or the Seller Funds.

3.Seller will not, directly or indirectly, solicit, encourage or facilitate the making or submission of any Acquisition Proposal or take any action that could reasonably be expected to lead to an Acquisition Proposal, including engaging in discussions or negotiations with any person with respect to any acquisition proposal or that could reasonably be expected to lead to an acquisition proposal.  For purposes of this subsection, an “Acquisition Proposal” means any offer, proposal, inquiry or indication of interest regarding an acquisition, merger or other similar transaction with the Seller Funds.

4.Seller will use its reasonable best efforts to cause the conditions set forth in Section IV to be satisfied and to consummate the transactions contemplated by this Agreement as soon as reasonably possible and in any event prior to the Closing Date.

SECTION III.

REPRESENTATIONS, WARRANTIES AND COVENANTS OF BUYER

Buyer represents and warrants  to Seller as of the date hereof the matters set forth in Sections III.A, B, C, D and E below and covenants with Seller the matters set forth in Sections III.F. and G. below as follows:

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A.Authority to Execute and Perform Agreements; Enforceability.

1.Buyer has the full legal right and power and all authority and approval required to enter into, execute and deliver this Agreement and to perform its obligations hereunder;

2.This Agreement has been duly authorized, executed and delivered and is a valid and binding obligation of Buyer, enforceable against Buyer in accordance with its terms, subject only to qualifications relating to the enforcement of rights and remedies created under bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting the rights and remedies of creditors and general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law);

3.Subject to approval of the Reorganization Agreement by the Board of Directors of the Wasatch Funds, the Wasatch Funds, on behalf of each of the Shell Funds, has the full legal right and power and all authority and approval required to enter into, execute and deliver the Reorganization Agreement and to perform its obligations thereunder;

4.The Reorganization Agreement is fully enforceable against the Shell Funds in accordance with its terms, subject only to qualifications relating to the enforcement of rights and remedies created under bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting the rights and remedies of creditors and general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law); and

5.Buyer has the financial capacity to pay the Initial Payment and to consummate this Agreement and transactions contemplated herein.

B.Non-Contravention; Compliance.

1.The execution, delivery and performance of this Agreement by Buyer, and the consummation of the transactions contemplated hereby on the terms and conditions stated herein, will not violate any Laws applicable to Buyer or Wasatch and will not conflict with, or result in the breach or termination of any provision of, or constitute a default under, any material contract, other instrument or agreement by which Buyer, Wasatch or their respective assets are bound;

2.To Buyer’s knowledge, the execution, delivery and performance of the Reorganization Agreement by Wasatch Funds on behalf of the Shell Funds, and the consummation of the transactions contemplated thereby on the terms and conditions stated therein, will not violate any provision of Law applicable to Wasatch Funds and will not conflict with, or result in the breach or termination of any provision of, or constitute a default under, any material contract, other instrument or agreement by which any of the Wasatch Funds or their respective assets are bound;

3.The Wasatch Funds, Buyer and Wasatch have at all times conducted their respective businesses and all operations in material compliance with, and each of them is in material compliance with, all Laws applicable to them and their respective businesses; and

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4.Wasatch is registered under the Advisers Act as an investment adviser with the SEC.

C.Litigation.  There is no litigation, proceeding or, to Buyer’s knowledge, investigation pending or threatened before any court or governmental or regulatory agency against Wasatch Funds, Buyer or Wasatch that involves or could be reasonably expected to adversely affect any of them or the transactions contemplated by this Agreement or the Reorganization Agreement.

D.Insolvency.  Neither Buyer nor Wasatch is insolvent, and no proceedings, in a court having jurisdiction, under any state or federal bankruptcy or insolvency law or under laws for relief of debtors, by or against Buyer or Wasatch have been made.

E.Disclosure Matters.  All information contained in the Registration Statement, the Amendment and the Prospectus/Proxy Statement (other than Seller Information) (collectively, “Wasatch Information”), will be true and correct in all material respects at the time indicated, as the case may be; and neither the Registration Statement, the Amendment or the Prospectus/Proxy Statement, when they shall be authorized for use, will, with respect to any Wasatch Information, include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading.

F.Office.  Prior to Closing, Buyer will establish an office in the South Bend area in a building whose principal tenant is not a financial institution which competes with Seller’s Bank.

G.Certain Covenants of Buyer.  Buyer will, and will cause its affiliates, including, without limitation, Wasatch, to use its reasonable best efforts to promptly cause the establishment of the Shell Funds, the Amendment to be filed with and declared effective by the SEC in an expeditious manner, to cause the Board of Trustees of the Wasatch Funds to approve the Reorganization Agreement and the transactions contemplated thereby with the fee schedules agreed to by Buyer and Seller, and to cause the transactions contemplated by this Agreement to be completed.  In connection therewith, Buyer will, and will cause Wasatch to provide Seller with a draft of any written presentation to be provided to the Wasatch Board in connection with this Agreement and the Reorganization (“Board materials”) and allow Seller to provide comments on the same.  Buyer will, and will cause Wasatch to provide Seller with final Board materials.

SECTION IV.

CLOSING CONDITIONS

A.Conditions to Closing Obligations of Seller.  The obligations of Seller to consummate the transactions by it in connection with the Closing are subject to the satisfaction or the waiver by Seller of the following conditions on or prior to the Closing Date:

1.All of the covenants and agreements herein on the part of Buyer to be complied with or performed on or before the Closing Date shall have been fully complied with and performed;

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2.All of the representations and warranties on the part of Buyer made in this Agreement shall be true and correct on the Closing Date to the same extent as if made at and as of such date;

3.Buyer shall have delivered a certificate, executed by an authorized officer, attesting to the satisfaction of conditions IV.A.1 and 2 above; and

B.Conditions to Closing Obligations of Buyer.  The obligations of Buyer to consummate the transactions by it in connection with the Closing are subject to the satisfaction or the waiver by Buyer of the following conditions on or prior to the Closing Date:

1.All of the covenants, agreements and conditions herein on the part of Seller to be complied with or performed on or before the Closing Date shall have been fully complied with and performed;

2.All of the representations and warranties of Seller made in this Agreement shall be true and correct on the Closing Date as though made at and as of such date;

3.There shall have been no event, occurrence or circumstance which could be reasonably expected to have a material adverse effect on the Business or the Seller Funds, other than events, occurrences or circumstances that impact similar businesses and/or funds in a similar manner; provided, that unfavorable investment performance by the Seller Funds shall in no event be deemed to be such an event, occurrence or circumstance; and

4.Seller shall have delivered a certificate, executed by an authorized officer, attesting to the satisfaction of conditions IV.B.1, 2 and 3 above.

C.Conditions to Closing Obligations of Both Parties.  The obligations of each party to this Agreement to consummate the transactions by it in connection with the Closing are subject to the satisfaction of the following conditions on or prior to the Closing Date:

1.Citi Fund Services (“Citi”) shall have provided notice of termination on behalf of the Seller Funds to Citi, Foreside Distribution Services L.P. and Fifth Third Bank with respect to the agreements between the Seller Funds and such parties.

2.The Prospectus/Proxy Statement and Amendment shall each have been declared effective by the SEC; no stop order suspending such effectiveness shall have been entered; and no proceedings to obtain such a stop order shall have been instituted or, to the knowledge of any of the parties to this Agreement, shall have been threatened by the SEC;

3.The Wasatch Board shall have approved the Reorganization Agreement, the investment advisory agreement between Wasatch and the Shell Funds (the “New Advisory Agreement”) and the New Investment Subadvisory Agreement, the Coventry Board shall have approved the Reorganization Agreement and the shareholders of each Seller Fund shall have approved the Reorganization Agreement by the requisite vote (the approval of the Wasatch Board, Coventry Board and shareholders of the Seller Funds shall be on the economic terms agreed to between Seller and Buyer, including, but not limited to, the management fee of the New Income Equity Fund, New Long/Short Fund and New Income Fund being .90%, 1.10% and

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.55% and the subadvisory fee of the New Income Fund being .52% of the respective fund’s average daily net assets without breakpoints in the management fees), Wasatch shall have entered into the New Advisory Agreement with Wasatch Funds and Seller shall have entered into the New Investment Subadvisory Agreement with Wasatch to subadvise the New Income Fund and the transactions contemplated by the Reorganization Agreement shall have been completed with respect to each Seller Fund simultaneously with the Closing of the transactions contemplated by this Agreement.

D.Waiver of Certain Conditions to Closing.  Anything in this Agreement to the contrary notwithstanding, if any one or more of the conditions specified in paragraphs A through C above shall not have been satisfied, the party or parties entitled to the benefit of such condition may waive such condition and nevertheless proceed with the transactions contemplated hereby.  In the event of any such waiver, the party granting such waiver shall not thereafter have the right to proceed against the other party for damages resulting from the failure of the condition waived to have been satisfied.

SECTION V.

INDEMNIFICATION

A.Indemnification by Buyer.  Buyer agrees, subject to subsections C and D below, to indemnify and hold harmless Seller and the Seller Funds, and their respective directors, trustees, officers, employees, agents, affiliates and managers (“Seller Indemnitees”), from and against all demands, claims, actions or causes of action, assessments, damages, liabilities, costs and further expenses, including, without limitation, interest, penalties and attorneys’ and professionals’ and experts’ fees and expenses (collectively, “Seller Losses”), asserted against, resulting to, imposed upon or incurred by any Seller Indemnitee, directly or indirectly, by reason of or resulting from:

1.a breach, misrepresentation or inaccuracy of any representation, warranty, covenant or agreement of Buyer contained in this Agreement or in any certificate delivered pursuant hereto;

2.any misstatement or omission in the Wasatch Information referred to in Section III.E; and

3.any liabilities relating to or arising out of the operation of the Business by Buyer from and after the Closing.

B.Indemnification by Seller.  Seller agrees, subject to subsections C, D and E below, to indemnify and hold harmless Buyer, Wasatch and the Wasatch Funds and their respective directors, trustees, officers, employees, agents, affiliates and managers (the “Buyer Indemnitees”), from and against all demands, claims, actions or causes of action, assessments, damages, liabilities, costs and further expenses, including, without limitation, interest, penalties and attorneys’ and professionals’ and experts’ fees and expenses (collectively, “Buyer Losses”), asserted against, resulting to, imposed upon or incurred by Buyer Indemnitee, directly or indirectly, by reason of or resulting from:

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1.a breach, misrepresentation or inaccuracy of any representation, warranty, covenant or agreement of Seller contained in this Agreement or any certificate delivered pursuant hereto;

2.any misstatement or omission in the Seller Information referred to in Section II.E; and

3.any liabilities relating to or arising out of the operation of the Business by Seller prior to the Closing.

C.Procedures for Indemnification.  Any party seeking indemnification hereunder (an “Indemnitee”) shall give prompt written notice to the party against which indemnification is sought (the “Indemnitor”) of any claims against the Indemnitee as to which a claim for indemnification is to be made hereunder, which notice shall specify the nature of such claim; provided, however, that the failure to provide such prompt written notice shall not affect the indemnification obligations hereunder, except to the extent that the Indemnitor is harmed by such failure or delay.  The Indemnitor shall have the right to participate, at its own expense, in the defense of any such claim or its settlement, and the Indemnitee shall permit the Indemnitor to take over the investigation, defense and settlement of any such claim with counsel reasonably satisfactory to the Indemnitee, provided that the Indemnitor bears the fees and expenses of such counsel.  Notwithstanding the preceding sentence, (i) the Indemnitor shall not settle any action without the consent of the Indemnitee unless the settlement has no monetary consequences to the Indemnitee and the terms of the settlement have no material impact on the conduct of the Indemnitee’s or its affiliates’ conduct of their business, and (ii) if the Indemnitee reasonably believes that it has defenses which conflict with or are in addition to those which may be asserted by the Indemnitor, the Indemnitee may, at the expense of the Indemnitor, retain separate counsel.  Notwithstanding the foregoing, no Indemnitor shall be obligated to indemnify any Indemnitee unless written notice of the claim with respect to which indemnification is sought was provided to such Indemnitor as provided in the first sentence of this paragraph within the two-year period following the Closing Date.

D.Survival of Representations and Warranties.  All representations and warranties made by any party in this Agreement shall survive the execution and delivery of this Agreement and the Closing for a period of two years following the Closing Date.  All covenants and agreements made by any party in this Agreement shall survive the execution and delivery of this Agreement and the Closing until fully performed or discharged.

E.Limitations on Indemnification Obligations of Seller.  The rights of the Buyer Indemnitees to indemnification pursuant to the provisions of Section V.B are subject to the following limitations:

1.the amount of any and all Buyer Losses will be determined net of (i) any amounts recovered by the Buyer Indemnitees under insurance policies or other collateral sources (such as contractual indemnities of any person that are contained outside of this Agreement) with respect to such Buyer Losses (and that the Buyer Indemnitees agree to use commercially reasonable efforts to cover all possible amounts from such sources) and (ii) any tax benefits actually realized with respect to such Buyer Losses;

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2.the Buyer Indemnitees will not be entitled to recover Buyer Losses pursuant to Section V.B until the total amount that the Buyer Indemnitees would recover under Section V.B, exceeds $50,000 (the “Basket”), provided that once the Basket amount is reached the Buyer Indemnitees will be entitled to receive the entire amount of Buyer Losses; and

3.the Buyer Indemnitees will not be entitled to recover Buyer Losses if the aggregate claims actually paid by Seller on account thereof exceed the Initial Payment (the “Cap”).

F.Limitations on Indemnification Obligations of Buyer.  The rights of the Seller Indemnitees to indemnification pursuant to the provisions of Section V.A are subject to the following limitations (which limitations shall not apply to any breach by Buyer of its covenants to pay the Purchase Price):

1.the amount of any and all Seller Losses will be determined net of (i) any amounts recovered by the Seller Indemnitees under insurance policies or other collateral sources (such as contractual indemnities of any person that are contained outside of this Agreement) with respect to such Seller Losses (and that the Seller Indemnitees agree to use commercially reasonable efforts to cover all possible amounts from such sources and (ii) any tax benefits actually realized with respect to such Seller Losses);

2.the Seller Indemnitees will not be entitled to recover Seller Losses pursuant to Section V.A until the total amount that the Seller Indemnitees would recover under Section V.A, exceeds $50,000 (the “Basket”), provided that once the Basket amount is reached the Seller Indemnitees will be entitled to receive the entire amount of Seller Losses; and

3.the Seller Indemnitees will not be entitled to recover Seller Losses if the aggregate claims actually paid by Buyer on account thereof exceed the Initial Payment (the “Cap”).

SECTION VI.

TERMINATION

Notwithstanding anything to the contrary contained herein, this Agreement and the transactions contemplated hereby with respect to an affected party may be terminated (a) by either party upon written notice to the other party if the Closing has not occurred on or before February 28, 2009; (b) if a party is in material breach of its obligations hereunder and has not cured such breach within 10 days following written notice thereof provided to it by the other party, upon written notice by the non-breaching party to the breaching party; or (c) by mutual written agreement of both parties.  In the event of termination of this Agreement as provided above, this Agreement shall forthwith become void, and there shall be no liability on the part of Seller or Buyer, except for willful breaches of this Agreement prior to the time of such termination, provided, however, the obligations of Buyer, Seller and their respective affiliates under that certain Non-Disclosure & Non-Solicitation Agreement, dated as of March 3, 2008, shall survive.

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SECTION VII.

POST-CLOSING COVENANTS

A.During the Earn-Out Fee Term, Buyer and its employees and affiliates will not pro-actively solicit separate account clients or compete with Seller and its affiliates to provide asset management or investment advisory services for any separate account clients within the Covered Counties; provided, however, that Buyer may reactively accept and follow up on any potential clients introduced to Buyer through any third party not affiliated with Buyer, including a consultant or pension advisory firm to which Wasatch has furnished data and/or has an ongoing relationship.  Furthermore, this Subsection A does not apply to wrap programs of national brokerage platforms that extend into the Covered Counties.  The term “Covered Counties” shall mean the following counties:  (i) Berrien, Cass and Kalamazoo counties in the State of Michigan, and (ii) Allen, Elkhart, Fulton, Huntington, Kosciusko, La Porte, Marshall, Porter, Pulaski, St. Joseph, Starke, Wells and Whitley counties in the State of Indiana.

B.1. Without the prior written consent of Seller, while employed by Buyer or an affiliate of Buyer, and for a period of twelve (12) months thereafter (the “One Year Tail Period”) (the last day of such employment, the “Termination Date”), Buyer will use its best efforts to causeeach of Shive and Shinnick to not directly or indirectly (either alone or in concert with others) provide any asset management or investment advisory services to clients or prospects of Seller with whom Shive or Shinnick had a professional relationship while Shive or Shinnick was employed by Seller or Buyer.

2.Buyer will include the foregoing restrictive covenant provisions in the Shive Employment Agreement and Shinnick Employment Agreement, will not amend such employment agreements to remove such provisions, will include Seller as a third party beneficiary of such covenants and will enforce such provisions against Shive and Shinnick to the best of its ability, including through litigation, if necessary.

C.Buyer acknowledges that the restrictions contained in this Section VII are reasonable and necessary to protect the legitimate interests of Seller and do not cause Buyer undue hardship.  Buyer acknowledges that any violation of this Section VII could cause irreparable harm to Seller, that damages for such harm may be incapable of precise measurement and that, as a result, Seller may not have an adequate remedy at law to redress the harm caused by such violations.  Therefore, in the event of an alleged violation of this Section VII by Buyer or any of its affiliates, Buyer agrees that, in addition to its other remedies, Seller shall be entitled to seek injunctive relief and other equitable remedies, including, but not limited to, immediate temporary injunction, temporary restraining order and/or preliminary or permanent injunction to restrain or enjoin any such violation.  Buyer hereby agrees to waive any requirement for the securing or posting of any bond in connection with such remedy.

D.If a court of competent jurisdiction construes the covenants in this Section VII or any part hereto, to be unenforceable because of its duration or the geographical area covered hereby, the court shall modify such unenforceable provision to the extent necessary so that the provision, as modified, shall then be enforceable.  The parties hereto intend that the provisions of Section VII shall be deemed to be a series of separate covenants, one for each and every county of each and every state of the United States of America within the Covered Counties.

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E.Buyer will, and will cause Wasatch to, use its reasonable best efforts to ensure that the New Income Equity Fund remains open for new investment by new and existing shareholders, and that the New Income Equity Fund is not merged into any other fund.

F.Buyer will, and will cause Wasatch to, use its reasonable best efforts to ensure that the New Long/Short Fund remains open for new investment by new and existing shareholders so long as its assets under management are not in excess of One Billion Dollars and that the New Long/Short Fund is not merged with any other fund.

G.For a period of seven (7) years following the Closing, Buyer shall provide Seller herewith access to any records which constitute a portion of the Business Assets for any reasonable purpose.

H.Unless otherwise agreed to in writing by Seller, until January 1, 2011, Seller will, and will cause Wasatch to, use its reasonable best efforts to ensure that the names of the New Funds will not be changed and that the term “1st Source” will continue to be included in such names.

I.Buyer and Seller each acknowledges that the Reorganization contemplated by this Agreement is intended to comply with the requirements of Section 15(f) of the 1940 Act.  In that regard:

1.Buyer shall cause Wasatch to use its reasonable best efforts to conduct its business so as to assure that, insofar as within the control of Buyer and Seller or Wasatch, for a period of two years after the Closing Date as specified in the Reorganization Agreement, no change in fees or addition of expenses to the New Funds or implementation of other arrangements will occur which would result in an “unfair burden” (as that term is used in Section 15(f) of the 1940 Act) to the New Funds; and

2.Buyer agrees that it shall cause Wasatch to use its reasonable best efforts to cause the directors of Wasatch Funds to take, or refrain from taking, such actions to ensure that, insofar as within the control of Buyer or Wasatch, for a period of three years after the Closing Date as specified in the Reorganization Agreement, at least 75% of the members of the board of directors of Wasatch Funds, including any successors thereto, shall not be “interested persons” (as that term is defined in the 1940 Act) of the Buyer, Seller or Wasatch.

SECTION VIII.

MISCELLANEOUS

A.Notices.  All notices hereunder shall be deemed to have been given when delivered in person or, five (5) days thereafter if mailed, by registered or certified mail, postage prepaid, addressed to any party at its address set forth below or at any other address identified in writing to the other parties hereto:

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If to Seller:

c/o 1st Source Bank

Attention:  Chief Executive Officer

100 North Michigan Street, P. O. Box 1602

South Bend, IN   46634

With a copy to:

Vedder Price P.C.

222 North LaSalle Street, Suite 2600

Chicago, Illinois  60601

Attention:                                William J. Bettman, Esq.

If to Buyer:

Wasatch Advisors, Inc.

150 Social Hall Avenue

4th Floor

Salt Lake City, UT  84111

With a copy to:

Alan Bell

Dorsey & Whitney LLP

136 South Main, Suite 1000

Salt Lake City, UT  84101

B.Captions.  The captions hereunder are for the convenience of the parties and shall not control or affect the interpretation or construction of this Agreement.

C.Controlling Law; Consent to Jurisdiction.  This Agreement shall be governed by and construed in accordance with the laws of the State of Indiana.  Seller and Buyer hereby consent to service of process and exclusive jurisdiction in the State of Indiana with respect to any disputes arising under or in relation to this Agreement.

D.Entire Agreement.  This Agreement and the agreements, documents, schedules and exhibits referred to herein constitute the entire agreement of the parties with respect to the transactions contemplated hereby and supersede all other agreements between the parties, whether written or oral which survives the execution and delivery hereof.  This Agreement may not be amended, except in a writing signed by each of the parties hereto.

E.Binding Effect.  This Agreement shall inure to the benefit of and bind the parties hereto and their respective successors and assigns.

F.No Assignment or Amendment.  Neither this Agreement nor any rights of any party hereunder may be assigned without obtaining the prior written consent of the other party hereto, which consent shall not be unreasonably withheld; provided, however, after the Closing

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Seller may assign its rights to receive payment of the Purchase Price to any party without the prior consent of Buyer.  Subject to the preceding sentence, this Agreement will be binding upon and inure to the benefit of the successors and permitted assigns of the parties.  This Agreement may not be amended and the terms hereof shall not otherwise be modified except by an instrument in writing signed by the parties hereto.

G.Expenses and Fees.  Each party shall pay its respective costs, expenses and legal fees in connection with this Agreement and the transactions contemplated hereby.  However, all costs relating to the solicitation of the shareholders of Seller Funds (inclusive of legal fees and expenses, printing, mailing the proxy statement and soliciting proxies) will be paid by Buyer.

H.Counterparts.  This Agreement may be executed in one or more counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument.

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

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IN WITNESS WHEREOF, the parties hereto have duly caused this Agreement to be executed as of the day and year first above written.

WA HOLDINGS, INC.

By:                                                                

Title:                                                              

1ST SOURCE CORPORATION INVESTMENT ADVISORS, INC.

By:                                                                

Title:                                                              

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EXHIBIT LIST

Exhibit A                                Agreement and Plan of Reorganization

Exhibit B Earn-Out Fee Calculation Spreadsheet

and

Aggregate IE Value Earn-Out Fee Calculation Spreadsheet

Exhibit C                                Income Fund New Investment Subadvisory Agreement

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EXHIBIT A

Agreement and Plan of Reorganization

A-1

EXHIBIT B

Example Earn-Out Fee Calculation

and

Example Aggregate IE Value Earn-Out Fee Calculation

C-1

EXHIBIT C

INCOME FUND NEW INVESTMENT SUBADVISORY AGREEMENT

E-1