1st Source - 10-Q quarterly report FY

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

For the quarterly period ended September 30, 2007

 

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)

 

(Registrant’s telephone number, including area code)
 

(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.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

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

Number of shares of common stock outstanding as of  October 25, 2007 – 24,172,983 shares

 

 

 

 

 

Note1.  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 2006 (2006 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, 2006, 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.  Acquisition Activity

On May 31, 2007, we acquired FINA Bancorp (FINA), the parent company of First National Bank, Valparaiso (FNBV), for $133.80 million.  FNBV is a full service bank with 26 banking facilities located in Porter, LaPorte and Starke 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 $80.12 million in cash.  The value of the common stock was $25.26.  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.  We expect to merge FNBV and 1st Source Bank in early 2008.

The acquisition was accounted for under the purchase method of accounting, and accordingly, the purchase price has been allocated to the tangible and identified intangible assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition.  There are refinements in the process of allocating the purchase price that have not been entirely completed.  Identified intangible assets and purchase accounting fair value adjustments are being amortized under various methods over the expected lives of the corresponding assets and liabilities.  Goodwill will not be amortized, but will be reviewed for impairment on an annual basis.   Currently, identified intangible assets from the acquisition subject to amortization are $8.59 million and total goodwill from the acquisition is $63.21 million.

On the date of acquisition, unaudited financial statements of FINA reflected assets of $619.31 million, which included $240.13 million of loans and $184.47 million of investment securities, $523.04 million of deposits and year-to-date net income of $3.85 million.  In conjunction with the $240.13 million of loans, FINA’s allowance for loan losses at the acquisition date was $2.42 million.  We applied the guidance required under the American Institute of Certified Public Accountants Statement of Position 03-3,Accounting for Certain Loans or Debt Securities Acquired in a Transfer(SOP 03-3) and determined that certain loans acquired in the FINA acquisition had evidence of deterioration of credit quality since origination and it was probable that all contractual required payments would not be collected on these loans.  We determined that two loans with book values totaling approximately $0.28 million and fair values of $0.07 million were within the guidelines set forth under SOP 03-3.  We recorded these loans at their fair value and reduced the allowance for loan losses by $0.21 million.  Accordingly, we recorded $2.21 million of reserve for loan losses on loans not subject to SOP 03-3.

The following pro forma condensed combined financial information presents the results of operations had the acquisition been completed as of the beginning of the periods indicated.

On May 1, 2007, the business of Trustcorp Mortgage Company was merged with 1st Source Bank; both of which are wholly owned subsidiaries of 1st Source Corporation.  We believe that this will allow us to focus our home mortgage efforts in 1st Source Bank’s retail footprint in Indiana and Michigan and provide a foundation for broadening direct relationships with our clients.  Prior to the acquisition by 1st Source Bank, both 1st Source Bank and Trustcorp Mortgage Company held a strong mortgage origination market share within 1st Source Bank’s traditional 15 county market of Northern Indiana and Southwestern Michigan.  This market will continue to be the focus of 1st Source Bank’s home mortgage business.

Note 3.  Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No.  157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, but it does not require any new fair value measurements.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  We are currently in the process of evaluating the impact of SFAS No. 157 on our Consolidated Financial Statements.

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).  This standard permits an entity to choose to measure many financial instruments and certain other items at fair value.  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 will adopt SFAS No. 159 on January 1, 2008.  We are evaluating the impact of SFAS No. 159 on the consolidated financial statements.

 

 

 

In July 2006, the FASB issued FASB Interpretation No. 48 (FIN No. 48), “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” which clarifies the accounting for uncertainty in tax positions. FIN No. 48 requires that we recognize in our financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN No. 48 are effective as of the beginning of our 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings.  We adopted the provisions of FIN No. 48 on January 1, 2007.  Details related to the adoption of FIN No. 48 and the impact on our financial statements are more fully discussed in Note 7 – Uncertainty in Income Taxes.

 

 

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, including a higher percentage reserve allocation for special attention loans and leases without a specific reserve, and reserves for pooled homogeneous loans and leases.  Management’s evaluation is based upon a continuing review of these portfolios, estimates of future customer performance, collateral values and dispositions and forecasts of future economic and geopolitical events, all of which are subject to judgment and will change.

Note 5.  Financial Instruments with Off-Balance-Sheet Risk

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.

1st Source Bank and FNBV, subsidiaries of 1st Source Corporation, grant 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.

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, 2007 and December 31, 2006, 1st Source Bank had commitments outstanding to originate and purchase mortgage loans aggregating $80.00 million and $113.25 million, respectively. Outstanding commitments to sell mortgage loans aggregated $39.38 million at September 30, 2007, and $73.87 million at December 31, 2006. Standby letters of credit totaled $62.03 million and $83.15 million at September 30, 2007, and December 31, 2006, respectively at 1st Source Bank.  At September 30, 2007, standby letters of credit totaled $1.89 million at FNBV. Standby letters of credit have terms ranging from six months to one year.

Note 6.  Stock-Based Compensation

As of September 30, 2007, we had five stock-based employee compensation plans, which are more fully described in Note K of the Consolidated Financial Statements in 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2006.  These plans include two stock option plans, the Employee Stock Purchase Plan, the Executive Incentive Plan, and the Restricted Stock Award Plan.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), using the modified prospective transition method and, therefore, have not restated results for prior periods. Under this transition method, stock-based compensation expense for the first quarter of 2006 included compensation expense for all stock-based compensation awards granted prior to, but that remained unvested as of, January 1, 2006. Compensation expense was based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123.

Prior to January 1, 2006, we accounted for stock-based compensation under the recognition, measurement and pro forma disclosure provisions of APB No. 25, the original provisions of SFAS No. 123, and SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (SFAS 148). In accordance with APB No. 25, we generally would have recognized compensation expense for stock awards on the grant date and we generally would have recognized compensation expense for stock options only when we granted options with a discounted exercise price or modified the terms of previously issued options, and would have recognized the related compensation expense ratably over the associated service period, which was generally the option vesting term.

Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006, 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.

As a result of our January 1, 2006, adoption of SFAS No.123(R), the impact to the Consolidated Financial Statements for the three month period ended September 30, 2006 on income before income taxes and on net income were additions of $0.27 million and $0.17 million, respectively; and for the nine month period ended

September 30, 2006 on income before income taxes and on net income were additions of $2.09 million and $1.29 million, respectively.  The cumulative effect of the change in accounting was $0.66 million before income taxes and $0.40 million, after income taxes. The impact on both basic and diluted earnings per share for the three months ended September 30, 2006 was $0.01 per share. The impact on both basic and diluted earnings per share for the nine months ended September 30, 2006 was $0.05 per share.   In addition, prior to the adoption of SFAS No. 123(R), we presented the tax benefit of stock option exercises as operating cash flows. Upon the adoption of SFAS No. 123(R), tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options are classified as financing cash flows.

The stock-based compensation expense recognized in the condensed consolidated statement of operations for the nine months ended September 30, 2007 and 2006 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 2007 (September 30, 2007) 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, 2007. This amount changes based on the fair market value of 1st Source’s stock. Total intrinsic value of options exercised for the nine months ended September 30, 2007 was $267 thousand. Total fair value of options vested and expensed was $35 thousand, net of tax, for the nine months ended September 30, 2007.

The following weighted-average assumptions were used to estimate the fair value of options granted during the nine months ended September 30, 2007:

No options were granted during the nine months ended September 30, 2006.

As of September 30, 2007, there was $1.79 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 5.16 years.

The following table summarizes information about stock options outstanding at September 30, 2007:

Note 7.  Uncertainty in Income Taxes

We adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007.  As a result of the implementation of FIN No. 48, we recognized no change in the liability for unrecognized tax benefits.

The total amount of unrecognized tax benefits at January 1, 2007, was $5.79 million.  Of that amount, $3.33 million would affect the effective tax rate if recognized.  We recognize interest and penalties through the income tax provision.  The total amount of interest and penalties on the date of adoption was $0.87 million.

Tax years that remain open and subject to audit include federal 2003–2006 years and Indiana 2002–2006 years.  Additionally, we have an open tax examination with the Indiana Department of Revenue for the tax years 2002-2004.  Indiana is currently proposing adjustments for certain apportionment issues.  We are appealing these adjustments.

The following management’s discussion and analysis is presented to provide information concerning our condition as of September 30, 2007, as compared to December 31, 2006, and the results of operations for the three and nine months ended September 30, 2007 and 2006. 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 2006 Annual Report.

 

 

The following disclosure is not determined in accordance with generally accepted accounting principles (GAAP) and is considered a non-GAAP disclosure.  Management believes that this presentation, while not in accordance with GAAP, provides useful insight as to the impact of the acquisition of First National Bank, Valparaiso on the financial condition from the date of acquisition to September 30, 2007.

We acquired First National Bank, Valparaiso (FNBV) on May 31, 2007 (See Note 2 of the Notes to Consolidated Financial Statements for information concerning this acquisition).  The following table shows (for selected balance sheet items at September 30, 2007) the consolidated balance sheet item, the total for the balance sheet item for FNBV, and the total for the balance sheet item without FNBV.

Our total assets at September 30, 2007, were $4.41 billion, up $605.34 million or 15.90% from December 31, 2006.  The increase in assets was due to the acquisition of FNBV which had assets, including goodwill, of $669.33 million at September 30, 2007.

Total loans and leases were $3.20 billion at September 30, 2007, an increase of $499.06 million or 18.47% from December 31, 2006.  The acquisition of FNBV contributed $241.58 million toward the increase in total loans and leases at September 30, 2007.

 

 

Total deposits at September 30, 2007, were $3.42 billion, up $366.89 million or 12.04% over the comparable figures at the end of 2006.  The increase in deposits was due to the acquisition of FNBV which had total deposits of $511.97 million at September 30, 2007.

Nonperforming assets at September 30, 2007, were $17.13 million compared to $17.67 million at December 31, 2006.  At September 30, 2007, nonperforming assets were 0.52% of net loans and leases compared to 0.64% at December 31, 2006.

Other assets were as follows:

As of September 30, 2007, total shareholders' equity was $427.20 million, up $58.29 million or 15.80% from the $368.90 million at December 31, 2006.  Common stock increased by $53.68 million due to the issuance of 2,124,974 1st Source common shares for the acquisition of FINA.  Other significant changes in shareholders’ equity during the first nine months of 2007 included net income of $22.71 million, $11.31 million in treasury stock purchases, and $9.73 million of dividends paid.  The accumulated other comprehensive income component of shareholders’ equity totaled $2.13 million at September 30, 2007, compared to an accumulated other comprehensive loss of $0.26 million at December 31, 2006.  The increase 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 9.68% as of September 30, 2007, compared to 9.69% at December 31, 2006. Book value per common share rose to $17.67 at September 30, 2007, up from $16.40 at December 31, 2006.

We declared and paid cash dividends per common share of $0.14 during the third quarter of 2007.  The trailing four quarters dividend payout ratio, representing dividends per share divided by diluted earnings per share, was 42.42%.   The dividend payout is continually reviewed by management and the Board of Directors.

 

 

 

 

 

 

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 72.55% at September 30, 2007 compared to 70.98% at December 31, 2006 and 72.54% at September 30, 2006.  Cash and cash equivalents totaled $117.56 million at September 30, 2007 compared to $118.13 million at December 31, 2006 and $87.17 million at September 30, 2006.  At September 30, 2007, the consolidated statement of financial condition was rate sensitive by $947.36 million more liabilities than assets scheduled to reprice within one year, or approximately 0.72%.  Management believes that the present funding sources provide adequate liquidity to meet our cash flow needs.

 

During the second quarter of 2007, we completed the private placement issuance of $40 million of trust preferred securities through, 1st Source Master Trust, a newly formed subsidiary trust organized under Delaware law.  The trust preferred securities were issued at $1,000.00 per share and bear a 7.2175 percent per annum fixed rate of interest, payable quarterly.  The securities are redeemable after five years and are due in 2037.  The net proceeds of the issuance were used to fund a portion of the purchase price for FINA.  Additionally, during the second quarter of 2007, we provided notice to the trustee for the 690,000 shares of floating rate trust preferred securities issued by 1st Source Capital Trust II of our plans to redeem these securities on August 1, 2007.

During the third quarter of 2007, we completed private placement of $17 million of trust preferred securities through 1st Source Master Trust.  The trust preferred securities were issued at $1,000.00 per share and bear a 7.095 percent per annum fixed rate of interest for the first ten years and a floating rate thereafter, payable quarterly.   The securities are redeemable after five years and are due in 2037.  The net proceeds of the trust preferred securities issuance were used to redeem $17.78 million in 7.03 percent floating-rate trust preferred securities issued by 1st Source Capital Trust II and $0.43 million of pre-tax capitalized debt issuance costs were written off.   We will dissolve our unconsolidated subsidiary 1st Source Capital Trust II.

Net income for the three- and nine-month periods ended September 30, 2007, was $6.13 million and $22.71 million respectively, compared to $10.96 million and $31.17 million for the same periods in 2006.  Diluted net income per common share was $0.25 and $0.96 respectively, for the three- and nine-month periods ended September 30, 2007, compared to $0.48 and $1.36 for the same periods in 2006.  Return on average common shareholders' equity was 7.58% for the nine months ended September 30, 2007, compared to 11.77% in 2006. The return on total average assets was 0.75% for the nine months ended September 30, 2007, compared to 1.19% in 2006.

 

 

The decrease in net income for the nine months ended September 30, 2007, over the first nine months of 2006, was primarily attributable to an increase of $6.92 million in our provision for loan and lease losses, a decline of $4.44 million in noninterest income, and an increase of $10.07 million in noninterest expense, which were primarily offset by a $5.83 million reduction in income tax expense.  Details of the changes in the various components of net income are further discussed below.

The taxable-equivalent net interest income for the three months ended September 30, 2007, was $32.74 million, up 16.64% from the comparable period in 2006.  The taxable-equivalent net interest income for the nine months ended September 30, 2007, was $89.40 million, an increase of 9.56% from the same period in 2006.

The net interest margin on a fully taxable-equivalent basis was 3.16% for the three months ended September 30, 2007, compared to 3.34% for three months ended September 30, 2006.  The net interest margin on a fully taxable-equivalent basis was 3.17% for the nine months ended September 30, 2007, compared to 3.36% for the nine months ended September 30, 2006.

Average earning assets increased $772.42 million or 23.19% and $521.36 million or 16.04%, respectively, for the three and nine month periods ended September 30, 2007, over the comparable periods in 2006.  Average interest-bearing liabilities increased $773.40 million or 27.59% and $523.44 million or 19.30%, respectively, for the three and nine month periods ended September 30, 2007, over the comparable period one year ago.  As of September 30, 2007, average earning assets at FNBV totaled $265.86 million and average interest-bearing liabilities totaled $229.74 million.

 

  The yield on average earning assets increased 16 basis points to 6.71% for the third quarter of 2007 from 6.55% for the third quarter of 2006.  The yield on average earning assets for the nine month period ended September 30, 2007, increased 40 basis points to 6.71% from 6.31% for the nine month period ended September 30, 2006. The rate earned on assets continued to experience positive impacts from the increases in short-term market interest rates from a year ago.  Total cost of average interest-bearing liabilities increased 25 basis points to 4.06% for the third quarter of 2007 from 3.81% for the third quarter of 2006. Total cost of average interest-bearing liabilities increased 58 basis points to 4.12% for the nine month period ended September 30, 2007 from 3.54% for the nine month period ended September 30, 2006.  The cost of interest-bearing liabilities was also affected by 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 a decrease of 18 basis points and 19 basis points, respectively, for the three and nine month periods ended September 30, 2007 from September 30, 2006.

       The largest contributor to the increase in the yield on average earning assets for the first nine months of 2007, on a volume-weighted basis, was the $391.52 million or 15.42% increase in higher yielding net loans and leases as compared to the first nine months of 2006.   Average loans and leases grew by $564.49 million or 21.59% during the third quarter of 2007, compared to the third quarter of 2006.  Average loans and leases outstanding increased across our entire portfolio, most notably in construction equipment financing, commercial loans, aircraft financing, loans secured by real estate, and medium and heavy duty truck financing for both the third quarter and year-to-date 2007 as compared to 2006.  As of  September 30, 2007, average loans and leases at FNBV totaled $107.56 million, the majority were loans secured by real estate.

 

 

  Total average investment securities increased 32.73% and 16.77%, respectively, for the three- and nine- month periods over one year ago.  This increase was mainly due to an increase in mortgage-backed and municipal securities.  Average mortgages held for sale decreased 62.22% and 43.78% respectively, for the three- and nine- month periods over the same periods one year ago.  Production volume decreased approximately 59% and 48%, respectively, during the third quarter and year-to-date 2007 compared to the third quarter and year-to-date 2006, primarily due to a reduction of our mortgage purchase activity with the majority of our production affiliates.  Other investments, which include federal funds sold, time deposits with other banks and commercial paper, increased 1.43 times for the three month period ended September 30, 2007 from same period one year ago, and 1.89 times for the first nine months of 2007 as compared to the first nine months of 2006 as excess funds were invested.   As of  September 30, 2007, the average investment securities portfolio at FNBV totaled $45.11 million, the majority of which was in federal agency and municipal securities.

      Average interest-bearing deposits increased $690.34 million or 28.25% and $508.41 million or 21.69%, respectively, for the third quarter of 2007 and first nine months of 2007, over the same periods in 2006. The effective rate paid on average interest-bearing deposits increased 31 basis points to 3.95% for the third quarter of 2007 compared to 3.64% for the third quarter of 2006.  The effective rate paid on average interest-bearing deposits increased 65 basis points to 4.00% for the first nine months of 2007 compared to 3.35% for the first nine months of 2006.The increase in the average cost of interest-bearing deposits during the third quarter and first nine months of 2007 as compared to the third quarter and first nine months of 2006 was primarily the result of increases in interest rates offered on deposit products due to increases in market interest rates and increased competition for deposits across all markets.  As of  September 30, 2007, average interest-bearing deposits at FNBV totaled $222.09 million.

Average short-term borrowings increased $37.29 million or 14.33% for the third quarter of 2007 as compared to the third quarter of 2006.  Short-term borrowings decreased $11.52 million or 4.20% for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006.   Average trust preferred borrowings increased $41.07 million or 69.58% and $17.46 million or 29.59%, respectively, for the third quarter of 2007 and the first nine months of 2007, over the same periods in 2006.  Interest paid on short-term and trust preferred borrowings decreased during the third quarter of 2007 as compared to the third quarter of 2006.  Interest paid on short-term borrowings and trust preferred borrowings increased on a year-to-date basis for 2007 as compared to 2006 primarily due to the interest rate increase in adjustable rate borrowings.  Average long-term debt increased $4.71 million or 11.92% during the third quarter of 2007 as compared to the third quarter of 2006.  Average long-term debt increased $9.09 million or 26.19% during the first nine months of 2007 as compared to the first nine months of 2006.  The majority of the increase in long-term debt was made up of Federal Home Loan Bank borrowings.  Additionally, we issued $40.00 million of trust preferred securities on June 7, 2007, which were used to fund a portion of the purchase price for FNBV, and $17.00 million of trust preferred securities on August 1, 2007, which were used primarily to redeem trust preferred securities issued by 1st Source Capital Trust II.

 

Average demand deposits increased $9.35 million for the three-month period ended September 30, 2007 as compared to the three-month period of 2006.  Average demand deposits decreased $19.75 million for the nine-month period ended September 30, 2007 as compared to the nine-month period ended September 30, 2006.  Much of the decline on a year-to-date basis was due to the reclassification of some of our deposit products from noninterest bearing to interest bearing and a decrease in escrow deposit accounts concurrent with the reduction in our mortgage servicing portfolio.  As of  September 30, 2007, average demand deposits at FNBV were $20.04 million.

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.