MAINSOURCE FINANCIAL GROUP - FORM 10-Q

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EX-31.2 - EX-31.2 - MAINSOURCE FINANCIAL GROUP	a11-9367_1ex31d2.htm
EX-32.1 - EX-32.1 - MAINSOURCE FINANCIAL GROUP	a11-9367_1ex32d1.htm
EX-32.2 - EX-32.2 - MAINSOURCE FINANCIAL GROUP	a11-9367_1ex32d2.htm
EX-31.1 - EX-31.1 - MAINSOURCE FINANCIAL GROUP	a11-9367_1ex31d1.htm

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011

COMMISSION FILE NUMBER 0-12422

MAINSOURCE FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

INDIANA		35-1562245
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

2105 NORTH STATE ROAD 3 BYPASS, GREENSBURG, INDIANA		47240
(Address of principal executive offices)		(Zip Code)

(812) 663-6734

(Registrant’s telephone number, including area code)

N/A

(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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer x

Non-accelerated filer o		Smaller reporting company o
(Do not check if a 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 o No x

As of May 10, 2011 there were outstanding 20,136,188 shares of common stock, without par value, of the registrant.

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MAINSOURCE FINANCIAL GROUP, INC.

FORM 10-Q

INDEX

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets

Consolidated Statements of Income and Comprehensive Income

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

PART II. OTHER INFORMATION

Item 6. Exhibits

Signatures

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MAINSOURCE FINANCIAL GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands except per share data)

Item 1. Financial Statements

	(Unaudited)
	March 31,			December 31,
	2011			2010
Assets
Cash and due from banks	$	75,525		$	40,423
Money market and federal funds sold	6,593			19,700
Cash and cash equivalents	82,118			60,123
Securities available for sale	817,235			806,071
Loans held for sale	1,859			5,845
Loans, net of allowance for loan losses of $43,255 and $42,605	1,599,445			1,638,366
Restricted stock, at cost	19,298			19,502
Premises and equipment, net	49,454			48,861
Goodwill	61,919			61,919
Purchased intangible assets	8,610			9,102
Cash surrender value of life insurance	48,047			47,756
Interest receivable and other assets	80,000			71,767
Total assets	$	2,767,985		$	2,769,312

Liabilities
Deposits
Noninterest bearing	$	293,648		$	268,390
Interest bearing	1,915,713			1,943,174
Total deposits	2,209,361			2,211,564
Securities sold under agreement to repurchase	30,957			33,181
Federal Home Loan Bank (FHLB) advances	145,981			152,065
Subordinated debentures	50,155			50,117
Other liabilities	22,473			19,815
Total liabilities	2,458,927			2,466,742

Shareholders’ equity
Preferred stock, no par value Authorized shares - 400,000 Issued and outstanding shares — 57,000 Aggregate liquidation preference — $57,000	56,233			56,183
Common stock $.50 stated value: Authorized shares - 100,000,000 Issued shares — 20,710,590 and 20,710,764 Outstanding shares — 20,136,188 and 20,136,362	10,394			10,394
Treasury stock — 574,402 at cost	(9,367		)	(9,367		)
Additional paid-in capital	223,151			223,134
Retained earnings	16,350			12,768
Accumulated other comprehensive income	12,297			9,458
Total shareholders’ equity	309,058			302,570
Total liabilities and shareholders’ equity	$	2,767,985		$	2,769,312

The accompanying notes are an integral part of these consolidated financial statements.

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MAINSOURCE FINANCIAL GROUP, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Dollar amounts in thousands except per share data)

	(Unaudited)
	Three months ended March 31,
	2011			2010
Interest income
Loans, including fees	$	23,970		$	26,633
Securities	7,184			7,615
Deposits with financial institutions	23			23
Total interest income	31,177			34,271
Interest expense
Deposits	4,286			6,232
Federal Home Loan Bank advances	1,460			2,301
Subordinated debentures	429			422
Other borrowings	52			85
Total interest expense	6,227			9,040
Net interest income	24,950			25,231
Provision for loan losses	5,600			9,500
Net interest income after provision for loan losses	19,350			15,731
Non-interest income
Insurance commissions	—			518
Mortgage banking	1,318			1,524
Trust and investment product fees	940			565
Service charges on deposit accounts	3,898			3,869
Net realized gains on securities	1,133			1,053
Increase in cash surrender value of life insurance	291			294
Interchange income	1,416			1,264
Other income	323			744
Total non-interest income	9,319			9,831
Non-interest expense
Salaries and employee benefits	12,833			12,445
Net occupancy	1,767			1,855
Equipment	1,980			1,898
Intangibles amortization	492			516
Telecommunications	472			464
Stationery, printing and supplies	414			333
FDIC assessment	1,261			1,263
Marketing	1,081			593
Collection expenses	1,014			575
Other expenses	2,506			2,543
Total non-interest expense	23,820			22,485
Income before income tax	4,849			3,077
Income tax expense/(benefit)	303			(172		)
Net income	$	4,546		$	3,249
Preferred dividends and discount accretion	(763		)	(763		)
Net income available to common shareholders	$	3,783		$	2,486

Comprehensive income	$	7,385		$	4,210

Cash dividends declared per common share	$	0.01		$	0.01

Net income per common share - basic and diluted	$	0.19		$	0.12

The accompanying notes are an integral part of these consolidated financial statements.

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MAINSOURCE FINANCIAL GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOW

(Dollar amounts in thousands)

	(Unaudited)
	Three months ended March 31,
	2011			2010
Operating Activities
Net income	$	4,546		$	3,249
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	5,600			9,500
Depreciation expense	1,272			1,370
Securities amortization, net	607			180
Stock based compensation expense	17			28
Amortization of purchased intangible assets	492			516
Increase in cash surrender value of life insurance policies	(291		)	(294		)
Gain on life insurance benefit	—			(67		)
Securities gains	(1,133		)	(1,053		)
Gain on loans sold	(906		)	(838		)
Loans originated for sale	(40,931		)	(39,939		)
Proceeds from loan sales	45,823			42,991
Change in other assets and liabilities	3,881			4,500
Net cash provided by operating activities	18,977			20,143

Investing Activities
Purchases of securities available for sale	(90,062		)	(77,186		)
Proceeds from calls, maturities, and payments on securities available for sale	40,365			26,840
Proceeds from sales of securities available for sale	43,428			40,028
Proceeds from life insurance benefit	—			124
Loan originations and payments, net	22,372			46,570
Purchases of premises and equipment	(1,865		)	(1,174		)
Proceeds from redemption of restricted stock	204			5,603
Net cash provided by investing activities	14,442			40,805

Financing Activities
Net change in deposits	(2,203		)	(51,287		)
Net change in other borrowings	(2,224		)	2,682
Repayment of FHLB advances	(6,084		)	(3,266		)
Cash dividends on preferred stock	(712		)	(712		)
Cash dividends	(201		)	(201		)
Net cash (used) by financing activities	(11,424		)	(52,784		)
Net change in cash and cash equivalents	21,995			8,164
Cash and cash equivalents, beginning of year	60,123			71,689
Cash and cash equivalents, end of period	$	82,118		$	79,853

The accompanying notes are an integral part of these consolidated financial statements.

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Dollar amounts in thousands except per share data)

NOTE 1 - BASIS OF PRESENTATION

The significant accounting policies followed by MainSource Financial Group, Inc. (“Company”) for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. The consolidated interim financial statements have been prepared according to accounting principles generally accepted in the United States of America and in accordance with the instructions for Form 10-Q. The interim statements do not include all information and footnotes normally included in the annual financial statements. All adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods reported have been included in the accompanying unaudited consolidated financial statements and all such adjustments are of a normal recurring nature. Some items in prior period financial statements were reclassified to conform to current presentation. It is suggested that these consolidated financial statements and notes be read in conjunction with the financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Adoption of New Accounting Standards

In April 2011, the FASB amended existing guidance for assisting a creditor in determining whether a restructuring is a troubled debt restructuring. The amendments clarify the guidance for a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. This guidance is effective for interim and annual reporting periods beginning after June 15, 2011, and should be applied retrospectively to restructurings occurring on or after the beginning of the annual period of adoption. For purposes of measuring impairment on newly identified troubled debt restructurings, the amendments should be applied prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company is currently evaluating the impact this guidance will have on its financial statements.

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NOTE 2 - STOCK PLANS AND STOCK BASED COMPENSATION

From time to time, common stock and options to buy common stock are granted to directors and officers of the Company under the MainSource Financial Group, Inc. 2007 Stock Incentive Plan (the “2007 Stock Incentive Plan”), which was adopted and approved by the Board of Directors of the Company on January 16, 2007. The plan was effective upon the approval of the plan by the Company’s shareholders, which occurred on April 26, 2007 at the Company’s annual meeting of shareholders. The 2007 Stock Incentive Plan provides for the grant of incentive stock options, nonstatutory stock options, stock bonuses and restricted stock awards. Incentive stock options may be granted only to employees. An aggregate of 650,000 shares of common stock are reserved for issuance under the 2007 Stock Incentive Plan. Shares issuable under the 2007 Stock Incentive Plan will be authorized and unissued shares of common stock or treasury shares. The 2007 Stock Incentive Plan is in addition to, and not in replacement of, the MainSource Financial Group, Inc. 2003 Stock Option Plan the (“2003 Option Plan”), which was approved by the Company’s Board of Directors on January 21, 2003, and was effective upon approval by the Company’s shareholders on April 23, 2003. The 2003 Option Plan provided for the grant of up to 607,754 incentive and nonstatutory stock options. Upon the approval of the 2007 Stock Incentive Plan, no further awards of options may be made under the 2003 Option Plan. Unexercised options which were previously issued under the 2003 Option Plan have not been terminated, but will otherwise continue in accordance with the 2003 Option Plan and the agreements pursuant to which the options were issued. All stock options granted under either the 2003 Option Plan or the 2007 Stock Incentive Plan have an exercise price that is at least equal to the fair market value of the Company’s common stock on the date the options were granted. The maximum option term is ten years, and options vest immediately for the directors’ grant and over four years for the officers’ grant, except as otherwise determined by the Executive Compensation Committee of the Board of Directors.

All share-based payments to employees, including grants of employee stock options, are recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values. For options with graded vesting, we value the stock option grants and recognize compensation expense as if each vesting portion of the award was a single award.

The following table summarizes stock option activity:

	Three Months Ended March 31, 2011
	Shares	Weighted Average Exercise Price
Outstanding, beginning of year	409,783	$	13.30
Granted	—	—
Exercised	—	—
Forfeited or expired	5,000	6.76
Outstanding, period end	404,783	$	13.38
Options exercisable at period end	301,466	$	15.25

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The following table details stock options outstanding:

	March 31, 2011		December 31, 2010
Stock options vested and currently exercisable:
Number	301,466		301,466
Weighted average exercise price	$	15.25	$	15.25
Aggregate intrinsic value	$	267	$	320
Weighted average remaining life (in years)	5.1		5.3

The intrinsic value for stock options is calculated based on the exercise price of the underlying awards and the market price of our common stock as of the reporting date. The Company recorded $17 and $28 in stock compensation expense during the three months ended March 31, 2011 and 2010 to salaries and employee benefits. There were 1,500 options granted in the first quarter of 2010. The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes based stock option valuation model. This model requires the input of subjective assumptions that will usually have a significant impact on the fair value estimate. Expected volatilities are based on historical volatility of the Company’s stock, and other factors. Expected dividends are based on dividend trends and the market price of the Company’s stock price at grant. The Company uses historical data to estimate option exercises within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

Unrecognized stock option compensation expense related to unvested awards for the remainder of 2011 and beyond is estimated as follows:

Year	(in thousands)
April 2011 - December 2011	$	49
2012	45
2013	11
2014	—
2015	—

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NOTE 3 - SECURITIES

The amortized cost and fair value of securities available for sale and related unrealized gains/losses recognized in accumulated other comprehensive income/(loss) was as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
As of March 31, 2011
Available for Sale
State and municipal	$	299,256	$	11,216	$	(680	)	$	309,792
Mortgage-backed securities-residential (GSE’s)	299,506		8,602		(1,055		)	307,053
Collateralized mortgage obligations	191,636		2,041		(1,224		)	192,453
Equity securities	4,405		—		—			4,405
Other securities	3,513		19		—			3,532
Total available for sale	$	798,316	$	21,878	$	(2,959	)	$	817,235

As of December 31, 2010
Available for Sale
State and municipal	$	294,706	$	7,193	$	(1,755	)	$	300,144
Mortgage-backed securities-residential (GSE’s)	304,347		9,513		(1,029		)	312,831
Collateralized mortgage obligations	184,549		3,129		(1,681		)	185,997
Equity securities	4,405		—		—			4,405
Other securities	3,514		—		(820		)	2,694
Total available for sale	$	791,521	$	19,835	$	(5,285	)	$	806,071

The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity or with no maturity are shown separately.

	Available for Sale
	Amortized Cost		Fair Value
Within one year	$	1,035	$	1,051
One through five years	34,180		35,709
Six through ten years	89,398		92,778
After ten years	178,156		183,786
Mortgage-backed securities-residential (GSE’s)	299,506		307,053
Collateralized mortgage obligations	191,636		192,453
Equity securities	4,405		4,405
Total available for sale securities	$	798,316	$	817,235

Proceeds from sales of securities available for sale were $43,428 and $40,028 for the three months ended March 31, 2011 and 2010, respectively. Gross gains of $1,216 and $1,092 and gross losses of $83 and $39 were realized on these sales during 2011 and 2010, respectively.

Below is a summary of securities with unrealized losses as of March 31, 2011 and December 31, 2010 presented by length of time the securities have been in a continuous unrealized loss position.

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	Less than 12 months					12 months or longer					Total
March 31, 2011 Description of securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
State and municipal	30,574		(586		)	653		(94		)	31,227		(680		)
Mortgage-backed securities-residential (GSE’s)	40,276		(1,055		)	—		—			40,276		(1,055		)
Collateralized mortgage obligations	89,242		(1,224		)	3		—			89,245		(1,224		)
Total temporarily impaired	$	160,092	$	(2,865	)	$	656	$	(94	)	$	160,748	$	(2,959	)

	Less than 12 months					12 months or longer					Total
December 31, 2010 Description of securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
State and municipal	69,009		(1,664		)	406		(91		)	69,415		(1,755		)
Mortgage-backed securities-residential (GSE’s)	42,926		(1,029		)	—		—			42,926		(1,029		)
Collateralized mortgage obligations	70,656		(1,681		)	—		—			70,656		(1,681		)
Other securities	1,010		(2		)	1,684		(818		)	2,694		(820		)
Total temporarily impaired	$	183,601	$	(4,376	)	$	2,090	$	(909	)	$	185,691	$	(5,285	)

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities are generally evaluated for OTTI under ASC 320. However, certain purchased beneficial interests, including non-agency mortgage-backed securities, asset-backed securities, and collateralized debt obligations, that had credit ratings at the time of purchase of below AA are evaluated using the model outlined in ASC 325-10 .

In determining OTTI under ASC 320, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs under either model, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

As of March 31, 2011, the Company’s security portfolio consisted of 953 securities, 91 of which were in an unrealized loss position. Unrealized losses on state and municipal securities have not been recognized into income because management has the ability to hold for a period of time sufficient to allow for any anticipated recovery in fair value and it is unlikely that management will be required to sell the securities before their anticipated recovery. The decline in value is primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. The Company monitors the financial condition of these issuers. The fair value of these debt securities is expected to recover as the securities approach their maturity date.

At March 31, 2011, 100% of the mortgage-backed securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae and Freddie Mac, which are institutions which the government has affirmed its commitment to support. Because the decline in fair value of approximately $1.1 million is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at March 31, 2011.

The Company’s collateralized mortgage obligation securities portfolio includes agency collateralized mortgage obligations with a market value of $192 million which had unrealized losses of approximately $1.2 million at March 31, 2011. The Company monitors to insure it has adequate credit support and as of March 31, 2011, the Company believes there is no OTTI and does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery. All securities are investment grade.

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NOTE 4 - LOANS AND ALLOWANCE

Loans were as follows:

	March 31, 2011			December 31, 2010
Commercial
Commercial and industrial	$	136,107		$	138,291
Agricultural	23,173			27,178
Commercial Real Estate
Farm	52,081			48,307
Hotel	151,819			152,416
Construction and development	40,763			59,319
Other	583,803			589,192
Residential
1-4 family	380,267			380,987
Home equity	209,518			213,607
Consumer
Direct	54,668			59,139
Indirect	10,501			12,535
Total loans	1,642,700			1,680,971
Allowance for loan losses	(43,255		)	(42,605		)
Net loans	$	1,599,445		$	1,638,366

Activity in the allowance for loan losses was as follows:

	March 31,
	2011			2010
Allowance for loan losses
Balances, January 1	$	42,605		$	46,648
Provision for losses	5,600			9,500
Recoveries on loans	1,043			629
Loans charged off	(5,993		)	(13,752		)
Balances, March 31	$	43,255		$	43,025

Activity in the allowance for loan losses for the three months ended March 31, 2011 and the recorded investment of loans and allowances by portfolio segment and impairment method as of March 31, 2011 were as follows:

	Commercial			Commercial Real Estate			Residential			Consumer			Total
Allowance for loan loss
Balance, January 1, 2011	$	6,386		$	32,653		$	2,281		$	1,285		$	42,605
Provision charged to expense	(206		)	4,366			1,047			393			5,600
Losses charged off	(259		)	(4,262		)	(922		)	(550		)	(5,993		)
Recoveries	28			472			201			342			1,043
Balance, March 31, 2011	$	5,949		$	33,229		$	2,607		$	1,470		$	43,255
Ending Balance individually evaluated for impairment	$	1,953		$	6,674		$	—		$	—		$	8,627
Ending Balance collectively evaluated for impairment	3,996			26,555			2,607			1,470			34,628
Total ending allowance balance	$	5,949		$	33,229		$	2,607		$	1,470		$	43,255
Loans
Ending Balance individually evaluated for impairment	$	7,518		$	44,298		$	13,244		$	997		$	66,057
Ending Balance collectively evaluated for impairment	152,259			787,377			579,131			64,424			1,583,191
Total ending loan balance includes $ 6,548 of accrued interest	$	159,777		$	831,675		$	592,375		$	65,421		$	1,649,248

The balance of recorded investment of loans and allowance for loan losses by portfolio segment and impairment method as of December 31, 2010 were as follows:

Balance, December 31, 2010	Commercial		Commercial Real Estate		Residential		Consumer		Total
Ending Balance individually evaluated for impairment	$	1,753	$	8,571	$	—	$	—	$	10,324
Ending Balance collectively evaluated for impairment	4,633		24,082		2,281		1,285		32,281
Total ending allowance balance	$	6,386	$	32,653	$	2,281	$	1,285	$	42,605

Loans
Ending Balance individually evaluated for impairment	$	8,223	$	64,048	$	16,801	$	1,504	$	90,576
Ending Balance collectively evaluated for impairment	157,804		788,474		580,412		70,484		1,597,174
Total ending loan balance includes $6,779 of accrued interest	$	166,027	$	852,522	$	597,213	$	71,988	$	1,687,750

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The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2011:

	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
With an allowance recorded
Commercial
Commercial and industrial	$	5,437	$	5,372	$	1,930
Agricultural	68		67		23
Commercial Real Estate
Farm	461		465		71
Hotel	6,242		5,923		565
Construction and development	16,261		5,823		1,442
Other	18,708		17,192		4,596
Total	$	47,177	$	34,842	$	8,627
With no related allowance recorded
Commercial
Commercial and industrial	$	2,473	$	2,018	$	—
Agricultural	353		61
Commercial Real Estate
Farm	762		721
Hotel	654		384
Construction and development	502		501
Other	16,084		13,289
Residential
1-4 Family	11,927		11,621
Home Equity	1,706		1,623
Consumer
Direct	944		932
Indirect	70		65
Total	$	35,475	$	31,215	$	—

The following table presents the average balance of impaired loans by class and interest income recognized on impaired loans and cash basis interest at March 31, 2011

	Average Balance		Interest Income Recognized / Cash Basic Interest
Commercial
Commercial and industrial	$	7,742	$	15
Agricultural	129
Commercial Real Estate
Farm	1,193
Hotel	9,485
Construction and development	12,663
Other	30,798		18
Residential
1-4 Family	13,255		4
Home Equity	1,767		5
Consumer
Direct	1,181		1
Indirect	70		5
Total	$	78,283	$	48

The amounts at March 31, 2010 were as follows:	$	94,821	$	24

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The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2010:

	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
With an allowance recorded
Commercial
Commercial and industrial	$	4,935	$	4,902	$	1,753
Agricultural
Commercial Real Estate
Farm	461		465		71
Hotel	13,178		12,603		1,151
Construction and development	41,924		17,613		3,110
Other	22,580		20,458		4,239
Total	$	83,078	$	56,041	$	10,324

With no related allowance recorded
Commercial
Commercial and industrial	$	3,966	$	3,191	$	—
Agricultural	422		130
Commercial Real Estate
Farm	766		735
Hotel	59		60
Construction and development	1,677		1,390
Other	14,120		10,724
Residential
1-4 Family	15,171		14,889
Home Equity	2,000		1,912
Consumer
Direct	1,431		1,430
Indirect	78		74
Total	$	39,690	$	34,535	$	—

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of March 31, 2011 and December 31, 2010

	March 31, 2011				December 31, 2010
	Non-accrual		Past due over 90 days and still accruing		Non-accrual		Past due over 90 days and still accruing
Commercial
Commercial and industrial	$	4,745	$	—	$	4,587	$	—
Agricultural	128				130
Commercial Real Estate
Farm	721				736
Hotel	6,307				6,533
Construction and development	6,324		4,334		19,003
Other	24,558		59		24,530		42
Residential
1-4 Family	9,819		684		10,681		869
Home Equity	1,509		200		1,688		86
Consumer
Direct	313		22		261		9
Indirect	65				74
Total	$	54,489	$	5,299	$	68,223	$	1,006

The following table presents the aging of the recorded investment in past due loans as of March 31, 2011 by class of loans:

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	Total Loans		30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Loans Not Past Due
Commercial
Commercial and industrial	$	136,497	$	867	$	524	$	3,035	$	4,426	$	132,071
Agricultural	23,280						128		128		23,152
Commercial Real Estate
Farm	52,476		79		14		577		670		51,806
Hotel	152,403		3,196				384		3,580		148,823
Construction and development	40,930		514				10,657		11,171		29,759
Other	585,866		6,093		2,962		14,541		23,596		562,270
Residential
1-4 Family	381,902		6,648		763		6,546		13,957		367,945
Home Equity	210,473		158		245		1,299		1,702		208,771
Consumer
Direct	54,879		274		30		128		432		54,447
Indirect	10,542		49		64		19		132		10,410
Total — includes $6,548 of accrued interest	$	1,649,248	$	17,878	$	4,602	$	37,314	$	59,794	$	1,589,454

The following table presents the aging of the recorded investment in past due loans as of December 31, 2010 by class of loans:

	Total Loans		30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Loans Not Past Due
Commercial
Commercial and industrial	$	138,760	$	1,214	$	235	$	3,151	$	4,600	$	134,160
Agricultural	27,267						130		130		27,137
Commercial Real Estate
Farm	48,721						528		528		48,193
Hotel	152,964						512		512		152,452
Construction and development	59,442				728		18,275		19,003		40,439
Other	591,395		4,267		2,732		17,647		24,646		566,749
Residential
1-4 Family	382,634		7,028		2,673		8,032		17,733		364,901
Home Equity	214,579		654		266		1,376		2,296		212,283
Consumer
Direct	59,398		513		155		138		806		58,592
Indirect	12,590		115		6		36		157		12,433
Total — includes $6,779 of accrued interest	$	1,687,750	$	13,791	$	6,795	$	49,825	$	70,411	$	1,617,339

At March 31, 2011, the Company had $11,503 of troubled debt restructurings compared to $22,250 at December 31, 2010. The Company has allocated $1,860 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2011. The Company has committed to lend additional amounts totaling $462 to customers with outstanding loans that are classified as troubled debt restructurings. At December 31, 2010, the comparable numbers were $2,599 of specific reserves and $517 of commitments.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of the borrower to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes commercial and commercial real estate loans individually by classifying the loans as to credit risk. This analysis includes credit relationships with an outstanding balance greater than $1 million on an annual basis. The Company uses the following definitions for risk ratings:

Special Mention — Loans classified as special mention have above average risk that requires management’s ongoing attention. The borrower may demonstrated inability to generate profits or to maintain net worth, chronic delinquency and/or a demonstrated lack of willingness or capacity to meet obligations.

Substandard — Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are classified by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

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Non-accrual — Loans classified as non-accrual are loans where the further accrual of interest is stopped because payment in full of principal and interest is not expected. In most cases, the principal and interest has been in default for a period of 90 days or more.

As of March 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

	Pass		Special Mention		Substandard		Non-accrual
Commercial
Commercial and industrial	$	115,455	$	10,107	$	6,190	$	4,745
Agricultural	22,311		663		178		128
Commercial Real Estate
Farm	46,987		2,503		2,265		721
Hotel	78,733		64,043		3,320		6,307
Construction and development	14,330		6,903		13,373		6,324
Other	467,736		51,940		41,633		24,558
Total	$	745,552	$	136,159	$	66,959	$	42,783

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be performing or non performing. These loans are primarily residential mortgage and consumer loans. Performing loans are loans risk graded 1-4 and nonperforming loans are loans risk graded 5, 6, or 9. As of March 31, 2011, the performing/non performing loans by class of loans are as follows:

	Performing		Non- performing
Residential
1-4 Family	$	349,833	$	32,069
Home Equity	204,514		5,959
Consumer
Direct	53,052		1,827
Indirect	10,292		250
Total	$	617,691	$	40,105

As of December 31, 2010, the risk category of loans by class of loans is as follows:

	Pass		Special Mention		Substandard		Non-accrual
Commercial
Commercial and industrial	$	113,744	$	14,050	$	6,379	$	4,587
Agricultural	25,198		1,769		170		130
Commercial Real Estate
Farm	38,581		7,611		1,793		736
Hotel	87,205		55,878		3,348		6,533
Construction and development	16,124		10,721		13,594		19,003
Other	481,646		45,705		39,514		24,530
Total	$	762,498	$	135,734	$	64,798	$	55,519

As of December 31, 2010, the performing/non performing loans by class of loans are as follows:

	Performing		Non- performing
Residential
1-4 Family	$	352,592	$	30,042
Home Equity	208,763		5,816
Consumer
Direct	57,489		1,909
Indirect	12,302		288
Total	$	631,146	$	38,055

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NOTE 5 — OTHER REAL ESTATE OWNED

Other real estate owned is recorded in other assets on the balance sheet. Activity in other real estate owned was as follows:

	2011			2010
Beginning Balance — January 1	$	11,453		$	10,363
Transfer to other real estate owned	10,949			930
Sales	(1,292		)	(1,210		)
Write down	(532		)	—
Ending Balance — March 31	$	20,578		$	10,083

Expenses related to foreclosed assets include:

	Three Months Ended
	March 31, 2011		March 31, 2010
Net loss (gain) on sales	$	365	$	(23	)
Operating expenses	168		39

NOTE 6 - DEPOSITS

	March 31, 2011		December 31, 2010

Noninterest-bearing demand	$	293,648	$	268,390
Interest-bearing demand	799,730		798,897
Savings	447,102		430,367
Certificates of deposit of $100 or more	217,164		231,019
Other certificates and time deposits	451,717		482,891
Total deposits	$	2,209,361	$	2,211,564

NOTE 7 - EARNINGS PER SHARE

Earnings per share (EPS) were computed as follows:

	March 31, 2011						March 31, 2010
				Weighted	Per					Weighted	Per
	Net			Average	Share		Net			Average	Share
For the three months ended	Income			Shares	Amount		Income			Shares	Amount
Basic earnings per share:
Net income	$	4,546		20,136,188	$		$	3,249		20,136,362	$
Preferred dividends and accretion	(763		)				(763		)
Net income available to common shareholders	3,783			20,136,188	0.19		2,486			20,136,362	0.12
Effect of dilutive shares				47,292						1,503
Net income available to common shareholders and assumed conversions	$	3,783		20,183,480	$	0.19	$	2,486		20,137,865	$	0.12

Stock options for 251,116 common shares and stock warrants for 571,906 common shares in 2011 and stock options for 312,941 common shares and stock warrants for 571,906 in 2010 were not considered in computing diluted earnings per share because they were antidilutive.

NOTE 8 — FAIR VALUE

ASC 820 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access

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as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or using market data utilizing pricing models, primarily Interactive Data Corporation (IDC), that vary based upon asset class and include available trade, bid, and other market information. Matrix pricing is used for most municipals, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. The grouping of securities is done according to insurer, credit support, state of issuance, and rating to incorporate additional spreads and municipal curves. For the general market municipals, the Thomson Municipal Market Data curve is used to determine the initial curve for determining the price, movement, and yield relationships with the municipal market (Level 2 inputs). Level 3 securities are largely comprised of small, local municipality issuances and Community Reinvestment Act (CRA) qualified credits. Fair values are derived through consideration of funding type, maturity and other features of the issuance, and include reviewing financial statements, earnings forecasts, industry trends and the valuation of comparative issuers.

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

The fair value of servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs).

The fair value of other real estate owned is measured based on the value of the collateral securing those assets and is determined using several methods. The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis (Level 3 inputs).

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value under ASC 820 on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:

			Fair Value Measurements at March 31, 2011 Using:
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
(Dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets
Securities available-for sale
States and municipals	$	309,792			$	309,792
Mortgage-backed securities - residential	307,053				307,053
Collateralized mortgage obligations	192,453				192,453
Equity securities	4,405		3,655				750
Other securities	3,532		3,532
Total securities available-for-sale	$	817,235	$	7,187	$	809,298	$	750

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			Fair Value Measurements at December 31, 2010 Using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets
Securities available-for sale
States and municipals	$	300,144			$	300,144
Mortgage-backed securities - residential	312,831				312,831
Collateralized mortgage obligations	185,997				185,997
Equity securities	4,405		3,655				750
Other securities	2,694				824		1,870
Total securities available-for-sale	$	806,071	$	3,655	$	799,796	$	2,620

The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three month period ended March 31, 2011:

Three months ended March 31, 2011

	Available for sale securities
Beginning balance, January 1, 2011	$	2,620
Total gains or losses (realized / unrealized)
Included in earnings
Other changes in fair value	—
Gains (losses) on securities	—
Included in other comprehensive income	97
Purchases, issuances, and settlements	—
Transfers in and / or out of Level 3	(1,967		)
Ending balance, March 31, 2011	$	750

The transfers out were securities that are being called by the issuer in the second quarter of 2011. The Company feels that the established call price is no longer indicative of a Level 3 value and thus transferred them to Level 1.

Three months ended March 31, 2010

	Available for sale securities
Beginning balance, January 1, 2010	$	3,220
Total gains or losses (realized / unrealized)
Included in earnings
Other changes in fair value	—
Gains (losses) on securities	—
Included in other comprehensive income	275
Purchases, issuances, and settlements	—
Transfers in and / or out of Level 3	—
Ending balance, March 31, 2010	$	3,495

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The table below summarizes changes in unrealized gains and losses recorded in earnings for the quarter ended March 31 for Level 3 asset and liabilities that are still held at March 31.

	Changes in Unrealized Gains/Losses Relating to Assets Still Held at Reporting Date for the Quarter Ended March 31
	2011		2010
Interest Income on Securities	$	—	$	52
Other Changes in Fair Value	—		275
Total	$	—	$	327

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements at March 31, 2011 Using
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans
Construction and development	$	4,381			4,381
Commercial real estate	12,596				12,596
Hotel	5,358				5,358
Commercial and industrial loans	3,442				3,442
Other	438				438
Total impaired loans	26,215				26,215
Servicing rights	5,499			5,499
Other real estate owned/assets held for sale	5,640				5,640

		Fair Value Measurements at December 31, 2010 Using
	Carrying Value	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$			$
Commercial and industrial	3,149			3,149
Farm	394			394
Hotel	11,452			11,452
Construction and development	14,503			14,503
Other	16,219			16,219
Total impaired loans	45,717			45,717
Servicing rights	5,498		5,498
Other real estate owned/assets held for sale	3,085			3,085

The following represent impairment charges recognized during the period:

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a gross carrying amount of $34,842, with a valuation allowance of $8,627 at March 31, 2011. The Company recorded $2,184 of provision expense associated with these loans for the three months ended March 31, 2011 and $4,644 of provision expense associated with these loans for the three months ended March 31, 2010. At December 31, 2010, impaired loans had a gross carrying amount of $56,041 with a valuation allowance of $10,324.

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Servicing rights, which are carried at lower of cost or fair value, were carried at a fair value of $5,499, which is made up of the gross outstanding balance of $5,993, net of a valuation allowance of $494 at March 31, 2011. There was no adjustment in the 2011 first quarter earnings and a recovery of $110 was included in 2010 first quarter earnings. At December 31, 2010, servicing rights were carried at a fair value of $5,498, which is made up of the gross outstanding balance of $5,992, net of a valuation allowance of $494.

Other real estate owned/assets held for sale is evaluated at the time a property is acquired through foreclosure or shortly thereafter. Fair value is based on appraisals by qualified licensed appraisers. During the first quarter of 2011, these properties were written down by $509. No adjustments were made in the first quarter of 2010.

The following table presents the carrying amounts and estimated fair values of financial instruments at March 31, 2011 and December 31, 2010:

	March 31, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	82,118	$	82,118	$	60,123	$	60,123
Securities available-for-sale	817,235		817,235		806,071		806,071
Restricted stock	19,298		N/A		19,502		N/A
Loans, net including loans held for sale	1,575,089		1,546,460		1,598,494		1,584,631
Interest receivable	11,299		11,299		11,552		11,552

Financial liabilities
Deposits	2,209,361		2,211,053		2,211,564		2,214,778
Other borrowings	30,957		30,957		33,181		33,181
Subordinated debentures	50,155		26,585		50,117		26,565
FHLB advances	145,981		155,749		152,065		163,498
Interest payable	2,759		2,759		3,391		3,391

The difference between the loan balance included above and the amounts shown in Note 4 are the impaired loans discussed above.

The methods and assumptions used to estimate fair value are described as follows:

Carrying amount is the estimated fair value of cash and cash equivalents, interest-bearing time deposits, accrued interest receivable and payable, demand and all other transactional deposits, short-term borrowings, variable rate notes payable, and variable rate loans or deposits that reprice frequently and fully. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of loans held for sale is based on market quotes. Fair value of FHLB advances and subordinated debentures is based on current rates for similar financing. It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements, and are not considered significant.

NOTE 9 — REGULATORY CAPITAL

Banks and bank holding companies are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. The assigned capital category is largely determined by three ratios that are calculated according to the regulations. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity’s activities that are not part of the calculated ratios. Failure to meet capital requirements can initiate regulatory action. During the first quarter of 2010, the Bank entered into an agreement with its regulators to maintain a Tier 1 leverage ratio of at least 8% and a total risk based capital ratio of at least 11%. (See Note 10 below).

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Actual and required capital amounts and ratios are presented below:

					Required for			To Comply with
	Actual				Adequate Capital			Regulatory Agreement
March 31, 2011	Amount		Ratio		Amount	Ratio		Amount	Ratio

MainSource Financial Group
Total capital (to risk-weighted assets)	$	296,651	17.4	%	136,279	8.0	%	N/A	N/A
Tier 1 capital (to risk-weighted assets)	275,210		16.2		68,140	4.0		N/A	N/A
Tier 1 capital (to average assets)	275,210		10.2		107,782	4.0		N/A	N/A

MainSource Bank
Total capital (to risk-weighted assets)	277,580		16.4	%	135,479	8.0	%	186,284	11.0	%
Tier 1 capital (to risk-weighted assets)	256,139		15.1		67,740	4.0		—	—
Tier 1 capital (to average assets)	256,139		9.6		106,582	4.0		213,163	8.0

					Required for			To Comply with
	Actual				Adequate Capital			Regulatory Agreement
December 31, 2010	Amount		Ratio		Amount	Ratio		Amount	Ratio

MainSource Financial Group
Total capital (to risk-weighted assets)	$	293,069	16.8	%	139,611	8.0	%	N/A	N/A
Tier 1 capital (to risk-weighted assets)	270,998		15.5		69,806	4.0		N/A	N/A
Tier 1 capital (to average assets)	270,998		9.7		112,069	4.0		N/A	N/A

MainSource Bank
Total capital (to risk-weighted assets)	271,430		15.7	%	138,237	8.0	%	190,076	11.0	%
Tier 1 capital (to risk-weighted assets)	249,571		14.4		69,118	4.0		—	—
Tier 1 capital (to average assets)	249,571		9.0		110,761	4.0		221,522	8.0

Management believes as of March 31, 2011, the Company and the Bank meet all capital adequacy requirements to which they are subject to be considered well-capitalized. The holding company is a source of additional financial strength to the Bank with its $11,000 in cash and its ability to downstream additional capital to the Bank.

NOTE 10 — REGULATORY ACTION

Effective April 22, 2010, the Bank entered into an informal agreement with the FDIC and the Indiana Department of Financial Institutions pursuant to which the Bank has agreed to take various actions and comply with certain requirements. The informal agreement is not a “written agreement” for purposes of Section 8 of the Federal Deposit Insurance Act. The agreement documents an understanding among the Bank, the FDIC and the DFI that, among other things, requires the Bank to maintain its Tier 1 leverage ratio at a minimum of 8% and its total risk based capital ratio at a minimum of 11%. Additionally the agreement requires the Bank to continue to obtain the approval of the FDIC and DFI prior to paying a cash dividend from the Bank to the Company, a practice in which the Bank was already engaged. At the time it entered into the agreement and at all times since that date, the Bank exceeded the required minimum capital levels and believes it is in substantial compliance with all other terms of the agreement.

The agreement will remain in effect until modified or terminated by the FDIC and the DFI. We do not expect the actions called for by the agreement to change in any material respect our ongoing efforts to improve the performance of the Bank by reducing non-performing assets and increasing earnings. The Board of Directors and management of the Bank have taken various actions to comply with the agreement, and will continue to take all actions necessary for continued compliance. Compliance with the terms of the agreement is not expected to have a material effect on the financial condition or results of operations of the Company or the Bank.

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MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Dollar amounts in thousands except per share data)

Overview

MainSource Financial Group, Inc. (“MainSource or Company”) is a financial holding company whose principal activity is the ownership and management of its subsidiary bank, MainSource Bank (“Bank”) headquartered in Greensburg, Indiana, MainSource Insurance, LLC (“MSI”), MainSource Title, LLC (“MST”), and Insurance Services Marketing, LLC (“ISM”). The Bank operates under a state charter and is subject to regulation by its state regulatory agencies and the Federal Deposit Insurance Corporation. Both MSI and MST are subject to regulation by the Indiana Department of Insurance.

Forward-Looking Statements

Except for historical information contained herein, the discussion in this report includes certain forward-looking statements based upon management expectations. Actual results and experience could differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. The Company disclaims any intent or obligation to update such forward looking statements. Factors which could cause future results to differ from these expectations include the following: general economic conditions; legislative and regulatory initiatives; monetary and fiscal policies of the federal government; deposit flows; the cost of funds; general market rates of interest; interest rates on competing investments; demand for loan products; demand for financial services; changes in accounting policies or guidelines; changes in the quality or composition of the Company’s loan and investment portfolios; the Company’s ability to integrate acquisitions, the impact of our continuing acquisition strategy, and other factors, including the risk factors set forth in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, and in other reports we file from time to time with the Securities and Exchange Commission. The Company intends the forward looking statements set forth herein to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995.

Results of Operations

Net income for the first quarter of 2011 was $4,546 compared to net income of $3,249 for the first quarter of 2010. The increase in net income was primarily attributable to a decrease in the Company’s loan loss provision expense of $3,900 from the first quarter of 2010 offset by losses on other real estate of $388 (primarily from two properties), additional marketing expenditures of $488 related to investments in a checking account acquisition program and a customer/employee engagement survey, and additional costs associated with collection expenses on problem loans of $439. Diluted earnings per common share for the first quarter totaled $0.19 in 2011, an increase from the $0.12 reported in the same period a year ago. Key measures of the financial performance of the Company are return on average shareholders’ equity and return on average assets. Return on average shareholders’ equity was 6.05% for the first quarter of 2011 while return on average assets was 0.67% for the same period, compared to 4.42% and 0.46% in the first quarter of 2010.

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Net Interest Income

The volume and yield of earning assets and interest-bearing liabilities influence net interest income. Net interest income reflects the mix of interest-bearing and non-interest-bearing liabilities that fund earning assets, as well as interest spreads between the rates earned on these assets and the rates paid on interest-bearing liabilities. First quarter net interest income of $24,950 in 2011 was a decrease of 1.1% versus the first quarter of 2010. Average earning assets decreased $106 million with the majority of the decrease the result of reduced loan balances of $194 million. Offsetting this decrease in loans was an increase in the investment portfolio of $82 million. Also affecting margin was an increase in average demand deposits and NOW accounts of $117 million which replaced higher costing CD and FHLB advances of $245 million. Net interest margin, on a fully-taxable equivalent basis, was 4.30% for the first quarter of 2011, a significant increase compared to 4.09% for the same period a year ago and a 29 basis point increase on a linked quarter basis.

Provision for Loan Losses

See “Loans, Credit Risk and the Allowance and Provision for Probable Loan Losses” below.

Non-interest Income

First quarter non-interest income for 2011 was $9,319 compared to $9,831 for the first quarter of 2010. Contributing to the $512 reduction was a decrease in insurance commissions of $518 as the Company sold the property and casualty insurance lines of business in the fourth quarter of 2010 and OREO losses of $388 primarily related to the write down of two properties. Offsetting these decreases was an increase in trust and investment product fees of $375 and interchange income of $152. The Company has increased its number of financial advisors in the last six months and this increase has resulted in greater fee income growth. Continued organic growth in deposit accounts has resulted in higher fee income.

Non-interest Expense

The Company’s non-interest expense was $23,820 for the first quarter of 2011 compared to $22,485 for the same period in 2010. The primary increases were in marketing costs and collection expenses. Marketing expenses increased by $488 thousand as the Company has made investments in a checking account acquisition program and a customer/employee engagement survey and improvement program. Collection expenses increased by $439 thousand as the Company is incurring costs as it aggressively works through its non-performing loans and problem assets. The Company’s efficiency ratio was 66.2% for the first quarter of 2011 compared to 62.0% for the same period a year ago.

Income Taxes

The effective tax rate for the first three months was 6.2% for 2011 compared to (5.6%) for the same period a year ago. The increase in the effective rate is due to the Company’s tax exempt income and credits which remained relatively consistent with prior quarters combined with an increase in GAAP income before taxes. The Company and its subsidiaries file consolidated income tax returns.

Financial Condition

Total assets at March 31, 2011 were $2,767,985 and decreased slightly from total assets of $2,769,312 as of December 31, 2010. An increase in cash and due of $22 million and securities of $11 million was offset primarily by a decrease in loans of $39 million. Average earning assets represented 90.9% of average total assets for the first three months of 2011 and 91.1% for the same period in 2010. Average loans represented 75.7% of average deposits in the first three months of 2011 and 83.5% for the comparable period in 2010. Management continues to emphasize quality loan growth to increase these averages. Average loans as a percent of average assets were 60.4% and 64.8% for the three-month periods ended March 31, 2011 and 2010 respectively.

The decrease in deposits of $2 million from December 31, 2010 to March 31, 2011 was due primarily to decreases in CD balances of $45 million offset by increases in noninterest bearing deposits of $25 million and savings deposits of $18 million.

Shareholders’ equity was $309 million on March 31, 2011 compared to $303 million on December 31, 2010. Book value (shareholders’ equity) per common share was $12.56 at March 31, 2011 versus $12.24 at year-end 2010. Accumulated other

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comprehensive income increased book value per share by $0.61 at March 31, 2011 and increased book value per share by $0.47 at December 31, 2010. Depending on market conditions, the unrealized gain or loss on securities available for sale can cause fluctuations in shareholders’ equity. Interest rates remained relatively steady during the first quarter of 2011 which caused the unrealized gain on securities to approximate the amount at December 31, 2010.

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Loans, Credit Risk and the Allowance and Provision for Probable Loan Losses

Loans remain the Company’s largest concentration of assets and, by their nature, carry a higher degree of risk. The loan underwriting standards observed by the Bank are viewed by management as a means of controlling problem loans and the resulting charge-offs. The Company believes credit risks may be elevated if undue concentrations of loans in specific industry segments and to out-of-area borrowers are incurred. Accordingly, the Company’s Board of Directors regularly monitors such concentrations to determine compliance with its loan allocation policy. The Company believes it has no undue concentrations of loans.

Management maintains a list of loans warranting either the assignment of a specific reserve amount or other special administrative attention. This watch list, together with a listing of all classified loans, nonaccrual loans and delinquent loans, is reviewed monthly by management and the Board of Directors. Additionally, the Company evaluates its consumer and residential real estate loan pools for probable losses incurred based on historical trends, adjusted by current delinquency and non-performing loan levels.

The Company has both internal and external loan review personnel who annually review the top 100 loan relationships. External loan review personnel examine all commercial credit relationships over $1.85 million.

The ability to absorb loan losses promptly when problems are identified is invaluable to a banking organization. Most often, losses incurred as a result of prompt, aggressive collection actions are much lower than losses incurred after prolonged legal proceedings. Accordingly, the Company observes the practice of quickly initiating stringent collection efforts in the early stages of loan delinquency. During the latter part of 2008, the Company established a separate group to address its deteriorating credit quality. This group consists of six full-time equivalent employees and reports directly to the Chief Credit Officer of the Company. At the present time, this group is charged with the task of efficiently resolving non-performing credits and disposing of foreclosed properties.

Total loans (excluding loans held for sale) decreased $38,271 from year end 2010. Almost 50% of the decrease was in the construction and development portfolio as the continued sluggish economy resulted in the Company ceasing origination of these loans and a high level of charge offs taken in the first quarter of 2011. The Company experienced weak overall demand across all segments. Residential real estate loans continue to represent a significant portion of the total loan portfolio. Such loans represented 23.1% of total loans at March 31, 2011 and 22.7% at December 31, 2010. The Company anticipates this category of loans to decrease as a large portion of future residential real estate loan originations will be sold to the secondary market. On March 31, 2011, the Company had $1,859 of residential real estate loans held for sale, which was a decrease from the year-end balance of $5,845. The Company generally retains the servicing rights on mortgages sold.

Loans are placed on “non-accrual” status when, in management’s judgment, the collateral value and/or the borrower’s financial condition does not justify accruing interest. As a general rule, commercial and real estate loans are reclassified to nonaccrual status at or before becoming 90 days past due. Interest previously recorded is reversed and charged against current income. Subsequent interest payments collected on nonaccrual loans are thereafter applied as a reduction of the loan’s principal balance. Non-performing loans were as follows:

	March 31, 2011			December 31, 2010			September 30, 2010			June 30, 2010			March 31, 2010
Amount	$	71,277		$	91,519		$	90,563		$	98,680		$	95,645
Percent of loans	4.34		%	5.44		%	5.25		%	5.62		%	5.24		%

The reduction of $20 million from year end was due to charge-offs taken in the first quarter, the transfer of balances to ORE, as well as some paydowns/payoffs. Of the $71,277 of non-performing loans at March 31, 2011, $34,830 had a specific reserve allocated of $8,627.

As of March 31, 2011, the Company has charged down approximately $16,600 of impaired collateral dependent loans to their estimated realizable value. $900 of this amount was charged down in the first quarter of 2011. As collateral dependent loans become impaired in the future, an appraisal will be used to establish a basis to charge down the loan. These loans are primarily land development and real estate backed loans. The Company is working with these borrowers in an attempt to minimize its losses. In the course of resolving nonperforming loans, the Company may choose to restructure the contractual terms of certain loans. The Company attempts to work out an alternative payment schedule with the borrower in order to avoid foreclosure actions. Any loans that are modified are reviewed by us to identify if a troubled debt restructuring (“TDR”) has occurred, which is when for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status and could include reduction of the stated interest rate other than normal market rate adjustments, extension of maturity dates, or reduction of principal balance or accrued interest. The decision to restructure a loan, versus aggressively enforcing the collection of the loan, may benefit us by increasing the ultimate probability of collection.

The provision for loan losses was $5,600 in the first quarter of 2011 compared to $9,500 for the same period in 2010 and $6,000 for the fourth quarter of 2010. The slight decrease in provision expense from the fourth quarter of 2010 was primarily due to the relative

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stabilization in the amount of non-performing and watch list loans in aggregate. New non-accrual loans have declined in the last 4 quarters. The amount of new non-accrual loans in the first quarter of 2011 was approximately the same as the fourth quarter of 2010.

Net loan losses were $4,950 for the first quarter of 2011 compared to $13,123 for the same period a year ago. Approximately 70% of the Company’s charge-offs for the first three months of 2011 was related to 10 commercial credits. All but approximately $850 of these charge-offs had an allowance allocated in prior quarters.

The adequacy of the allowance for loan losses is reviewed at least quarterly. The determination of the provision amount in any period is based upon management’s continuing review and evaluation of loan loss experience, changes in the composition of the loan portfolio, classified loans including non-accrual and impaired loans, current economic conditions, the amount of loans presently outstanding, and the amount and composition of loan growth. The allowance for loan losses as of March 31, 2011 was considered adequate by management. The allowance for loan losses was $43,255 as of March 31, 2011 and represented 2.63% of total outstanding loans compared to $42,605 as of December 31, 2010 or 2.53% of total outstanding loans

Investment Securities

Investment securities offer flexibility in the Company’s management of interest rate risk and are an important source of liquidity as a response to changing characteristics of assets and liabilities. The Company’s investment policy prohibits trading activities and does not allow investment in high-risk derivative products, junk bonds or foreign investments.

As of March 31, 2011, the Company had $817,235 of investment securities. All of these securities were classified as “available for sale” (“AFS”) and were carried at fair value with unrealized gains and losses, net of taxes, reported as a separate component of shareholders’ equity. An unrealized pre-tax gain of $18,919 was recorded to adjust the AFS portfolio to current market value at March 31, 2011, compared to an unrealized pre-tax gain of $14,550 at December 31, 2010. Unrealized losses on AFS securities have not been recognized into income because management does not intend to sell and does not expect to be required to sell these securities for the foreseeable future and the decline in fair value is largely due to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. The fair value is expected to recover as the securities approach their maturity dates. All securities in the Company’s portfolio are performing as expected with no disruption in cash flows and all rated securities are rated investment grade.

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Sources of Funds

The Company relies primarily on customer deposits, securities sold under agreements to repurchase and shareholders’ equity to fund earning assets. FHLB advances are also used to provide additional funding.

Deposits generated within local markets provide the major source of funding for earning assets. Average total deposits funded 87.7% and 85.2% of total average earning assets for the three-month periods ending March 31, 2011 and 2010. Total

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interest-bearing deposits averaged 87.6% and 89.2% of average total deposits for the three-month periods ending March 31, 2011 and 2010, respectively. Management constantly strives to increase the percentage of transaction-related deposits to total deposits due to the positive effect on earnings.

The Company had FHLB advances of $145,981 outstanding at March 31, 2011. These advances have interest rates ranging from 2.47% to 5.90%. All of the current advances were originally long-term advances with approximately $10,000 maturing in 2011, $21,000 maturing in 2012, $15,000 maturing in 2013, $25,000 maturing in 2014, $11,000 maturing in 2015, and $64,000 maturing in 2016 and beyond.

Capital Resources

Total shareholders’ equity was $309,058 at March 31, 2011, which was an increase of $6,488 compared to the $302,570 of shareholders’ equity at December 31, 2010. The increase in shareholders’ equity was primarily attributable to the Company’s net income of $4,546 for the first quarter of 2011 and the increase in other comprehensive income of $2,839, offset by the preferred dividend of $763.

The Federal Reserve Board and other regulatory agencies have adopted risk-based capital guidelines that assign risk weightings to assets and off-balance sheet items. The Company’s core capital consists of shareholders’ equity, excluding accumulated other comprehensive income/loss, while Tier 1 capital consists of core capital less goodwill and intangibles. Trust preferred securities qualify as Tier 1 capital or core capital with respect to the Company under the risk-based capital guidelines established by the Federal Reserve. Under such guidelines, capital received from the proceeds of the sale of trust preferred securities cannot constitute more than 25% of the total core capital of the Company. Consequently, the amount of trust preferred securities in excess of the 25% limitation constitutes Tier 2 capital of the Company. Total regulatory capital consists of Tier 1, certain debt instruments and a portion of the allowance for loan losses. At March 31, 2011, Tier 1 capital to total average assets was 10.2%. Tier 1 capital to risk-adjusted assets was 16.2%. Total capital to risk-adjusted assets was 17.4%. All three ratios exceed all required ratios established for bank holding companies. The Company has entered into an agreement with its regulators regarding capital levels at the Bank. See Footnote 10 for information regarding this agreement. Risk-adjusted capital levels of the Company’s subsidiary bank exceed regulatory definitions of well-capitalized institutions.

The Company declared and paid common dividends of $0.01 per share in the first quarter of 2011 versus $0.01 for the first quarter of 2010. To prudently manage capital, the Company elected to reduce its dividend starting in the second quarter of 2009.

Liquidity

Liquidity management involves maintaining sufficient cash levels to fund operations and to meet the requirements of borrowers, depositors, and creditors. Higher levels of liquidity bear higher corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets, and higher interest expense involved in extending liability maturities. Liquid assets include cash and cash equivalents, loans and securities maturing within one year, and money market instruments. In addition, the Company holds AFS securities maturing after one year, which can be sold to meet liquidity needs.

Maintaining a relatively stable funding base, which is achieved by diversifying funding sources and extending the contractual maturity of liabilities, supports liquidity and limits reliance on volatile short-term purchased funds. Short-term funding needs arise from declines in deposits or other funding sources, funding of loan commitments and requests for new loans. The Company’s strategy is to fund assets to the maximum extent possible with core deposits that provide a sizable source of relatively stable and low-cost funds. Average core deposits funded approximately 78.8% of total earning assets for the three months ended March 31, 2011 and 74.6% for the same period in 2010.

Management believes the Company has sufficient liquidity to meet all reasonable borrower, depositor, and creditor needs in the present economic environment. In addition, the Bank has access to the Federal Home Loan Bank for borrowing purposes.

Interest Rate Risk

Asset/liability management strategies are developed by the Company to manage market risk. Market risk is the risk of loss in financial instruments including investments, loans, deposits and borrowings arising from adverse changes in prices/rates. Interest rate risk is the Company’s primary market risk exposure, and represents the sensitivity of earnings to changes in market interest rates.

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Effective asset/liability management requires the maintenance of a proper ratio between maturing or repriceable interest-earning assets and interest-bearing liabilities. It is the policy of the Company that the cumulative gap divided by total assets must be not greater than plus or minus 30% at the 1-year time horizon.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk of the Company encompasses exposure to both liquidity and interest rate risk and is reviewed monthly by the Asset/Liability Committee and the Board of Directors. There have been no material changes in the quantitative and qualitative disclosures about market risks as of March 31, 2011 from the analysis and disclosures provided in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Item 4. Controls and Procedures

As of the end of the quarterly period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)). Based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms as of such date.

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s first fiscal quarter of 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

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Item 6. Exhibits

3.1	Amended and Restated Articles of Incorporation of MainSource Financial Group, Inc. (incorporated by reference to Exhibit 3.1 to the Quarterly Report on Form 10-Q of the registrant filed August 10, 2009 with the Commission (Commission File No. 0-12422)).

3.2	Amended and Restated Bylaws of MainSource Financial Group, Inc. dated July 19, 2010 (incorporated by reference to Exhibit 3.1 to the Report on Form 8-K of the registrant filed July 22, 2010 with the Commission (Commission File No. 0-12422)).

31.1	Certification pursuant to Rule 13a-14(a)/15d-14(a) by Chief Executive Officer

31.2	Certification pursuant to Rule 13a-14(a)/15d-14(a) by Chief Financial Officer

The following exhibits shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, and are not incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent the Company specifically incorporates them by reference.

32.1	Certification pursuant to Section 1350 by Chief Executive Officer

32.2	Certification pursuant to Section 1350 by Chief Financial Officer

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MAINSOURCE FINANCIAL GROUP, INC.

FORM 10-Q

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	MAINSOURCE FINANCIAL GROUP, INC.


	May 10, 2011

	/s/ Archie M. Brown, Jr.
	Archie M. Brown, Jr.
	President and Chief Executive Officer


	May 10, 2011

	/s/ James M. Anderson
	James M. Anderson
	Senior Vice President & Chief Financial Officer

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