The purpose of this analysis is to provide the reader with information relevant to understanding and assessing our results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis the reader is encouraged to review the consolidated financial statements and statistical data presented in this document.

Forward-Looking Statements

This report, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements. Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. Words such as "believe", "contemplate", "seek", "estimate", "plan", "project", "anticipate", "possible", "assume", "expect", "intend", "targeted", "continue", "remain", "will", "should", "indicate", "would", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-

looking statements provide current expectations or forecasts of future events and are not guarantees of future performance, nor should they be relied upon as representing management's views as of any subsequent date. The forward-looking statements are based on our expectations and are subject to a number of risks and uncertainties.

All written or oral forward-looking statements that are made by or attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise, or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made. We have expressed our expectations, beliefs, and projections in good faith and we believe they have a reasonable basis. However, we make no assurances that our expectations, beliefs, or projections will be achieved or accomplished. These forward-looking statements may not be realized due to a variety of factors, including, without limitation, the following:

· Local, regional, national, and international economic conditions and the impact they may have on us and our clients and our assessment of that impact.

· Changes in the level of nonperforming assets and charge-offs.

· Changes in estimates of future cash reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.

· The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.

· Inflation, interest rate, securities market, and monetary fluctuations.

· Political instability.

· Acts of war or terrorism.

· Substantial increases in the cost of fuel.

· The timely development and acceptance of new products and services and perceived overall value of these products and services by others.

· Changes in consumer spending, borrowings, and savings habits.

· Changes in the financial performance and/or condition of our borrowers.

· Technological changes.

· Acquisitions and integration of acquired businesses.

· The ability to increase market share and control expenses.

· Changes in the competitive environment among bank holding companies.

· The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, and insurance) with which we and our subsidiaries must comply.

· The effect of changes in accounting policies and practices and auditing requirements, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standard setters.

· Changes in our organization, compensation, and benefit plans.

· The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquires and the results of regulatory examinations or reviews.

· Greater than expected costs or difficulties related to the integration of new products and lines of business.

· Our success at managing the risks described in Item 1A. Risk Factors.

Application of Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U. S. generally accepted accounting principles and follow general practices within the industries in which we operate. Application of these principles requires our management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates or judgments reflect our management's view of the most appropriate manner in which to record and report our overall financial performance. Because these estimates or judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experience. As such, changes in these estimates, judgments, and/or assumptions may have a significant impact on our financial statements. All accounting policies are important, and all policies described in Part II, Item 8, Financial Statements and Supplementary Data, Note A (Note A), should be reviewed for a greater understanding of how our financial performance is recorded and reported.

We have identified three policies as being critical because they require our management to make particularly difficult, subjective, and/or complex estimates or judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the determination of the reserve for loan and lease losses, the valuation of mortgage servicing rights, and the valuation of securities. Our management has used the best information available to make the estimations or judgments necessary to value the related assets and liabilities. Actual performance that differs from estimates or judgments and future changes in the key variables could change future valuations and impact net income. Our management has reviewed the application of these policies with the Audit Committee of the Board of Directors. Following is a discussion of the areas we view as our most critical accounting policies.

Reserve for Loan and Lease Losses - The reserve for loan and lease losses represents our management's estimate of probable losses inherent in the loan and lease portfolio and the establishment of a reserve that is sufficient to absorb those losses. In determining an adequate reserve, our management makes numerous judgments, assumptions, and estimates based on continuous review of the loan and lease portfolio, estimates of client performance, collateral values, and disposition, as well as historical loss rates and expected cash flows. In assessing these factors, our management benefits from a lengthy organizational history and experience with credit decisions and related outcomes. Nonetheless, if our management's underlying assumptions prove to be inaccurate, the reserve for loan and lease losses would have to be adjusted. Our accounting policy related to the reserve is disclosed in Note A under the heading "Reserve for Loan and Lease Losses."

Fair Value Measurements: - We use fair value measurements to record certain financial instruments and to determine fair value disclosures.
Available-for-sale securities, mortgage loans held for sale, and interest rate swap agreements are financial instruments recorded at fair value on a recurring basis. Additionally,

from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve write-downs of, or specific reserves against, individual assets. SFAS No. 157, Fair Value Measurements establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used in the measurement are observable or unobservable. Observable inputs reflect market-driven or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data.

The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market data. For financial instruments that trade actively and have quoted market prices or observable market data, there is minimal subjectivity involved in measuring fair value. When observable market prices and data are not fully available, management judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, we use valuation techniques that require more management judgment to estimate the appropriate fair value measurement. Fair value is discussed further in Note A under the heading "Fair Value Measurements" and in Note S, "Fair Values of Financial Instruments."

Mortgage Servicing Rights Valuation - We recognize as assets the rights to service mortgage loans for others, known as mortgage servicing rights, whether the servicing rights are acquired through purchases or through originated loans. Mortgage servicing rights do not trade in an active open market with readily observable market prices. Although sales of mortgage servicing rights do occur, the precise terms and conditions may not be readily available. As such, the value of mortgage servicing assets are established and valued using discounted cash flow modeling techniques which require management to make estimates regarding estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors. The expected rates of mortgage loan prepayments are the most significant factors driving the value of mortgage servicing assets. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced. In determining the fair value of the mortgage servicing assets, mortgage interest rates (which are used to determine prepayment rates), and discount rates are held constant over the estimated life of the portfolio. Expected mortgage loan prepayment rates are derived from a third-party model and adjusted to reflect our actual prepayment experience. Mortgage servicing assets are carried at the lower of the initial capitalized amount, net of accumulated amortization, or fair value. The values of these assets are sensitive to changes in the assumptions used and readily available market pricing does not exist. The valuation of mortgage servicing assets is discussed further in Note A under the heading "Mortgage Banking Activities."

Recent Market Developments

The global and U.S. economies are experiencing significantly reduced business activity as a result of, among other factors, disruptions in the financial system during the past year. Dramatic declines in the housing market during the past year, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of residential-related loans and mortgage-backed securities, but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.

Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. The availability of credit, confidence in the financial sector, and level of volatility in the financial markets have been significantly adversely affected as a result. In recent months, volatility and disruption in the capital and credit markets have reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers' underlying financial strength.

In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 ("EESA") was signed into law on October 3, 2008. The EESA authorizes the Treasury to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The EESA also provided a temporary increase in deposit insurance coverage from $100,000 to $250,000 per insured account until December 31, 2009.

On October 14, 2008, Secretary Paulson, after consulting with the Federal Reserve and the FDIC, announced that the Treasury will purchase equity stakes in certain banks and thrifts. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the "TARP Capital Purchase Program"), the Treasury will make $250 billion of capital available to U.S. financial institutions in the form of preferred stock (from the $700 billion authorized by the EESA). In conjunction with the purchase of preferred stock, the Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the Treasury's standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program.

Also on October 14, 2008, after receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Paulson signed the systemic risk exception to the FDIC Act, enabling the FDIC to temporarily provide a 100% guarantee of the senior unsecured debt of all FDIC-insured institutions and their holding companies, as well as deposits in noninterest-bearing transaction deposit accounts under a Temporary Liquidity Guarantee Program through December 31, 2009. All insured depository institutions automatically participated in the Temporary Liquidity Guarantee Program for 30 days following the announcement of the program without charge (subsequently extended to December 5, 2008) and thereafter, unless an institution opted out, at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for noninterest-bearing transaction deposits.

1st Source elected to participate in the TARP Capital Purchase Program, and on January 23, 2009 received $111.00 million in additional capital through the program. In exchange, the Treasury received a like amount of 1st Source Corporation preferred stock that pays an annual dividend of 5.00 percent for the first five years, and an annual dividend of 9.00 percent in any years thereafter. We may redeem the preferred shares issued to Treasury in full during the first three years following issuance only with the proceeds of a qualifying equity offering. Thereafter, the preferred shares may be redeemed in full or in part at any time. We also issued a warrant to the Treasury to purchase 837,947 shares of 1st Source common stock, which, upon issuance, would represent approximately 3.3 percent of our outstanding common shares, based upon current information. The warrant is exercisable at any time during the ten-year period following issuance at an exercise price of $19.87.

Notwithstanding the foregoing, The American Recovery and Reinvestment Act of 2009 ("ARRA"), which was signed into law by President Obama on February 17, 2009, provides that the Secretary of the Treasury shall permit a recipient of funds under the Troubled Assets Relief Program, subject to consultation with the recipient's appropriate Federal banking agency, to repay such assistance without regard to whether the recipient has replaced such funds from any other source or to any waiting period. ARRA further provides that when the recipient repays such assistance, the Secretary of the Treasury shall liquidate the warrants associated with the assistance at the current market price. While Treasury has not yet issued implementing regulations, it appears that ARRA will permit 1st Source, if it so elects and following consultation with the FRB, to redeem the Series A Preferred Stock at any time without restriction.

Additionally, 1st Source has decided to continue to participate in the Temporary Liquidity Guarantee Program following the expiration of the initial opt-out period. Our participation includes both the Transaction Account Guarantee Program related to the guarantee of noninterest bearing deposit accounts and eligible, low earning NOW accounts (interest rate equal to or less than 0.50%) and the Debt Guarantee Program related to the guarantee of applicable senior unsecured debt.

It is not clear at this time what impact the EESA, the TARP Capital Purchase Program, the Temporary Liquidity Guarantee Program, or other liquidity and funding initiatives will have on the financial markets and the other difficulties described above, including the high levels of volatility and limited credit availability currently being experienced, or on the U.S. banking and financial industries and the broader U.S. global economies. Further adverse effects could have an adverse effect on our business.

Earnings Summary

Net income in 2008 was $33.39 million, up from $30.54 million in 2007 and down from $39.30 million in 2006. Diluted net income per common share was in $1.37 in 2008, $1.28 in 2007, and $1.72 in 2006. Return on average total assets was 0.76% in 2008 compared to 0.74% in 2007, and 1.11% in 2006. Return on average common shareholders' equity was 7.52% in 2008 versus 7.47% in 2007, and 10.98% in 2006.

Net income in 2008 was favorably impacted by an 11.14% increase in net interest income over 2007, an $11.49 million gain on the sale of certain assets of Investment Advisors and increased noninterest income. These increases were offset by increased provision for loan and lease losses, investment securities impairment and increased noninterest expenses. Net income in 2007 was favorably affected by an 11.72% increase in net interest income over 2006. However, this increase was more than offset by an increase in the provision for loan and lease losses, decreased mortgage banking income, investment securities impairment and increased noninterest expenses.

Dividends paid on common stock in 2008 amounted to $0.58 per share, compared to $0.56 per share in 2007, and $0.534 per share in 2006. The level of earnings reinvested and dividend payouts are based on management's assessment of future growth opportunities and the level of capital necessary to support them.

Acquisition of First National Bank, Valparaiso - On May 31, 2007, we acquired FINA Bancorp (FINA), the parent company of First National Bank, Valparaiso for $134.19 million. First National was a full service bank with 16 banking facilities, as of December 31, 2007, located in Porter and LaPorte Counties of Indiana. Pursuant to the definitive agreement, FINA shareholders were able to choose whether to receive 1st Source common stock and/or cash pursuant to the election procedures described in the definitive agreement. Under the terms of the transaction, FINA was acquired in exchange for 2,124,974 shares of 1st Source common stock valued at $53.68 million and $80.51 million in cash. The value of the common stock was $25.26 per share. We believe that the purchase of FINA is a natural extension of our service area and is consistent with our growth and market expansion initiatives. On June 6, 2008, First National was merged with 1st Source Bank.

Upgrade of Core Systems - During 2007, we upgraded a majority of our core and ancillary data processing systems. Numerous internal teams were formed to manage the installation and conversion of data and various systems. The core technology includes a loan system, deposit system, general ledger system, and customer information file system. Additionally, ATM networks, a voice response unit (VRU) system, and document imaging systems were installed. Total 2007 expenses for this upgrade were $2.71 million.

Net Interest Income - Our primary source of earnings is net interest income, the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities while deposits and borrowings represent the major portion of interest-bearing liabilities. For purposes of the following discussion, comparison of net interest income is done on a tax equivalent basis, which provides a common basis for comparing yields on earning assets exempt from federal income taxes to those which are fully taxable.

Net interest margin (the ratio of net interest income to average earning assets) is affected by movements in interest rates and changes in the mix of earning assets and the liabilities that fund those assets. Net interest margin on a fully taxable equivalent basis was 3.34% in 2008 compared to 3.18% in 2007, and 3.29% in 2006. The higher margin in 2008 reflects lower funding costs compared with the decline in yields on earning assets. Net interest income was $132.16 million for 2008, compared to $118.91 million for 2007. Tax-equivalent net interest income totaled $135.75 million for 2008, an increase of $13.22 million from the $122.53 million reported for 2007. The $13.22 million increase is mainly due to changes in rates.

During 2008, average earning assets increased $215.89 million while average interest-bearing liabilities increased $194.30 million over the comparable period. The yield on average earning assets decreased 81 basis points to 5.87% for 2008 from 6.68% for 2007. The rate earned on assets was negatively impacted by decreases in market rates. Total cost of average interest-bearing liabilities decreased 112 basis points during 2008 as liabilities were also impacted by decreases in market rates. The result was an increase of 31 basis points to net interest spread, or the difference between interest income on earning assets and expense on interest-bearing liabilities.

The largest contributor to the decrease in the yield on average earning assets in 2008 was the 97 basis point decrease in the loan and lease portfolio yield. The decrease in the loan and lease portfolio yield was offset by an increase in net loan and lease outstandings. Average net loans and leases increased $270.74 million or 9.05% in 2008 from 2007.

During 2008, the tax-equivalent yield on securities available for sale decreased 28 basis points to 4.60% while the average balance decreased $22.99 million.

Average interest-bearing deposits increased $78.07 million during 2008 while the effective rate paid on those deposits decreased 104 basis points. Average demand deposits increased $26.39 million during 2008.

Average short-term borrowings increased $115.47 million during 2008; however, the effective rate paid decreased 206 basis points. Average subordinated notes which represent our trust preferred borrowings increased $8.55 million during 2008, while the effective rate increased four basis points. Average long-term debt decreased $7.79 million during 2008 as the effective rate decreased 57 basis points.

The following table provides an analysis of net interest income and illustrates interest income earned and interest expense charged for each major component of interest earning assets and the 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.

                                          2008                                                    2007                                                   2006
(Dollars in           Average            Interest                              Average           Interest                            Average            Interest
thousands)            Balance         Income/Expense        Yield/Rate         Balance        Income/Expense       Yield/Rate        Balance         Income/Expense       Yield/Rate
ASSETS
Investment
securities:
Taxable             $   491,061     $           22,170             4.51 %    $   510,949     $         25,136             4.92 %   $   458,152     $           19,177            4.19 %
Tax-exempt              222,751                 10,692             4.80          225,849               10,800             4.78         173,652                  7,416            4.27
Mortgages held
for sale                 33,925                  2,069             6.10           28,913                1,892             6.54          53,034                  3,549            6.69
Net loans and
leases                3,263,276                202,539             6.21        2,992,540              214,725             7.18       2,566,217                178,125            6.94
Other investments        57,601                  1,425             2.47           94,478                4,657             4.93          64,049                  3,271            5.11
Total earning
assets                4,068,614                238,895             5.87        3,852,729              257,210             6.68       3,315,104                211,538            6.38
Cash and due from
banks                    83,270                                                   81,714                                                78,365
Reserve for loan
and lease losses        (71,358 )                                                (61,555 )                                             (59,082 )
Other assets            319,997                                                  278,421                                               217,914
Total assets        $ 4,400,523                                              $ 4,151,309                                           $ 3,552,301
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing
deposits            $ 2,996,830     $           86,903             2.90 %    $ 2,918,756     $        115,113             3.94 %   $ 2,418,344     $           85,067            3.52 %
Short-term
borrowings              386,850                  7,626             1.97          271,377               10,935             4.03         265,824                 11,011            4.14
Subordinated
notes                    90,960                  6,714             7.38           82,414                6,051             7.34          59,022                  4,320            7.32
. . .