Mainsource Financial (MSFG) 10-Q 2012 Q3 Quarterly report

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 SEPTEMBER 30, 2012

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 x 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 November 9, 2012 there were outstanding 20,304,525 shares of common stock, without par value, of the registrant.

MAINSOURCE FINANCIAL GROUP, INC.

FORM 10-Q

INDEX

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements	3
Consolidated Balance Sheets	3
Consolidated Statements of Income and Comprehensive Income	4
Consolidated Statements of Cash Flow	5
Notes to the Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3. Quantitative and Qualitative Disclosures About Market Risk	41
Item 4. Controls and Procedures	41
PART II. OTHER INFORMATION
Item 1A. Risk Factors	42
Item 6. Exhibits	42
Signatures	43

2

MAINSOURCE FINANCIAL GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands except per share data)

Item 1. Financial Statements

	(Unaudited)
	September 30,			December 31,
	2012			2011
Assets
Cash and due from banks	$	65,772		$	66,864
Money market funds and federal funds sold	6,645			42,284
Cash and cash equivalents	72,417			109,148
Securities available for sale	902,178			876,090
Loans held for sale	23,929			16,620
Loans, net of allowance for loan losses of $35,246 and $39,889	1,496,279			1,494,490
Restricted stock, at cost	15,642			15,856
Premises and equipment, net	49,521			50,652
Goodwill	61,919			61,919
Purchased intangible assets	7,418			7,163
Cash surrender value of life insurance	59,064			48,204
Interest receivable and other assets	66,639			74,038
Total assets	$	2,755,006		$	2,754,180
Liabilities
Deposits
Noninterest bearing	$	350,790		$	334,345
Interest bearing	1,732,228			1,825,555
Total deposits	2,083,018			2,159,900
Securities sold under agreement to repurchase and federal funds purchased	47,733			25,789
Federal Home Loan Bank (FHLB) advances	201,119			151,427
Subordinated debentures	50,380			50,267
Other liabilities	34,232			30,244
Total liabilities	2,416,482			2,417,627
Shareholders’ equity
Preferred stock, no par value Authorized shares - 400,000 Issued and outstanding shares — 34,150 and 57,000 Aggregate liquidation preference — $34,150 and $57,000	33,874			56,387
Common stock $.50 stated value: Authorized shares - 100,000,000 Issued shares — 20,851,827 and 20,780,616 Outstanding shares — 20,297,325 and 20,206,214	10,443			10,411
Treasury stock — 554,502 and 574,402 at cost	(9,043		)	(9,367		)
Additional paid-in capital	223,836			223,510
Retained earnings	51,292			32,720
Accumulated other comprehensive income	28,122			22,892
Total shareholders’ equity	338,524			336,553
Total liabilities and shareholders’ equity	$	2,755,006		$	2,754,180

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

3

MAINSOURCE FINANCIAL GROUP, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Dollar amounts in thousands except per share data)

	Three months ended September 30,						Nine months ended September 30,
	2012			2011			2012			2011
Interest income
Loans, including fees	$	20,843		$	23,128		$	63,595		$	70,823
Securities	5,954			7,163			18,683			21,680
Other interest income	35			54			141			141
Total interest income	26,832			30,345			82,419			92,644
Interest expense
Deposits	1,771			3,361			6,046			11,476
Federal Home Loan Bank advances	1,239			1,449			4,044			4,330
Subordinated debentures	460			430			1,382			1,296
Other borrowings	31			35			88			132
Total interest expense	3,501			5,275			11,560			17,234
Net interest income	23,331			25,070			70,859			75,410
Provision for loan losses	2,000			5,000			7,600			14,600
Net interest income after provision for loan losses	21,331			20,070			63,259			60,810
Non-interest income
Mortgage banking	2,114			1,428			6,328			3,943
Trust and investment product fees	819			740			2,555			2,493
Service charges on deposit accounts	5,282			4,872			14,568			13,287
Net realized gains on securities	832			1,263			1,867			4,917
Other-than-temporary loss
Total impairment loss	—			—			(500		)	—
Loss recognized in other comprehensive income	—			—			—			—
Net impairment loss recognized in earnings	—			—			(500		)	—
Increase in cash surrender value of life insurance	293			309			860			903
Interchange income	1,582			1,642			4,964			4,622
Gain/(Loss) on sale and write-down of OREO	(172		)	(651		)	(385		)	(1,212		)
Other income	827			675			1,885			2,164
Total non-interest income	11,577			10,278			32,142			31,117
Non-interest expense
Salaries and employee benefits	12,151			12,713			36,942			38,126
Net occupancy	1,762			1,616			5,108			5,031
Equipment	2,137			1,970			6,380			5,888
Intangibles amortization	445			493			1,345			1,477
Telecommunications	441			507			1,278			1,472
Stationery printing and supplies	321			358			993			1,157
FDIC assessment	542			898			1,962			3,066
Marketing	1,139			1,085			3,081			3,292
Prepayment penalty on FHLB advance	1,313			—			1,313			—
Collection expense	821			1,298			2,838			3,214
Consultant expense	325			—			575			—
Other expenses	3,006			2,967			9,311			8,385
Total non-interest expense	24,403			23,905			71,126			71,108
Income before income tax	8,505			6,443			24,275			20,819
Income tax expense	1,519			828			4,296			3,032
Net income	6,986			5,615			19,979			17,787
Preferred dividends and discount accretion	(458		)	(763		)	(1,694		)	(2,290		)
Redemption of preferred stock	—			—			1,302			—
Net income available to common shareholders	$	6,528		$	4,852		$	19,587		$	15,497
Net income	$	6,986		$	5,615		$	19,979		$	17,787
Other comprehensive income:
Unrealized holding gain arising during the period	4,594			17,165			9,415			29,900
Reclassification adjustment for (gains) included in net income	(832		)	(1,263		)	(1,867		)	(4,917		)
Reclassification adjustment for other than temporary loss included in net income	—			—			500			—
Tax effect	(1,317		)	(5,565		)	(2,818		)	(8,744		)
Net of tax	2,445			10,337			5,230			16,239
Comprehensive income	$	9,431		$	15,952		$	25,209		$	34,026
Cash dividends declared per common share	0.03			0.01			0.05			0.03
Net income per common share:
Basic	.32			.24			.97			.77
Diluted	.32			.24			.96			.77

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

4

MAINSOURCE FINANCIAL GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOW

(Dollar amounts in thousands)

	Nine month ended September 30,
	2012			2011
Operating Activities
Net income	$	19,979		$	17,787
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	7,600			14,600
Depreciation expense	4,057			3,792
Amortization of mortgage servicing rights	1,426			877
Valuation allowance on mortgage servicing rights	451			—
Securities amortization, net	3,506			1,794
Stock based compensation expense	562			252
Amortization of purchased intangible assets	1,345			1,477
Earnings on cash surrender value of life insurance policies	(860		)	(903		)
Gain on life insurance benefit	—			(141		)
Securities gains	(1,367		)	(4,917		)
Prepayment penalty on FHLB advance	1,313			—
Loss on sale and write-down of OREO	385			1,212
Gain on loans sold	(4,144		)	(2,386		)
Loans originated for sale	(162,764		)	(120,413		)
Proceeds from loan sales	159,599			122,101
Change in other assets and liabilities	1,028			4,098
Net cash provided by operating activities	32,116			39,230
Investing Activities
Purchases of securities available for sale	(177,484		)	(285,169		)
Proceeds from calls, maturities, and payments on securities available for sale	93,128			90,330
Proceeds from sales of securities available for sale	64,176			161,744
Proceeds from life insurance benefit	—			893
Proceeds from sale of OREO	9,609			11,918
Loan originations and payment, net	(13,605		)	81,749
Purchases of premises and equipment	(2,926		)	(5,494		)
Purchase of life insurance policies	(10,000		)	—
Cash paid for agency acquisition	(1,600		)	—
Proceeds from redemption of restricted stock	214			2,394
Net cash provided/(used) by investing activities	(38,488		)	58,365
Financing Activities
Net change in deposits	(76,882		)	(43,817		)
Net change in other borrowings	21,944			(7,855		)
Repayment of FHLB advances	(26,621		)	(15,568		)
Proceeds from FHLB advances	75,000			15,000
Proceeds from exercise of stock options	120			—
Repurchase of preferred stock	(21,324		)	—
Cash dividends on preferred stock	(1,582		)	(2,138		)
Cash dividends on common stock	(1,014		)	(605		)
Net cash provided/(used) by financing activities	(30,359		)	(54,983		)
Net change in cash and cash equivalents	(36,731		)	42,612
Cash and cash equivalents, beginning of year	109,148			60,123
Cash and cash equivalents, end of period	$	72,417		$	102,735

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

5

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, 2011.

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 from 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, the Company values the stock option grants and recognizes compensation expense as if each vesting portion of the award was a single award.

6

The following table summarizes stock option activity:

	Nine Months Ended September 30, 2012
	Shares		Weighted Average Exercise Price
Outstanding, beginning of year	408,223		$	13.09
Granted	66,000		11.73
Exercised	(19,900	)	(5.40		)
Forfeited or expired	(22,465	)	(11.38		)
Outstanding, period end	431,858		$	13.32
Options exercisable at period end	314,852		$	14.71
Fully vested and expected to vest	422,971		$	13.37

The following table details stock options outstanding:

	September 30, 2012		December 31, 2011
Stock options vested and currently exercisable:
Number	314,852		311,154
Weighted average exercise price	$	14.71	$	14.19
Aggregate intrinsic value	$	581	$	294
Weighted average remaining life (in years)	3.7		4.5

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 $43 and $91 in stock compensation expense during the three and nine months ended September 30, 2012 and $16 and $49 in stock compensation expense during the three and nine months ended September 30, 2011 to salaries and employee benefits. There were 66,000 options granted in the second quarter of 2012.  In order to calculate the fair value of the options granted in 2012, the following weighted-average assumptions were used as of the grant dates:  risk free interest rate of 1.34%, expected option life 7.0 years, expected price volatility 40.5%, and dividend yield of 0.34%.  The weighted average fair value of the options issued in 2012 was $4.91.  There were 6,000 options granted in the first quarter of 2011, 5,000 options in the second quarter of 2011, and 10,000 in the third quarter of 2011.  In order to calculate the fair value of the options granted in 2011, the following weighted-average assumptions were used as of the grant dates:  risk free interest rate of 2.36%, expected option life 7.0 years, expected price volatility 61.4%, and dividend yield of 0.46%.  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 2012 and beyond is estimated as follows:

Year	(in thousands)
October 2012 - December 2012	$	48
2013	105
2014	111
2015	93

During the second quarter of 2011 and 2012, the Compensation Committee of the Board of Directors of the Company granted restricted stock awards in lieu of cash awards to certain executive officers pursuant to the Company’s annual performance-based incentive bonus plan.  Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the issue date.  The value of the awards was determined by multiplying the award amount by the closing price of a share of Company common stock on the grant date, April 25, 2012 ($11.85) and April 8, 2011 ($9.68).  The stock awards vest as follows — 80% on the second anniversary of the date of grant and 20% on the third anniversary of the date of grant.  A total of 48,061 shares of common stock of the Company were granted in 2012 and 46,244 shares of common stock were granted in 2011.  Total compensation expense for the restricted stock grants was $91 and $220 for the three and nine month periods ended September 30, 2012.  The compensation expense for the three and nine month periods ended September 30, 2011 was $28 and $75.

A summary of changes in the Company’s nonvested shares for the year follows:

7

	Shares	Weighted Average Grant Date Fair Value
Nonvested at January 1, 2012	46,244	$	9.68
Granted	48,061	11.85
Vested	0	0
Forfeited	0	0
Nonvested at September 30, 2012	94,305	$	10.79

As of September 30, 2012, there was $819 of total unrecognized compensation costs related to nonvested restricted stock awards granted under this plan that will be recognized over the remaining vesting period of approximately 2.0 years.  The recognized compensation costs related to this plan were $220 and $75 for the first nine months of 2012 and 2011 respectively.

Beginning with the retainer paid to the Board in 2011, members of the Board of Directors of the Company can make an annual election to have their retainer paid in cash, Company stock, or a combination of cash and stock during the following year.  The annual retainer is paid quarterly, on May 1, August 1, November 1, and February 1 of each year, for all directors serving on the Board on those dates.  Other expense is recognized over the three month period of the awards based on the fair value of the stock at the issue dates.  The value of the quarterly awards is determined by multiplying the award amount by the average closing price of a share of Company common stock on the five trading days prior to the issuance of the stock ($9.53 for the second quarter 2011 payouts, $8.80 for the third quarter 2011 payouts, $9.44 for the fourth quarter 2011 payouts, $9.29 for the first quarter 2012 payouts, $11.83 for the second quarter 2012 payouts, and $11.58 for the third quarter 2012 payouts).  The shares issued vest immediately. Shares awarded by quarter were as follows:

Quarter	Year	Shares
2 Q	2011	6,750
3 Q	2011	7,902
4 Q	2011	9,130
1 Q	2012	8,750
2 Q	2012	7,200
3Q	2012	7,200

The expense associated with the directors’ shares was $83 and $250 for the three and nine month periods ended September 30, 2012.  For the three and nine month periods ended September 30, 2011, the expense was $70 and $134.

8

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 was as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
As of September 30, 2012	Cost		Gains		Losses			Value
Available for Sale
U. S. government agency	$	1,851	$	33	$	—		$	1,884
State and municipal	303,380		29,224		(15		)	332,589
Mortgage-backed securities-residential (GSE’s)	226,028		9,570		—			235,598
Collateralized mortgage obligations	319,147		4,653		(187		)	323,613
Equity securities	4,939		—		—			4,939
Other securities	3,567		—		(12		)	3,555
Total available for sale	$	858,912	$	43,480	$	(214	)	$	902,178

As of December 31, 2011
Available for Sale
State and municipal	$	320,269	$	24,723	$	(115	)	$	344,877
Mortgage-backed securities-residential (GSE’s)	264,619		7,074		(189		)	271,504
Collateralized mortgage obligations	246,985		3,807		(25		)	250,767
Equity securities	5,410		—		—			5,410
Other securities	3,589		—		(57		)	3,532
Total available for sale	$	840,872	$	35,604	$	(386	)	$	876,090

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
September 30, 2012	Amortized Cost		Fair Value
Within one year	$	5,802	$	5,877
One through five years	50,678		53,389
Six through ten years	86,632		94,213
After ten years	165,686		184,549
Mortgage-backed securities-residential (GSE’s)	226,028		235,598
Collateralized mortgage obligations	319,147		323,613
Equity securities	4,939		4,939
Total available for sale securities	$	858,912	$	902,178

Proceeds from sales of securities available for sale were $64,176 and $161,744 for the nine months ended September 30, 2012 and 2011, respectively. Gross gains of $1,944 and $5,000 and gross losses of $77 and $83 were realized on these sales during 2012 and 2011, respectively.  In addition to the gross gains and losses from sales, there was a $500 impairment loss recognized on one investment during the first quarter of 2012.

Proceeds from sales of securities available for sale were $43,290 and $41,144 for the three months ended September 30, 2012 and 2011, respectively. Gross gains of $874 and $1,263 and gross losses of $42 and $0 were realized on these sales during 2012 and 2011, respectively.

9

Below is a summary of securities with unrealized losses as of September 30, 2012 and December 31, 2011 presented by length of time the securities have been in a continuous unrealized loss position.

	Less than 12 months					12 months or longer					Total
September 30, 2012 Description of securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
State and municipal	$	340	$	(6	)	$	282	$	(9	)	$	622	$	(15	)
Mortgage-backed securities-residential (GSE’s)	—		—			—		—			—		—
Collateralized mortgage obligations	36,516		(187		)	—		—			36,516		(187		)
Other securities	990		(12		)	—		—			990		(12		)
Total temporarily impaired	37,846		(205		)	282		(9		)	38,128		(214		)

	Less than 12 months					12 months or longer					Total
December 31, 2011 Description of securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
State and municipal	$	1,576	$	(72	)	$	237	$	(43	)	$	1,813	$	(115	)
Mortgage-backed securities-residential (GSE’s)	50,493		(189		)	—		—			50,493		(189		)
Collateralized mortgage obligations	25,527		(25		)	—		—			25,527		(25		)
Other securities	945		(57		)	—		—			945		(57		)
Total temporarily impaired	$	78,541	$	(343	)	$	237	$	(43	)	$	78,778	$	(386	)

10

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 September 30, 2012, the Company’s security portfolio consisted of 969 securities, 9 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.

The Company’s collateralized mortgage obligation securities portfolio includes agency collateralized mortgage obligations with a market value of $323,613 which had unrealized losses of approximately $187 at September 30, 2012. The Company monitors to ensure it has adequate credit support and as of September 30, 2012, 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.

The unrealized losses on other securities are related to one single issue trust preferred security and 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 security before its anticipated recovery. The Company performs a quarterly review of this security and based on this review, no evidence of adverse changes in expected cash flows is anticipated. The decline in value is primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not the expected cash flows of the individual security. Currently, the issuer has made all contractual payments and given no indication that they will not be able to make them into the future. The fair value of these debt securities is expected to recover as the securities approach their maturity date. As of September 30, 2012, the fair value of the security was $990 with an unrealized loss of $12.

During the first quarter of 2012, the Company determined that one of its equity holdings was other than temporarily impaired and wrote down the security by $500 to its fair value of $250. This amount was included in net realized gains/(losses) on securities.

11

NOTE 4 - LOANS AND ALLOWANCE

Loans were as follows:

	September 30,2012			December 31, 2011
Commercial
Commercial and industrial	123,783			114,367
Agricultural	23,088			20,741
Commercial Real Estate
Farm	55,532			46,308
Hotel	138,507			146,358
Construction and development	30,312			30,746
Other	507,156			540,752
Residential
1-4 family	381,956			365,710
Home equity	221,844			212,202
Consumer
Direct	46,322			51,157
Indirect	3,025			6,038
Total loans	1,531,525			1,534,379
Allowance for loan losses	(35,246		)	(39,889		)
Net loans	$	1,496,279		$	1,494,490

Activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2012 and 2011 were as follows:

	Commercial			Commercial Real Estate			Residential			Consumer			Total
Allowance for loan loss
Balance, January 1, 2012	$	5,562		$	30,476		$	2,972		$	879		$	39,889
Provision charged to expense	(572		)	4,555			2,549			1,068			7,600
Losses charged off	(455		)	(10,025		)	(2,910		)	(2,468		)	(15,858		)
Recoveries	522			1,630			232			1,231			3,615
Balance, September 30, 2012	$	5,057		$	26,636		$	2,843		$	710		$	35,246

	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	1,151			10,162			2,383			904			14,600
Losses charged off	(1,834		)	(12,283		)	(2,308		)	(1,793		)	(18,218		)
Recoveries	210			943			420			873			2,446
Balance, September 30, 2011	$	5,913		$	31,475		$	2,776		$	1,269		$	41,433

The balance of recorded investment of loans and allowance for loan losses by portfolio segment as of September 30, 2012 and December 31, 2011 were as follows:

As of September 30, 2012
Ending Balance individually evaluated for impairment	$	1,817	$	4,348	$	—	$	—	$	6,165
Ending Balance collectively evaluated for impairment	3,240		22,288		2,843		710		29,081
Total ending allowance balance	$	5,057	$	26,636	$	2,843	$	710	$	35,246
Loans
Ending Balance individually evaluated for impairment	$	5,126	$	30,391	$	13,797	$	1,003	$	50,317
Ending Balance collectively evaluated for impairment	141,745		701,116		590,003		48,344		1,481,208
Total ending loan balance excludes $5,664 of accrued interest	$	146,871	$	731,507	$	603,800	$	49,347	$	1,531,525

12

As of December 31, 2011	Commercial		Commercial Real Estate		Residential		Consumer		Total
Ending Balance individually evaluated for impairment	$	1,193	$	5,476	$	—	$	—	$	6,669
Ending Balance collectively evaluated for impairment	4,369		25,000		2,972		879		33,220
Total ending allowance balance	$	5,562	$	30,476	$	2,972	$	879	$	39,889
Loans
Ending Balance individually evaluated for impairment	$	5,144	$	41,149	$	14,522	$	1,116	$	61,931
Ending Balance collectively evaluated for impairment	129,964		723,015		563,390		56,079		1,472,448
Total ending loan balance excludes $5,835 of accrued interest	$	135,108	$	764,164	$	577,912	$	57,195	$	1,534,379

The recorded investment in loans excludes accrued interest receivable due to immateriality.

Activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2012 and September 30, 2011 was as follows:

	September 30, 2012
	Commercial			Commercial Real Estate			Residential			Consumer			Total
Allowance for loan loss
Balance, July 1	$	4,945		$	29,580		$	2,975		$	789		$	38,289
Provision charged to expense	223			464			840			473			2,000
Losses charged off	(178		)	(3,936		)	(1,078		)	(962		)	(6,154		)
Recoveries	67			528			106			410			1,111
Balance, September 30	$	5,057		$	26,636		$	2,843		$	710		$	35,246

	September 30, 2011
	Commercial			Commercial Real Estate			Residential			Consumer			Total
Allowance for loan loss
Balance, July 1	$	5,789		$	31,851		$	2,588		$	1,234		$	41,462
Provision charged to expense	1,410			2,346			730			514			5,000
Losses charged off	(1,291		)	(3,017		)	(598		)	(755		)	(5,661		)
Recoveries	5			295			56			276			632
Balance, September 30	$	5,913		$	31,475		$	2,776		$	1,269		$	41,433

13

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2012:

September 30, 2012	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
With an allowance recorded
Commercial
Commercial and industrial	$	3,026	$	3,010	$	1,817
Commercial Real Estate
Farm	461		461		146
Construction and development	2,878		1,765		669
Other	14,295		13,964		3,533
Subtotal — impaired with allowance recorded	20,660		19,200		6,165
With no related allowance recorded
Commercial
Commercial & industrial	2,731		2,114
Agricultural	12		2
Commercial Real Estate
Farm	805		739
Hotel	265		—
Construction and development	4,806		2,877
Other	15,578		10,585
Residential
1-4 Family	12,616		11,185
Home Equity	2,765		2,612
Consumer
Direct	988		972
Indirect	34		31
Subtotal — impaired with allowance recorded	40,600		31,117
Total impaired loans	$	61,260	$	50,317	$	6,165

The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality.

The following tables presents the three and nine month average balance of impaired loans at September 30, 2012 and 2011.

At September 30, 2012	Three Month Average Balance		Nine Month Average Balance
Commercial
Commercial and industrial	$	5,233	$	5,052
Agricultural	12		29
Commercial Real Estate
Farm	1,147		1,078
Hotel	—		1,493
Construction and development	4,708		5,403
Other	25,964		26,195
Residential
1-4 family	11,691		11,835
Home equity	2,845		2,742
Consumer
Direct	1,007		1,035
Indirect	42		47
Total loans	52,649		54,909

14

At September 30, 2011	Three Month Average Balance		Nine Month Average Balance
Commercial
Commercial and industrial	$	5,809	$	6,775
Agricultural	101		115
Commercial Real Estate
Farm	1,072		1,133
Hotel	5,810		7,647
Construction and development	7,345		10,004
Other	28,342		29,570
Residential
1-4 family	10,286		11,771
Home equity	1,929		1,848
Consumer
Direct	1,135		1,158
Indirect	58		64
Total loans	$	61,887	$	70,085

Total interest income recognized and cash basis interest recognized on impaired loans for the third quarter of 2012 and 2011 was $120 and $16 and total income recognized and cash basis interest recognized on impaired loans on the first nine months of 2012 and 2011 was $148 and $89.

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

December 31, 2011	Unpaid Principal Balance	Recorded Investment	Allowance for Loan Losses Allocated
With an allowance recorded
Commercial
Commercial and industrial	3,130	3,057	1,193
Agricultural
Commercial Real Estate
Farm	486	486	193
Hotel	5,385	5,385	100
Construction and development	5,558	5,476	2,371
Other	14,400	14,322	2,812
Subtotal — impaired with allowance recorded	28,959	28,726	6,669
With no related allowance recorded
Commercial
Commercial & industrial	2,720	2,030
Agricultural	351	57
Commercial Real Estate
Farm	579	531
Hotel	876	384
Construction and development	2,996	1,839
Other	16,325	12,726
Residential
1-4 Family	12,344	12,045
Home Equity	2,548	2,477
Consumer
Direct	1,096	1,083
Indirect	35	33
Subtotal — impaired with allowance recorded	39,870	33,205
Total impaired loans	68,829	61,931	6,669

15

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 September 30, 2012 and December 31, 2011

	Non-accrual				Past due over 90 days and still accruing
	September 30, 2012		December 31, 2011		September 30, 2012		December 31, 2011
Commercial
Commercial and industrial	$	5,101	$	2,518	$		$	—
Agricultural	2		57
Commercial Real Estate
Farm	1,200		1,016
Hotel	—		384
Construction and development	4,642		3,240
Other	21,144		21,060				3,259
Residential
1-4 Family	10,200		10,873		360
Home Equity	2,196		2,105		12
Consumer
Direct	246		242		7		7
Indirect	31		33
Total	$	44,762	$	41,528	$	379	$	3,266

The following table presents the aging of the recorded investment in past due loans as of September 30, 2012 by class of loans:

September 30, 2012	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	$	123,783	$	1,401	$	438	$	4,338	$	6,177	$	117,606
Agricultural	23,088		—		—		2		2		23,086
Commercial Real Estate
Farm	55,532		297		76		1,032		1,405		54,127
Hotel	138,507		—		—		—		—		138,507
Construction and development	30,312		901		108		4,411		5,420		24,892
Other	507,156		2,873		759		11,901		15,533		491,623
Residential
1-4 Family	381,956		2,481		1,828		6,412		10,721		371,235
Home Equity	221,844		848		429		1,499		2,776		219,068
Consumer
Direct	46,322		221		174		46		441		45,881
Indirect	3,025		34		10		3		47		2,978
Total — excludes $5,664 of accrued interest	$	1,531,525	$	9,056	$	3,822	$	29,644	$	42,522	$	1,489,003

16

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

December 31, 2011	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	$	114,367	1,139	655	1,831	3,625	110,742
Agricultural	20,741				57	57	20,684
Commercial Real Estate
Farm	46,308			58	905	963	45,345
Hotel	146,358				384	384	145,974
Construction and development	30,746		61		3,179	3,240	27,506
Other	540,752		4,249	3,576	16,529	24,354	516,398
Residential
1-4 Family	365,710		9,327	2,233	7,182	18,742	346,968
Home Equity	212,202		1,417	500	1,491	3,408	208,794
Consumer
Direct	51,157		382	146	129	657	50,500
Indirect	6,038		87	24	16	127	5,911
Total — excludes $5,835 of accrued interest	$	1,534,379	16,662	7,192	31,703	55,557	1,478,822

17

Troubled Debt Restructurings

During the period ending September 30, 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan or an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk.

Modifications involving a reduction of the stated interest rate of the loan were for periods ranging from 60 months to 30 years. Modifications involving an extension of the maturity date were for periods ranging from 6 months to 14 months.

The troubled debt restructurings increased the allowance for loan losses by $10 for both the three month period and the nine month period ending September 30, 2012.

The following table presents loans by class modified as troubled debt restructurings that occurred during the three month period ending September 30, 2012:

		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded
September 30, 2012	Number of Loans	Investment		Investment
Commercial
Commercial and industrial	1	$	91	$	91
Total	1	$	91	$	91

The following table presents loans by class modified as troubled debt restructurings that occurred during the three month period ending September 30, 2011:

		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded
	Number of Loans	Investment		Investment
Commercial
Commercial and industrial	1	$	181	$	181
Commercial Real Estate
Construction and development	2	3,779		3,779
Other	4	1,862		1,862
Residential
1-4 Family	2	217		217
Home Equity	16	308		308
Total	25	$	6,347	$	6,347

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine month period ending September 30, 2012:

		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded
	Number of Loans	Investment		Investment
Commercial
Commercial and industrial	1	$	91	$	91
Residential
Home Equity	1	70		70
Consumer
Direct	1	4		4
Total	3	$	165	$	165

18

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine month period ending September 30, 2011:

		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded
	Number of Loans	Investment		Investment
Commercial
Commercial and industrial	2	$	213	$	213
Commercial Real Estate
Construction and development	3	4,287		4,287
Hotel	1	5,833		5,410
Other	16	4,325		3,701
Residential
1-4 Family	6	406		406
Home Equity	39	693		693
Consumer
Direct	7	53		53
Total	74	$	15,810	$	14,763

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the three month period ending September 30, 2012:

	Number of Loans	Recorded Investment
Commercial
Commercial and industrial	2	$	2,058
Commercial real estate:
Other	1	370
Residential
1-4 Family	2	125
Total	5	$	2,553

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the three month period ending September 30, 2011:

Troubled Debt Restructurings
That Subsequently Defaulted:	Number of Loans	Recorded Investment
Residential
1-4 Family	2	$	125
Total	2	$	125

19

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the nine month period ending September 30, 2012:

	Number of Loans	Recorded Investment
Commercial
Commercial and industrial	3	$	2,195
Commercial real estate:
Development	1	323
Other	9	3,332
Residential
1-4 Family	2	125
Home Equity	1	12
Total	16	$	5,987

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the nine month period ending September 30, 2011:

Troubled Debt Restructurings
That Subsequently Defaulted:	Number of Loans	Recorded Investment
Commercial
Commercial and industrial	3	$	597
Commercial real estate:
Farm	2	532
Other	7	910
Residential
1-4 Family	4	311
Home Equity	3	33
Total	19	$	2,383

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the company’s internal underwriting policy.

The Company has allocated $265 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2012. The Company has committed to lend additional amounts totaling $0 to customers with outstanding loans that are classified as troubled debt restructurings.  At December 31, 2011, the comparable numbers were $3,013 of specific reserves and $0 of commitments.

During the third quarter of 2012, charge offs of $0 were taken on troubled debt restructuring loans.  No reserves were provided on these loans in prior quarters.  For the first nine months of 2012, charge offs of $2,399 were taken on troubled debt restructurings with reserves of $1,768 provided on these loans in prior quarters.

The terms of certain other loans were modified during the nine month period ending September 30, 2012 that did not meet the definition of a troubled debt restructuring. These loans have a total recorded investment as of September 30, 2012 of $18,668. The modification of these loans involved either a modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant

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:

20

Special Mention — Loans classified as special mention have above average risk that requires management’s ongoing attention. The borrower may demonstrate 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.

Non-accrual — Loans classified as non-accrual are loans where 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.

21

As of September 30, 2012 and December 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

September 30, 2012	Pass		Special Mention		Substandard		Non-accrual
Commercial
Commercial and industrial	$	104,776	$	6,222	$	7,684	$	5,101
Agricultural	23,079		—		7		2
Commercial Real Estate
Farm	52,747		1,105		480		1,200
Hotel	88,918		49,589		—		—
Construction and development	21,006		1,507		3,157		4,642
Other	433,277		30,802		21,933		21,144
Total	$	723,803	89,225		33,261		32,089

December 31, 2011	Pass	Special Mention	Substandard	Non-accrual
Commercial
Commercial and industrial	93,380	11,935	6,534	2,518
Agricultural	20,150	524	10	57
Commercial Real Estate
Farm	42,847	2,151	294	1,016
Hotel	77,259	51,900	16,815	384
Construction and development	15,498	3,212	8,796	3,240
Other	422,385	66,377	30,930	21,060
Total	671,519	136,099	63,379	28,275

Beginning in late 2011, loans not meeting the criteria above that are analyzed individually as part of the above described process are classified by delinquency. These loans are primarily residential mortgage and consumer loans. All consumer loans fully or partially secured by 1-4 residential real estate that are 60-89 days are classified as Watch. If loans are greater than 90 days past due, they are classified as Substandard. Consumer loans not secured by 1-4 family residential real estate that are 60-119 days past due are classified Substandard while loans greater than 119 days are classified as Loss. As of September 30, 2012 and December 31, 2011, the performing/non performing loans by category of loans is as follows

September 30, 2012	Performing		Watch		Substandard
Residential
1-4 Family	$	373,728	$	1,825	$	6,403
Home Equity	219,911		431		1,502
Total	$	593,639	$	2,256	$	7,905

December 31, 2011	Performing		Watch	Substandard
Residential
1-4 Family	$	356,295	2,233	7,182
Home Equity	210,211		500	1,491
Total	566,506		2,733	8,673

September 30, 2012	Performing		Substandard		Loss
Consumer
Direct	$	46,102	$	202	$	18
Indirect	3,012		13		—
Total	$	49,114	$	215	$	18

December 31, 2011	Performing		Substandard		Loss
Consumer
Direct	50,882		201		74
Indirect	5,998		25		15
Total	$	56,880	$	226	$	89

22

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:

	2012			2011
Beginning Balance — January 1	$	15,456		$	11,453
Transfer to other real estate owned	4,216			21,158
Sales — out of other real estate owned	(8,975		)	(12,725		)
Write-down	(1,020		)	(1,617		)
Ending Balance — September 30	$	9,677		$	18,269

Activity in the valuation account for other real estate was as follows:

	2012			2011
Beginning Balance — January 1	$	(4,003	)	$	(1,332	)
Impairments during year	(1,020		)	(1,617		)
Recovery on impairments	—			—
Reductions	2,486			281
Ending Balance — September 30	$	(2,537	)	$	(2,668	)

Expenses related to foreclosed assets include:

	2012			2011
Write downs	$	1,020		$	1,617
Losses / (gains) on sales	(635		)	(405		)
Net loss / (gain)	$	385		$	1,212
Operating expenses	$	383		$	844

The value of the sale amount above is the carrying value of the property when it is sold.

NOTE 6 — DEPOSITS

	September 30, 2012		December 31, 2011
Noninterest-bearing demand	$	350,790	$	334,345
Interest-bearing demand	807,763		816,512
Savings	457,457		461,667
Certificates of deposit of $100 or more	155,254		176,056
Other certificates and time deposits	311,754		371,320
Total deposits	$	2,083,018	$	2,159,900

NOTE 7 - EARNINGS PER SHARE

Earnings per common share (EPS) were computed as follows:

	September 30, 2012						September 30, 2011
For the three months ended:	Net Income			Weighted Average Shares	Per Share Amount		Net Income			Weighted Average Shares	Per Share Amount
Basic earnings per common share:
Net income	$	6,986		20,289,609			$	5,615		20,194,421
Preferred dividends and accretion	(458		)				(763		)
Net income available to common shareholders	$	6,528		20,289,609	$	0.32	$	4,852		20,194,421	$	0.24
Effect of Dilutive stock options				57,989						36,674
Net income available to common shareholders and assumed conversions	$	6,528		20,347,598	$	0.32	$	4,852		20,231,095	$	0.24

23

Stock options for 306,929 common shares and stock warrants for 571,906 common shares in 2012 and stock options for 260,616 common shares and stock warrants for 571,906 in 2011 were not considered in computing diluted earnings per share because they were antidilutive.

	September 30, 2012						September 30, 2011
For the nine months ended:	Net Income			Weighted Average Shares	Per Share Amount		Net Income			Weighted Average Shares	Per Share Amount
Basic earnings per common share:
Net income	$	19,979		20,253,560			$	17,787		20,171,550
Preferred dividends and accretion	(1,694		)				(2,290		)
Redemption of preferred stock	1,302
Net income available to common shareholders	19,587			20,253,560	$	0.97	15,497			20,171,550	$	0.77
Effect of Dilutive stock options				59,400						40,192
Net income available to common shareholders and assumed conversions	$	19,587		20,312,960	$	0.96	$	15,497		20,211,742	$	0.77

Stock options for 286,943 common shares and stock warrants for 571,906 common shares in 2012 and stock options for 260,616 common shares and stock warrants for 571,906 in 2011 were not considered in computing diluted earnings per share because they were antidilutive.

The majority of the redemption of the preferred stock occurred in the quarter ended March 31, 2012.  It is reflected, above, in income attributable to common shareholders for the nine months ended September 30, 2012 totaling $1.3 million, but was not included in the first quarter’s earnings per share computation.  The Company has elected to not restate prior quarters’ earnings for the above redemption amount.   The amount of the discount represented 21% of net income and $0.06 on an earnings per share basis.  Reported earnings per share for the first quarter of 2012 was $0.26 compared to $0.19 in the prior year.  This was a significant improvement on a year-over-year basis and the Company does not feel that an additional $0.06, $.32 per share, would have materially affected the investment community’s outlook on its performance.

24

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 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.  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.  In most cases, the book value of the security is used as the fair value as meaningful pricing data is not readily available.  The fair values are determined by a third party and reviewed by the Company’s investment advisor who reports to the Company’s Asset/Liability and Investments Manager who reports to the Company’s Chief Financial Officer.  Twice a year, a sample of prices supplied by the pricing agent is validated by comparison to prices obtained from other third party sources.

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals or industry accepted valuation methods. In a limited number of situations, the Company’s appraisal department is determining the value of appraisal.  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 loan officers 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.  These adjustments typically range from 0%-50%.  Impaired loans are evaluated quarterly for additional impairment and take into account changing market conditions, specific information in the market the property is located, and the overall economic climate as well as overall changes in the credit.  The Company’s Appraisal Manager has the overall responsibility for all appraisals.  The Company’s loan officer responsible for the loan, the special assets officer, as well as the senior officers of the Company review the adjustments made to the appraisal for market and disposal costs on the loan.

The fair value of servicing rights is based on a valuation model from a third party 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 inputs used include estimates of prepayment speeds, discount rate, cost to service, contractual servicing fee income, late fees, and float income. The most significant assumption used to value mortgage servicing rights is prepayment rate. Prepayment rates are estimated based on published industry consensus prepayment rates. The most significant unobservable assumption is the discount rate. At September 30, 2012 the constant prepayment speed (PSA) used was 346 and the discount rate was 9.0%. At December 31, 2011 the constant prepayment speed (PSA) used was 317 and the discount rate was 9.0%.  The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 3 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 (third party). 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.  Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers whose qualifications and licenses have been reviewed and verified by the Company.  Once received, a member of the Appraisal Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.  Fair values are reviewed on at least an annual basis.  The Company normally applies an internal discount to the value of appraisals used in the fair value evaluation of OREO.  The deductions take into account changing business factors and market conditions.  These deductions range from 0% to 50%.  As noted in the impaired loans discussion above, the Company’s Appraisal Manager has the overall responsibility for all appraisals.  The Appraisal Manager reports to the Vice President of Credit Administration who reports to the Chief Credit Officer of the Company.

25

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 September 30, 2012 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
Investment Securities available-for sale
U.S. government agency	$	1,884			$	1,884
States and municipals	332,589				317,065		15,524
Mortgage-backed securities — residential —Government Sponsored Entity	235,598				235,598
Collateralized mortgage obligations — Government Sponsored Entity	323,613				323,613
Equity securities	4,939		4,689				250
Other securities	3,555				990		2,565
Total securities available-for-sale	$	902,178	$	4,689	$	879,150	$	18,339

	Fair Value Measurements at December 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
Investment Securities available-for sale
States and municipals	344,877				321,321		23,556
Mortgage-backed securities — residential —Government Sponsored Entity	271,504				271,504
Collateralized mortgage obligations — Government Sponsored Entity	250,767				250,767
Equity securities	5,410		4,660				750
Other securities	3,532				945		2,587
Total securities available-for-sale	$	876,090	$	4,660	$	844,537	$	26,893

There were no transfers between Level 1 and Level 2 during the first nine months of 2012.

26

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 and nine month periods ended September 30, 2012 and 2011:

Three months ended September 30

States and municipal	2012			2011
Beginning balance, July 1	$	16,021		$	11,180
Total gains or losses (realized / unrealized)
Included in earnings
Included in other comprehensive income	(15		)	—
Transfers into Level 2	(296		)	—
Settlements	(186		)	(230		)
Ending balance, September 30	$	15,524		$	10,950

Equity securities	2012		2011
Beginning balance, July 1	$	250	$	750
Total gains or losses (realized / unrealized)
Included in earnings
Ending balance, September 30	$	250	$	750

Other securities	2012			2011
Beginning balance, July 1	$	2,572		$	—
Total gains or losses (realized / unrealized)
Included in earnings
Included in other comprehensive income	(7		)	—
Ending balance, September 30	$	2,565		$	—

Nine months ended September 30

States and municipal	2012			2011
Beginning balance, January 1	$	23,556		$	—
Total gains or losses (realized / unrealized)
Included in earnings
Gains (losses) on securities	361			—
Included in other comprehensive income	(33		)	—
Sales	(7,268		)	—
Settlements	(796		)	(230		)
Transfers into Level 2	(296		)	—
Transfers into Level 3	—			11,180
Ending balance, September 30	$	15,524		$	10,950

27

Equity securities	2012			2011
Beginning balance, January 1	$	750		$	750
Total gains or losses (realized / unrealized)
Included in earnings
Gains (losses) on securities	(500		)	—
Ending balance, September 30	$	250		$	750

Other securities	2012			2011
Beginning balance, January 1	$	2,587		$	1,870
Total gains or losses (realized / unrealized)
Included in earnings
Included in other comprehensive income	(22		)	97
Transfer out of Level 3	—			(1,967		)
Ending balance, September 30	$	2,565		$	—

Transfers out of level 3 were securities that were called by the issuer early in the second quarter of 2011.  The Company felt that as of March 31, 2011, the established call price was no longer indicative of a Level 3 value and transferred them to Level 2.  Transfers into Level 3 were local municipal securities where the Company’s pricing service no longer priced these securities due to the illiquidity of those securities.  These investments are carried at fair value, which approximate book value and are classified as Level 3.  The municipal transfer into Level 2 was a security that was acquired late in the second quarter.  Pricing was not available on this security at the end of the second quarter and resulted in a Level 3 valuation.  Pricing was obtained in the third quarter which resulted in a transfer into Level 2.

The Company’s state and municipal security valuations were supported by analysis prepared by an independent third party.  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.  In most cases, the book value of the security is used as the fair value as meaningful pricing data is not readily available.

The Company’s equity security valuation was supported by an analysis prepared by the Company’s Investments Manager. Fair value is derived through consideration of funding type, maturity and other features of the issuance, and includes reviewing financial statements, earnings forecasts, industry trends and the valuation of comparative issuers.  In this case, the book value of the security is used as the fair value as meaningful pricing data is not readily available.

The Company’s other security valuation was supported by analysis prepared by an independent third party.  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.  In most cases, the book value of the security is used as the fair value as meaningful pricing data is not readily available.

28

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 September 30, 2012 Using
	September 30, 2012		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	$	1,194			$	1,194
Agricultural	—				—
Farm	315				315
Construction and development	1,096				1,096
Other	7,457				7,457
Total impaired loans	$	10,062			$	10,062
Servicing rights	3,630				$	3,630
Other real estate owned/assets held for sale
Construction and development	$	2,897			$	2,897
Other commercial real estate	953				953
1-4 Family	172				172
Total other real estate owned/assets held for sale	$	4,022			$	4,022

			Fair Value Measurements at December 31, 2011  Using
	December 31, 2011		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	$	519			$	519
Agricultural	43				43
Farm	292				292
Construction and development	763				763
Other	6,125				6,125
Total impaired loans	$	7,742			$	7,742
Servicing rights	$	4,000			$	4,000
Other real estate owned/assets held for sale
Construction and development	$	1,880			$	1,880
Other commercial real estate	3,636				3,636
Total other real estate owned/assets held for sale	$	5,516			$	5,516

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 $16,002, with a valuation allowance of $5,940 at September 30, 2012. The Company recorded $1,279 of provision expense associated with these loans for the three months ended September 30, 2012 and $1,320 of provision expense associated with these loans for the nine months ended September 30, 2012. The Company recorded $1,177 of provision expense associated with these loans for the three month period ended September 30, 2011, and recorded $5,447 of provision expense for the nine month period ended September 30, 2011. At December 31, 2011, impaired loans had a gross carrying amount of $11,399 with a valuation allowance of $3,657. A breakdown of these loans by portfolio class at September 30, 2012 is as follows:

	Gross Balance		Valuation Allowance		Net
Commercial and industrial	$	3,011	$	1,817	$	1,194
Farm	461		146		315
Construction and development	1,764		668		1,096
Other commercial real estate	10,766		3,309		7,457
Ending Balance	$	16,002	$	5,940	$	10,062

29

Servicing rights, which are carried at lower of cost or fair value, were written down to a fair value of $3,630, resulting in a valuation allowance of $900.  A $225 charge was included in the third quarter 2012 earnings and a $451 charge was included in the first nine months of 2012 earnings.  At September 30, 2011, servicing rights were written down to a fair value of $5,240 resulting in a valuation allowance of $724.  A $230 charge was included in both the third quarter 2011 earnings and the first nine months earnings.  At December 31, 2011, servicing rights were carried at a fair value of $4,000, which is made up of the gross outstanding balance of $4,449, net of a valuation allowance of $449.

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.  At September 30, 2012, other real estate owned was carried at a fair value of $4,022, which is made up of the gross outstanding balance of $6,469, net of a valuation allowance of $2,447.  During the third quarter of 2012, these properties were written down by $339.  For the first nine months of 2012, these properties were written down by $340.  At December 31, 2011, other real estate/assets held for sale was carried at a fair value of $5,516, which is made up of the gross outstanding balance of $9,519, net of a valuation allowance of $4,003.  During the third quarter of 2011, these properties were written down by $980 and for the first nine months of 2011 they were written down by $1,717.  A breakdown of these properties by portfolio class at September 30, 2012 is as follows:

	Gross Balance		Valuation Allowance		Net
Construction and development	$	5,156	$	2,259	$	2,897
Other commercial real estate	1,113		160		953
1-4 Family	200		28		172
Ending Balance	$	6,469	$	2,447	$	4,022

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2012.  Impaired commercial, commercial real estate loans, and other real estate owned that are deemed collateral dependent are valued based on the fair value of the underlying collateral. These estimates are based on the most recently available appraisals with certain adjustments made based on the type of property, age of appraisal, current status of the property and other related factors to estimate the current value of the collateral.

	Fair Value (in thousands)		ValuationTechnique(s)	Unobservable Input(s)	Range
Impaired Loans:
Commercial & industrial	$	1,194	Liquidation value of inventory	Management adjustment	25%-100% 35% Avg
Farm real estate	315		Sales comparison approach	Adjustment for differences between comparable sales	30% 30% Avg
Construction and development	1,096		Sales comparison approach	Adjustment for differences between comparable sales	0%-60% 26% Avg
Other commercial real estate	7,457		Sales comparison approach, income approach	Adjustment for differences between comparable sales, type of property, current status of property	0%-50% 32% Avg
	$	10,062
Other real estate owned:
Construction and development	$	2,897	Sales comparison approach	Adjustment for differences between comparable sales.	0%-36% 24% Avg
Other real estate	1,125		Sales comparison approach	Adjustment for differences between comparable sales.	10%-18% 15% Avg
	$	4,022

30

The following table presents the carrying amounts and estimated fair values of financial instruments, not previously presented, is as follows:

September 30, 2012	Carrying Amount			Level 1			Level 2			Level 3		Total
Assets:
Cash and cash equivalents	$	72,417		$	65,772		$	6,645				$	72,417
Loans including loans held for sale, net	1,545,392						23,879			1,529,798		1,553,677
Restricted stock	15,642											N/A
Interest receivable	10,213						4,549			5,664		10,213
Liabilities
Deposits	(2,083,018		)	(350,790		)	(1,734,326		)			(2,085,116		)
Other borrowings	(47,733		)				(24,428		)			(24,428		)
FHLB advances	(201,119		)				(212,728		)			(212,728		)
Interest payable	(1,229		)				(1,229		)			(1,229		)
Subordinated debentures	(50,380		)							(31,683	)	(31,683		)

December 31,2011	Carrying Amount			Fair Value
Assets:
Cash and cash equivalents	$	109,148		$	109,148
Loans including loans held for sale, net	1,503,368			1,507,310
Restricted stock	15,856			N/A
Interest receivable	10,814			10,814
Liabilities
Deposits	(2,159,900		)	(2,161,888		)
Other borrowings	(25,789		)	(25,789		)
FHLB advances	(151,427		)	(164,209		)
Interest payable	(1,891		)	(1,891		)
Subordinated debentures	(50,267		)	(26,645		)

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, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Noninterest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(c) Loans, Net

Fair values of loans are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.  Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(d) Deposits

The fair values disclosed for non-interest bearing deposits are equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in a Level 2 classification.  Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(e) Securities Sold Under Agreements to Repurchase

The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.

31

(f) Other Borrowings

The fair values of the Company’s FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

The fair values of the Company’s subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(g) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

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.

Actual and required capital amounts and ratios are presented below:

32

	Actual				Required for Adequate Capital				To Be Well Capitalized
September 30, 2012	Amount		Ratio		Amount		Ratio		Amount		Ratio
MainSource Financial Group
Total capital (to risk-weighted assets)	$	310,322	18.8	%	$	132,235	8.0	%	N/A		N/A
Tier 1 capital (to risk-weighted assets)	289,665		17.5		66,118		4.0		N/A		N/A
Tier 1 capital (to average assets)	289,665		10.9		106,383		4.0		N/A		N/A
MainSource Bank
Total capital (to risk-weighted assets)	$	290,097	17.7	%	$	131,035	8.0	%	$	163,712	10.0	%
Tier 1 capital (to risk-weighted assets)	269,442		16.5		65,518		4.0		98,227		6.0
Tier 1 capital (to average assets)	269,442		10.2		105,183		4.0		135,074		5.0
	Actual				Required for Adequate Capital				To Comply with Regulatory Agreement
December 31, 2011	Amount		Ratio		Amount		Ratio		Amount		Ratio
MainSource Financial Group
Total capital (to risk-weighted assets)	$	313,902	18.9	%	133,201		8.0	%	N/A		N/A
Tier 1 capital (to risk-weighted assets)	293,039		17.6		66,601		4.0		N/A		N/A
Tier 1 capital (to average assets)	293,039		10.8		108,875		4.0		N/A		N/A
MainSource Bank	299,054		18.1	%	132,001		8.0	%	181,502		11.0	%
Total capital (to risk-weighted assets)	278,191		16.9		66,001		4.0		—		—
Tier 1 capital (to risk-weighted assets)	278,191		10.3		107,675		4.0		215,350		8.0
Tier 1 capital (to average assets)

Management believes as of September 30, 2012, 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 $13,000 in cash and its ability to downstream additional capital to the Bank.

NOTE 10 — REGULATORY ACTION

The Federal Deposit Insurance Corporation (“FDIC”) and the Indiana Department of Financial Institutions (“Indiana DFI”) notified MainSource Bank (the “Bank”) that, effective March 16, 2012, it was no longer subject to the informal agreement entered into on April 22, 2010.  The informal agreement was not a “written agreement” for purposes of Section 8 of the Federal Deposit Insurance Act. Among its terms, the agreement documented an understanding among the Bank, the FDIC and the Indiana DFI that required 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%. The agreement also required the Bank to obtain the approval of the FDIC and Indiana DFI prior to paying a cash dividend from the Bank to the Company.

NOTE 11 — TARP REPURCHASE

On March 28, 2012, the U.S. Department of the Treasury priced its secondary public offering of 57,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, series A (the “Preferred Stock”).  The Company successfully bid for the purchase of 21,030 shares of the Preferred Stock for a total purchase price of $19,581, plus accrued and unpaid dividends on the Preferred Stock from and including February 15, 2012 to the settlement date, April 3, 2012. The book value of the preferred stock retired was $20,823.  As a result of its successful bid in the offering, the Company retired 21,030 shares of its original sale of 57,000 shares of Preferred Stock on March 29, 2012.  The difference between the book value and the bid price of $1,242 was credited to retained earnings.  The settlement of the offering took place on April 3, 2012.  On May 31, 2012 the Company purchased an additional 1,820 shares or $1,820 in liquidation value of the preferred stock at a cost of $1,747.  The difference between the book value and the bid price of $60 was credited to retained earnings.  None of the remaining shares of outstanding Preferred Stock are held by the U.S. Treasury.  Included in the first nine months of 2012 operating results are $250 of expenses associated with Treasury’s auction and the Company’s purchase of the Preferred Stock.

NOTE 12 — BRANCH CLOSURES

In March 2012, the Board of Directors approved the closure of six branch offices in the following locations: Potomac, Illinois, and Frankton, Charlestown, Liberty, Jeffersonville and Anderson, Indiana.  These branches were closed during the third quarter of 2012.  The Company operated two offices in Anderson, Indiana but consolidated those offices into a single location.  In total, the six branches closed represented approximately $54 million in deposits.  Included in the first nine months of 2012 operating results are $200 thousand of severance costs, $400 thousand of impairment costs for the affected properties, and $100 thousand of other costs related to the closing of the branches.

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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, and MainSource Title, LLC (“MST”). The Bank operates under a state charter and is subject to regulation by its state regulatory agencies and the Federal Deposit Insurance Corporation. MST is 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, 2011, 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 third quarter of 2012 was $6,986 compared to net income of $5,615 for the third quarter of 2011. The increase in net income was primarily attributable to a decrease of $3,000 in the loan loss provision expense and an increase in mortgage banking income of $686.  Offsetting these increases was a decrease in net interest income of $1,739 and a prepayment penalty of $1,313 on a FHLB advance.  Diluted earnings per common share for the second quarter totaled $0.32 in 2012, an increase from the $0.24 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 8.30% for the third quarter of 2012 while return on average assets was 1.02% for the same period, compared to 6.83% and 0.80% in the third quarter of 2011.

For the nine months ended September 30, 2012, net income was $19,979 compared to net income of $17,787 for the same period a year ago.  The increase in net income was also primarily attributable to a decrease in the Company’s loan loss provision expense of $7,000 from 2011 and an increase in mortgage banking income of $2,385 offset by a decrease in net interest income of $4,551, a decrease in securities gains of $3,550, and the aforementioned prepayment penalty of $1,313.  Earnings per share increased to $.97 for the first nine months of 2012 from $.77 for the same period in 2011. Return on average shareholders’ equity was 7.99% for the first nine months of 2012 while return on average assets was 0.97% for the same period, compared to 7.55% and 0.85% in the first nine months of 2011.

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. Third quarter net interest income of $23,331 in 2012 was a slight decrease of 6.9% versus the third quarter of 2011. The decrease in net interest income was primarily due to declining reinvestment rates on loans and securities as well as a $200 million repositioning in investment securities in December 2011.  Average earning assets decreased $53 million with the majority of the decrease the result of reduced loan balances of $49 million and fed funds sold of $36 million.  Offsetting this decrease in loans was an increase in the investment portfolio of $45 million. Also affecting margin was an increase in average demand deposits, NOW accounts, and savings accounts of $110 million which offset a decrease in higher costing CD and money market accounts of $173 million.  Net interest margin, on a fully-taxable equivalent basis, was 4.05% for the third quarter of 2012, a twenty basis point decrease compared to 4.25% for the same period a year ago and flat on a linked quarter basis.

For the first nine months of 2012, the Company’s net interest margin was 4.09% compared to 4.27% for the first nine months of 2011.

Provision for Loan Losses

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

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Non-interest Income

Third quarter non-interest income for 2012 was $11,577 compared to $10,278 for the third quarter of 2011.  Contributing to the increase of $1,299 was a net decrease in securities gains of $431 offset by an increase in mortgage banking of $686, service charges (primarily overdraft fees) of $410 and a reduction in OREO losses of $479.  Continued organic growth in deposit accounts has resulted in higher fee income.  The continued low interest rate environment as well as an increase in mortgage loan originators throughout the Company’s footprint has resulted in continued refinancing activities and an increase in mortgage banking income.

For the nine months ended September 30, 2012, non-interest income was $32,142 compared to $31,117 for the same period a year ago. Contributing to the increase of $1,025 was a net decrease in securities gains of $3,550 and other income of $279.  The primary cause of the other income decrease was the write down of the book value of six branches closed in the third quarter of 2012.  (See Note 12 in the Notes to the Consolidated Financial Statements).  Offsetting these decreases were increases in mortgage banking income of $2,385, service charges on deposit accounts of $1,281, interchange income of $342, and higher write downs of ORE property of $827 taken in 2011.

Non-interest Expense

The Company’s non-interest expense was $24,403 for the third quarter of 2012, compared to $23,905 for the same period in 2011.  The primary increases were a prepayment penalty of $1,313 incurred in connection with the early payoff of an FHLB advance and an increase in consultant expenses on $325.  The consultant expenses are related to the third party consulting firm the Company started using in 2011.  The increases were offset by reductions in salary and employee benefits of $562, the Company’s FDIC assessment of $356, and collection expenses of $477. The Company’s salaries and employee benefits decreased due to the Company’s efficiency improvement project completed in the second half of 2011 as well as the closing of six small branch offices while its FDIC premium decreased as a result of its exit from its informal agreement with the FDIC and Indiana DFI during the first quarter of 2012, as well as a change in the FDIC’s methodology for calculating the premium.  The Company’s efficiency ratio was 66.6% for the third quarter of 2012 compared to 64.3% for the same period a year ago.

For the nine months ended September 30, 2012, non-interest expense was $71,126 compared to $71,108 for the same period a year ago. The primary decreases were in salaries and employee benefits of $1,184, the aforementioned FDIC assessment of $1,104, and collection expenses of $376.  The reduction in employee costs is a direct result of the efficiency initiatives completed by the Company in 2011.  Offsetting these decreases were the aforementioned prepayment penalty on the FHLB advance of $1,313 and consulting expenses of $575, increases in equipment expenses of $492 and other expenses of $926.  Other expenses increased primarily due to the expenses related to the Treasury’s auction of its Series A Preferred Stock in the Company and the Company’s bid to purchase such stock and costs related to the closing of six branches announced in the first quarter of 2012.  The Company’s efficiency ratio was 65.7% for the first nine months of 2012 compared to 63.6% for the same period a year ago.

Income Taxes

The effective tax rate for the third quarter of 2012 was 17.9% versus 12.9% for the same period 2011.  The increase in the effective tax rate was due to the increase in GAAP income before taxes while the Company’s tax exempt income and credits remained relatively consistent with prior periods.

The effective tax rate for the first nine months was 17.7% for 2012 compared to 14.6% for the same period a year ago.  The increase in the effective tax rate was due to the same comment as above.  The Company and its subsidiaries file consolidated income tax returns.

Financial Condition

Total assets at September 30, 2012 were $2,755,006, a slight increase from total assets of $2,754,180 as of December 31, 2011.  The individual components of the asset side of the balance sheet remained basically the same as the balances at December 31, 2011.  The securities portfolio grew $26,088 but this was more than offset be a reduction in money markets and fed funds sold of $35,639.  Average earning assets represented 90.0% of average total assets for the first nine months of 2012 and 90.7% for the same period in 2011. Average loans represented 71.8% of average deposits in the first nine months of 2012 and 73.7% for the comparable period in 2011. Management continues to emphasize quality loan growth to increase these averages. Average loans as a percent of average assets were 56.2% and 58.6% for the nine month periods ended September 30, 2012 and 2011 respectively.

Deposits decreased $77 million from December 31, 2011.  The increase in noninterest bearing deposits and savings deposits of $42 million were more than offset by a reduction of higher priced CD balances of $80 million and interest bearing demand and money market accounts of $39 million.  The Company was in a fed funds purchased position of $17 million at September 30, 2012.

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Shareholders’ equity was $339 million on September 30, 2012 compared to $337 million on December 31, 2011.  Book value (shareholders’ equity) per common share was $15.01 at September 30, 2012 versus $13.87 at year-end 2011. Accumulated other comprehensive income increased book value per share by $1.39 at September 30, 2012 and increased book value per share by $1.13 at December 31, 2011.  Depending on market conditions, the unrealized gain or loss on securities available for sale can cause fluctuations in shareholders’ equity.  As mentioned in Note 11, the Company was able to buy back and retire $23 million of its preferred shares in the first nine months of 2012 at a discount.

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

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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 approximately 50% of all loans. External loan review personnel examine the top 100 commercial credit relationships. This equates to approximately all relationships above $1,750.

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 $2,854 from year end 2011.  The Company is experiencing some overall demand across all segments which have been offset by early payoffs on other credits.  Residential real estate loans continue to represent a significant portion of the total loan portfolio. Such loans represented 24.9% of total loans at September 30, 2012 and 23.8% at December 31, 2011.  On September 30, 2012, the Company had $23,929 of residential real estate loans held for sale, which was an increase from the year-end balance of $16,620. 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 (non-accrual loans + loans past due 90 days and still accruing + troubled debt restructurings):

	September 30, 2012			June 30, 2012			March 31, 2012			December 31, 2011			September 30, 2011
Amount	$	50,698		$	54,944		$	52,677		$	65,197		$	65,231
Percent of loans	3.31		%	3.55		%	3.44		%	4.25		%	4.18		%

Of the $50,698 of non-performing loans at September 30, 2012, $19,200 had a specific reserve allocated of $6,165.

A reconciliation of non-performing assets (non-performing loans + OREO) for the first nine months of 2012 and 2011 is as follows:

	2012			2011
Beginning Balance - NPA - January 1	$	80,732		$	102,998
Non-accrual
Add: New non-accruals	29,181			38,330
Less: To accrual/payoff/restructured	(9,488		)	(27,390		)
Less: To OREO	(4,216		)	(21,158		)
Less: Charge offs	(12,243		)	(15,773		)
Increase/(Decrease): Non-accrual loans	3,234			(25,991		)
Other Real Estate Owned (OREO)
Add: New OREO properties	4,216			21,158
Less: OREO sold	(8,975		)	(12,725		)
Less: OREO losses (write-downs)	(1,020		)	(1,617		)
Increase/(Decrease): OREO	(5,779		)	6,816
Increase/(Decrease): 90 Days Delinquent	(2,887		)	3
Increase/(Decrease): Repossessions	(79		)	13
Increase/(Decrease): TDR’s	(14,846		)	(300		)
Total NPA change	(20,357		)	(19,459		)
Ending Balance - NPA - September 30	$	60,375		$	83,539

At September 30, 2012, four of the non-accrual loan balances were greater than $1,000 compared to three loan balances greater than $1,000 at June 30, 2012.  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

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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 and mitigate loss to the Bank. Any loans that are modified are reviewed by us to identify if a troubled debt restructuring 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 Company reviews each relationship before it grants the concession to insure the creditor can comply with the new terms.  To date, most of the concessions have been extensions of maturity dates.

During the first nine months of 2012, the Company experienced a $30 million reduction in its Substandard loans and a $47 reduction in its Special Mentions loans in the commercial portfolio.  In both categories, 60% of the decrease was in the Hotel category and 30% in Other Real Estate.  The loans upgraded were the result of overall improvement in the underlying fundamentals of the credit. This also resulted in a decrease in the allowance allocated to loans collectively evaluated for impairment by $3,841.

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The provision for loan losses was $2,000 in the third quarter of 2012 compared to $5,000 for the same period in 2011 and $2,500 for the second quarter of 2012. For the first nine months of 2012 and 2011, the provision for loan loss was $7,600 and $14,600 respectively.  The decrease in provision expense from 2011 was primarily due to the relative stabilization in the amount of non-performing and watch list loans in aggregate and decrease in net charge-offs.  The amount of new non-accrual loans in the third quarter of 2012 was approximately $2,000 lower than the second quarter of 2012.

Net loan losses were $5,043 for the third quarter of 2012 compared to $5,029 for the same period a year ago and $12,243 for the first nine months of 2012 compared to $15,772 a year ago.  During the third quarter of 2012, the Company executed the sale of approximately $5,200 of problem loans in the secondary market.  This transaction resulted in charge-offs of $3,000.  The Company had identified and specifically provided for these losses in previous quarters.  Approximately 50% of the Company’s charge-offs for the first nine months of 2012 was related to 11 commercial credits.  All but approximately $2,562 of these charge-offs had an allowance allocated in 2011 or prior.

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 September 30, 2012 was considered adequate by management.  The allowance for loan losses was $35,246 as of September 30, 2012 and represented 2.30% of total outstanding loans compared to $39,889 as of December 31, 2011 or 2.60% of total outstanding loans.  The decrease in the percentage was due to an improvement in nonperforming assets for the nine month period ending September 30, 2012.

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 September 30, 2012, the Company had $902,178 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 $43,266 was recorded to adjust the AFS portfolio to current market value at September 30, 2012, compared to an unrealized pre-tax gain of $35,218 at December 31, 2011. 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.

Sources of Funds

The Company relies primarily on customer deposits, federal funds purchased, 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 87.0% and 87.7% of total average earning assets for the nine-month periods ending September 30, 2012 and 2011. Total interest-bearing deposits averaged 84.2% and 87.2% of average total deposits for the nine-month periods ending September 30, 2012 and 2011, 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 $201,119 outstanding at September 30, 2012. These advances have interest rates ranging from 0.51% to 5.90%.  All of the current advances, with the exception of the 2012 advances, were originally long-term advances with approximately $80,000 maturing in 2012, $16,000 maturing in 2013, $25,000 maturing in 2014, $0 maturing in 2015, and $80,000 maturing in 2016 and beyond.  During the third quarter of 2012, the Company paid off a $10,000 advance that was due in 2015and incurred a $1,313 penalty.  The Company believed it had adequate liquidity that allowed it pay off this advance early and save future interest expense.

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Capital Resources

Total shareholders’ equity was $338,524 at September 30, 2012, which was an increase of $1,971 compared to the $336,553 of shareholders’ equity at December 31, 2011. The increase in shareholders’ equity was primarily attributable to the Company’s net income of $19,979 for the first nine months of 2012, other comprehensive income of $5,230 for the first nine months of 2012, and an increase in retained earnings of $1,302 as a result of buying the preferred stock at less than par value offset by the purchase and retirement of a portion of its preferred shares of $22,626, and payment of preferred and common dividends of $1,582 and $1,014 respectively.

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 September 30, 2012, Tier 1 capital to total average assets was 10.9%. Tier 1 capital to risk-adjusted assets was 17.5%. Total capital to risk-adjusted assets was 18.8%. All three ratios exceed all required ratios established for bank holding companies. Risk-adjusted capital levels of the Bank exceed regulatory definitions of well-capitalized institutions.

The Company declared and paid common dividends of $0.03 per share in the third quarter of 2012 versus $0.01 for the third quarter of 2011.  To prudently manage capital, the Company elected to reduce its dividend starting in the second quarter of 2009.  The increase in the third quarter dividend is the first increase in the dividend rate in over three years.

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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 80.3% of total earning assets for the nine months ended September 30, 2012 and 79.3% for the same period in 2011.

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.

Effective asset/liability management requires the maintenance of a proper ratio between maturing or repriceable interest-earning assets and interest-bearing liabilities. In an effort to estimate the impact of sustained interest rate movements to the Company’s earnings, the Company monitors interest rate risk through computer-assisted simulation modeling of its net interest income. The Company’s simulation modeling monitors the potential impact to net interest income under various interest rate scenarios. The Company’s objective is to actively manage its asset/liability position within a one-year interval and to limit the risk in any of the interest rate scenarios to a reasonable level of tax-equivalent net interest income within that interval.

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 September 30, 2012 from the analysis and disclosures provided in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

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 third fiscal quarter of 2012 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

Item 1A. Risk Factors

The new Basel III capital rules proposed in August 2012 by the Federal Reserve and the FDIC to implement the Basel III capital guidelines may adversely affect the Company’s and the Bank’s capital adequacy and the costs of conducting its business.

If adopted and effective in their current form, many of these proposals will be applicable to the Company and the Bank, and will include several significant changes, including changes to the definition of “capital” for regulatory purposes, the types and minimum levels of capital required under the prompt corrective action rules and for other regulatory purposes and the risk-weighting of various assets.  In addition, among other things, for bank holding companies with under $15 billion in assets, trust preferred securities will be phased out as Tier 1 capital over 10 years.  Based on the current components and levels of our capital and assets, we believe that we would be in compliance with the requirements in the proposed rules if they were currently in effect.  There is no assurance that the Basel III proposals will be adopted in their current form, what changes may be made prior to adoption, or when the final rules will be effective.  Until the proposals are finalized and the timing of implementation of the new rules is determined, some uncertainty will exist with respect to the impact of the rules on us and the banking industry generally.

Other than as set forth above, there have been no material changes to the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, 2011, as filed with the SEC on March 12, 2012.

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 Sections 11 and 12 of the Securities Act of 1933, 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
101	The following financial statements and notes from the MainSource Financial Group Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted in XBRL pursuant to Rule 405 of Regulation S-T: (i)  Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Income; (iii) Condensed Consolidated Statements of Cash Flows; and (iv) the Notes to the condensed consolidated financial statements.

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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.

November 9, 2012

/s/ Archie M. Brown, Jr.

Archie M. Brown, Jr.

President and Chief Executive Officer

November 9, 2012

/s/ James M. Anderson

James M. Anderson

Senior Vice President & Chief Financial Officer

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