Employee Stock Benefit Plans

As of December 31, 2013, the Company had four active stock-based employee compensation plans. These plans include three executive stock award plans, namely, the Executive Incentive Plan (EIP), the Restricted Stock Award Plan (RSAP), and the 1998 Performance Compensation Plan (PCP); and the Employee Stock Purchase Plan (ESPP). The 2011 Stock Option Plan was approved by the shareholders on April 21, 2011 but the Company had not made any grants through December 31, 2013. These stock-based employee compensation plans were established to help retain and motivate key employees. All of the plans have been approved by the shareholders of 1st Source Corporation. The Executive Compensation and Human Resources Committee (the “Committee”) of the 1st Source Corporation Board of Directors has sole authority to select the employees, establish the awards to be issued, and approve the terms and conditions of each award under the stock-based compensation plans.

Stock-based compensation to employees is recognized as compensation cost in the Statements of Income based on their fair values on the measurement date, which, for 1st Source, is the date of grant. Stock-based compensation expense is recognized ratably over the requisite service period for all awards. The total fair value of share awards vested was $1.97 million during 2013, $4.30 million in 2012, and $2.45 million in 2011.

The following table shows the combined summary of activity regarding active stock option and stock award plans.



			Non-Vested Stock Awards Outstanding				Stock Options Outstanding
	Shares Available for Grant		Number of Shares		Weighted-Average Grant-Date Fair Value		Number of Shares		Weighted-Average Exercise Price
Balance, January 1, 2011	2,319,648		438,610		$	16.92	62,508		$	17.18
Shares authorized - 2011 EIP	190,515		—		—		—		—
Shares authorized - 2011 Stock Option Plan	2,000,000		—		—		—		—
Shares authorized - 1982 Restricted Stock Plan	100,000		—		—		—		—
Shares authorized - 1998 Performance Compensation Plan	100,000		—		—		—		—
Granted	(261,523	)	261,523		20.15		—		—
Stock options exercised	—		—		—		(5,090	)	19.15
Stock awards vested	—		(121,744	)	17.08		—		—
Forfeited	1,029		(47,541	)	13.71		(35,418	)	20.09
Canceled	(2,129,177	)	—		—		—		—
Balance, December 31, 2011	2,320,492		530,848		18.76		22,000		12.04

Shares authorized - 2012 EIP	76,815		—		—		—		—
Shares authorized - 1998 Performance Compensation Plan	2,302		—		—		—		—
Granted	(98,617	)	98,617		21.95		—		—
Stock options exercised	—		—		—		(14,500	)	12.04
Stock awards vested	—		(190,674	)	17.24		—		—
Forfeited	4,124		(5,587	)	19.71		—		—
Canceled	—		—		—		—		—
Balance, December 31, 2012	2,305,116		433,204		20.15		7,500		12.04

Shares authorized - 2013 EIP	61,970		—		—		—		—
Shares authorized - 1998 Performance Compensation Plan	2,010		—		—		—		—
Granted	(88,980	)	88,980		24.19		—		—
Stock options exercised	—		—		—		(7,500	)	12.04
Stock awards vested	—		(85,985	)	19.58		—		—
Forfeited	5,642		(10,754	)	20.71		—		—
Canceled	—		—		—		—		—
Balance, December 31, 2013	2,285,758		425,445		$	21.09	—		$	—

Stock Option Plans — Incentive stock option plans include the 2001 Stock Option Plan (the “2001 Plan”) and the 2011 Stock Option Plan (the “2011 Plan”). The 2001 Plan was terminated, except for outstanding options, after the 2011 Plan was approved by the shareholders. During 2013, all remaining shares available for issuance upon exercise from previous grants under the 2001 Plan were exercised. No additional grants will be made under the 2001 Plan. There were 2,000,000 shares available for issuance under the 2011 Plan.

Each award from all plans is evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the option pertains, and such other provisions as the Committee determines. The option price is equal to the fair market value of a share of 1st Source Corporation’s common stock on the date of grant. Options granted expire at such time as the Committee determines at the date of grant and in no event does the exercise period exceed a maximum of ten years. Upon merger, consolidation, or other corporate consolidation in which 1st Source Corporation is not the surviving corporation, as defined in the plans, all outstanding options immediately vest.

There were 7,500, 14,500 and 5,090 stock options exercised during 2013, 2012 and 2011, respectively. All shares issued in connection with stock option exercises and non-vested stock awards are issued from available treasury stock.

No stock-based compensation expense related to stock options was recognized in 2013 or 2012 and an insignificant amount was recognized in 2011.

The fair value of each option on the date of grant is estimated using the Black-Scholes option pricing model. Expected volatility is based on the historical volatility estimated over a period equal to the expected life of the options. In estimating the fair value of stock options under the Black-Scholes valuation model, separate groups of employees that have similar historical exercise behavior are considered separately. The expected life of the options granted is derived based on past experience and represents the period of time that options granted are expected to be outstanding.

Stock Award Plans — Incentive stock award plans include the EIP, the PCP and the RSAP. The EIP is administered by the Committee. Awards under the EIP and PCP include “book value” shares and “market value” shares of common stock. These shares are awarded annually based on weighted performance criteria and generally vest over a period of five years. The EIP book value shares may only be sold to 1st Source and such sale is mandatory in the event of death, retirement, disability, or termination of employment. The RSAP is designed for key employees. Awards under the RSAP are made to employees recommended by the Chief Executive Officer and approved by the Committee. Shares granted under the RSAP vest over a two to ten years period and vesting is based upon meeting certain various criteria, including continued employment with 1st Source.

Stock-based compensation expense relating to the EIP, PCP and RSAP totaled $2.90 million in 2013, $2.07 million in 2012, and $2.09 million in 2011. The total income tax benefit recognized in the accompanying Statements of Income related to stock-based compensation was $1.10 million in 2013, $0.78 million in 2012, and $0.79 million in 2011. Unrecognized stock-based compensation expense related to non-vested stock awards (EIP/PCP/RSAP) was $6.09 million at December 31, 2013. At such date, the weighted-average period over which this unrecognized expense was expected to be recognized was 3.08 years.

The fair value of non-vested stock awards for the purposes of recognizing stock-based compensation expense is market price of the stock on the measurement date, which, for the Company’s purposes is the date of the award.

Employee Stock Purchase Plan — The Company offers an ESPP for substantially all employees with at least two years of service on the effective date of an offering under the plan. Eligible employees may elect to purchase any dollar amount of stock, so long as such amount does not exceed 25% of their base rate of pay and the aggregate stock accrual rate for all offerings does not exceed $25,000 in any calendar year. The purchase price for shares offered is the lower of the closing market bid price for the offering date or the average market bid price for the five business days preceding the offering date. The purchase price and discount to the actual market closing price on the offering date for the 2013, 2012, and 2011 offerings were $24.32 (1.82%), $20.54 (0.15%), and $20.29 (0.00%), respectively. Payment for the stock is made through payroll deductions over the offering period, and employees may discontinue the deductions at any time and exercise the option or take the funds out of the program. The most recent offering began June 3, 2013 and runs through June 1, 2015, with $180,190 in stock value to be purchased at $24.32 per share.