** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D. C. 20549**

**FORM 10-K**

**Annual Report Pursuant to Section 13 or 15(d) of the**

**Securities Exchange Act of 1934**

**Forthe fiscal year ended December 31, 2006**

**Commissionfile number 0-12422**

**MAINSOURCE FINANCIAL GROUP, INC.**

(Exact name of registrantas specified in its charter)

| **Indiana**                        |   | **35–1562245**  |
|------------------------------------|--------|----------------------|
| (State or other  jurisdiction      |   | (I.R.S. Employer     |
| of incorporation  or organization) |   | Identification  No.) |

 

**201 North BroadwayGreensburg, Indiana 47240**(Address of principal executive offices) (Zip code)

Registrant’s telephonenumber, including area code: **(812) 663-0157**

Securities registeredpursuant to Section 12(b) of the Act:**None**

Securities registeredpursuant to Section 12(g) of the Act

**Common shares, no-par value**(Title of Class)

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes  o    No  x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) of the Act.Yes  o    No  x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes  x    No  o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of accelerated filer and large accelerated filer in Rule 12b-2 ofthe Exchange Act. Large accelerated filer oAccelerated filer x Non acceleratedfiler o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act). Yes  o    No  x

The aggregate market value (not necessarily a reliableindication of the price at which more than a limited number of shares wouldtrade) of the voting stock held by non-affiliates of the registrant was$312,983,956 as of June 30, 2006.

As of March 10, 2007, there were outstanding18,751,547 common shares, without par value, of the registrant.

DOCUMENTS INCORPORATED BYREFERENCE

|                                        |   | **Part of  Form 10-K**          |
|----------------------------------------|--------|---------------------------------|
| **Documents**                          |   | **Into  Which Incorporated**    |
| Definitive Proxy  Statement for Annual |   | Part III (Items  10 through 14) |
| Meeting of  Shareholders to be held    |   |                            |
| April 26, 2007                         |   |                            |

 

 

----

FORM 10-K TABLE OF CONTENTS
| Part I   |   |                                                                                                                |
|----------|--------|---------------------------------------------------------------------------------------------------------------------|
| Item 1   |   | Business                                                                                                            |
| Item 1A  |   | Risk Factors                                                                                                        |
| Item  1B |   | Unresolved  Staff Comments                                                                                          |
| Item 2   |   | Properties                                                                                                          |
| Item  3  |   | Legal  Proceedings                                                                                                  |
| Item 4   |   | Submission of  Matters to a Vote of Security Holders                                                                |
| Part II  |   |                                                                                                                |
| Item 5   |   | Market For  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |
| Item 6   |   | Selected Financial  Data                                                                                            |
| Item 7   |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |
| Item 7A  |   | Quantitative  and Qualitative Disclosures About Market Risk                                                         |
| Item 8   |   | Financial  Statements and Supplementary Data                                                                        |
| Item 9   |   | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                               |
| Item 9A  |   | Controls and Procedures                                                                                             |
| Item 9B  |   | Other Information                                                                                                   |
| Part III |   |                                                                                                                |
| Item 10  |   | Directors, Executive Officers and Corporate  Governance                                                             |
| Item 11  |   | Executive Compensation                                                                                              |
| Item 12  |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                     |
| Item 13  |   | Certain Relationships and Related Transactions and  Director Independence                                           |
| Item 14  |   | Principal Accounting Fees and Services                                                                              |
| Part IV  |   |                                                                                                                |
| Item 15  |   | Exhibits,  Financial Statement Schedules                                                                            |

 

Pursuant to General Instruction G, the informationcalled for by Items 10-14 is omitted by MainSource Financial Group, Inc. sinceMainSource Financial Group, Inc. will file with the Commission a definitiveproxy statement to shareholders pursuant to regulation 14A not later than 120days after the close of the fiscal year containing the information required byItems 10-14.

2

----

**Part I.**

**ITEM1.     BUSINESS**

**(Dollars in thousands except per sharedata)**

**GENERAL**

MainSource Financial Group, Inc. (“the Company”) is afinancial holding company based in Greensburg, Indiana. As of December 31,2006, the Company owned five banking subsidiaries: MainSource Bank, MainSourceBank of Illinois, MainSource Bank — Crawfordsville, MainSource Bank — Ohio, andMainSource Bank — Hobart (together “the Banks”). Through its non-bankaffiliates, the Company provides services incidental to the business ofbanking. Since its formation in 1982, the Company has acquired and establishedvarious institutions and financial services companies and may acquireadditional financial institutions and financial services companies in thefuture. For further discussion of the business of the Company see Management’sDiscussion and Analysis in Part II, Item 7.

As of December 31, 2006, the Company operated 80branch banking offices in Indiana, Illinois, and Ohio as well as eightinsurance offices in Indiana. As of December 31, 2006, the Company hadconsolidated assets of $2,429,773, consolidated deposits of $1,859,689 andshareholders’ equity of $253,247.

Through its Banks, the Company offers a broad range offinancial services, including: accepting time and transaction deposits; makingconsumer, commercial, agribusiness and real estate mortgage loans; renting safedeposit facilities; providing general agency personal and business insuranceservices; providing personal and corporate trust services; and providing othercorporate services such as letters of credit and repurchase agreements.

The lending activities of the Banks are separated intoprimarily the categories of commercial/agricultural, real estate and consumer.Loans are originated by the lending officers of the Banks subject tolimitations set forth in lending policies. The Boards of Directors of each Bankreviews loans up to the Bank’s legal lending limits, monitors concentrations ofcredit, problem and past due loans and charge-offs of uncollectible loans andformulates loan policy. The Banks maintain conservative loan policies andunderwriting practices in order to address and manage loan risks. Thesepolicies and practices include granting loans on a sound and collectible basis,serving the legitimate needs of the community and the general market area whileobtaining a balance between maximum yield and minimum risk, ensuring thatprimary and secondary sources of repayment are adequate in relation to theamount of the loan, developing and maintaining adequate diversification of theloan portfolio as a whole and of the loans within each category and developingand applying adequate collection policies.

Commercial loans include secured and unsecured loans,including real estate loans, to individuals and companies and to governmentalunits within the market area of the Banks for a myriad of business purposes.

Agricultural loans are generated in the Banks’markets. Most of the loans are real estate loans on farm properties. Loans arealso made for agricultural production and such loans are generally reviewedannually.

Residential real estate lending has been the largestcomponent of the loan portfolio for many years. All affiliate banks generateresidential mortgages for their own portfolios. However, the Company elects tosell the majority of its fixed rate mortgages into the secondary market whilemaintaining the servicing of such loans. At December 31, 2006, the Company was servicing a $522 million loanportfolio.  By originating loans for salein the secondary market, the Company can more fully satisfy customer demand forfixed rate residential mortgages and increase fee income, while reducing therisk of loss caused by rising interest rates.

3

----

The principal source of revenues for the Company isinterest and fees on loans, which accounted for 67.6% of total revenues in2006, 63.7% in 2005 and 61.9% in 2004.

The Company’s investment securities portfolio isprimarily comprised of U. S. Treasuries, federal agencies, state and municipalbonds, U. S. government sponsored entity’s mortgage-backed securities andcorporate securities. The Company has classified its entire investmentportfolio as available for sale, with fair value changes reported separately inshareholders’ equity. Funds invested in the investment portfolio generallyrepresent funds not immediately required to meet loan demand. Income related tothe Company’s investment portfolio accounted for 16.0% of total revenues in2006, 18.3% in 2005 and 16.6% in 2004. As of December 31, 2006, the Company hadnot identified any securities as being “high risk” as defined by the FFIEC SupervisoryPolicy Statement on Securities Activities.

The primary sources of funds for the Banks aredeposits generated in local market areas. To attract and retain stabledepositors, the Banks market various programs for demand, savings and timedeposit accounts. These programs include interest and non-interest bearingdemand and individual retirement accounts.

Currently, national retailing and manufacturingsubsidiaries, brokerage and insurance firms and credit unions are fiercecompetitors within the financial services industry. Mergers between financialinstitutions within Indiana and neighboring states, which became permissibleunder the Interstate Banking and Branching Efficiency Act of 1994, have alsoadded competitive pressure.

The Company’s Banks are located in predominantlynon-metropolitan areas and their business is centered in loans and depositsgenerated within markets considered largely rural in nature. In addition tocompeting vigorously with other banks, thrift institutions, credit unions and financecompanies located within their service areas, they also compete, directly andindirectly, with all providers of financial services.

**EMPLOYEES**

As of December 31, 2006, the Company and itssubsidiaries had 829 full-time equivalent employees to whom it provides avariety of benefits and with whom it enjoys excellent relations.

**REGULATION AND SUPERVISION OF THECOMPANY**

The Company is a financial holding company (“FHC”)within the meaning of the Bank Holding Company Act of 1956, as amended (“Act”).This Act subjects FHC’s to regulations of the Federal Reserve Board (“FRB”) andrestricts the business of FHC’s to financial and related activities.

The Gramm-Leach-Bliley Financial Modernization Act of1999 was enacted on November 12, 1999. The Modernization Act, which amended theBank Holding Company Act, provides the following:

·                  it allows bank holding companies thatqualify as “financial holding companies” to engage in a broad range offinancial and related activities;

·                  it allows insurers and otherfinancial services companies to acquire banks;

·                  it removes various restrictions thatapplied to bank holding company ownership of securities firms and mutual fundadvisory companies; and

·                  it establishes the overall regulatorystructure applicable to bank holding companies that also engage in insuranceand securities operations.

4

----

The Company initially qualified as a financial holdingcompany in December, 2004. Thus the Company is authorized to operate as afinancial holding company and is eligible to engage in, or acquire companiesengaged in, the broader range of activities that are permitted by theModernization Act. These activities include those that are determined to be “financialin nature,” including insurance underwriting, securities underwriting anddealing, and making merchant banking investments in commercial and financialcompanies. If any of our banking subsidiaries ceases to be “well capitalized”or “well managed” under applicable regulatory standards, the Federal ReserveBoard may, among other things, place limitations on our ability to conductthese broader financial activities or, if the deficiencies persist, require usto divest the banking subsidiary. In addition, if any of our bankingsubsidiaries receives a rating of less than satisfactory under the CommunityReinvestment Act of 1977 (“CRA”), we would be prohibited from engaging in anyadditional activities other than those permissible for bank holding companiesthat are not financial holding companies. Our banking subsidiaries currentlymeet these capital, management and CRA requirements.

Acquisitions by the Company of banks and savingsassociations are subject to federal and state regulation. Any acquisition bythe Company of more than five percent of the voting stock of any bank requiresprior approval of the FRB, the FHC and, if applicable, state regulators.Acquisition of savings associations is also subject to the approval of the OTS.

Indiana law permits FHCs to acquire bank holdingcompanies and banks out of state on a reciprocal basis, subject to certainlimitations. Under current law, the Company may acquire banks, and may beacquired by bank holding companies, located in any state in the United Statesthat permits reciprocal entry by Indiana FHCs. Under the Act, FHCs may acquiresavings associations without geographic restrictions.

A FHC and its subsidiaries are prohibited fromengaging in certain tying arrangements in connection with the extension ofcredit, lease or sale of property, or the provision of any property or service.

The Company is under the jurisdiction of theSecurities and Exchange Commission (“SEC”) and state securities commission formatters relating to the offering and sale of its securities. The Company issubject to the SEC’s rules and regulations relating to periodic reporting,reporting to shareholders, proxy solicitation and insider trading.

The Company’s liquidity is principally derived fromdividends paid on the common stock of its subsidiaries. The payment of thesedividends is subject to certain regulatory restrictions.

Under bank holding company policy, the Company isexpected to act as a source of financial strength to, and commit resources tosupport, its affiliates. As a result of such policy, the Company may berequired to commit resources to its affiliate banks in circumstances where itmight not otherwise do so.

Certain regulations define relevant capital measuresfor five capital categories. A “well capitalized” institution is one that has atotal risk-based capital ratio of at least 10%, a Tier 1 risk-based capitalratio of at least 8%, a leverage ratio of at least 5% and is not subject toregulatory direction to maintain a specific level for any capital measure. An “adequatelycapitalized” institution is one that has ratios greater than 8%, 4% and 4%. Aninstitution is “undercapitalized” if its respective ratios are less than 8%, 4%and 4%.  “Significantly undercapitalized”institutions have ratios of less than 6%, 3% and 3%. An institution is deemedto be “critically undercapitalized” if it has a ratio of tangible equity tototal assets that is 2% or less. Institutions with capital ratios at levels of “undercapitalized”or lower are subject to various limitations that, in most situations, willreduce the competitiveness of the institution.

5

----

**REGULATION AND SUPERVISION OF THESUBSIDIARY BANKS**

The Company’s affiliate banks are supervised,regulated and examined by their respective state regulatory banking agenciesand the Federal Deposit Insurance Corporation (“FDIC”), except for MainSourceBank — Hobart, which is a federal savings bank and is therefore regulated bythe Office of Thrift Supervision (“OTS”). A cease-and-desist order may beissued against the banks, if the respective agency finds that the activities ofthe bank represent an unsafe and unsound banking practice or violation of law.

The deposits of the five banking subsidiaries areinsured to the maximum extent permitted by law by the Deposit Insurance Fund (“DIF”)of the FDIC, which was created in 2006 as the result of the merger of the BankInsurance Fund and the Savings Association Insurance Fund in accordance withthe Federal Deposit Insurance Reform Act of 2005 (the “FDI” Act). The FDI Actprovided for several additional changes to the deposit insurance system,including adjusting the deposit insurance limits (currently $100,000 for mostaccounts) every 5 years beginning in 2011 based on an inflation index,increasing the insurance limit for retirement accounts from $100,000 to $250,000,and allocating an aggregate of $4.7 billion of one-time credits to banks tooffset the insurance premiums charged to such banks by the FDIC.

Branching by banks in Indiana is subject to thejurisdiction, and requires the prior approval, of the bank’s primary federalregulatory authority and, if the branching bank is a state bank, of the IndianaDepartment of Financial Institutions (“DFI”). Under Indiana law, banks maybranch anywhere in the state.

The Company is a legal entity separate and distinctfrom its subsidiary Banks.  There arevarious legal limitations on the extent to which the Banks can supply funds tothe Company. The principal source of the Company’s funds consists of dividendsfrom its subsidiary Banks. State and Federal law restricts the amount ofdividends that may be paid by banks. In addition, the Banks are subject tocertain restrictions on extensions of credit to the Company, on investments inthe stock or other securities of the Company and in taking such stock orsecurities as collateral for loans.

**CAPITAL REQUIREMENTS**

The Company and its subsidiary Banks must meet certainminimum capital requirements mandated by each of their state or federalregulators. These regulatory agencies require BHCs and banks to maintaincertain minimum ratios of primary capital to total assets and total capital tototal assets. The FRB requires BHCs to maintain a minimum Tier 1 leverage ratioof 3 percent capital to total assets; however, for all but the most highlyrated institutions which do not anticipate significant growth, the minimum Tier1 leverage ratio is 3 percent plus an additional cushion of 100 to 200 basispoints. As of December 31, 2006, the Company’s leverage ratio of capital tototal assets was 7.0%. The FRB and FDIC each have approved the imposition of “risk-adjusted”capital ratios on BHCs and financial institutions. The Company’s Tier 1 Capitalto Risk-Weighted Assets Ratio was 10.3% and its Total Capital to Risk-WeightedAssets Ratio was 11.2% at December 31, 2006. The Company’s Banks had capital toasset ratios and risk- adjusted capital ratios at December 31, 2006, in excessof the applicable regulatory minimum requirements.

6

----

**ITEM 1A.               RISK FACTORS**

In addition to the otherinformation contained in this report, the following risks may affect us.  If any of these risks actually occur, our business, financial condition or results ofoperations may suffer. As a result, the price of our common shares coulddecline.

***Like most banking organizations,our business is highly susceptible to credit risk.***

As a lender, we areexposed to the risk that our customers will be unable to repay their loansaccording to their terms and that the collateral securing the payment of theirloans (if any) may not be sufficient to assure repayment. Credit losses couldhave a material adverse effect on our operating results.

As of December 31, 2006,our total loan portfolio was approximately $1.6 billion or 65% of our totalassets. Three major components of the loan portfolio are loans principallysecured by real estate, approximately $1,246 million or 79% of total loans,other commercial loans, approximately $174 million or 11% of total loans, andconsumer loans, approximately $130 million or 8% of total loans.  Our credit risk with respect to our consumerinstallment loan portfolio and commercial loan portfolio relates principally tothe general creditworthiness of individuals and businesses within our localmarket area.  Our credit risk withrespect to our residential and commercial real estate mortgage and constructionloan portfolio relates principally to the general creditworthiness ofindividuals and businesses and the value of real estate serving as security forthe repayment of the loans.  A relatedrisk in connection with loans secured by commercial real estate is the effectof unknown or unexpected environmental contamination, which could make the realestate effectively unmarketable or otherwise significantly reduce its value assecurity.

***Ourallowance for loan losses may not be sufficient to cover actual loan losses,which could adversely affect our earnings.***

We maintain an allowancefor loan losses at a level estimated to be sufficient to cover probableincurred loan losses in our loan portfolio. Additional loan losses will likely occur in the future and may occur ata rate greater than we have experienced to date.  In determining the size of the allowance, ourmanagement makes various assumptions and judgments about the collectibility ofour loan portfolio, including the diversification by industry of our commercialloan portfolio, the effect of changes in the local real estate market oncollateral values, the results of recent regulatory examinations, the effectson the loan portfolio of current economic indicators and their probable impacton borrowers, the amount of charge-offs for the period, the amount ofnonperforming loans and related collateral security, and the evaluation of ourloan portfolio by an external loan review. If our assumptions and judgments prove to be incorrect, our currentallowance may not be sufficient and adjustments may be necessary to allow fordifferent economic conditions or adverse developments in our loanportfolio.  Federal and state regulatorsalso periodically review our allowance for loan losses and may require us toincrease our provision for loan losses or recognize further loan charge-offs, basedon judgments different than those of our management.  Any increase in our allowance for loan lossesor loan charge-offs could have an adverse effect on our operating results andfinancial condition.

***We rely heavily on our management and other key personnel, and the lossof any of them may adversely affect our operations.***

Weare and will continue to be dependent upon the services of our management team,including James L. Saner, Sr., our President and Chief Executive Officer, JamesM. Anderson, our Senior Vice President and Chief Financial Officer, thepresidents of our subsidiary banks and our other senior managers.  Theloss of either Mr. Saner or Mr. Anderson, or any of our other senior managers,could have an adverse effect on our growth and performance because of theirskills, knowledge of the markets in which we operate and years of industryexperience and the difficulty of promptly finding qualified replacementpersonnel.  The loss of key personnel ina particular market could have an adverse effect on our performance in thatmarket because it may be difficult to find qualified replacement personnel whoare already located in or would be willing to relocate to a non-metropolitanmarket.

***Significant interest ratevolatility could reduce our profitability.***

Our results of operationsare affected principally by net interest income, which is the differencebetween interest earned on loans and investments and interest expense paid ondeposits and other borrowings. We cannot predict or control changes in interestrates. National, regional and local economic conditions and the policies ofregulatory authorities, including monetary policies of the Board of Governorsof the Federal Reserve System, affect market interest rates.  While we have instituted policies andprocedures designed to manage the risks from changes in market interest rates,at any given time our assets and liabilities will likely be affecteddifferently by a given change in interest rates, principally because we do notmatch the maturities of our loans and investments precisely with our depositsand other funding sources.  Changes ininterest rates may also affect the level of voluntary prepayments on our loansand the level of financing or refinancing by customers.   As of December 31, 2006, we had a negativeinterest rate gap of 35% of interest earning assets in the one-year time frame.Although this is within our internal policy limits, our earnings will beadversely affected in periods of rising interest rates because, during suchperiods, the interest expense paid on deposits and borrowings will generallyincrease more rapidly than the interest income earned on loans andinvestments.  If such an interest rateincrease occurred gradually, we would use our established procedures to attemptto mitigate the effects over time. However, if such an interest rate increase occurred rapidly, or interestrates exhibited volatile increases and decreases, we might be unable tomitigate the effects, and our net interest income could suffer significant adverseeffects.  While management intends tocontinue to take 

7

----

measures to mitigateinterest rate risk, we cannot assure you that such measures will be entirelyeffective in minimizing our exposure to the risk of rapid changes in interestrates.

***Thegeographic concentration of our markets makes our business highly susceptibleto local economic conditions.***

Unlike larger bankingorganizations that are more geographically diversified, our operations arecurrently concentrated in 30 counties in Indiana, three counties in Illinois,and two counties in Ohio. As a result of this geographic concentration in threefairly contiguous markets, our financial results depend largely upon economicconditions in these market areas.  Adeterioration in economic conditions in one or all of these markets couldresult in one or more of the following:

·                  anincrease in loan delinquencies;

·                  anincrease in problem assets and foreclosures;

·                  adecrease in the demand for our products and services; and

·                  adecrease in the value of collateral for loans, especially real estate, in turnreducing customers’ borrowing power, the value of assets associated withproblem loans and collateral coverage.

***If we do not adjust to rapid changes in the financialservices industry, our financial performance may suffer.***

We face substantialcompetition for deposit, credit and trust relationships, as well as othersources of funding in the communities we serve. Competing providers includeother banks, thrifts and trust companies, insurance companies, mortgage bankingoperations, credit unions, finance companies, money market funds and otherfinancial and nonfinancial companies which may offer products functionallyequivalent to those offered by our banks. Competing providers may have greaterfinancial resources than we do and offer services within and outside the marketareas we serve.  In addition to thischallenge of attracting and retaining customers for traditional bankingservices, our competitors now include securities dealers, brokers, mortgagebankers, investment advisors and finance and insurance companies who seek tooffer one-stop financial services to their customers that may include servicesthat banks have not been able or allowed to offer to their customers in thepast. The increasingly competitive environment is primarily a result of changesin regulation, changes in technology and product delivery systems and theaccelerating pace of consolidation among financial service providers.  If we are unable to adjust both to increasedcompetition for traditional banking services and changing customer needs andpreferences, it could adversely affect our financial performance and yourinvestment in our common stock.

***Ourhistorical growth and financial performance trends may not continue if ouracquisition strategy is not successful.***

Growth in asset size andearnings through acquisitions is an important part of our businessstrategy.  As consolidation of thebanking industry continues, the competition for suitable acquisition candidatesmay increase.  We compete with otherbanking companies for acquisition opportunities, and many of these competitorshave greater financial resources and acquisition experience than we do and maybe able to pay more for an acquisition than we are able or willing to pay.  We also may need additional debt or equityfinancing in the future to fund acquisitions. We may not be able to obtain additional financing or, if available, itmay not be in amounts and on terms acceptable to us.  We may use our common stock as theconsideration for an acquisition or we may issue additional common stock anduse the proceeds for the acquisition. Our issuance of additional securities will dilute your equity interestin us and may have a dilutive effect on our earnings per share.  If we are unable to locate suitableacquisition candidates willing to sell on terms acceptable to us, or we areotherwise unable to obtain additional debt or equity financing necessary for usto continue our acquisition strategy, we would be required to find other methodsto grow our business and we may not grow at the same rate we have in the past,or at all.

***Acquisitionsentail risks which could negatively affect our operations.***

Acquisitionsinvolve numerous risks, including:

·                  exposureto asset quality problems of the acquired institution;

·                  maintainingadequate regulatory capital;

·                  diversionof management’s attention from other business concerns;

·                  risksand expenses of entering new geographic markets;

·                  potentialsignificant loss of depositors or loan customers from the acquired institution;and

8

----

·                  exposureto undisclosed or unknown liabilities of an acquired institution.

Any of these acquisitionrisks could result in unexpected losses or expenses and thereby reduce theexpected benefits of the acquisition.

***Unanticipated costs related to ouracquisition strategy could reduce MainSource’s future earnings per share.***

MainSourcebelieves it has reasonably estimated the likely costs of integrating theoperations of the banks it acquires into MainSource and the incremental costsof operating such banks as a part of the MainSource family.  However, it is possible that unexpectedtransaction costs such as taxes, fees or professional expenses or unexpectedfuture operating expenses, such as increased personnel costs or increasedtaxes, as well as other types of unanticipated adverse developments, could havea material adverse effect on the results of operations and financial conditionof MainSource.  If unexpected costs areincurred, acquisitions could have a dilutive effect on MainSource’s earningsper share.  In other words, if MainSourceincurs such unexpected costs and expenses as a result of its acquisitions,MainSource believes that the earnings per share of MainSource common stockcould be less than they would have been if those acquisitions had not beencompleted.

***MainSource may be unable to successfullyintegrate the operations of the banks it has acquired and may acquire in thefuture and retain employees of such banks.***

MainSource’sacquisition strategy involves the integration of the banks MainSource hasacquired and may acquire in the future as MainSource subsidiary banks.  The difficulties of integrating theoperations of such banks with MainSource and its other subsidiary banks include:

·                  coordinatinggeographically separated organizations;

·                  integratingpersonnel with diverse business backgrounds;

·                  combiningdifferent corporate cultures; and

·                  retaining keyemployees.

Theprocess of integrating operations could cause an interruption of, or loss ofmomentum in, the activities of one or more of MainSource, its subsidiary banksand the banks MainSource has acquired and may acquire in the future and theloss of key personnel.  The integrationof such banks as MainSource subsidiary banks requires the experience andexpertise of certain key employees of such banks who are expected to beretained by MainSource.  We cannot besure, however, that MainSource will be successful in retaining these employeesfor the time period necessary to successfully integrate such banks’ operationsas subsidiary banks of MainSource.  Thediversion of management’s attention and any delays or difficulties encounteredin connection with the mergers, along with the integration of the banks asMainSource subsidiary banks, could have an adverse effect on the business andresults of operation of MainSource.

9

----

***Changes in governmental regulation and legislation couldlimit our future performance and growth.***

We are subject toextensive state and federal regulation, supervision and legislation that governalmost all aspects of our operations, as well as any acquisitions we maypropose to make. Any change in applicable federal or state laws or regulationscould have a substantial impact on us, our subsidiary banks and our operations.While we cannot predict what effect any presently contemplated or futurechanges in the laws or regulations or their interpretations would have on us,these changes could reduce the value of your investment.

***Our strategy to minimize Indiana state taxes on our investmentportfolio may be unsuccessful.***

Since2002, our Indiana state financial institutions taxes have been reduced by ouruse of subsidiaries we formed in the State of Nevada to hold a significantportion of our investment portfolio. Nevada has no state or local income tax, and we take the position thatnone of this income is subject to the Indiana financial institutions tax.  For the year ended December 31, 2006, our netsavings in Indiana tax from this arrangement (after federal tax) wasapproximately $900,000.   Although managementbelieves that this arrangement is permitted under Indiana law, and Indiana taxauthorities have not challenged our tax returns in this regard, we understandthat Indiana tax authorities have challenged a similar arrangement implementedby at least one other Indiana-based bank holding company.   If we were not permitted to realize statetax savings from this arrangement, it would cause our net income after taxes tobe lower in the future, and if Indiana tax authorities challenged ourarrangement and were successful in assessing additional taxes, interest andpenalties for prior years, we might be forced to take a special charge to ourearnings in the amount of the assessment.

10

----

**ITEM 1B.               UNRESOLVED STAFF COMMENTS.**

None.

**ITEM 2.     PROPERTIES**

In September 2005, MainSource Financial Grouppurchased a property in Greensburg, Indiana that will eventually serve as itscorporate headquarters.  The Company’stotal current investment in this property is $1.4 million and expects tooccupy the property in 2007.  As ofDecember 31, 2006, the Company leased space from one of its subsidiaries foruse as its corporate headquarters.   TheCompany’s subsidiaries own, or lease, all of the facilities from which theyconduct business. All leases are comparable to other leases in the respectivemarket areas and do not contain provisions materially detrimental to theCompany or its subsidiaries. As of December 31, 2006 the Company had 80 bankinglocations of which MainSource Bank had 56, MainSource Bank of Illinois had seven,MainSource Bank — Crawfordsville had six, MainSource Bank — Hobart had six, andMainSource Bank — Ohio had five. In addition, the Company operates eightinsurance offices in Indiana. At December 31, 2006, the Company hadapproximately $40 million invested in premises and equipment.

11

----

**ITEM 3.     LEGAL PROCEEDINGS**

The Company’s subsidiaries may be parties (bothplaintiff and defendant) to ordinary litigation incidental to the conduct ofbusiness. Management is presently not aware of any material claims.

**ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

No matters were submitted during the fourth quarter of2006 to a vote of security holders, through the solicitation of proxies orotherwise.

**PART II**

**ITEM 5.      MARKET FOR THE REGISTRANT’S COMMON EQUITY,RELATED STOCKHOLDER MATTERS AND ISSUER’S PURCHASES OF EQUITY SECURITIES**

**Market Information**

The Company’s Common Stock is traded on NASDAQ’sNational Market System under the symbol MSFG. The Common Stock was held byapproximately 3,800 shareholders at March 10, 2007. The quarterly high and lowclosing prices for the Company’s common stock as reported by NASDAQ andquarterly cash dividends declared and paid are set forth in the tables below.All per share data is retroactively restated for all stock dividends andsplits.

The range of known per share prices by calendarquarter, based on actual transactions, excluding commissions, is shown below.

 
| ** ** | ** ** | **Market Prices** | ** ** |
|------------|------------|------------------------|------------|
| **2006**   | ** ** | **Q4**                 | ** ** | **Q3** | ** ** | **Q2** | ** ** | **Q1** | ** ** |
| High       |       | $                      | 17.88      |   | $ | 16.93 |   | $ | 18.13 |   | $ | 18.52 |   |
| Low        |       | $                      | 16.05      |   | $ | 15.30 |   | $ | 15.57 |   | $ | 17.05 |   |

 
| **2005** | ** ** | **Q4** | ** ** | **Q3** | ** ** | **Q2** | ** ** | **Q1** | ** ** |
|----------|------------|--------|------------|--------|------------|--------|------------|--------|------------|
| High     |       | $      | 17.92      |   | $          | 18.62  |       | $      | 20.59      |   | $ | 22.82 |   |
| Low      |       | $      | 16.33      |   | $          | 16.89  |       | $      | 16.48      |   | $ | 19.96 |   |

 
| ** ** | ** ** | **Cash Dividends** | ** ** |
|------------|------------|-------------------------|------------|
| **2006**   | ** ** | **Q4**                  | ** ** | **Q3** | ** ** | **Q2** | ** ** | **Q1** | ** ** |
|       |       | $                       | 0.133      |   | $ | 0.133 |   | $ | 0.133 |   | $ | 0.129 |   |
|       |       |                    |       |   |   |   |   |   |   |
|            |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 
| **2005** | ** ** | **Q4** | ** ** | **Q3** | ** ** | **Q2** | ** ** | **Q1** | ** ** |
|----------|------------|--------|------------|--------|------------|--------|------------|--------|------------|
|     |       | $      | 0.124      |   | $          | 0.124  |       | $      | 0.124      |   | $ | 0.124 |   |
|          |            |        |            |        |            |        |            |        |            |  |  |  |  |

 

**Equity Compensation PlanInformation**

The following table setsforth information regarding securities authorized for issuance under equitycompensation plans:

 
| **Plan category**                                      | ** ** | **Number of securities to be  issued upon exercise of  outstanding options,   warrants and rights  (a)** | ** ** | **Weighted-average exercise  price of outstanding options,  warrants and rights  (b)** | ** ** | **Number of securities remaining  available for future issuance  under equity compensation  plans (excluding securities  reflected in column (a))  (c)** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation  plans approved by security holders     |       | 204,781                                                                                                                                                         |       | $                                                                                                                    | 18.43      |                                                                                                                                                                                                                      | 387,671    |   |
| Equity  compensation plans not approved by security holders |       | 58,564                                                                                                                                                          | (1)        | 16.16                                                                                                                | (1)        | —                                                                                                                                                                                                                    |       |
| **Total**                                                   |       | 263,345                                                                                                                                                         |       | $                                                                                                                    | 17.93      |                                                                                                                                                                                                                      | 387,671    |   |

----

(1) Represents stockoptions assumed in connection with the Company’s acquisition of Peoples OhioFinancial Corporation

12

----

**Stock Performance Graph**

The following performancegraph compares the performance of our common shares to the performance of theNASDAQ Market Index (U.S.) and the NASDAQ Bank Stocks Index for the 60 monthsended December 31, 2006.  The graphassumes an investment of $100 in each of the Company’s common shares, theNASDAQ Market Index (U.S.) and the NASDAQ Bank Stocks Index on December 21,2001.

 
| ** **                  | ** ** | **12/31/01** | ** ** | **12/31/02** | ** ** | **12/31/03** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** |
|-----------------------------|------------|--------------|------------|--------------|------------|--------------|------------|--------------|------------|--------------|------------|--------------|------------|
| MainSource  Financial Group |       | $            | 100.00     |         | $          | 142.37       |       | $            | 189.98     |         | $          | 232.44       |       | $ | 175.29 |   | $ | 175.02 |   |
| NASDAQ MARKET  INDEX (U.S.) |       | 100.00       |       | 68.47        |       | 102.72       |       | 111.54       |       | 113.07       |       | 123.84       |       |
| NASDAQ Bank Stocks  Index   |       | 100.00       |       | 104.52       |       | 135.80       |       | 150.73       |       | 144.20       |       | 160.07       |       |
|                             |            |              |            |              |            |              |            |              |            |              |            |              |            |  |  |  |  |  |  |

 

13

----

**Purchases of Equity Securities**

**Theactivity in the Company’s Stock Repurchase Program for the fourth quarter of2006 was as follows:**

 
| ** **    | ** ** | ** **                  | ** ** | ** **                   | ** ** | ** **                                           | ** ** | **Maximum Number**                                      | ** ** |
|---------------|------------|-----------------------------|------------|------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **    | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Total Number of Shares**            | ** ** | **(or Approximate Dollar**                         | ** ** |
| ** **    | ** ** | **Total Number**       | ** ** | **Average Price**       | ** ** | **(or Units) Purchased as Part** | ** ** | **Value) of Shares (or Units)**          | ** ** |
| ** **    | ** ** | **of Shares (or** | ** ** | **Paid Per Share** | ** ** | **of Publicly Announced Plans**       | ** ** | **That May Yet Be Purchased**            | ** ** |
| **Period**    | ** ** | **Units) Purchased**   | ** ** | **(or Unit)**           | ** ** | **or Programs**                                 | ** ** | **Under the Plans or Programs (1)** | ** ** |
|          |       |                        |       |                         |       |                                                 |       |                                                         |       |
| October 2006  |       | —                      |       | $                            | —     |                                                 | —     |                                                         | 362,250    |   |
|          |       |                        |       |                         |       |                                                 |       |                                                         |       |
| November 2006 |       | 57,750                      |       | $                            | 17.30      |                                                 | 57,750     |                                                         | 304,500    |   |
|          |       |                        |       |                         |       |                                                 |       |                                                         |       |
| December 2006 |       | 47,284                      |       | $                            | 16.93      |                                                 | 47,284     |                                                         | 257,216    |   |

----

(1)                                     OnMarch 31, 2006, the Company announced that its Board of Directors had approveda stock repurchase program for up to 375,000 of its outstanding commonshares.  The plan expires on March 31,2007. 

 

**ITEM 6.     SELECTED FINANCIAL DATA**

**SelectedFinancial Data**

*(Dollaramounts in thousands except per share data)*

 
| ** **                                                                    | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** |
|-------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|
| **Results  of Operations**                                                    |       |      |       |      |       |      |       |      |       |      |       |
| Net interest  income                                                          |       | $         | 68,268     |      | $          | 53,648    |       | $         | 50,002     |      | $          | 44,232 |   | $ | 45,050 |   |
| Provision for  loan losses                                                    |       | 1,819     |       | 1,040     |       | 600       |       | 1,325     |       | 2,995     |       |
| Noninterest  income                                                           |       | 23,039    |       | 17,332    |       | 19,544    |       | 19,443    |       | 14,379    |       |
| Noninterest  expense                                                          |       | 59,642    |       | 48,576    |       | 45,880    |       | 40,448    |       | 35,610    |       |
| Income before  income tax                                                     |       | 29,846    |       | 21,364    |       | 23,066    |       | 21,902    |       | 20,824    |       |
| Income tax                                                                    |       | 7,605     |       | 5,172     |       | 6,273     |       | 6,597     |       | 6,813     |       |
| Net income                                                                    |       | 22,241    |       | 16,192    |       | 16,793    |       | 15,305    |       | 14,011    |       |
| Dividends paid  on common stock                                               |       | 8,944     |       | 6,514     |       | 5,421     |       | 4,873     |       | 4,485     |       |
|                                                                          |       |      |       |      |       |      |       |      |       |      |       |
| **Per  Common Share ***                                                       |       |      |       |      |       |      |       |      |       |      |       |
| Earnings per  share (basic)                                                   |       | $         | 1.30       |      | $          | 1.23      |       | $         | 1.41       |      | $          | 1.31 |   | $ | 1.18 |   |
| Earnings per  share (diluted)                                                 |       | 1.29      |       | 1.23      |       | 1.41      |       | 1.31      |       | 1.18      |       |
| Dividends paid                                                                |       | 0.529     |       | 0.495     |       | 0.453     |       | 0.415     |       | 0.378     |       |
| Book value - end  of period                                                   |       | 13.50     |       | 11.39     |       | 10.17     |       | 9.02      |       | 8.46      |       |
| Market price -  end of period                                                 |       | 16.94     |       | 17.00     |       | 22.74     |       | 18.55     |       | 13.83     |       |
|                                                                          |       |      |       |      |       |      |       |      |       |      |       |
| **At Year  End**                                                              |       |      |       |      |       |      |       |      |       |      |       |
| Total assets                                                                  |       | $         | 2,429,773  |      | $          | 1,645,605 |       | $         | 1,549,379  |      | $          | 1,442,729 |   | $ | 1,251,760 |   |
| Available for  sale securities                                                |       | 485,259   |       | 450,814   |       | 428,686   |       | 425,542   |       | 351,143   |       |
| Loans, excluding  held for sale                                               |       | 1,574,384 |       | 957,995   |       | 929,005   |       | 855,471   |       | 740,167   |       |
| Allowance for  loan losses                                                    |       | 12,792    |       | 10,441    |       | 11,698    |       | 11,509    |       | 9,517     |       |
| Total deposits                                                                |       | 1,859,689 |       | 1,352,697 |       | 1,226,367 |       | 1,191,310 |       | 1,034,307 |       |
| Notes payable                                                                 |       | —    |       | —    |       | 9,100     |       | 12,500    |       | 2,400     |       |
| Federal Home  Loan Bank advances                                              |       | 208,443   |       | 41,547    |       | 90,981    |       | 62,751    |       | 50,235    |       |
| Subordinated  debentures                                                      |       | 41,239    |       | 29,898    |       | 29,898    |       | 29,898    |       | 30,425    |       |
| Shareholders’  equity                                                    |       | 253,247   |       | 161,069   |       | 123,320   |       | 105,424   |       | 99,771    |       |
|                                                                          |       |      |       |      |       |      |       |      |       |      |       |
| **Financial  Ratios**                                                         |       |      |       |      |       |      |       |      |       |      |       |
| Return on  average assets                                                     |       | 1.06      | %          | 1.04      | %          | 1.13      | %          | 1.14      | %          | 1.16      | %          |
| Return on  average common shareholders’ equity                           |       | 10.39     |       | 11.27     |       | 14.70     |       | 15.07     |       | 14.90     |       |
| Allowance for  loan losses to total loans (year end, excluding held for sale) |       | 0.81      |       | 1.09      |       | 1.26      |       | 1.35      |       | 1.29      |       |
| Allowance for  loan losses to total non-performing loans (year end)           |       | 73.18     |       | 102.19    |       | 83.31     |       | 77.65     |       | 119.86    |       |
| Shareholders’  equity to total assets (year end)                         |       | 10.42     |       | 9.79      |       | 7.96      |       | 7.31      |       | 7.97      |       |
| Average equity  to average total assets                                       |       | 10.13     |       | 9.18      |       | 7.95      |       | 7.57      |       | 7.77      |       |
| Dividend payout  ratio                                                        |       | 40.21     |       | 40.23     |       | 32.28     |       | 31.84     |       | 32.01     |       |

----

*Adjusted forstock split and dividends

14

----

**ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

**Management’sDiscussion and Analysis**

**(Dollar amounts in thousands exceptper share data)**

**Forward-Looking Statements**

Except for historical information contained herein,the discussion in this Annual Report includes certain forward-lookingstatements based upon management expectations. Factors which could cause futureresults to differ from these expectations include the following: generaleconomic conditions; legislative and regulatory initiatives; monetary andfiscal 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 accountingpolicies or guidelines; and changes in the quality or composition of theCompany’s loan and investment portfolios.

The forward-looking statements included in theManagement’s Discussion and Analysis (“MD&A”) relating to certain mattersinvolve risks and uncertainties, including anticipated financial performance,business prospects, and other similar matters, and reflect management’s bestjudgment based on factors currently known. Actual results and experience coulddiffer materially from the anticipated results or other expectations expressedin the Company’s forward-looking statements as a result of a number of factors,including but not limited to those discussed in the MD&A.

**Overview**

MainSource Financial Group, Inc. (“MainSource orCompany”) is a financial holding company whose principal activity is theownership and management of its five wholly owned subsidiary banks (“Banks”):MainSource Bank of Indiana headquartered in Greensburg, Indiana, MainSourceBank of Illinois headquartered in Kankakee, Illinois, MainSource Bank —Crawfordsville headquartered in Crawfordsville, Indiana, MainSource Bank — Ohioheadquartered in Troy, Ohio, and MainSource Bank — Hobart headquartered inHobart, Indiana.  The banks, with theexception of MainSource Bank — Hobart, operate under state charters and aresubject to regulation by their respective state regulatory agencies and theFederal Deposit Insurance Corporation. MainSource Bank — Hobart is a thriftinstitution and is subject to regulation by the Office of Thrift Supervisionand the Federal Deposit Insurance Corporation. MainSource Insurance is a wholly owned subsidiary of the Companyoperating eight insurance agency offices in Indiana and is subject toregulation by the Indiana Department of Insurance. The Company also has whollyowned subsidiaries to hold investment securities. These investment subsidiariesare incorporated in Nevada. During 2005, the Company also formed MainSourceTitle, LLC, a title insurance agency, and MainSource Mortgage, LLC, a mortgageorigination company.

**Business Strategy**

The Company operates under the broad tenets of along-term strategic plan (“Plan”) designed to improve the Company’s financialperformance, expand its competitive position and enhance long-term shareholdervalue. The Plan is premised on the belief of the Company’s Board of Directorsthat it can best promote long-term shareholder interests by pursuing strategieswhich will continue to preserve its community-focused philosophy. The dynamicsof the Plan assure continually evolving goals, with the enhancement ofshareholder value being the constant, overriding objective. The extent of theCompany’s success will depend upon how well it anticipates and responds tocompetitive changes within its markets, the interest rate environment and otherexternal forces.

TheCompany continued its history of external growth through acquisitions during2006 by acquiring three whole bank institutions and purchasing five branchesfrom an in-market competitor.  In March, 2006, the Company acquired 100% ofthe outstanding shares of Union Community Bancorp (“Union”).  Union operated a total of six offices inMontgomery, Fountain, Warren, and Tippecanoe Counties in Indiana through itswholly-owned subsidiary, Union Federal Bank and Trust Association.  The aggregate purchase price was $55.2million comprised of $26.0 million in cash and $29.2 million in stock issued.

15

----

In May, 2006, the Company acquired 100% of theoutstanding shares of HFS Bank, F.S.B. (“HFS”). HFS operated a total of six offices in Hobart, Portage, Griffith, andCrown Point Indiana.  As a result of thisacquisition, the Company expects to expand its market share into northwestIndiana, expand its customer base to enhance deposit fee income, provide anopportunity to market additional products and services to new customers, andreduce operating costs through economies of scale.  The aggregate purchase price was $36.5million comprised of  $17.7 million incash and $18.8 million in stock issued.

In June, 2006, the Company acquired 100% of theoutstanding shares of Peoples Ohio Financial Corporation (“Peoples”).  Peoples operated a total of six offices inMontgomery and Miami Counties in Ohio. As a result of this acquisition, the Company expects to expand itsmarket share into western Ohio, expand its customer base to enhance deposit feeincome, provide an opportunity to market additional products and services tonew customers, and reduce operating costs through economies of scale.  The aggregate purchase price was $42.5million comprised of $11.4 million in cash and $31.1 million in stock issued.

In August, 2006, the Company purchased five branchesfrom First Financial Bank.  Thesebranches were located in Madison, Vevay, East Enterprise, and Liberty,Indiana.  As a result of thisacquisition, the Company expects to further solidify its market share insouthern Indiana, expand its customer base to enhance deposit fee income,provide an opportunity to market additional products and services to newcustomers, and reduce operating costs through economies of scale.  The purchase price resulted in approximately$3.5 million in goodwill and $1.1 million in core deposit intangible.

The Company is continuously reviewing otheracquisition targets including branches, whole banks, and other financialservice related entities focusing on the four-state Midwest region of Indiana,Illinois, Kentucky, and Ohio.

**Results of Operations**

Net income was $22,241 in 2006, $16,192 in 2005, and$16,793 in 2004.  Earnings per commonshare on a fully diluted basis were $1.29 in 2006, $1.23 in 2005, $1.41 in2004.  As previously mentioned, theCompany’s operating results for 2006 were dramatically impacted by theacquisition activity in 2006.  In total,net income increased in 2006 by $6,049, or 37.4%, compared to 2005.  Key measures of the operating performance ofthe Company are return on average assets, return on average shareholders’equity, and efficiency ratio.  TheCompany’s return on average assets was 1.06% for 2006 compared to 1.04% for2005 and return on average Shareholders’ equity was 10.4% in 2006 compared to11.3% in 2005.  The Company’s efficiencyratio, which measures the non-interest expenses of the Company as a percentageof its net interest income (on a fully taxable equivalent basis) and itsnon-interest income, was 63.6% in 2006 compared to 66.6% in 2005.

16

----

**Net Interest Income**

Net interest income and net interest margin areinfluenced by the volume and yield or cost of earning assets andinterest-bearing liabilities. Tax equivalent net interest income of $71,345 in2006 increased from $56,205 in 2005. As rates rose throughout 2006, the Company’syield on earning assets increased to 6.62% in 2006 from 5.89% in 2005.  Offsetting the increase in yield, the Companyincurred a corresponding increase in its overall cost of deposits andborrowings.  The Company’s total cost offunds was 3.09% in 2006 compared to 2.12% in 2005. The increase in the Company’scost of funds was primarily caused by two factors: the general repricing of itsfunding base in a rising rate environment and a shift in the overall mix of thedeposit base.  Throughout the year,customers moved balances away from lower cost deposit accounts into higher costaccounts such as certificates of deposits, and high-yield money marketaccounts.  The overall effect was adecrease in the Company’s net interest margin in 2006 of 18 basis points goingfrom 3.99% in 2005 to 3.81% in 2006.

The following table summarizes net interest income (ona tax-equivalent basis) for each of the past three years.

**AverageBalance Sheet and Net Interest Analysis (Taxable Equivalent Basis)***
| ** **                                                                                         | ** ** | **2006**    | ** ** | **2005**     | ** ** | **2004**    | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                                                                         | ** ** | **Average** | ** ** | ** **   | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Assets**                                                                                         | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| ** **                                                                                         | ** ** | ** **  | ** ** | ** **   | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Short-term  investments                                                                            |       | $           | 4,210      |         | $          | 141         |       | 3.35 | % | $ | 4,010 |   | $ | 71 |   | 1.77 | % | $ | 6,139 |   | $ | 42 |   | 0.68 | % |
| Federal funds  sold and money market accounts                                                      |       | 8,249       |       | 394          |       | 4.78        |       | 4,889 |   | 197 |   | 4.03 |   | 4,377 |   | 76 |   | 1.74 |   |
| Securities                                                                                         |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                            |       | 382,912     |       | 18,176       |       | 4.75        |       | 359,116 |   | 13,819 |   | 3.85 |   | 353,457 |   | 12,094 |   | 3.42 |   |
| Non-taxable*                                                                                       |       | 121,257     |       | 7,540        |       | 6.22        |       | 105,251 |   | 6,251 |   | 5.94 |   | 79,882 |   | 4,691 |   | 5.87 |   |
| Total securities                                                                                   |       | 504,169     |       | 25,716       |       | 5.10        |       | 464,367 |   | 20,070 |   | 4.32 |   | 433,339 |   | 16,785 |   | 3.87 |   |
| Loans **                                                                                           |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial                                                                                         |       | 594,294     |       | 43,128       |       | 7.26        |       | 490,832 |   | 33,056 |   | 6.73 |   | 490,595 |   | 31,455 |   | 6.41 |   |
| Residential real estate                                                                            |       | 488,477     |       | 33,362       |       | 6.83        |       | 225,358 |   | 14,083 |   | 6.25 |   | 223,100 |   | 13,913 |   | 6.24 |   |
| Consumer                                                                                           |       | 270,885     |       | 21,067       |       | 7.78        |       | 219,281 |   | 15,555 |   | 7.09 |   | 185,783 |   | 11,610 |   | 6.25 |   |
| Total loans                                                                                        |       | 1,353,656   |       | 97,557       |       | 7.21        |       | 935,471 |   | 62,694 |   | 6.70 |   | 899,478 |   | 56,978 |   | 6.33 |   |
| Total earning assets                                                                               |       | 1,870,284   |       | 123,808      |       | 6.62        |       | 1,408,737 |   | 83,032 |   | 5.89 |   | 1,343,333 |   | 73,881 |   | 5.50 |   |
|                                                                                               |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                                                                           |       | 58,562      |       |         |       |        |       | 47,595 |   |   |   |   |   | 46,920 |   |   |   |   |   |
| Unrealized gains  (losses) on securities                                                           |       | (7,643      | )          |         |       |        |       | (2,601 | ) |   |   |   |   | 693 |   |   |   |   |   |
| Allowance for  loan losses                                                                         |       | (12,667     | )          |         |       |        |       | (11,754 | ) |   |   |   |   | (11,798 | ) |   |   |   |   |
| Premises and  equipment,net                                                                        |       | 35,926      |       |         |       |        |       | 26,291 |   |   |   |   |   | 24,769 |   |   |   |   |   |
| Intangible assets                                                                                  |       | 103,008     |       |         |       |        |       | 50,845 |   |   |   |   |   | 44,332 |   |   |   |   |   |
| Accrued interest  receivable and other assets                                                      |       | 55,580      |       |         |       |        |       | 44,905 |   |   |   |   |   | 40,617 |   |   |   |   |   |
| Total assets                                                                                       |       | $           | 2,103,050  |         |       |        |       |   | $ | 1,564,018 |   |   |   |   |   | $ | 1,488,866 |   |   |   |   |   |
|                                                                                               |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Liabilities                                                                                        |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits                                                                          |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| DDA, savings, and money market accounts                                                            |       | $           | 711,111    |         | $          | 11,130      |       | 1.57 |   | $ | 616,398 |   | $ | 6,916 |   | 1.12 |   | $ | 551,885 |   | $ | 3,438 |   | 0.62 |   |
| Certificates of deposit                                                                            |       | 731,603     |       | 28,152       |       | 3.85        |       | 483,457 |   | 13,183 |   | 2.73 |   | 521,112 |   | 12,928 |   | 2.48 |   |
| Total interest-bearing deposits                                                                    |       | 1,442,714   |       | 39,282       |       | 2.72        |       | 1,099,855 |   | 20,099 |   | 1.83 |   | 1,072,997 |   | 16,366 |   | 1.53 |   |
| Short-term  borrowings                                                                             |       | 33,586      |       | 1,332        |       | 3.97        |       | 38,720 |   | 975 |   | 2.52 |   | 44,806 |   | 580 |   | 1.29 |   |
| Subordinated  debentures                                                                           |       | 31,750      |       | 2,475        |       | 7.80        |       | 29,898 |   | 1,938 |   | 6.48 |   | 29,898 |   | 1,677 |   | 5.61 |   |
| Notes payable and  FHLB borrowings                                                                 |       | 189,171     |       | 9,374        |       | 4.96        |       | 95,525 |   | 3,815 |   | 3.99 |   | 82,836 |   | 3,216 |   | 3.88 |   |
| Total interest-bearing liabilities                                                                 |       | 1,697,221   |       | 52,463       |       | 3.09        |       | 1,263,998 |   | 26,827 |   | 2.12 |   | 1,230,537 |   | 21,839 |   | 1.77 |   |
| Demand deposits                                                                                    |       | 174,218     |       |         |       |        |       | 144,647 |   |   |   |   |   | 131,110 |   |   |   |   |   |
| Other liabilities                                                                                  |       | 17,622      |       |         |       |        |       | 11,737 |   |   |   |   |   | 13,004 |   |   |   |   |   |
| Total liabilities                                                                                  |       | 1,889,061   |       |         |       |        |       | 1,420,382 |   |   |   |   |   | 1,374,651 |   |   |   |   |   |
| Shareholders’  equity                                                                         |       | 213,989     |       |         |       |        |       | 143,636 |   |   |   |   |   | 114,215 |   |   |   |   |   |
| Total liabilities  and shareholders’ equity                                                   |       | $           | 2,103,050  |         | 52,463     |        | 2.81       | *** | $ | 1,564,018 |   | 26,827 |   | 1.90 | *** | $ | 1,488,866 |   | 21,839 |   | 1.63 | *** |
| Net interest  income                                                                               |       |        |       | $            | 71,345     |        | 3.81       | **** |   |   | $ | 56,205 |   | 3.99 | **** |   |   | $ | 52,042 |   | 3.87 | **** |
|                                                                                               |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Conversion of tax  exempt income to a fully taxable equivalent basis using a marginal rate of  35% |       |        |       | $            | 3,077      |        |       |   |   |   | $ | 2,557 |   |   |   |   |   | $ | 2,040 |   |   |   |

----

| *    | Adjusted to reflect income related to securities and  loans exempt from Federal income taxes. |
|------|-----------------------------------------------------------------------------------------------|
| **   | Nonaccruing loans have been included in the average  balances.                                |
| ***  | Total interest expense divided by total earning  assets.                                      |
| **** | Net interest income divided by total earning assets.                                          |

 

The following table sets forth for the periodsindicated a summary of the changes in interest income and interest expense resultingfrom changes in volume and changes in rates.

17

----

**Volume/RateAnalysis of Changes in Net Interest Income**

*(TaxEquivalent Basis)*
| ** **                                                      | ** ** | **2006 OVER 2005** | ** ** | **2005 OVER 2004** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                      | ** ** | **Volume**                   | ** ** | **Rate**                     | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest  income**                                            |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Loans                                                           |       | $                            | 30,092     |                         | $          | 4,771 |   | $ | 34,863 |   | $ | 2,388 |   | $ | 3,328 |   | $ | 5,716 |   |
| Securities                                                      |       | 2,024                        |       | 3,622                        |       | 5,646 |   | 1,335 |   | 1,950 |   | 3,285 |   |
| Federal funds sold and money market funds                       |       | 166                          |       | 31                           |       | 197 |   | 22 |   | 99 |   | 121 |   |
| Short-term investments                                          |       | (1                           | )          | 71                           |       | 70 |   | (38 | ) | 67 |   | 29 |   |
| Total interest income                                           |       | 32,281                       |       | 8,495                        |       | 40,776 |   | 3,707 |   | 5,444 |   | 9,151 |   |
| **Interest  expense**                                           |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Interest-bearing DDA, savings, and money market  accounts       |       | $                            | 1,440      |                         | $          | 2,774 |   | $ | 4,214 |   | $ | 719 |   | $ | 2,759 |   | $ | 3,478 |   |
| Certificates of deposit                                         |       | 9,554                        |       | 5,415                        |       | 14,969 |   | (1,048 | ) | 1,303 |   | 255 |   |
| Borrowings                                                      |       | 4,428                        |       | 1,488                        |       | 5,916 |   | 352 |   | 642 |   | 994 |   |
| Subordinated debentures                                         |       | 142                          |       | 395                          |       | 537 |   | — |   | 261 |   | 261 |   |
| Total interest expense                                          |       | 15,564                       |       | 10,072                       |       | 25,636 |   | 23 |   | 4,965 |   | 4,988 |   |
| Change in net  interest income                                  |       | $                            | 16,717     |                         | $          | (1,577 | ) | 15,140 |   | $ | 3,684 |   | $ | 479 |   | 4,163 |   |
| Change in tax  equivalent adjustment                            |       |                         |       |                         |       | 520 |   |   |   |   |   | 517 |   |
| Change in net  interest income before tax equivalent adjustment |       |                         |       |                         |       | $  | 14,620 |   |   |   |   |   | $  | 3,646 |   |

 

**Provisionfor Loan Losses**

The Company expensed $1,819 in provision for loanlosses in 2006. This level of provision allowed the Company to maintain anadequate allowance for loan losses. This topic is discussed in detail under theheading “Loans, Credit Risk and the Allowance and Provision for Loan Losses”.

**Non-interestIncome and Expense**
| ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Percent Change** | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **06/05**               | ** ** | **05/04** | ** ** |
|                                               |       |       |       |       |       |       |       |                    |       |   |   |
| Non-interest  income                               |       |       |       |       |       |       |       |                    |       |   |   |
| Insurance commissions                              |       | $          | 1,821      |       | $          | 1,991      |       | $                       | 2,643      |   | -8.5 | % | -24.7 | % |
| Mortgage banking                                   |       | 2,279      |       | 2,693      |       | 3,198      |       | -15.4                   | %          | -15.8 | % |
| Trust and investment product fees                  |       | 1,187      |       | 1,119      |       | 911        |       | 6.1                     | %          | 22.8 | % |
| Service charges on deposit accounts                |       | 9,491      |       | 7,510      |       | 6,912      |       | 26.4                    | %          | 8.7 | % |
| Net realized gains/(losses) on securities sales    |       | 145        |       | (2,179     | )          | 991        |       | -106.7                  | %          | -319.9 | % |
| Increase in cash surrender value of life insurance |       | 1,255      |       | 891        |       | 1,016      |       | 40.9                    | %          | -12.3 | % |
| Interchange income                                 |       | 2,617      |       | 1,926      |       | 1,996      |       | 35.9                    | %          | -3.5 | % |
| Other                                              |       | 4,244      |       | 3,381      |       | 1,877      |       | 25.5                    | %          | 80.1 | % |
| Total non-interest income                          |       | $          | 23,039     |       | $          | 17,332     |       | $                       | 19,544     |   | 32.9 | % | -11.3 | % |
|                                               |       |       |       |       |       |       |       |                    |       |   |   |
| Non-interest  expense                              |       |       |       |       |       |       |       |                    |       |   |   |
| Salaries and employee benefits                     |       | $          | 33,073     |       | $          | 27,121     |       | $                       | 25,411     |   | 21.9 | % | 6.7 | % |
| Net occupancy                                      |       | 4,755      |       | 3,542      |       | 3,165      |       | 34.2                    | %          | 11.9 | % |
| Equipment                                          |       | 5,361      |       | 4,123      |       | 3,949      |       | 30.0                    | %          | 4.4 | % |
| Intangibles amortization                           |       | 2,236      |       | 1,306      |       | 1,059      |       | 71.2                    | %          | 23.3 | % |
| Telecommunications                                 |       | 1,916      |       | 1,664      |       | 1,581      |       | 15.1                    | %          | 5.2 | % |
| Stationery, printing, and supplies                 |       | 1,408      |       | 984        |       | 988        |       | 43.1                    | %          | -0.4 | % |
| Other                                              |       | 10,893     |       | 9,836      |       | 9,727      |       | 10.7                    | %          | 1.1 | % |
| Total  non-interest expense                        |       | $          | 59,642     |       | $          | 48,576     |       | $                       | 45,880     |   | 22.8 | % | 5.9 | % |

 

**Non-interestIncome**

Total non-interest income was $23,039 for 2006compared to $17,332 for 2005, an increase of $5,707 and 32.9%  The primary drivers of the increase innon-interest income were the aforementioned acquisition of the three wholebanks in 2006 and the change in securities gains and losses year over year.  In total, these acquisitions accounted forapproximately $2,175 with approximately half of this income related to servicecharges on deposit accounts.  In 2005,the Company incurred net losses on securities sales of $2,179 compared to netgains on securities sales of $145 in 2006.

Total non-interest income was $17,332 for 2005compared to $19,544 for 2004.  Excludingthe $2,179 loss on the sale of securities in 2005, non-interest income wouldhave been $19,511 for 2005 or relatively flat compared to 2004.  Increases in service charges on depositaccounts and other income were offset by decreases in mortgage banking andinsurance commissions.  Service chargesincreased primarily due to the increase in overall account levels fromacquisitions.  Other income increased dueto death benefits on bank-owned life insurance, the establishment of the titleinsurance agency, an increase in annuity sales, the acquisition of Madison, andthe full-year effect of the Peoples Trust acquisition in June 2004.  Insurance commissions decreased as theCompany disposed of the Kentucky division of its insurance subsidiary in thefirst quarter of 2005.

**Non-interestExpense**

Total non-interest expense was $59,642 in 2006compared to $48,576 in 2005, an increase of $11,066 and 22.8%.  The primary driver of the increase innon-interest income was the aforementioned acquisition of the three whole banksin 2006.  In total, these acquisitionsaccounted for approximately $9,700 of non-interest expense in 2006 withapproximately half of this expense related to salaries and employeebenefits.  Excluding acquisition-relatedactivity, the Company’s non-interest expense would have been approximately$49,950 in 2006, an increase of 2.8%.

Total non-interest expense increased 5.9% in 2005 to$48,576 compared to $45,880 in 2004, an increase of $2,696. The largestcomponent of non-interest expense in both years was salaries and employeebenefits. These expenses were $27,121 in 2005 compared to $25,411 in 2004. Theincrease of $1,710 was primarily related to the full-year effect of theacquisition of Peoples Trust, the acquisition of Madison in August 2005, andnormal staff salary increases.  Occupancyand intangible amortization expenses increased in 2005 due to the acquisitionactivity in 2004 and 2005.

18

----

**Income Taxes**

The effective tax rate was 25.5% in 2006, 24.2% in2005, and 27.2% in 2004.  The increase inthe Company’s effective tax rate in 2006 was primarily related to the overallincrease in pre-tax income.

**Balance Sheet**

At December 31, 2006, total assets were $2,429,773compared to $1,645,605 at December 31, 2005, an increase of $784,168. Theincrease was primarily attributable to the acquisitions closed in 2006.  In total these acquisitions addedapproximately $798 million in assets.

**Loans, Credit Risk and the Allowanceand Provision for Loan Losses**

Loans remain the Company’s largest concentration ofassets and continue to represent the greatest potential risk. The loanunderwriting standards observed by the Company’s subsidiaries are viewed bymanagement as a means of controlling problem loans and the resultingcharge-offs.

The Company’s conservative loan underwriting standardshave historically resulted in higher loan quality and generally lower levels ofnet charge-offs than peer group averages. The Company also believes creditrisks may be elevated if undue concentrations of loans in specific industrysegments and to out-of-area borrowers are incurred. Accordingly, the Company’sBoard of Directors regularly monitors such concentrations to determine compliancewith its loan concentration policy. The Company believes it has no undueconcentrations of loans.

Total loans (excluding those held for sale) increasedby $616,389 from year-end 2005. The increase was primarily related to theacquisitions in 2006, which added approximately $598 million in net loans.Excluding the acquisition-related activity, the Company’s total loan portfolioincreased by approximately $18 million. Residential real estate loans continueto represent the largest portion of the total loan portfolio.  With the acquisition of the three thriftinstitutions in 2006 and their corresponding large residential real estateportfolios, such loans represented 50.2% of total loans at December 31, 2006 comparedto 38.5% of total loans at the end of 2005.

The following table details the Company’s loanportfolio by type of loan.

**LoanPortfolio**
| ** **                         | ** ** | **December 31** | ** ** |
|------------------------------------|------------|----------------------|------------|
| ** **                         | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Types of loans**                 |       |                 |       |   |   |   |   |   |   |   |   |
| Commercial and  industrial         |       | $                    | 163,093    |   | $ | 134,754 |   | $ | 143,511 |   | $ | 141,571 |   | $ | 98,526 |   |
| Agricultural production  financing |       | 25,588               |       | 23,871 |   | 22,647 |   | 25,897 |   | 25,105 |   |
| Farm real estate                   |       | 46,051               |       | 38,833 |   | 38,281 |   | 37,107 |   | 43,762 |   |
| Commercial real estate  mortgage   |       | 326,284              |       | 202,047 |   | 213,359 |   | 183,938 |   | 156,277 |   |
| Residential real estate  mortgage  |       | 790,962              |       | 368,953 |   | 353,515 |   | 315,848 |   | 301,232 |   |
| Construction and  development      |       | 82,261               |       | 51,736 |   | 38,056 |   | 34,686 |   | 34,987 |   |
| Consumer                           |       | 129,681              |       | 123,481 |   | 108,430 |   | 99,724 |   | 72,702 |   |
| State and political                |       | 10,464               |       | 14,320 |   | 11,206 |   | 16,700 |   | 7,576 |   |
| Total loans                        |       | $                    | 1,574,384  |   | $ | 957,995 |   | $ | 929,005 |   | $ | 855,471 |   | $ | 740,167 |   |

 

The following table indicates the amounts of loans(excluding residential and commercial mortgages and consumer loans) outstandingas of December 31, 2006 which, based on remaining scheduled repayments ofprincipal, are due in the periods indicated.

**Maturities and Sensitivity to Changesin Interest Rates of Commercial and Construction Loans**
| **Due:**                          | ** ** | **Within 1 Year** | ** ** | **1 - 5 Years** | ** ** | **Over 5 years** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|--------------------------------|------------|----------------------------|------------|-----------|------------|
| **Loan  Type**                    |       |                        |       |                           |       |                       |       |      |       |
| Commercial and industrial         |       | $                           | 63,190     |                           | $          | 51,015                     |       | $         | 48,888     |   | 163,093 |   |
| Agricultural production financing |       | 19,420                      |       | 4,330                          |       | 1,838                      |       | 25,588    |       |
| Construction and development      |       | 49,092                      |       | 21,901                         |       | 11,268                     |       | 82,261    |       |
| Totals                            |       | $                           | 131,702    |                           | $          | 77,246                     |       | $         | 61,994     |   | $ | 270,942 |   |
|                              |       |                        |       |                           |       |                       |       |      |       |
| Percent                           |       | 49                          | %          | 29                             | %          | 22                         | %          | 100       | %          |
|                              |       |                        |       |                           |       |                       |       |      |       |
| **Rate Sensitivity**              |       |                        |       |                           |       |                       |       |      |       |
|                              |       |                        |       |                           |       |                       |       |      |       |
| Fixed Rate                        |       | $                           | 41,877     |                           | $          | 38,502                     |       | $         | 12,908     |   | $ | 93,287 |   |
| Variable Rate                     |       | 139,312                     |       | 37,759                         |       | 584                        |       | 177,655   |       |
| Totals                            |       | $                           | 181,189    |                           | $          | 76,261                     |       | $         | 13,492     |   | $ | 270,942 |   |

 

The Company regards its ability to identify andcorrect loan quality problems as one of its greatest strengths. Loans areplaced on “non-accrual” status when, in management’s judgment, the collateralvalue and/or the borrower’s financial condition does not justify accruinginterest.

19

----

As a general rule, commercial and real estate loansare 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 thereafterapplied as a reduction of the loan’s principal balance.

Non-performing loans were $17,481 as of December 31,2006 compared to $10,217 as of December 31, 2005 and represented 1.11% of totalloans at December 31, 2006 versus 1.07% one year ago.  The increase in non-performing loans wasprimarily attributable to the acquisitions closed in 2006.

The following table details the Company’snon-performing loans as of December 31 for the years indicated.

**Non-performingLoans**
| ** **                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Nonaccruing  loans                                     |       | $        | 16,021     |     | $          | 9,984    |       | $        | 13,611     |     | $          | 14,626 |   | $ | 7,695 |   |
| Accruing loans  contractually past due 90 days or more |       | 1,460    |       | 233      |       | 431      |       | 196      |       | 245      |       |
| Total                                                  |       | $        | 17,481     |     | $          | 10,217   |       | $        | 14,042     |     | $          | 14,822 |   | $ | 7,940 |   |
| % of total loans                                       |       | 1.11     | %          | 1.07     | %          | 1.51     | %          | 1.73     | %          | 1.07     | %          |

 

The provision for loan losses was $1,819 in 2006,$1,040 in 2005, and $600 in 2004.  Theincrease in the Company’s provision in 2006 was primarily due to the increasein non-performing loans in 2006 and the increase in net charge-offs during2006. Net charge-offs were $3,363 in 2006 compared to $3,299 in 2005 and $2,186in 2004.  As a percentage of averageloans, net charge-offs equaled .25%, .35%, and .24% in 2006, 2005 and 2004,respectively.

**Summaryof the Allowance for Loan Losses**
| ** **                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Balance at  January 1                       |       | $        | 10,441     |     | $          | 11,698   |       | $        | 11,509     |     | $          | 9,517 |   | $ | 8,894 |   |
| Chargeoffs                                  |       |     |       |     |       |     |       |     |       |     |       |
| Commercial                                  |       | 1,653    |       | 1,164    |       | 1,069    |       | 588      |       | 1,715    |       |
| Commercial real estate mortgage             |       | —   |       | 594      |       | 43       |       | —   |       | —   |       |
| Residential real estate mortgage            |       | 412      |       | 869      |       | 534      |       | 555      |       | 473      |       |
| Consumer                                    |       | 1,834    |       | 956      |       | 886      |       | 777      |       | 583      |       |
| Total Chargeoffs                            |       | 3,899    |       | 3,583    |       | 2,532    |       | 1,920    |       | 2,771    |       |
| Recoveries                                  |       |     |       |     |       |     |       |     |       |     |       |
| Commercial                                  |       | 65       |       | 46       |       | 123      |       | 160      |       | 116      |       |
| Commercial real estate mortgage             |       | —   |       | —   |       | 2        |       | 43       |       | 5        |       |
| Residential real estate mortgage            |       | 66       |       | 35       |       | 43       |       | 54       |       | 127      |       |
| Consumer                                    |       | 405      |       | 203      |       | 178      |       | 252      |       | 151      |       |
| Total Recoveries                            |       | 536      |       | 284      |       | 346      |       | 509      |       | 399      |       |
| Net Chargeoffs                              |       | 3,363    |       | 3,299    |       | 2,186    |       | 1,411    |       | 2,372    |       |
| Addition  resulting from acquisition        |       | 3,895    |       | 1,002    |       | 1,775    |       | 2,078    |       | —   |       |
| Provision for  loan losses                  |       | 1,819    |       | 1,040    |       | 600      |       | 1,325    |       | 2,995    |       |
| Balance at  December 31                     |       | $        | 12,792     |     | $          | 10,441   |       | $        | 11,698     |     | $          | 11,509 |   | $ | 9,517 |   |
| Net Chargeoffs  to average loans            |       | 0.25     | %          | 0.35     | %          | 0.24     | %          | 0.18     | %          | 0.31     | %          |
| Provision for  loan losses to average loans |       | 0.13     | %          | 0.11     | %          | 0.07     | %          | 0.17     | %          | 0.39     | %          |
| Allowance to  total loans at year end       |       | 0.81     | %          | 1.09     | %          | 1.26     | %          | 1.35     | %          | 1.29     | %          |

 

**Allocationof the Allowance for Loan Losses**
| ** **                   | ** ** | **2006**   | ** ** | **2005**          | ** ** | **2004**   | ** ** | **2003**          | ** ** | **2002**   | ** ** |
|------------------------------|------------|------------|------------|-------------------|------------|------------|------------|-------------------|------------|------------|------------|
| ** **                   | ** ** | ** ** | ** ** | **Percent**       | ** ** | ** ** | ** ** | **Percent**       | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                   | ** ** | ** ** | ** ** | **of loans** | ** ** | ** ** | ** ** | **of loans** | ** ** | ** ** | ** ** | **of loans** | ** ** | ** ** | ** ** | **of loans** | ** ** | ** ** | ** ** | **of loans** | ** ** |
| ** **                   | ** ** | ** ** | ** ** | **to total** | ** ** | ** ** | ** ** | **to total** | ** ** | ** ** | ** ** | **to total** | ** ** | ** ** | ** ** | **to total** | ** ** | ** ** | ** ** | **to total** | ** ** |
| **December 31**         | ** ** | **Amount** | ** ** | **loans**         | ** ** | **Amount** | ** ** | **loans**         | ** ** | **Amount** | ** ** | **loans** | ** ** | **Amount** | ** ** | **loans** | ** ** | **Amount** | ** ** | **loans** | ** ** |
| Real estate                  |       |       |       |              |       |       |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Residential                  |       | $          | 2,514      |              | 50         | %          | $          | 1,018             |       | 39         | %          | $ | 1,123 |   | 38 | % | $ | 1,230 |   | 37 | % | $ | 2,097 |   | 41 | % |
| Farm real estate             |       | 247        |       | 3                 |       | 625        |       | 4                 |       | 681        |       | 4 |   | 704 |   | 4 |   | 776 |   | 6 |   |
| Commercial                   |       | 4,045      |       | 21                |       | 3,233      |       | 21                |       | 3,997      |       | 23 |   | 3,907 |   | 21 |   | 2,715 |   | 21 |   |
| Construction and development |       | 359        |       | 5                 |       | 763        |       | 5                 |       | 648        |       | 4 |   | 658 |   | 4 |   | 647 |   | 5 |   |
| Total real estate            |       | 7,165      |       | 79                |       | 5,639      |       | 69                |       | 6,449      |       | 69 |   | 6,499 |   | 66 |   | 6,235 |   | 73 |   |
| Commercial                   |       |       |       |              |       |       |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Agribusiness                 |       | 138        |       | 2                 |       | 412        |       | 3                 |       | 464        |       | 3 |   | 491 |   | 3 |   | 388 |   | 3 |   |
| Other commercial             |       | 2,189      |       | 11                |       | 2,440      |       | 16                |       | 2,831      |       | 17 |   | 3,003 |   | 19 |   | 1,810 |   | 14 |   |
| Total Commercial             |       | 2,327      |       | 13                |       | 2,852      |       | 19                |       | 3,295      |       | 20 |   | 3,494 |   | 22 |   | 2,198 |   | 17 |   |
| Consumer                     |       | 2,053      |       | 8                 |       | 1,435      |       | 12                |       | 1,581      |       | 11 |   | 1,053 |   | 12 |   | 951 |   | 10 |   |
| Unallocated                  |       | 1,247      |       |              |       | 515        |       |              |       | 373        |       |   |   | 463 |   |   |   | 133 |   |   |   |
| Total                        |       | $          | 12,792     |              | 100        | %          | $          | 10,441            |       | 100        | %          | $ | 11,698 |   | 100 | % | $ | 11,509 |   | 100 | % | $ | 9,517 |   | 100 | % |

 

Management maintains a list of loans warranting eitherthe assignment of a specific reserve amount or other special administrativeattention. This watch list, together with a listing of all classified loans,nonaccrual loans and delinquent loans, is reviewed monthly by the Board of Directorsof each subsidiary. Additionally, the Company evaluates its consumer andresidential real estate loan pools for probable losses incurred based onhistorical trends, adjusted by current delinquency and non-performing loanlevels.

The ability to absorb loan losses promptly whenproblems are identified is invaluable to a banking organization. Most often,losses incurred as a result of prompt, aggressive collection actions are muchlower than losses incurred after prolonged legal proceedings. Accordingly, theCompany observes the practice of quickly initiating stringent collectionefforts in the early stages of loan delinquency.

20

----

The adequacy of the allowance for loan losses in eachsubsidiary is reviewed at least quarterly. The determination of the provisionamount in any period is based upon management’s continuing review andevaluation of loan loss experience, changes in the composition of the loanportfolio, classified loans including non-accrual and impaired loans, currenteconomic conditions, the amount of loans presently outstanding, and the amountand composition of loan growth. The Company’s allowance for loan losses was$12,792, or 0.81% of total loans, at December 31, 2006 compared to $10,441, or1.09% of total loans, at the end of 2005. The decrease in the loan loss reserve as a percentage of total loans wasanticipated by the Company and is primarily due to the thrift acquisitions in2006 and their corresponding large residential real estate loanportfolios.  Of the $598 million in loansacquired in the thrift acquisitions, approximately $410 million werecollateralized by residential real estate. As these loans have historically lower levels of losses, the Company’sloan loss reserve as a percentage of total loans decreased.  In addition, several large credits withsignificant specific reserve allocations improved throughout the year, thusreducing the amount required in the allowance for those loans.

During 2006 the Company purchased certain loans thatwere subject to the accounting treatment under SOP 03-3 (see Note 5 to theConsolidated Financial Statements).  Atthe time of acquisition, these loans had evidence of credit deterioration.  In applying this accounting standard, an allowancefor loan losses amount was not carried over or established for these loans.  Instead these loans are carried at their fairvalue at date of acquisition including consideration of expected cash flows tobe received.  The valuation allowance forthese purchased loans as of December 31, 2006 was $1,088.  Before the adoption of SOP 03-3, thisvaluation allowance would have been included in the allowance for loan lossesbalance.  Had this amount been includedin the allowance for loan losses amount at December 31, 2006, the allowancewould have been $13,880, or 0.88% of total loans.

**Securities**

Securities offer flexibility in the Company’smanagement of interest rate risk, and are the primary means by which theCompany provides liquidity and responds to changing maturity characteristics ofassets and liabilities. The Company’s investment policy prohibits tradingactivities and does not allow investment in high-risk derivative products orjunk bonds.

As of December 31, 2006, all of the securities areclassified as “available for sale” (“AFS”) and are carried at fair value withunrealized gains and losses, net of taxes, excluded from earnings and reportedas a separate component of shareholders’ equity. A net unrealized loss of$2,291 was recorded to adjust the AFS portfolio to current market value atDecember 31, 2006 compared to a net unrealized loss of $5,272 at December 31,2005.

21

----

**InvestmentSecurities**
| **Investment Securities**                           | ** ** | **Within**      | ** ** | ** **       | ** ** | ** **        | ** ** | **Beyond 10** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|-----------------|------------|------------------|------------|-------------------|------------|--------------------|------------|-----------|------------|
| **(Carrying Values at December 31)** | ** ** | **1 Year** | ** ** | **1-5 Yrs** | ** ** | **6-10 Yrs** | ** ** | **Years**          | ** ** | **2006**  | ** ** |
|                                                     |       |            |       |             |       |              |       |               |       |      |       |
| Available for sale                                       |       |            |       |             |       |              |       |               |       |      |       |
| Federal agencies                                         |       | $               | 1,832      |             | $          | 75,458            |       | $                  | 12,995     |      | $          | — |   | $ | 90,285 |   |
| State and  municipal                                     |       | 3,540           |       | 14,270           |       | 40,634            |       | 63,899             |       | 122,343   |       |
| Mortgage-backed  securities                              |       | 101             |       | 667              |       | 47,776            |       | 214,462            |       | 263,006   |       |
| Equity and other  securities                             |       | —          |       | 3,806            |       | —            |       | 5,819              |       | 9,625     |       |
| Total available  for sale                                |       | $               | 5,473      |             | $          | 94,201            |       | $                  | 101,405    |      | $          | 284,180 |   | $ | 485,259 |   |
|                                                     |       |            |       |             |       |              |       |               |       |      |       |
| Weighted average yield*                                  |       | 5.76            | %          | 4.85             | %          | 4.93              | %          | 5.36               | %          | 5.17      | %          |

 

*Adjusted to reflectincome related to securities exempt from federal income taxes

Amounts in the tableabove are based on scheduled maturity dates. Variable interest rates are subject to change not less than annuallybased upon certain interest rate indices. Expected maturities will differ from contractual maturities becauseissuers may have the right to call or prepay obligations with or without callor prepayment penalties.

As of December 31, 2006, there were no corporate bondsand other securities which represent more than 10% of shareholders’ equity.

For 2006 the tax equivalent yield of the investmentsecurities portfolio was 5.10%, compared to 4.32% and 3.87% for 2005 and 2004,respectively. The average life of the Company’s investment security portfoliowas 5.36 years at December 31, 2006.****The portfoliorestructuring completed at the end of 2005 allowed the portfolio to achieve animproved yield without any further duration extension.  During 2006 the investment portfolio cashflows were reinvested to maintain the portfolio’s composition and strategicpositioning.  The flat yield curve inplace for most of 2006 allowed management to selectively invest in productsalong the yield curve that enhanced the strategic positioning of the portfoliowhile continuing to improve the portfolio’s overall yield.  Entering 2007 the portfolio continues toremain positioned for long term performance with stable cash flows and improvedyield.  Management anticipates that theportfolio will likely maintain its current duration and expects limited changesto its yield performance.

**Sources of Funds**

The Company relies primarily on customer deposits andsecurities sold under agreement to repurchase (“repurchase agreements”), alongwith shareholders’ equity to fund earning assets. Federal Home Loan Bank (“FHLB”)advances are used to provide additional funding. The Company also attempts toobtain deposits through branch and whole bank acquisitions.

Deposits generated within local markets provide themajor source of funding for earning assets. Average total deposits were 86.4%and 88.5% of total average earning assets in 2006 and 2005, respectively. Totalinterest-bearing deposits averaged 89.2% and 88.4% of average total depositsduring 2006 and 2005. Management is continuing efforts to increase thepercentage of transaction-related deposits to total deposits due to thepositive effect on earnings.

Repurchase agreements are high denominationinvestments utilized by public entities and commercial customers as an elementof their cash management responsibilities. During 2006, repurchase agreementsaveraged $23,200, with an average cost of 3.31%

Another source of funding is the Federal Home LoanBank (FHLB). The Company had FHLB advances of $208,443 outstanding at December31, 2006. These advances have interest rates ranging from 2.4% to 6.5% (seenote 10 to the consolidated financial statements for the maturity schedule ofthese advances). The Company averaged $176,895 in FHLB advances during 2006compared to $89,674 during 2005.  Thisincrease in FHLB borrowings was primarily due to the acquisitions of the thriftinstitutions in 2006 and their significant reliance on wholesale borrowings.

**AverageDeposits**
| ** **              | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004**   | ** ** |
|-------------------------|------------|------------|------------|----------|------------|------------|------------|
| ** **              | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
| Demand                  |       | $          | 174,218    |     |       |       | $          | 144,647 |   |   |   | $ | 131,110 |   |   |   |
| Interest Bearing Demand |       | 367,790    |       | 1.35     | %          | 309,551    |       | 0.84 | % | 301,611 |   | 0.54 | % |
| Savings/Money Markets   |       | 343,321    |       | 1.80     |       | 306,847    |       | 1.41 |   | 250,274 |   | 0.73 |   |
| Certificates of Deposit |       | 731,603    |       | 3.85     |       | 483,457    |       | 2.73 |   | 521,112 |   | 2.48 |   |
| Totals                  |       | $          | 1,616,932  |     | 2.72       | %          | $          | 1,244,502 |   | 1.62 | % | $ | 1,204,107 |   | 1.36 | % |

 

As of December 31,2006, certificates of deposit and other time deposits of $100 or more mature asfollows:

 
| ** ** | ** ** | **3 months or less** | ** ** | **4-6 months** | ** ** | **6-12 months** | ** ** | **over 12 months** | ** ** | **Total** | ** ** |
|------------|------------|-------------------------------------|------------|---------------------|------------|----------------------|------------|------------------------------|------------|-----------|------------|
| Amount     |       | $                                   | 99,426     |                | $          | 72,864               |       | $                            | 68,272     |      | $          | 44,700 |   | $ | 285,262 |   |
| Percent    |       | 35                                  | %          | 26                  | %          | 24                   | %          | 15                           | %          |      |       |
|            |            |                                     |            |                     |            |                      |            |                              |            |           |            |  |  |  |  |  |

 

**Capital Resources**

The Federal Reserve Board and other regulatoryagencies have adopted risk-based capital guidelines that assign risk weightingsto assets and off-balance sheet items. The Company’s core capital (“Tier 1”)consists of common shareholders’ equity adjusted for unrealized gains or losseson available for sale (AFS) securities plus limited amounts of Trust PreferredSecurities less goodwill and intangible assets. Total capital consists of corecapital, certain debt instruments and a portion of the allowance for loan losses.At December 31, 2006, Tier 1 capital to average assets was 7.0%. Total capitalto risk-weighted assets was 11.2%. Both ratios exceed all required ratiosestablished for bank holding companies. Risk-adjusted capital levels of each ofthe Company’s subsidiary banks exceed regulatory definitions ofwell-capitalized institutions.

22

----

The Trust Preferred Securities (which are classifiedas subordinated debentures) qualify as Tier 1 capital or core capital withrespect to the Company under the risk-based capital guidelines established bythe Federal Reserve. Under such guidelines, capital received from the proceedsof the sale of these securities cannot constitute more than 25% of the totalTier 1 capital of the Company. Consequently, the amount of Trust PreferredSecurities in excess of the 25% limitation constitutes Tier 2 capital, orsupplementary capital, of the Company. As of December 31, 2006, all of the Company’s Trust Preferred Securitiesqualify as Tier 1 capital.

Common shareholders’ equity is impacted by the Company’sdecision to categorize its securities portfolio as available for sale (AFS).Securities in this category are carried at fair value, and common shareholders’equity is adjusted to reflect unrealized gains and losses, net of taxes.

The Company declared and paid common dividends of$.529 per share in 2006 compared to $.495 and $.453 in 2005 and 2004respectively. Book value per common share increased to $13.50 at December 31,2006 compared to $11.39 at the end of 2005. The net adjustment for AFSsecurities decreased book value per share by $.08 at December 31, 2006 and by$.22 at December 31, 2005.  Depending onmarket conditions, the adjustment for AFS securities can cause significantfluctuations in equity.

**Liquidity**

Liquidity management involves maintaining sufficientcash levels to fund operations and to meet the requirements of borrowers,depositors and creditors. Higher levels of liquidity bear higher correspondingcosts, measured in terms of lower yields on short-term, more liquid earningassets and higher interest expense involved in extending liability maturities.Liquid assets include cash and cash equivalents, loans and securities maturingwithin one year and money market instruments. In addition, the Company holdsapproximately $434 million of AFS securities maturing after one year, which canbe sold to meet liquidity needs.

Maintaining a relatively stable funding base, which isachieved by diversifying funding sources, supports liquidity, extends thecontractual maturity of liabilities, and limits reliance on volatile short-termpurchased funds. Short-term funding needs may arise from declines in depositsor other funding sources, funding of loan commitments and requests for newloans. The Company’s strategy is to fund assets to the maximum extent possiblewith core deposits, which provide a sizable source of relatively stablelow-cost funds. The Company defines core deposits as all deposits exceptcertificates of deposits greater than $100. Average core deposits fundedapproximately 74.1% of total earning assets during 2006 and approximately 78.8%in 2005.

Management believes the Company has sufficientliquidity to meet all reasonable borrower, depositor and creditor needs in thepresent economic environment. The Company has not received any directives fromregulatory authorities that would materially affect liquidity, capitalresources or operations.

**ContractualObligations as of December 31, 2006**
| ** **               | ** ** | ** ** | ** ** | **Less than** | ** ** | **1 - 3** | ** ** | **3 - 5** | ** ** | **More than** | ** ** |
|--------------------------|------------|------------|------------|--------------------|------------|---------------------|------------|---------------------|------------|--------------------|------------|
| ** **               | ** ** | **Total**  | ** ** | **1 Year**    | ** ** | **Years**           | ** ** | **Years**           | ** ** | **5 Years**   | ** ** |
| Time Deposits            |       | $          | 864,559    |               | $          | 670,933             |       | $                   | 155,485    |               | $          | 31,315 |   | $ | 6,826 |   |
| FHLB Advances            |       | 208,443    |       | 40,653             |       | 39,473              |       | 92,208              |       | 36,109             |       |
| Subordinated  Debentures |       | 41,239     |       | —             |       | —              |       | —              |       | 41,239             |       |
| Total                    |       | $          | 1,114,241  |               | $          | 711,586             |       | $                   | 194,958    |               | $          | 123,523 |   | $ | 84,174 |   |

 

**Interest Rate Risk Management**

Interest rate risk is the exposure of the Company’s financial conditionto adverse changes in market interest rates. In an effort to estimate theimpact of sustained interest rate movements to the Company’s earnings, theCompany monitors interest rate risk through computer-assisted simulationmodeling of its net interest income. The Company’s simulation modeling monitorsthe potential impact to net interest income under various interest ratescenarios. The Company’s objective is to actively manage its asset/liabilityposition within a one-year interval and to limit the risk in any of theinterest rate scenarios to a reasonable level of tax-equivalent net interestincome within that interval. The Company monitors compliance within establishedguidelines of the Funds Management Policy. See Item 7A. Quantitative andQualitative Disclosures About Market Risk section for further discussionregarding interest rate risk.

23

----

**CriticalAccounting Policies**

The accounting and reporting policies of the Companycomply with accounting principles generally accepted in the United States andconform to general practices within the banking industry. These policiesrequire estimates and assumptions. Changes in underlying factors, assumptions,or estimates in any of these areas could have a material impact on the Company’sfuture financial condition and results of operations. In management’s opinion,some of these areas have a more significant impact than others on the Company’sfinancial reporting. These areas currently include accounting for the allowancefor loan losses and goodwill.

Allowance for Loan Losses — The level of the allowancefor loan losses is based upon management’s evaluation of the loan and leaseportfolios, past loan loss experience, known and inherent risks in theportfolio, adverse situations that may affect the borrower’s ability to repay(including the timing of future payments), the estimated value of anyunderlying collateral, composition of the loan portfolio, economic conditions,and other pertinent factors. This evaluation is inherently subjective as itrequires material estimates including the amounts and timing of future cashflows expected to be received on impaired loans that may be susceptible tosignificant change. The level of allowance maintained is believed by managementto be adequate to cover losses inherent in the portfolio. The allowance isincreased by provisions charged to expense and decreased by charge-offs, net ofrecoveries of amounts previously charged-off.

Goodwill — Statement of Financial Accounting StandardsNo. 141 “Business Combinations” and No. 142 “Goodwill and Other IntangibleAssets” were issued in June of 2001 and were effective for fiscal yearsbeginning after December 15, 2001. Under these rules, goodwill and intangibleassets deemed to have indefinite lives, if any, will no longer be amortized,but will be subject to annual impairment tests in accordance with theStatements. The Company has selected June 30 as its date for annual impairmenttesting.

**New Accounting Matters**

See Note 1 to the Consolidated Financial Statementsregarding the adoption of new accounting standards in 2006.

**ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

The Company’s exposure tomarket risk is reviewed on a regular basis by the Asset/Liability Committeesand Boards of Directors of the holding company and its affiliate banks. Primarymarket risks, which impact the Company’s operations, are liquidity risk andinterest rate risk, as discussed above.

As discussed previously, theCompany monitors interest rate risk by the use of computer simulation modelingto estimate the potential impact on its net interest income under variousinterest rate scenarios. Another method by which the Company’s interest raterisk position can be estimated is by computing estimated changes in its netportfolio value (“NPV”). This method estimates interest rate risk exposure frommovements in interest rates by using interest rate sensitivity analysis todetermine the change in the NPV of discounted cash flows from assets andliabilities. Computations are based on a number of assumptions, including therelative levels of market interest rates and prepayments in mortgage loans andcertain types of investments. These computations do not contemplate any actionsmanagement may undertake in response to changes in interest rates, and shouldnot be relied upon as indicative of actual results. In addition, certainshortcomings are inherent in the method of computing NPV. Should interest ratesremain or decrease below current levels, the proportion of adjustable rateloans could decrease in future periods due to refinancing activity. In theevent of an interest rate change, prepayment levels would likely be differentfrom those assumed in the table. Lastly, the ability of many borrowers to repaytheir adjustable rate debt may decline during a rising interest rateenvironment.

The following tableprovides an assessment of the risk to NPV in the event of sudden and sustained1% and 2% increases and decreases in prevailing interest rates. The tableindicates that as of December 31, 2006 the Company’s estimated NPV might beexpected to increase in the event of an increase in prevailing interest rates,and might be expected to decrease in the event of a decrease to prevailinginterest rates (dollars in thousands).
| **Change in Rates** | ** ** | **$ Amount** | ** ** | **% Change** | ** ** | **NPV Ratio** | ** ** | **Change** | ** ** |
|-------------------------------|------------|-------------------|------------|-------------------|------------|--------------------|------------|------------|------------|
| +2%                           |       | 289,646           |       | $                 | (3,442     | )                  | 12.74      | %          | (15)bp     |   |
| +1%                           |       | 305,265           |       | 12,177            |       | 13.42              | %          | 54bp       |       |
| Base                          |       | 293,088           |       | —            |       | 12.89              | %          | —     |       |
| -1%                           |       | 267,988           |       | (25,100           | )          | 11.79              | %          | (110)bp    |       |
| -2%                           |       | 231,239           |       | (61,849           | )          | 10.17              | %          | (272)bp    |       |
|                               |            |                   |            |                   |            |                    |            |            |            |  |

 

The above discussion, and the portions of MANAGEMENT’S DISCUSSION ANDANALYSIS in Item 7 of this Report that are referenced in the above discussioncontains statement relating to future results of the Company that areconsidered “forward-looking-statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. These statements relate to, amongother things, simulation of the impact on net interest income from changes ininterest rates. Actual results may differ materially from those expressed orimplied therein as a result of certain risks and uncertainties, including thoserisks and uncertainties expressed above, those that are described inMANAGEMENT’S DISCUSSION AND ANALYSIS in Item 7 of this Report, and those thatare described in Item 1 of this Report, “Business,” under the caption“Forward-Looking-Statements and Associated Risks,” which discussions areincorporated herein by reference.

 

24

----

**ITEM 8.      FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

** **

**Crowe Chizek and Company LLC**

Member Horwath International

 

Report of Independent Registered PublicAccounting Firm ON FINANCIAL STATEMENTS

 

 

Shareholders and Board ofDirectors

MainSource Financial Group,Inc. 

Greensburg, Indiana

 

We have audited theaccompanying balance sheets of MainSource Financial Group, Inc. as of December31, 2006 and 2005, and the related statements of income, shareholders' equity,and cash flows for each of the three years in the period ended December 31,2006. These consolidated financial statements are the responsibility of theCompany's management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

 

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States).  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of the Company as of December 31,2006 and 2005, and the results of its operations and its cash flows for each ofthe three years in the period ended December 31, 2006, in conformity with U.S.generally accepted accounting principles.

 

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the MainSource Financial Group Inc.'sinternal control over financial reporting as of December 31, 2006, based oncriteria established in *Internal Control -Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 6, 2007expressed an unqualified opinion thereon.

 

                                                                                                      

                                                                                                      CroweChizek and Company LLC

 

Louisville, Kentucky

March 6, 2007

 

25

----

**MAINSOURCE FINANCIAL GROUP, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(Dollar amounts in thousands exceptper share data)**
| ** **                                                                                                       | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                       |       |                        |       |                        |       |
| Cash and due  from banks                                                                                         |       | $                           | 90,546     |                        | $          | 51,069 |   |
| Money market funds  and federal funds sold                                                                       |       | 13,609                      |       | 35,136                      |       |
| Cash and cash  equivalents                                                                                       |       | 104,155                     |       | 86,205                      |       |
| Interest bearing  time deposits                                                                                  |       | 116                         |       | 210                         |       |
| Securities  available for sale                                                                                   |       | 485,259                     |       | 450,814                     |       |
| Loans held for  sale                                                                                             |       | 2,162                       |       | 2,566                       |       |
| Loans, net of  allowance for loan losses of $12,792 and $10,441                                                  |       | 1,561,592                   |       | 947,554                     |       |
| Restricted  stock, at cost                                                                                       |       | 22,947                      |       | 10,940                      |       |
| Premises and  equipment, net                                                                                     |       | 40,370                      |       | 27,863                      |       |
| Goodwill                                                                                                         |       | 120,609                     |       | 51,301                      |       |
| Purchased  intangible assets                                                                                     |       | 15,944                      |       | 9,274                       |       |
| Cash surrender  value of life insurance                                                                          |       | 39,885                      |       | 24,467                      |       |
| Interest receivable  and other assets                                                                            |       | 36,734                      |       | 34,411                      |       |
| **Total  assets**                                                                                                |       | $                           | 2,429,773  |                        | $          | 1,645,605 |   |
|                                                                                                             |       |                        |       |                        |       |
| **Liabilities**                                                                                                  |       |                        |       |                        |       |
| Deposits                                                                                                         |       |                        |       |                        |       |
| Noninterest  bearing                                                                                             |       | $                           | 193,513    |                        | $          | 161,568 |   |
| Interest bearing                                                                                                 |       | 1,666,176                   |       | 1,191,129                   |       |
| Total deposits                                                                                                   |       | 1,859,689                   |       | 1,352,697                   |       |
| Other borrowings                                                                                                 |       | 42,306                      |       | 26,516                      |       |
| Federal Home  Loan Bank (FHLB) advances                                                                          |       | 208,443                     |       | 41,547                      |       |
| Subordinated  debentures                                                                                         |       | 41,239                      |       | 29,898                      |       |
| Other  liabilities                                                                                               |       | 24,849                      |       | 33,878                      |       |
| **Total  liabilities**                                                                                           |       | 2,176,526                   |       | 1,484,536                   |       |
|                                                                                                             |       |                        |       |                        |       |
| **Commitments and contingent  liabilities (Note 15)**                                                            | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| ** **                                                                                                       | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| **Shareholders’ equity**                                                                                    |       |                        |       |                        |       |
| Preferred stock,  no par value  Authorized shares - 400,000  Issued and outstanding shares - none                |       | —                      |       | —                      |       |
| Common stock  $.50 stated value:  Authorized shares - 25,000,000  Issued shares – 18,240,772 and 13,755,409 |       |                        |       |                        |       |
| Outstanding  shares – 17,859,603 and 13,472,616                                                             |       | 9,139                       |       | 6,881                       |       |
| Common stock to  be distributed for stock dividend, 912,038 and 0 shares                                         |       | 456                         |       | —                      |       |
| Treasury stock –  381,169 and 282,793, at cost                                                              |       | (6,586                      | )          | (4,835                      | )          |
| Additional  paid-in capital                                                                                      |       | 196,788                     |       | 105,089                     |       |
| Retained  earnings                                                                                               |       | 54,914                      |       | 57,067                      |       |
| Accumulated  other comprehensive loss                                                                            |       | (1,464                      | )          | (3,133                      | )          |
| **Total  shareholders’ equity**                                                                             |       | 253,247                     |       | 161,069                     |       |
| **Total liabilities and  shareholders’ equity**                                                             |       | $                           | 2,429,773  |                        | $          | 1,645,605 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

26

----

**MAINSOURCEFINANCIAL GROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**(Dollaramounts in thousands except per share data)**
| ** **                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                 |       |     |       |     |       |     |       |
| Interest income                                      |       |     |       |     |       |     |       |
| Loans, including fees                                |       | $        | 97,121     |     | $          | 62,321   |       | $ | 56,580 |   |
| Securities                                           |       |     |       |     |       |     |       |
| Taxable                                              |       | 18,176   |       | 13,819   |       | 12,094   |       |
| Tax exempt                                           |       | 4,899    |       | 4,067    |       | 3,049    |       |
| Federal funds sold and money market funds            |       | 394      |       | 197      |       | 76       |       |
| Deposits with financial institutions                 |       | 141      |       | 71       |       | 42       |       |
| Total interest income                                |       | 120,731  |       | 80,475   |       | 71,841   |       |
| Interest expense                                     |       |     |       |     |       |     |       |
| Deposits                                             |       | 39,282   |       | 20,099   |       | 16,366   |       |
| Federal Home Loan Bank advances                      |       | 8,704    |       | 3,561    |       | 2,885    |       |
| Subordinated debentures                              |       | 2,475    |       | 1,938    |       | 1,677    |       |
| Other borrowings                                     |       | 2,002    |       | 1,229    |       | 911      |       |
| Total interest expense                               |       | 52,463   |       | 26,827   |       | 21,839   |       |
| Net interest  income                                 |       | 68,268   |       | 53,648   |       | 50,002   |       |
| Provision for loan losses                            |       | 1,819    |       | 1,040    |       | 600      |       |
| Net interest  income after provision for loan losses |       | 66,449   |       | 52,608   |       | 49,402   |       |
| Non-interest  income                                 |       |     |       |     |       |     |       |
| Insurance commissions                                |       | 1,821    |       | 1,991    |       | 2,643    |       |
| Mortgage banking                                     |       | 2,279    |       | 2,693    |       | 3,198    |       |
| Trust and investment product fees                    |       | 1,187    |       | 1,119    |       | 911      |       |
| Service charges on deposit accounts                  |       | 9,491    |       | 7,510    |       | 6,912    |       |
| Net realized gains(losses) on securities sales       |       | 145      |       | (2,179   | )          | 991      |       |
| Increase in cash surrender value of life insurance   |       | 1,255    |       | 891      |       | 1,016    |       |
| Interchange income                                   |       | 2,617    |       | 1,926    |       | 1,996    |       |
| Other income                                         |       | 4,244    |       | 3,381    |       | 1,877    |       |
| Total non-interest income                            |       | 23,039   |       | 17,332   |       | 19,544   |       |
| Non-interest  expense                                |       |     |       |     |       |     |       |
| Salaries and employee benefits                       |       | 33,073   |       | 27,121   |       | 25,411   |       |
| Net occupancy expenses                               |       | 4,755    |       | 3,542    |       | 3,165    |       |
| Equipment expenses                                   |       | 5,361    |       | 4,123    |       | 3,949    |       |
| Intangibles amortization                             |       | 2,236    |       | 1,306    |       | 1,059    |       |
| Telecommunications                                   |       | 1,916    |       | 1,664    |       | 1,581    |       |
| Stationery printing and supplies                     |       | 1,408    |       | 984      |       | 988      |       |
| Other expenses                                       |       | 10,893   |       | 9,836    |       | 9,727    |       |
| Total non-interest expense                           |       | 59,642   |       | 48,576   |       | 45,880   |       |
| Income before  income tax                            |       | 29,846   |       | 21,364   |       | 23,066   |       |
| Income tax expense                                   |       | 7,605    |       | 5,172    |       | 6,273    |       |
| Net income                                           |       | $        | 22,241     |     | $          | 16,192   |       | $ | 16,793 |   |
|                                                 |       |     |       |     |       |     |       |
| Net income per  share - basic                        |       | $        | 1.30       |     | $          | 1.23     |       | $ | 1.41 |   |
| Net income per share –  diluted                 |       | $        | 1.29       |     | $          | 1.23     |       | $ | 1.41 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

27

----

**MAINSOURCEFINANCIAL GROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY**

**(Dollar amounts in thousands exceptper share data)**
| ** **                                                              | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|--------------|------------|------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                              | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | **Other**    | ** ** | ** **             | ** ** | ** ** | ** ** |
| ** **                                                              | ** ** | **Shares**            | ** ** | ** **     | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Comprehensive**      | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                              | ** ** | **Outstanding**       | ** ** | **Amount**     | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Total**  | ** ** | **Income**        | ** ** |
| **Balance,  January 1, 2004**                                           |       | 7,070,476             |       | $              | 1,393      |        | $          | 53,478       |       | $                      | 49,338     |       | $          | 1,215             |       | $ | 105,424 |   |   |   |
| Net income                                                              |       |                  |       |           |       |        |       | 16,793       |       |                   |       | 16,793     |       | $                 | 16,793     |   |
| Change in fair value of cash flow hedge, net                            |       |                  |       |           |       |        |       |         |       | 148                    |       | 148        |       | 148               |       |
| Change in fair value of securities net of  reclassification adjustment  |       |                  |       |           |       |        |       |         |       | (1,266                 | )          | (1,266     | )          | (1,266            | )          |
| Total comprehensive income                                              |       |                  |       |           |       |        |       |         |       |                   |       |       |       | $                 | 15,675     |   |
| Cash dividends ($ .453 per share)                                  |       |                  |       |           |       |        |       | (5,391       | )          |                   |       | (5,391     | )          |              |       |
| Stock  split/dividend and fractional shares                             |       | 3,581,508             |       | 1,791          |       | (1,821      | )          |         |       |                   |       | (30        | )          |              |       |
| Issuance of  common stock in acquisition                                |       | 449,224               |       | 225            |       | 8,701       |       |         |       |                   |       | 8,926      |       |              |       |
| 5% Stock Dividend                                                       |       | 559,818               |       | 280            |       | 13,089      |       | (13,369      | )          |                   |       | —     |       |              |       |
| Exercise of stock  options                                              |       | 1,575                 |       | 24             |       | 4           |       |         |       |                   |       | 28         |       |              |       |
| Purchase of treasury  stock                                             |       | (117,662              | )          | (1,312         | )          |        |       |         |       |                   |       | (1,312     | )          |              |       |
| **Balance,  December 31, 2004**                                         |       | 11,544,939            |       | $              | 2,401      |        | $          | 73,451       |       | $                      | 47,371     |       | $          | 97                |       | $ | 123,320 |   |   |   |
| Net income                                                              |       |                  |       |           |       |        |       | $            | 16,192     |                   |       |       | $          | 16,192            |       | $ | 16,192 |   |
| Change in fair value of cash flow hedge, net                            |       |                  |       |           |       |        |       |         |       | 225                    |       | 225        |       | 225               |       |
| Change in fair value of securities net of  reclassification adjustment  |       |                  |       |           |       |        |       |         |       | (3,455                 | )          | (3,455     | )          | (3,455            | )          |
| Total comprehensive income                                              |       |                  |       |           |       |        |       |         |       |                   |       |       |       | $                 | 12,962     |   |
| Cash dividends ($ .495 per share)                                  |       |                  |       |           |       |        |       | (6,496       | )          |                   |       | (6,496     | )          |              |       |
| 5% Stock Dividend  - Treasury shares                                    |       | (10,562               | )          |           |       |        |       |         |       |                   |       |       |       |              |       |
| Fractional Shares  - 5% stock dividend                                  |       | (766                  | )          |           |       | (18         | )          |         |       |                   |       | (18        | )          |              |       |
| Exercise of stock  options                                              |       | 3,142                 |       | 52             |       | (4          | )          |         |       |                   |       | 48         |       |              |       |
| Purchase of  treasury stock                                             |       | (1,209                | )          | (27            | )          |        |       |         |       |                   |       | (27        | )          |              |       |
| Disposal of  insurance division                                         |       | (62,928               | )          | (1,380         | )          |        |       |         |       |                   |       | (1,380     | )          |              |       |
| Stock issued                                                            |       | 2,000,000             |       | 1,000          |       | 31,660      |       |         |       |                   |       | 32,660     |       |              |       |
| **Balance,  December 31, 2005**                                         |       | 13,472,616            |       | $              | 2,046      |        | $          | 105,089      |       | $                      | 57,067     |       | $          | (3,133            | )          | $ | 161,069 |   |   |   |
| Net income                                                              |       |                  |       |           |       |        |       | $            | 22,241     |                   |       |       | $          | 22,241            |       | 22,241 |   |
| Change in fair value of cash flow hedge, net                            |       |                  |       |           |       |        |       |         |       | (256                   | )          | (256       | )          | (256              | )          |
| Change in fair value of securities, net of  reclassification adjustment |       |                  |       |           |       |        |       |         |       | 1,925                  |       | 1,925      |       | 1,925             |       |
| Total comprehensive income                                              |       |                  |       |           |       |        |       |         |       |                   |       |       |       | $                 | 23,910     |   |
| Stock option  expense                                                   |       |                  |       |           |       | 69          |       |         |       |                   |       | 69         |       |              |       |
| Issuance of  common stock in acquisitions                               |       | 4,484,008             |       | 2,242          |       | 76,945      |       |         |       |                   |       | 79,187     |       |              |       |
| Cash dividends ($ .529 per share)                                  |       |                  |       |           |       |        |       | (8,944       | )          |                   |       | (8,944     | )          |              |       |
| Purchase of  treasury stock                                             |       | (130,032              | )          | (2,290         | )          |        |       |         |       |                   |       | (2,290     | )          |              |       |
| 5% Stock Dividend                                                       |       | 912,038               |       | 456            |       | 14,994      |       | (15,450      | )          |                   |       | —     |       |              |       |
| Exercise of stock  options                                              |       | 31,656                |       | 555            |       | (309        | )          |         |       |                   |       | 246        |       |              |       |
| Other                                                                   |       | 1,355                 |       |           |       |        |       |         |       |                   |       | —     |       |              |       |
| **Balance,  December 31, 2006**                                         |       | 18,771,641            |       | $              | 3,009      |        | $          | 196,788      |       | $                      | 54,914     |       | $          | (1,464            | )          | $ | 253,247 |   |   |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

28

----

**MAINSOURCEFINANCIAL GROUP, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOW**

**(Dollarsin thousands)**
| ** **                                                                         | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Operating  Activities**                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $          | 22,241     |       | $          | 16,192     |       | $ | 16,793 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |       |       |       |       |       |       |
| Provision for loan losses                                                          |       | 1,819      |       | 1,040      |       | 600        |       |
| Depreciation and amortization                                                      |       | 3,869      |       | 3,087      |       | 2,962      |       |
| Amortization of mortgage servicing rights                                          |       | 519        |       | 558        |       | 956        |       |
| Securities amortization, net                                                       |       | (521       | )          | 1,197      |       | 2,469      |       |
| Amortization of core deposit intangibles                                           |       | 2,236      |       | 1,306      |       | 1,059      |       |
| Increase in cash surrender value of life insurance  policies                       |       | (1,255     | )          | (891       | )          | (930       | )          |
| Gain on life insurance benefit                                                     |       | —     |       | (459       | )          | —     |       |
| Securities (gains) losses                                                          |       | (145       | )          | 2,179      |       | (991       | )          |
| Gain on the sale of loans                                                          |       | (599       | )          | (944       | )          | (1,301     | )          |
| Change in loans held for sale                                                      |       | 1,003      |       | (798       | )          | 2,442      |       |
| Stock based compensation expense                                                   |       | 69         |       | —     |       | —     |       |
| Change in other assets and liabilities                                             |       | (5,002     | )          | 12,699     |       | 2,904      |       |
| Net cash provided by operating activities                                          |       | 24,234     |       | 35,166     |       | 26,963     |       |
|                                                                               |       |       |       |       |       |       |       |
| **Investing  Activities**                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net change in short-term investments                                               |       | 210        |       | 94         |       | 197        |       |
| Proceeds from maturities and payments on securities  held to maturity              |       | —     |       | 277        |       | —     |       |
| Purchases of securities available for sale                                         |       | (92,757    | )          | (257,256   | )          | (166,864   | )          |
| Proceeds from maturities and payments on securities  available for sale            |       | 64,855     |       | 119,472    |       | 110,650    |       |
| Proceeds from sales of securities available for sale                               |       | 26,075     |       | 106,556    |       | 69,347     |       |
| Purchases of restricted stock                                                      |       | —     |       | (2,834     | )          | (455       | )          |
| Proceeds from life insurance benefit                                               |       | —     |       | 1,675      |       | —     |       |
| Loan originations and payments, net                                                |       | (17,792    | )          | 19,856     |       | 4,435      |       |
| Purchases of premises and equipment                                                |       | (3,381     | )          | (3,455     | )          | (2,468     | )          |
| Proceeds from redemption of restricted stock                                       |       | 2,628      |       | —     |       | —     |       |
| Cash received (paid) for bank acquisitions, net                                    |       | (2,210     | )          | 111,785    |       | (342       | )          |
| Net cash provided (used) by investing activities                                   |       | (22,372    | )          | 96,170     |       | 14,500     |       |
|                                                                               |       |       |       |       |       |       |       |
| **Financing  Activities**                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net change in deposits                                                             |       | 16,992     |       | (58,374    | )          | (64,660    | )          |
| Net change in other borrowings                                                     |       | 15,790     |       | (30,659    | )          | 29,343     |       |
| Repayment of note payable                                                          |       | —     |       | (9,100     | )          | (4,100     | )          |
| Proceeds from FHLB advances                                                        |       | 197,000    |       | 220,000    |       | 123,500    |       |
| Repayment of FHLB advances                                                         |       | (213,706   | )          | (269,434   | )          | (99,426    | )          |
| Proceeds from issuance of subordinated debentures                                  |       | 11,000     |       | —     |       | —     |       |
| Proceeds from common stock issuance                                                |       | —     |       | 32,660     |       | —     |       |
| Purchase of treasury shares                                                        |       | (2,290     | )          | (27        | )          | (1,312     | )          |
| Cash dividends and fractional share payments                                       |       | (8,944     | )          | (6,514     | )          | (5,421     | )          |
| Proceeds from exercise of stock options                                            |       | 246        |       | 48         |       | 28         |       |
| Net cash provided (used) by financing activities                                   |       | 16,088     |       | (121,400   | )          | (22,048    | )          |
| Net change in  cash and cash equivalents                                           |       | 17,950     |       | 9,936      |       | 19,415     |       |
| Cash and cash  equivalents, beginning of year                                      |       | 86,205     |       | 76,269     |       | 56,854     |       |
| Cash and cash equivalents,  end of year                                            |       | $          | 104,155    |       | $          | 86,205     |       | $ | 76,269 |   |
|                                                                               |       |       |       |       |       |       |       |
| Supplemental  Information                                                          |       |       |       |       |       |       |       |
| Interest paid                                                                      |       | $          | 47,804     |       | $          | 25,845     |       | $ | 22,640 |   |
| Income taxes paid                                                                  |       | 3,760      |       | 5,658      |       | 3,487      |       |
| Loan balances  transferred to foreclosed real estate                               |       | 4,071      |       | 3,692      |       | 2,741      |       |

 

SeeNote 2 regarding non-cash transactions included in acquisitions anddispositions and Note 4 regarding non-cash securities transfer in 2005.

Theaccompanying notes are an integral part of these consolidated financialstatements.

29

----

**NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS**

**(Dollar amounts in thousands except per sharedata)**

 

**NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

Nature of Operations and Principles of Consolidation:  The consolidated financial statements includeMainSource Financial Group, Inc. and its wholly owned subsidiaries,together referred to as “the Company”. Intercompany transactions and balances are eliminated in consolidation.

 

The Company’s wholly owned subsidiaries include MainSource Bank,MainSource Bank of Illinois, MainSource Bank – Crawfordsville, MainSource Bank –Hobart, MainSource Bank – Ohio, MainSource Insurance, LLC, MainSource Title,LLC, and MainSource Mortgage, LLC.  InFebruary 2006, the Company disposed of IUB Reinsurance.  The disposition did not result in asignificant gain or loss to the Company.

 

The Company provides financial services through its offices in Indiana,Illinois, and Ohio.  Its primary depositproducts are checking, savings, and term certificate accounts, and its primary lendingproducts are residential mortgage, commercial, and installment loans.  Substantially all loans are secured byspecific items of collateral including business assets, consumer assets andreal estate.  Commercial loans areexpected to be repaid from cash flow from operations of businesses.  Real estate loans are secured by bothresidential and commercial real estate. Other financial instruments which potentially represent concentrationsof credit risk include deposit accounts in other financial institutions andfederal funds sold.

 

Use of Estimates:  To prepare financial statements in conformitywith accounting principles generally accepted in the United States of America,management makes estimates and assumptions based on available information.  These estimates and assumptions affect theamounts reported in the financial statements and the disclosures provided andactual results could differ.  Theallowance for loan losses, loan servicing rights, and fair values of financialinstruments are particularly subject to change.

 

Cash Flows:  Cash and cash equivalents include cash anddue from banks, interest bearing deposits with other financial institutionswith maturities under 90 days, money market funds and federal funds sold.  Net cash flows are reported for loan anddeposit transactions, federal funds purchased and repurchase agreements.

 

Interest-bearing Deposits in Other FinancialInstitutions:  Interest-bearingdeposits in other financial institutions mature within one year and are carriedat cost.

 

Securities:  Securities are classified as available forsale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealizedholding gains and losses reported in other comprehensive income.

 

Interest income includes amortization of purchase premium ordiscount.  Premiums and discounts onsecurities are amortized on the level-yield method, which considers prepaymentson mortgage-backed securities.  Gains andlosses on sales are based on the amortized cost of the security sold.  Declines in the fair value of securitiesbelow their cost that are other than temporary are reflected as realizedlosses.  In estimatingother-than-temporary losses, management considers the length of time and extentthat fair value has been less than cost, the financial condition and near termprospects of the issuer, and the Company’s ability and intent to hold thesecurity for a period sufficient to allow for any anticipated recovery in fairvalue.

 

Loans Held for Sale:  Loans originated and intended for sale in thesecondary market are carried at the lower of cost or market in theaggregate.  Net unrealized losses, ifany, are recorded as a valuation allowance and charged to earnings.

 

Mortgage loans held for sale are generally sold with servicing rightsretained. Gains and losses on sales of mortgage loans are based on the salesproceeds, the amount allocated to servicing rights retained, and the carryingvalue of the loan.

30

----

Loans:  Loans that management has the intent andability to hold for the foreseeable future or until maturity or payoff arereported at the principal balance outstanding, net of unearned interest,deferred loan fees and costs, and an allowance for loan losses.  Interest income is accrued on the unpaidprincipal balance.  Loan originationsfees, net of certain direct origination costs, are deferred and recognized ininterest income using the level-yield method without anticipating prepayments.

 

Interest income is not reported when full loan repayment is in doubt,typically when the loan is impaired or payments are past due over 90 days.  Loans are placed on non-accrual orcharged-off at an earlier date if collection of principal or interest isconsidered doubtful.

 

All interest accrued but not received for loans placed on nonaccrual isreversed against interest income. Payments received on such loans subsequent to being placed onnon-accrual are applied to the principal balance of the loans.  Loans are returned to accrual status when allthe principal and interest amounts contractually due are brought current andfuture payments are reasonably assured.

 

Purchased Loans:  The Company purchases individual loans andgroups of loans.  Beginning in 2005,purchased loans that show evidence of credit deterioration since originationare recorded at the amount paid (or allocated fair value in a purchase businesscombination), such that there is no carryover of the seller’s allowance forloan losses.  After acquisition, incurredlosses are recognized by an increase in the allowance for loan losses.

 

Purchased loans are accounted for individually based on common riskcharacteristics (e.g., credit score, loan type, and date of origination).  The Company estimates the amount and timingof expected cash flows for each purchased loan, and the expected cash flows inexcess of amount paid is recorded as interest income over the remaining life ofthe loan (accretable yield).  The excessof the loan’s contractual principal and interest over expected cash flows isnot recorded (nonaccretable difference).

 

Over the life of the loan, expected cash flows continue to beestimated.  If the present value ofexpected cash flows is less than the carrying amount, a loss is recorded.  If the present value of expected cash flowsis greater than the carrying amount, it is recognized as part of futureinterest income.

 

Allowancefor Loan Losses:  Theallowance for loan losses is a valuation allowance for probable incurred creditlosses.  Loan losses are charged againstthe allowance when management believes the uncollectibility of a loan balanceis confirmed.  Subsequent recoveries, ifany, are credited to the allowance. Management estimates the allowance balance required using past loan lossexperience, the nature and volume of the portfolio, information about specificborrower situations and estimated collateral values, economic conditions, andother factors.  Allocations of theallowance may be made for specific loans, but the entire allowance is availablefor any loan that, in management’s judgment, should be charged-off.

Theallowance consists of specific and general components.  The specific component relates to loans thatare individually classified as impaired or loans otherwise classified assubstandard or doubtful.  The generalcomponent covers pools of other loans and is based on historical lossexperience adjusted for current factors.

A loan is considered impaired when, based on current information andevents, it is probable that the Company will be unable to collect the scheduledpayments of principal or interest when due according to the contractual termsof the loan agreement.  Factorsconsidered by management in determining impairment include payment status,collateral value, and the probability of collecting scheduled principal andinterest payments when due.  Loans thatexperience insignificant payment delays and payment shortfalls generally arenot classified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on a case-by-casebasis, taking into consideration all of the circumstances surrounding the loanand the borrower, including the length of the delay, the reasons for the delay,the borrower’s prior payment record, and the amount of the shortfall inrelation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial andconstruction loans by either the present value of expected future cash flowsdiscounted at the loan’s effective interest rate, the loan’s obtainable marketprice, or the fair value of the collateral if the loan is collateraldependent.  Large groups of smallerbalance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separatelyidentify individual consumer and residential real estate loans for impairmentdisclosures.

 

RestrictedStock:  The Bank is amember of the FHLB system.  Members arerequired to own a certain amount of stock based on the level of borrowings andother factors, and may invest in additional amounts.  FHLB stock is carried at cost, classified asa restricted security, and periodically evaluated for impairment.  Because this stock is viewed as a long terminvestment, impairment is based on ultimate recovery of par value.  Both cash and stock dividends are reported asincome.

Premisesand Equipment:  Land iscarried at cost.  Premises and equipmentare stated at cost less accumulated depreciation.  Buildings and related components are depreciatedusing the straight-line method with useful lives ranging from 30 to 39 yearsfor buildings and 5 to 15 years for components. Furniture, fixtures and equipment are depreciated using thestraight-line method with useful lives ranging from 3 to 10 years.

ForeclosedAssets:  Assetsacquired through or instead of loan foreclosure are initially recorded at fairvalue when acquired net of estimated selling costs, establishing a new costbasis.  If fair value declines afteracquisition, a valuation allowance is recorded through expense.  Costs after acquisition are expensed.

31

----

CompanyOwned Life Insurance: The Company has purchased life insurance policies on certainemployees.  Company owned life insuranceis recorded at its cash surrender value, or the amount that can be realized.

ServicingAssets:  Servicingassets represent the allocated value of retained servicing rights on loanssold.  Servicing assets are expensed inproportion to, and over the period of, estimated net servicing revenues.  Impairment is evaluated based on the fair valueof the assets, using groupings of the underlying loans as to product type andinterest rates.  Fair value is determinedusing prices for similar assets with similar characteristics, when available,or based upon discounted cash flows using market-based assumptions.  Any impairment of a grouping is reported as avaluation allowance, to the extent that fair value is less than the capitalizedamount for a grouping.

**Transfersof Financial Assets**:  Transfers of financial assets are accountedfor as sales when control over the assets has been surrendered.  Control over transferred assets is deemed tobe surrendered when the assets have been isolated from the Company, thetransferee obtains the right (free of conditions that constrain it from takingadvantage of that right) to pledge or exchange the transferred assets, and theCompany does not maintain effective control over the transferred assets throughan agreement or option to repurchase them before their maturity.

Goodwill and Other Intangible Assets:  Goodwill results from business acquisitionsand represents the excess of the purchase price over the fair value of acquiredtangible assets and liabilities and identifiable intangible assets. Goodwill isassessed at least annually for impairment and any such impairment will berecognized in the period identified.

Other intangible assets consist largely ofcore deposit intangibles arising from whole bank and branch acquisitions.  They are initially measured at fair value andthen are amortized on an accelerated method over their estimated useful lives,generally ten years.

Long-term Assets:** **Premises andequipment and other long-term assets are reviewed for impairment when eventsindicate their carrying amount may not be recoverable from future undiscountedcash flows.  If impaired, the assets arerecorded at fair value.

Repurchase Agreements:  Substantially all repurchase agreementliabilities represent amounts advanced by various customers.  Securities are pledged to cover theseliabilities, which are not covered by federal deposit insurance.  Repurchase agreements are included in otherborrowings on the consolidated balance sheets.

IncomeTaxes:  Income taxexpense is the total of the current year income tax due or refundable and thechange in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amountsfor the temporary differences between carrying amounts and tax bases of assetsand liabilities, computed using enacted tax rates.  A valuation allowance, if needed, reducesdeferred tax assets to the amount expected to be realized.

LoanCommitments and Related Financial Instruments:  Financial instruments include off-balancesheet credit instruments, such as commitments to make loans and commercialletters of credit, issued to meet customer financing needs.  The face amount for these items representsthe exposure to loss, before considering customer collateral or ability torepay.  Such financial instruments arerecorded when they are funded.

Derivatives:  All derivative instruments are recorded attheir fair values.  If derivative instrumentsare designated as hedges of fair values, both the change in the fair value ofthe hedge and the hedged item are included in current earnings.  Fair value adjustments related to cash flowhedges are recorded in other comprehensive income and reclassified to earningswhen the hedged transaction is reflected in earnings.  Ineffective portions of hedges are reflectedin earnings as they occur.

32

----

MortgageBanking Income: Mortgage banking income consists of gains on loan sales, mortgageservicing rights, and loan servicing fee income, net of amortization ofmortgage servicing rights.

Stock Compensation:  Effective January 1, 2006, the Companyadopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), *Share-based Payment*, using the modified prospectivetransition method.  Accordingly, theCompany has recorded stock-based employee compensation cost using the fairvalue method starting in 2006.  For 2006,adopting this standard resulted in a reduction of income before income taxes of$69 and a reduction in net income of $41.

Prior to January 1, 2006,employee compensation expense under stock options was reported using theintrinsic value method; therefore, no stock-based compensation cost isreflected in net income for the years ending December 31, 2005 and 2004, as alloptions granted had an exercise price equal to or greater than the market priceof the underlying common stock at date of grant.

The following tableillustrates the effect on net income and earnings per share if expense was measuredusing the fair value recognition provisions of FASB Statement No. 123, *Accounting for Stock-Based Compensation,*for the yearsending December 31.  During 2005, theCompany accelerated vesting on selected pools of stock options granted in orderto reduce expense that would have been recognized upon adoption of FAS 123(R).
|                                                                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income as  reported                                                                   |       | $        | 16,192     |     | $          | 16,793 |   |
| Deduct:  Stock-based compensation expense, net, determined under fair value based  method |       | 517      |       | 92       |       |
| Pro forma net  income                                                                     |       | $        | 15,675     |     | $          | 16,701 |   |
|                                                                                      |       |     |       |     |       |
| Basic earnings  per share as reported                                                     |       | $        | 1.23       |     | $          | 1.41 |   |
| Pro forma basic  earnings per share                                                       |       | $        | 1.19       |     | $          | 1.40 |   |
|                                                                                      |       |     |       |     |       |
| Diluted earnings  per share as reported                                                   |       | $        | 1.23       |     | $          | 1.41 |   |
| Pro forma diluted  earnings per share                                                     |       | $        | 1.19       |     | $          | 1.40 |   |

 

Retirement Plans: Employee 401(k) and profit sharing plan expense is the amount ofmatching contributions.

EarningsPer Common Share: Basic earnings per common share is net income divided by the weightedaverage number of common shares outstanding during the period.  Diluted earnings per common share includesthe dilutive effect of additional potential common shares issuable under stockoptions.  Earnings and dividends pershare are restated for all stock splits and dividends through the date of issueof the financial statements.

ComprehensiveIncome:  Comprehensiveincome consists of net income and other comprehensive income.  Other comprehensive income includesunrealized gains and losses on securities available for sale and unrealizedgains and losses on cash flow hedges, which are also recognized as a separatecomponent of equity.

Loss Contingencies:  Loss contingencies, including claims andlegal actions arising in the ordinary course of business, are recorded asliabilities when the likelihood of loss is probable and an amount or range ofloss can be reasonably estimated. Management does not believe there are now any such matters that willhave a material effect on the financial statements.

Equity:  Stock dividends in excess of 20% are reportedby transferring the par value of the stock issued from retained earnings tocommon stock.  Stock dividends for 20% orless are reported by transferring the fair value, as of the ex-dividenddate, of the stock issued from retained earnings to common stock and additionalpaid-in capital.  Fractional shareamounts are paid in cash with a reduction in retained earnings.

DividendRestriction:  Bankingregulations require maintaining certain capital levels and may limit thedividends paid by the banks to the holding company or by the holding company toshareholders.

33

----

FairValue of Financial Instruments:  Fair values of financial instruments areestimated using relevant market information and other assumptions, as morefully disclosed in a separate note.  Fairvalue estimates involve uncertainties and matters of significant judgmentregarding interest rates, credit risk, prepayments, and other factors,especially in the absence of broad markets for particular items.  Changes in assumptions or in marketconditions could significantly affect the estimates.

Operating Segments:  While the Company’s chief decision-makersmonitor the revenue streams of the various Company products and services, theidentifiable segments are not material and operations are managed and financialperformance is evaluated on a Company-wide basis.  Accordingly, all of the Company’s financialservice operations are considered by management to be aggregated in onereportable operating segment.

Reclassifications:  Some items in the prior year financialstatements were reclassified to conform to the current presentation.

Recently Issued Accounting Standards: During 2006, the Companyadopted the following accounting standards and guidance:

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 123(R), *Share-based Payment*.  See “Stock Compensation” above for furtherdiscussion of the effect of adopting this standard.

SAB 108:

In September 2006, the Securities and ExchangeCommission (SEC) released Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements (SAB 108),*whichis effective for fiscal years ending on or after November 15, 2006.  SAB 108 provides guidance on how the effectsof prior-year uncorrected financial statement misstatements should beconsidered in quantifying a current year misstatement.  SAB 108 requires public companies to quantifymisstatements using both an income statement (rollover) and balance sheet (ironcurtain) approach and evaluate whether either approach results in amisstatement that, when all relevant quantitative and qualitative factors areconsidered, is material.  If prior yearerrors that had been previously considered immaterial now are consideredmaterial based on either approach, no restatement is required so long asmanagement properly applied its previous approach and all relevant facts andcircumstances were considered. Adjustments considered immaterial in prior years under the method previouslyused, but now considered material under the dual approach required by SAB 108,are to be recorded upon initial adoption of SAB 108.  The adoption of SAB 108 had no effect on theCompany’s financial statements for the year ending December 31, 2006.

Effect of Newly IssuedBut Not Yet Effective Accounting Standards:

In February 2006, the Financial Accounting Standards Board (FASB)issued Statement No. 155, *Accounting for CertainHybrid Financial Instruments-an amendment to FASB Statements No. 133 and 140*.  This Statement permits fair valuere-measurement for any hybrid financial instruments, clarifies whichinstruments are subject to the requirements of Statement No. 133, andestablishes a requirement to evaluate interests in securitized financial assetsand other items.  The new standard iseffective for financial assets acquired or issued after the beginning of theentity’s first fiscal year that begins after September 15, 2006.  Management does not expect the adoption ofthis statement to have a material impact on its consolidated financial positionor results of operations.

InMarch 2006, the FASB issued Statement No. 156, *Accountingfor Servicing of Financial Assets-an amendment of FASB Statement No. 140.*  This Statement provides the following: 1)revised guidance on when a servicing asset and servicing liability should berecognized; 2) requires all separately recognized servicing assets andservicing liabilities to be initially measured at fair value, if practicable;3) permits an entity to elect to measure servicing assets and servicingliabilities at fair value each reporting date and report changes in fair valuein earnings in the period in which the changes occur; 4) upon initial adoption,permits a onetime reclassification of available-for-sale securities to tradingsecurities for securities which are identified as offsetting the entity’sexposure to changes in the fair value of servicing assets or liabilities that aservicer elects to subsequently measure at fair value; and 5) requires separatepresentation of servicing assets and servicing liabilities subsequentlymeasured at fair value in the statement of financial position and additionalfootnote disclosures.  This standard iseffective as of the beginning of an entity’s first fiscal year that beginsafter September 15, 2006 with the effects of initial adoption being reported asa cumulative-effect adjustment to retained earnings.  Management does not expect the adoption ofthis statement will have a material impact on its consolidated financialposition or results of operations.

InSeptember 2006, the FASB issued Statement No. 157, *Fair ValueMeasurements*.  This Statementdefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements.  This Statement establishes a fair valuehierarchy about the assumptions used to measure fair value and clarifiesassumptions about risk and the effect of a restriction on the sale or use of anasset.  The standard is effective forfiscal years beginning after November 15, 2007. The Company has not completed its evaluation of the impact of theadoption of this standard.

In July 2006, theFASB issued FASB Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes — an interpretation of FASB Statement No. 109* (FIN48), which prescribes a recognition threshold and measurement attribute for atax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition.  FIN48 is effective for fiscal years beginning after December 15, 2006.  The Company has determined that the adoptionof FIN 48 will not have a material effect on the financial statements.

34

----

In September 2006, the FASB Emerging IssuesTask Force finalized Issue No. 06-4, *Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements*. This issue requires that a liability be recorded during the serviceperiod when a split-dollar life insurance agreement continues afterparticipants’ employment or retirement. The required accrued liability will be based on either thepost-employment benefit cost for the continuing life insurance or based on thefuture death benefit depending on the contractual terms of the underlyingagreement.  This issue is effective forfiscal years beginning after December 15, 2007. The Company has determined that the adoption of this EITF willnot have a material effect on the financial statements.

InSeptember 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5, *Accounting for Purchases of Life Insurance - Determining the AmountThat Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4(Accounting for Purchases of Life Insurance).*This issue requiresthat a policyholder consider contractual terms of a life insurance policy indetermining the amount that could be realized under the insurancecontract.  It also requires that if thecontract provides for a greater surrender value if all individual policies in agroup are surrendered at the same time, that the surrender value be determinedbased on the assumption that policies will be surrendered on an individual basis. Lastly, the issue discusses whether the cash surrender value should be discountedwhen the policyholder is contractually limited in its ability to surrender apolicy.  This issue is effective forfiscal years beginning after December 15, 2006. The Company does not believe the adoption of this issue will have amaterial impact on the financial statements.

35

----

**NOTE 2 – BUSINESS COMBINATIONS**

In March, 2006, the Company acquired 100% of theoutstanding shares of Union Community Bancorp (“Union”).  Union operated a total of six offices inMontgomery, Fountain, Warren, and Tippecanoe Counties in Indiana through its wholly-ownedsubsidiary, Union Federal Bank and Trust Association.  As a result of this acquisition, the Companyexpects to expand its market share into west central Indiana, expand itscustomer base to enhance deposit fee income, provide an opportunity to marketadditional products and services to new customers, and reduce operating coststhrough economies of scale.

The aggregate purchase price was $55.2 millioncomprised of $26.0 million in cash and $29.2 million in stock issued.  The purchase price resulted in approximately$28.1 million in goodwill and $2.0 million in core deposit intangible.  The core deposit intangible asset is beingamortized over 10 years, using an accelerated method.  Goodwill will not be amortized but willinstead be evaluated periodically for impairment. As of the date of thisreport, the Company was in the process of obtaining third party valuations andcompleting fair value estimates for certain assets acquired and liabilitiesassumed, and the allocation of the purchase price is subject to refinement.

  Thefollowing table summarizes the estimated fair value of assets acquired andliabilities assumed at the date of acquisition.
| Cash                                    |   | $        | 16,745 |   |
|-----------------------------------------|--------|----------|--------|--------|
| Securities                              |   | 2,974    |   |
| Loans, net                              |   | 213,481  |   |
| Fixed Assets                            |   | 4,429    |   |
| Restricted Stock                        |   | 3,799    |   |
| Cash surrender  value of life insurance |   | 7,243    |   |
| Goodwill                                |   | 28,115   |   |
| Core deposit  intangible                |   | 1,987    |   |
| Other assets                            |   | 10,888   |   |
| Total assets acquired                   |   | 289,661  |   |
| Deposits                                |   | (179,134 | )      |
| FHLB advances                           |   | (52,117  | )      |
| Other  Liabilities                      |   | (3,253   | )      |
| Total liabilities assumed               |   | (234,504 | )      |
| Net assets  acquired                    |   | $        | 55,157 |   |

 

In May, 2006, the Company acquired 100% of theoutstanding shares of HFS Bank, F.S.B. (“HFS”). HFS operated a total of six offices in Hobart, Portage, Griffith, andCrown Point, Indiana.  As a result ofthis acquisition, the Company expects to expand its market share into northwestIndiana, expand its customer base to enhance deposit fee income, provide anopportunity to market additional products and services to new customers, andreduce operating costs through economies of scale.

The aggregate purchase price was $36.5 millioncomprised of $17.7 million in cash and $18.8 million in stock issued.  The purchase price resulted in approximately$18.8 million in goodwill and $2.5 million in core deposit intangible.  The core deposit intangible asset is beingamortized over 10 years, using an accelerated method.  Goodwill will not be amortized but willinstead be evaluated periodically for impairment. As of the date of thisreport, the Company was in the process of obtaining third party valuations andcompleting fair value estimates for certain assets acquired and liabilitiesassumed, and the allocation of the purchase price is subject to refinement.

The following table summarizes the estimated fairvalue of assets acquired and liabilities assumed at the date of acquisition.
| Cash                                    |   | $        | 12,042 |   |
|-----------------------------------------|--------|----------|--------|--------|
| Securities                              |   | 22,029   |   |
| Loans, net                              |   | 178,093  |   |
| Fixed Assets                            |   | 4,423    |   |
| Restricted Stock                        |   | 4,595    |   |
| Cash surrender  value of life insurance |   | 2,408    |   |
| Goodwill                                |   | 18,843   |   |
| Core deposit  intangible                |   | 2,526    |   |
| Other assets                            |   | 3,679    |   |
| Total assets acquired                   |   | 248,638  |   |
| Deposits                                |   | (141,579 | )      |
| FHLB advances                           |   | (68,985  | )      |
| Other  Liabilities                      |   | (1,552   | )      |
| Total liabilities assumed               |   | (212,116 | )      |
| Net assets  acquired                    |   | $        | 36,522 |   |

 

36

----

In June, 2006, the Company acquired 100% of theoutstanding shares of Peoples Ohio Financial Corporation (“Peoples”).  Peoples operated a total of six offices inMontgomery and Miami Counties in Ohio. As a result of this acquisition, the Company expects to expand itsmarket share into western Ohio, expand its customer base to enhance deposit feeincome, provide an opportunity to market additional products and services tonew customers, and reduce operating costs through economies of scale.

The aggregate purchase price was $42.5 millioncomprised of $11.4 million in cash and $31.1 million in stock issued.  The purchase price resulted in approximately$18.5 million in goodwill and $3.3 million in core deposit intangible.  The core deposit intangible asset is beingamortized over 10 years, using an accelerated method.  Goodwill will not be amortized but willinstead be evaluated periodically for impairment. As of the date of thisreport, the Company was in the process of obtaining third party valuations andcompleting fair value estimates for certain assets acquired and liabilitiesassumed, and the allocation of the purchase price is subject to refinement.

The following table summarizes the estimated fairvalue of assets acquired and liabilities assumed at the date of acquisition.
| Cash                                    |   | $        | 6,268  |   |
|-----------------------------------------|--------|----------|--------|--------|
| Securities                              |   | 3,968    |   |
| Loans, net                              |   | 178,467  |   |
| Fixed Assets                            |   | 3,620    |   |
| Restricted Stock                        |   | 5,974    |   |
| Cash surrender value  of life insurance |   | 4,517    |   |
| Goodwill                                |   | 18,462   |   |
| Core deposit  intangible                |   | 3,272    |   |
| Other assets                            |   | 1,706    |   |
| Total assets acquired                   |   | 226,254  |   |
| Deposits                                |   | (117,912 | )      |
| FHLB advances                           |   | (62,500  | )      |
| Other  Liabilities                      |   | (3,304   | )      |
| Total liabilities assumed               |   | (183,716 | )      |
| Net assets  acquired                    |   | $        | 42,538 |   |

 

In August, 2006, the Company purchased five branchesfrom First Financial Bank.  Thesebranches are located in Madison, Vevay, East Enterprise, and Liberty,Indiana.  As a result of thisacquisition, the Company expects to further solidify its market share insouthern Indiana, expand its customer base to enhance deposit fee income,provide an opportunity to market additional products and services to newcustomers, and reduce operating costs through economies of scale.

The purchase price of $4.8 million in cash resultedin approximately $3.5 million in goodwill and $1.1 in core depositintangible.  The core deposit intangibleasset is being amortized over 10 years, using an accelerated method.  Goodwill will not be amortized but willinstead be evaluated periodically for impairment.  Goodwill and intangible assets will bededucted for tax purposes over 15 years using a straight line method.  As of the date of this report, the Companywas in the process of obtaining third party valuations and completing fairvalue estimates for certain assets acquired and liabilities assumed, and theallocation of the purchase price is subject to refinement.

  Thefollowing table summarizes the estimated fair value of assets acquired and liabilitiesassumed at the date of acquisition.
| Cash                      |   | $       | 875     |   |
|---------------------------|--------|---------|---------|--------|
| Loans, net                |   | 28,178  |    |
| Fixed Assets              |   | 689     |    |
| Goodwill                  |   | 3,530   |    |
| Core deposit  intangible  |   | 1,122   |    |
| Other assets              |   | 153     |    |
| Total assets acquired     |   | 34,547  |    |
| Deposits                  |   | (51,375 | )       |
| Other Liabilities         |   | (178    | )       |
| Total liabilities assumed |   | (51,553 | )       |
| Net liabilities  assumed  |   | $       | (17,006 | )      |

 

The following table presents pro forma information forthe periods ended December 31 as if the acquisitions had occurred at thebeginning of 2006 and 2005. The pro forma financial information is notnecessarily indicative of the results of operations as they would have been hadthe transaction been effected on the assumed dates and is not intended to be aprojection of future results.

37

----

 
|                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Net Interest  Income                 |       | $        | 75,869     |     | $          | 78,201 |   |
| Net Income                           |       | 23,470   |       | 21,130   |       |
| Net Income per  share — basic   |       | 1.25     |       | 1.12     |       |
| Net Income per share —  diluted |       | 1.25     |       | 1.12     |       |
|                                      |            |          |            |          |            |  |  |

 

38

----

**NOTE 3 –RESTRICTION ON CASH AND DUE FROM BANKS**

TheBanks are required to maintain reserve funds in cash or on deposit with theFederal Reserve Bank which do not earn interest. The reserves required atDecember 31, 2006 and 2005 were $17,573 and $23,313, respectively.  The Company also had compensating balances of$4,499 and $3,382 at December 31, 2006 and 2005 respectively.

39

----

**NOTE 4 - SECURITIES**

Thefair value of securities available for sale and related unrealized gains andlosses recognized in accumulated other comprehensive income (loss) was asfollows:
|                                   | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross   Unrealized  Losses** | ** ** |
|-----------------------------------|------------|-----------------|------------|------------------------------|------------|-------------------------------------|------------|
| **As of  December 31, 2006**      | ** ** | ** **      | ** ** | ** **                   | ** ** | ** **                          | ** ** |
| Available for  Sale               |       |            |       |                         |       |                                |       |
| Federal agencies                  |       | $               | 90,285     |                         | $          | 104                                 |       | $ | (481 | ) |
| State and municipal               |       | 122,343         |       | 1,752                        |       | (436                                | )          |
| Mortgage-backed securities        |       | 263,006         |       | 716                          |       | (4,127                              | )          |
| Equity and other securities       |       | 9,625           |       | 181                          |       | —                              |       |
| Total available for sale          |       | $               | 485,259    |                         | $          | 2,753                               |       | $ | (5,044 | ) |
|                              |       |            |       |                         |       |                                |       |
| **As of  December 31, 2005** | ** ** | ** **      | ** ** | ** **                   | ** ** | ** **                          | ** ** |
| Available for  Sale               |       |            |       |                         |       |                                |       |
| Federal agencies                  |       | $               | 77,196     |                         | $          | 94                                  |       | $ | (552 | ) |
| State and municipal               |       | 112,785         |       | 995                          |       | (1,369                              | )          |
| Mortgage-backed securities        |       | 246,994         |       | 344                          |       | (5,211                              | )          |
| Equity and other securities       |       | 13,839          |       | 427                          |       | —                              |       |
| Total available  for sale         |       | $               | 450,814    |                         | $          | 1,860                               |       | $ | (7,132 | ) |

 

During the third quarterof 2005, management transferred all held to maturity securities to theavailable for sale category.  Thisredesignation resulted in the transfer of securities with an amortized cost of$3,005 and a fair value of $3,113 from held to maturity to available for sale.  This transfer resulted in an increase toshareholders’ equity of $70 as of September 30, 2005.  For the foreseeable future, newly acquiredsecurities will not be classified as held to maturity.

Contractual maturities ofsecurities at December 31, 2006 were as follows.  Securities not due at a single maturity or withno maturity at year end are shown separately.
|                                      | ** ** | **Available  for Sale** | ** ** |
|--------------------------------------|------------|------------------------------|------------|
| ** **                           | ** ** | **Fair  Value**              | ** ** |
| Within one year                      |       | $                            | 5,371      |   |
| One through five  years              |       | 90,775                       |       |
| Six through ten  years               |       | 52,583                       |       |
| After ten years                      |       | 63,899                       |       |
| Mortgage-backed                      |       | 263,006                      |       |
| Equity and other                     |       | 9,625                        |       |
| Total available  for sale securities |       | $                            | 485,259    |   |

 

Gross proceeds from salesof securities available for sale during 2006, 2005 and 2004 were $26,075,$106,556, and $69,347. Gross gains of $166, $294, and $1,020 and gross lossesof $21, $2,473, and $29 were realized on those sales in 2006, 2005 and 2004,respectively.  The tax benefit(provision) related to these net realized gains and losses was ($56), $796, and($364) respectively.

Securities with acarrying value of $165,683 and $152,542 were pledged at December 31, 2006and 2005 to secure certain deposits, repurchase agreements and for otherpurposes as permitted or required by law.

At year end 2006 and2005, there were no holdings of securities of any one issuer, other than theU.S. Government and its agencies, in an amount greater than 10% of shareholders’equity.

40

----

Belowis a summary of securities with unrealized losses as of year-end 2006 and 2005presented by length of time the securities have been in a continuous unrealizedloss position.

**2006**
| ** **                              | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**           | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|---------------------|------------|
| **Description of securities** | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses**                 | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
| Federal agencies                        |       | $                                      | 33,918     |                                   | $          | (94                 | )          | $ | 27,203 |   | $ | (387 | ) | $ | 61,121 |   | $ | (481 | ) |
| State and municipal                     |       | 6,442                                  |       | (32                                    | )          | 30,189              |       | (404 | ) | 36,631 |   | (436 | ) |
| Mortgage-backed  securities             |       | 49,859                                 |       | (188                                   | )          | 154,855             |       | (3,939 | ) | 204,714 |   | (4,127 | ) |
| Equity and other  securities            |       | —                                 |       | —                                 |       | —              |       | — |   | — |   | — |   |
| Total temporarily impaired              |       | $                                      | 90,219     |                                   | $          | (314                | )          | $ | 212,247 |   | $ | (4,730 | ) | $ | 302,466 |   | $ | (5,044 | ) |

 

**2005**
| ** **                              | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**           | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|---------------------|------------|
| **Description of securities** | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses**                 | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
| Federal agencies                        |       | $                                      | 52,984     |                                   | $          | (552                | )          | $ | — |   | $ | — |   | $ | 52,984 |   | $ | (552 | ) |
| State and municipal                     |       | 45,073                                 |       | (689                                   | )          | 20,782              |       | (680 | ) | 65,855 |   | (1,369 | ) |
| Mortgage-backed  securities             |       | 172,599                                |       | (4,082                                 | )          | 36,818              |       | (1,129 | ) | 209,417 |   | (5,211 | ) |
| Equity and other  securities            |       | —                                 |       | —                                 |       | —              |       | — |   | — |   | — |   |
| Total temporarily impaired              |       | $                                      | 270,656    |                                   | $          | (5,323              | )          | $ | 57,600 |   | $ | (1,809 | ) | $ | 328,256 |   | $ | (7,132 | ) |

 

Unrealized losses onstate and municipal securities have not been recognized into income becausemanagement has the intent and ability to hold for a period of time sufficientto allow for any anticipated recovery in fair value.   The fair value of debt securities isexpected to recover as the securities approach their maturity date.

Unrealized losses onmortgage-backed securities and agencies have not been recognized into income asthe decline in fair value is largely due to increases in market interestrates.  The fair value is expected torecover as the bonds approach their maturity date and/or market rates decline.

41

----

**NOTE 5 - LOANS AND ALLOWANCE FOR LOAN LOSSES**
|                                    | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
|                               |       |                        |       |                        |       |
| Commercial and  industrial loans   |       | $                           | 173,557    |                        | $          | 149,074 |   |
| Agricultural  production financing |       | 25,588                      |       | 23,871                      |       |
| Farm real estate                   |       | 46,051                      |       | 38,833                      |       |
| Commercial real  estate            |       | 286,603                     |       | 160,061                     |       |
| Hotel                              |       | 42,681                      |       | 47,939                      |       |
| Residential real  estate           |       | 790,962                     |       | 368,953                     |       |
| Construction and  development      |       | 79,261                      |       | 45,783                      |       |
| Consumer                           |       | 129,681                     |       | 123,481                     |       |
| Total loans                        |       | 1,574,384                   |       | 957,995                     |       |
| Allowance for  loan losses         |       | (12,792                     | )          | (10,441                     | )          |
| Net loans                          |       | $                           | 1,561,592  |                        | $          | 947,554 |   |

 

Activity in the allowancefor loan losses was as follows:
| **December 31**                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |     |       |
| Allowance for loan  losses            |       |     |       |     |       |     |       |
| Balances,  January 1             |       | $        | 10,441     |     | $          | 11,698   |       | $ | 11,509 |   |
| Addition resulting  from acquisitions |       | 3,895    |       | 1,002    |       | 1,775    |       |
| Provision for  losses                 |       | 1,819    |       | 1,040    |       | 600      |       |
| Recoveries on  loans                  |       | 536      |       | 284      |       | 346      |       |
| Loans charged  off                    |       | (3,899   | )          | (3,583   | )          | (2,532   | )          |
| Balances,  December 31           |       | $        | 12,792     |     | $          | 10,441   |       | $ | 11,698 |   |

 

Impaired loans were asfollows:
| **December 31**                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                               |       |     |       |     |       |     |       |
| Impaired loans with an  allowance allocated        |       | $        | 6,608      |     | $          | 5,888    |       | $ | 8,908 |   |
| Impaired loans with no  allocated allowances       |       | 15,359   |       | 4,239    |       | —   |       |
| Total impaired  loans                              |       | $        | 21,967     |     | $          | 10,127   |       | $ | 8,908 |   |
| Allowance allocated for  impaired loans            |       | $        | 1,613      |     | $          | 1,615    |       | $ | 1,578 |   |
| Average balance of  impaired loans during the year |       | $        | 17,934     |     | $          | 13,431   |       | $ | 6,758 |   |
| Interest income  recognized on impaired loans      |       | —   |       | —   |       | —   |       |
| Cash basis interest included above                 |       | —   |       | —   |       | —   |       |

 

Nonperforming loans wereas follows:
| December 31                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Loans past due  90 days or more still on accrual |       | $        | 1,460      |     | $          | 233 |   |
| Nonaccrual loans                                 |       | 16,021   |       | 9,984    |       |
|                                             |       | $        | 17,481     |     | $          | 10,217 |   |

 

Nonperformingloans include both smaller balance homogeneous loans that are collectivelyevaluated for impairment and individually classified impaired loans.

**PurchasedLoans subject to SOP 03-3**

TheCompany has purchased loans in 2006, for which there was, at acquisition,evidence of deterioration of credit quality since origination and it wasprobable, at acquisition, that all contractually required payments would not becollected.  The carrying amount of thoseloans is as follows as of December 31, 2006:
|                         | ** ** | **2006** | ** ** |
|-------------------------|------------|----------|------------|
| Commercial real  estate |       | $        | 7,747      |   |
| Construction            |       | 1,452    |       |
| Mortgage                |       | 527      |       |
| Consumer                |       | 269      |       |
| Outstanding balance     |       | 9,995    |       |
| Carrying amount         |       | $        | 8,907      |   |

 

Forthose purchased loans disclosed above, the Company did not increase theallowance for loan losses during 2006. These loans were considered impaired at December 31, 2006 and noaccretable yield was assigned at the date of acquisition.

Purchasedloans for which it was probable at acquisition that all contractually requiredpayments would not be collected are as follows:
|                                                     | ** ** | **2006** | ** ** |
|-----------------------------------------------------|------------|----------|------------|
| Contractually required payments receivable of loans |       |     |       |
| purchased during the year:                          |       |     |       |
| Commercial real estate                              |       | $        | 8,903      |   |
| Construction                                        |       | 1,454    |       |
| Mortgage loans                                      |       | 1,626    |       |
| Consumer                                            |       | 296      |       |
| Total                                               |       | 12,279   |       |
|                                                |       |     |       |
| Cash flows  expected to be collected at acquisition |       | 11,554   |       |
| Basis in acquired loans  at acquisition             |       | 11,554   |       |
|                                                     |            |          |            |  |

 

42

----

**NOTE 6 -PREMISES AND EQUIPMENT**
| December 31          | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |
| Land                      |       | $        | 7,847      |     | $          | 4,762 |   |
| Buildings                 |       | 36,082   |       | 27,314   |       |
| Furniture and  equipment  |       | 28,203   |       | 25,260   |       |
| Total cost                |       | 72,132   |       | 57,336   |       |
| Accumulated  depreciation |       | (31,762  | )          | (29,473  | )          |
| Net                       |       | $        | 40,370     |     | $          | 27,863 |   |

 

Depreciationexpense was $3,869, $3,087, and $2,962 in 2006, 2005 and 2004.

43

----

**NOTE 7 - GOODWILL AND INTANGIBLE ASSETS**

**Goodwill**

Thechange in carrying amount of goodwill is as follows:
|                                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Beginning of  year                          |       | $        | 51,301     |     | $          | 40,642 |   |
| Goodwill from  acquisitions                 |       | 69,308   |       | 11,990   |       |
| Goodwill reduced  from disposal of business |       | —   |       | (1,331   | )          |
| End of year                                 |       | $        | 120,609    |     | $          | 51,301 |   |

 

**Acquired Intangible Assets**
|                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Core deposit  intangibles      |       | $        | 25,002     |     | $          | 16,096 |   |
| Accumulated  amortization      |       | (9,058   | )          | (6,822   | )          |
| Core deposit  intangibles, net |       | $        | 15,944     |     | $          | 9,274 |   |

 

Aggregateamortization expense was $2,236, $1,306, and $1,059 for 2006, 2005, and 2004.

Estimatedamortization expense for each of the next five years follows:
| 2007 |   | $     | 2,666  |   |
|------|--------|-------|--------|--------|
| 2008 |   | 2,521 |   |
| 2009 |   | 1,924 |   |
| 2010 |   | 1,786 |   |
| 2011 |   | 1,670 |   |

 

44

----

**NOTE 8 - DEPOSITS**
|                                          | ** ** | **December 31  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| Non-interest-bearing  demand             |       | $                          | 193,513    |                        | $          | 161,568 |   |
| Interest-bearing  demand                 |       | 466,212                    |       | 330,592                     |       |
| Savings                                  |       | 335,405                    |       | 321,661                     |       |
| Certificates of  deposit of $100 or more |       | 285,262                    |       | 173,656                     |       |
| Other  certificates and time deposits    |       | 579,297                    |       | 365,220                     |       |
| Total deposits                           |       | $                          | 1,859,689  |                        | $          | 1,352,697 |   |

 

Certificatesand other time deposits mature as follows:

| 2007       |   | $       | 670,933 |   |
|------------|--------|---------|---------|--------|
| 2008       |   | 107,666 |    |
| 2009       |   | 47,819  |    |
| 2010       |   | 22,725  |    |
| 2011       |   | 8,590   |    |
| Thereafter |   | 6,826   |    |
| Total      |   | 864,559 |    |

 

45

----

**NOTE 9 – OTHER BORROWINGS**
| **December 31**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
| Other borrowings  consisted of the following at year-end: |       |     |       |     |       |
| Securities sold under  repurchase agreements              |       | $        | 29,306     |     | $          | 26,516 |   |
| Line of credit                                            |       | 13,000   |       | —   |       |
| Total short-term borrowings                               |       | $        | 42,306     |     | $          | 26,516 |   |

 

Securitiessold under repurchase agreements (“agreements”) consist of obligations securedby Federal agency securities, and a safekeeping agent holds suchcollateral.  The maximum amount ofoutstanding repurchase agreements at any month-end during 2006, 2005, and 2004totaled $36,212, $28,581, and $28,782. The daily average of such agreements during 2006, 2005, and 2004 totaled$23,200, $21,661, and $22,166.   Theweighted average rate was 3.31%, 2.36%, and 1.34% at December 31, 2006,2005, and 2004 while the weighted average rate during 2006, 2005, and 2004 wasapproximately 3.22%, 1.98%, and 0.96% respectively.  The majority of the agreements atDecember 31, 2006 mature within 30 days.

TheCompany has a revolving credit facility for $30,000 as a standby for fundingneeds which matures September 30, 2009.  The interest rate is 120 basis points above the 3-month LIBOR rate whichresulted in a rate of 6.55% at year-end 2006.  There was a balance of $13,000 as of December 31, 2006.  The line is secured by the stock ofMainSource Bank.  The line of creditagreement contains various financial and non-financial covenants.  The Company was either in compliance orreceived a waiver for these covenants at December 31, 2006.

46

----

**NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES**

FederalHome Loan Bank (“FHLB”) advances at year end were:
|                                                                                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Maturities  February 2007 through May 2022, primarily fixed rates from 2.4% to  6.5%, averaging 4.8% |       | $        | 208,443    |     | $          | — |   |
|                                                                                                           |       |     |       |     |       |
| Maturities  March 2006 through August 2012, primarily fixed rates from 2.4% to  6.3%, averaging 4.4% |       | —   |       | 41,547   |       |
|                                                                                                           |       | $        | 208,443    |     | $          | 41,547 |   |

 

Themajority of the FHLB advances are secured by first mortgage loans totalingapproximately 150% of the advance under a blanket security agreement.   The advances are subject to restrictions orpenalties in the event of prepayment.

Maturitiesover the next five years are:
| 2007       |   | $      | 40,653 |   |
|------------|--------|--------|--------|--------|
| 2008       |   | 29,252 |   |
| 2009       |   | 10,221 |   |
| 2010       |   | 72,530 |   |
| 2011       |   | 19,678 |   |
| Thereafter |   | 36,109 |   |

 

47

----

**NOTE 11 – SUBORDINATED DEBENTURES**

The Company formed four separate trusts in 2002, 2003,and 2006 that issued floating rate trust preferred securities as part of pooledofferings. The Company issued subordinated debentures to the trusts in exchangefor the proceeds of the offerings, which debentures represent the sole asset ofthe trusts. In accordance with FASB Interpretation No. 46, the trusts arenot consolidated with the Company’s financial statements, but rather thesubordinated debentures are shown as a liability. Other than the items detailedbelow, the terms of the subordinated debentures are generally the same. Interestpayments are payable quarterly in arrears and the Company has the option todefer interest payments from time to time for a period not to exceed 20consecutive quarters. The subordinated debentures mature in 30 years fromissuance and can be called anytime after five years at par. The following tablesummarizes the other terms of each issuance.
|         | ** ** | **Issuance** | ** ** | **Amount** | ** ** | **Variable  Rate** | ** **  | **Rate as of  12/31/06** | ** ** | **Maturity** | ** ** |
|---------|------------|--------------|------------|------------|------------|--------------------|-------------|------------------------------------|------------|--------------|------------|
| Trust 1 |       | 2002         |       | $          | 8,248      |               | LIBOR +3.25 | %                                  | 8.62       | %            | 2032       |   |
| Trust 2 |       | 2003         |       | 14,433     |       | LIBOR +3.25        | %           | 8.61                               | %          | 2033         |       |
| Trust 3 |       | 2003         |       | 7,217      |       | LIBOR +3.15        | %           | 8.51                               | %          | 2033         |       |
| Trust 4 |       | 2006         |       | 11,341     |       | LIBOR +1.63        | %           | 6.99                               | %          | 2036         |       |
|         |            |              |            |            |            |                    |             |                                    |            |              |            |  |

 

During2003, the Company entered into an interest rate swap and cap to mitigateoverall risk to changes in interest rates. Both the interest rate swap and thecap had a 60 month term and a notional principal amount of $14,000. Thenotional amount of the interest rate swaps do not represent amounts exchangedby the parties. The amount exchanged is determined by reference to the notionalamounts and other terms of the contract. The interest rate swap and cap weredesignated as cash flow hedges against a portion of the subordinateddebentures. As such, the aggregate fair value of the swaps were recorded asother assets or other liabilities with changes in the fair value recorded inother comprehensive income and no amount of ineffectiveness was included in netincome. Under the interest rate swap agreement, the Company made fixed ratepayments at 6.65%, and received variable payments based on LIBOR. Netsettlement expense or benefit was included in interest expense. The interestrate cap required the counter-party to pay the Company the excess of 3 monthLIBOR over 12%. The total fair value for the interest rate swap and cap was$426 at December 31, 2005 and was included in other assets. The interestrate swap and cap were settled during 2006 resulting in a payment to theCompany of $483.

48

----

**NOTE 12 – LOAN SERVICING**

Loans serviced for others are not included in theaccompanying consolidated balance sheets. Loan servicing fee income was $1,383,$1,318, and $1,532 for 2006, 2005, and 2004. The unpaid principal balances ofloans serviced for others totaled $521,908 and $509,211 at December 31,2006 and 2005. Mortgage servicing rights are included in other assets on theconsolidated balance sheets. The fair value of capitalized mortgage servicingassets is based on comparable market values and expected cash flows, withimpairment assessed based on portfolio characteristics including product typeand interest rates. No valuation allowance was necessary during 2006 or 2005.The fair market value of capitalized mortgage servicing rights was estimated at$6,419 and $4,861 at year end 2006 and 2005.
|                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |
| Mortgage  servicing assets            |       |     |       |     |       |
| Balances, January 1              |       | $        | 3,158      |     | $          | 2,888 |   |
| Servicing assets capitalized/acquired |       | 852      |       | 828      |       |
| Amortization of servicing assets      |       | (519     | )          | (558     | )          |
| Balance,  December 31            |       | $        | 3,491      |     | $          | 3,158 |   |

 

49

----

**NOTE 13 – INCOME TAX**

Income tax expense (benefit) was as follows:
| **Year Ended December 31** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |     |       |
| Income tax expense                        |       |     |       |     |       |     |       |
| Currently  payable                        |       | $        | 4,706      |     | $          | 2,972    |       | $ | 4,154 |   |
| Deferred                                  |       | 2,049    |       | 1,561    |       | 1,877    |       |
| Change in  valuation reserve              |       | 850      |       | 639      |       | 242      |       |
| Total income tax  expense                 |       | $        | 7,605      |     | $          | 5,172    |       | $ | 6,273 |   |

 

Effectivetax rates differ from the federal statutory rate of 35% applied to incomebefore income taxes due to the following:
| Federal statutory income tax rate   |   | 35     | %      | 35     | %      | 35     | %      |
|-------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Federal statutory income tax        |   | $      | 10,446 |   | $      | 7,477  |   | $ | 8,073 |   |
| Tax exempt interest                 |   | (1,922 | )      | (1,612 | )      | (1,231 | )      |
| Effect of state income taxes        |   | 96     |   | 25     |   | 63     |   |
| Non-deductible expenses             |   | 53     |   | 36     |   | 50     |   |
| Tax exempt income on life insurance |   | (439   | )      | (472   | )      | (356   | )      |
| Low income housing credits          |   | (377   | )      | (132   | )      | (132   | )      |
| Other                               |   | (252   | )      | (150   | )      | (194   | )      |
| Income tax  expense                 |   | $      | 7,605  |   | $      | 5,172  |   | $ | 6,273 |   |

 

The components of the netdeferred tax asset (liability) are as follows:
| December 31                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Assets                                            |       |     |       |     |       |
| Allowance for loan losses                         |       | $        | 4,477      |     | $          | 3,653 |   |
| Net operating loss carryforward                   |       | 1,731    |       | 881      |       |
| Deferred compensation                             |       | 425      |       | 435      |       |
| Fair value adjustments on assets acquired         |       | 3,536    |       | 336      |       |
| Accrued expenses                                  |       | 250      |       | 343      |       |
| Unrealized loss on securities AFS                 |       | 827      |       | 1,845    |       |
| Other                                             |       | 384      |       | 136      |       |
| Total assets                                      |       | $        | 11,630     |     | $          | 7,629 |   |
|                                              |       |     |       |     |       |
| Liabilities                                       |       |     |       |     |       |
| Accretion on securities                           |       | (135     | )          | (56      | )          |
| Depreciation                                      |       | (1,694   | )          | (1,228   | )          |
| Intangibles                                       |       | (3,673   | )          | (3,004   | )          |
| Mortgage servicing rights                         |       | (1,239   | )          | (1,105   | )          |
| Deferred loan fees/costs                          |       | (570     | )          | (285     | )          |
| FHLB stock dividends                              |       | (1,622   | )          | (336     | )          |
| Net unrealized appreciation on interest rate swap |       | —   |       | (149     | )          |
| Other                                             |       | (1,165   | )          | (1,224   | )          |
| Total liabilities                                 |       | $        | (10,098    | )        | $          | (7,387 | ) |
| Less: Valuation  allowance                        |       | $        | (1,731     | )        | $          | (881 | ) |
| Net deferred tax  asset(liability)                |       | $        | (199       | )        | $          | (639 | ) |

 

The Company has a stateoperating loss carryforward of $20,364, which begins to expire in 2019. The Companymaintains a valuation allowance as it does not anticipate generating taxableincome in Indiana to utilize this carryforward prior to expiration.

 

Retainedearnings of certain subsidiary banks include approximately $10,977 for which nodeferred income tax liability has been recognized.  This amount represents an allocation of incometo bad debt deductions as of December 31, 1987 for tax purposes only. Reductionof amounts so allocated for purposes other than tax bad debt losses includingredemption of bank stock or excess dividends, or loss of “bank” status wouldcreate income for tax purposes only, which would be subject to the then-currentcorporate income tax rate. The unrecorded deferred income tax liability on theabove amount for MainSource at December 31, 2006 was approximately $3,842.

50

----

**NOTE 14 – OTHER COMPREHENSIVE INCOME**
| **Year Ended December 31, 2006**                | ** ** | **Before-Tax  Amount** | ** ** | **Tax (Expense)/  Benefit** | ** ** | **Net-of-Tax  Amount** | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------|------------|
|                                                                |       |                   |       |                             |       |                   |       |
| Unrealized holding gains on available for sale  securities          |       | $                      | 3,126      |                             | $          | (1,112                 | )          | $ | 2,014 |   |
| Change in fair value of interest rate swap and cap                  |       | 57                     |       | (23                              | )          | 34                     |       |
| Less: reclassification adjustment for gains realized  in net income |       | 628                    |       | (249                             | )          | 379                    |       |
| Other  comprehensive income                                         |       | $                      | 2,555      |                             | $          | (886                   | )          | $ | 1,669 |   |

 
| **Year Ended December 31, 2005**                 | ** ** | **Before-Tax  Amount** | ** ** | **Tax (Expense)/  Benefit** | ** ** | **Net-of-Tax  Amount** | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------|------------|
|                                                                 |       |                   |       |                             |       |                   |       |
| Unrealized holding losses on available for sale  securities          |       | $                      | (7,626     | )                                | $          | 2,788                  |       | $ | (4,838 | ) |
| Change in fair value of interest rate swap and cap                   |       | 374                    |       | (149                             | )          | 225                    |       |
| Less: reclassification adjustment for losses realized  in net income |       | (2,179                 | )          | 796                              |       | (1,383                 | )          |
| Other  comprehensive loss                                            |       | $                      | (5,073     | )                                | $          | 1,843                  |       | $ | (3,230 | ) |

 
| **Year Ended December 31, 2004**                | ** ** | **Before-Tax  Amount** | ** ** | **Tax (Expense)/  Benefit** | ** ** | **Net-of-Tax  Amount** | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------|------------|
|                                                                |       |                   |       |                             |       |                   |       |
| Unrealized  holding losses on available for sale securities         |       | $                      | (1,019     | )                                | $          | 380                    |       | $ | (639 | ) |
| Change in fair  value of interest rate swap and cap                 |       | 247                    |       | (99                              | )          | 148                    |       |
| Less:  reclassification adjustment for gains realized in net income |       | 991                    |       | (364                             | )          | 627                    |       |
| Other comprehensive  loss                                           |       | $                      | (1,763     | )                                | $          | 645                    |       | $ | (1,118 | ) |

 

51

----

**NOTE 15 – COMMITMENTS**

Somefinancial instruments, such as loan commitments, credit lines, letters ofcredit, and overdraft protection, are issued to meet customer financing needs. Theseare agreements to provide credit or to support the credit of others, as long asconditions established in the contract are met, and usually have expirationdates. Commitments may expire without being used. Off-balance-sheet risk tocredit loss exists up to the face amount of these instruments, althoughmaterial losses are not anticipated. The same credit policies are used to makesuch commitments as are used for loans, including obtaining collateral atexercise of the commitment.

Financialinstruments whose contract amount represents credit risk as of December 31were as follows:
| ** **                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Commitments to  extend credit |       | $        | 331,000    |     | $          | 222,373 |   |
| Commercial letters of  credit |       | 20,591   |       | 14,404   |       |
|                               |            |          |            |          |            |  |  |

 

Commitmentsare predominantly short-term and variable in rate.

52

----

**NOTE 16 –STOCK DIVIDENDS AND SPLITS**

OnDecember 21, 2006, the Company announced a 5% stock dividend to be paid onJanuary 16, 2007 to shareholders of record as of December 31, 2006. Thestock dividend was recorded in 2006, and all share and per share amounts havebeen retroactively adjusted for all prior years to reflect this stock dividend.

OnNovember 29, 2004, the Company announced a 5% stock dividend to be paid onJanuary 15, 2005 to shareholders of record as of December 31, 2004. Thestock dividend was recorded in 2004, and all share and per share amounts havebeen retroactively adjusted for all prior years to reflect this stock dividend.

OnMarch 16, 2004, the Company announced a 3-for-2 stock split to bedistributed on April 16, 2004 to shareholders of record as ofMarch 31, 2004. The stock split was recorded in 2004, and all share andper share amounts have been retroactively adjusted for all prior years toreflect this stock split.

53

----

**NOTE 17**–**DIVIDENDS**

Withoutprior approval, the Banks are restricted by state and federal regulations as tothe maximum amount of dividends they can pay to the holding company in anycalendar year. The Banks may dividend their retained net profits (as defined)for that year and the two preceding years. From time to time, the holdingcompany may seek the approval of the appropriate regulatory authorities toallow the banks to pay additional dividends to the holding company in excess ofthe aforementioned amount. At December 31, 2006, total shareholders’equity of the Banks was $297,529 of which $296,628 was restricted or limitedfrom dividend distribution to the holding company.

**NOTE 18 –DIVIDEND REINVESTMENT PLAN**

TheCompany maintains an Automatic Dividend Reinvestment Plan. The plan enablesshareholders to elect to have their cash dividends on all or a portion ofshares held automatically reinvested in additional shares of the Company’scommon stock. The stock is purchased by the Company’s transfer agent on theopen market and credited to participant accounts at fair market value. Dividendsare reinvested on a quarterly basis.

54

----

**NOTE 19 - REGULATORY CAPITAL**

Banksand bank holding companies are subject to various regulatory capitalrequirements administered by the federal banking agencies and are assigned to acapital category. The assigned capital category is largely determined by threeratios that are calculated according to the regulations. The ratios areintended to measure capital relative to assets and credit risk associated withthose assets and off-balance sheet exposures. The capital category assigned toan entity can also be affected by qualitative judgments made by regulatoryagencies about the risk inherent in the entity’s activities that are not partof the calculated ratios.

Thereare five capital categories defined in the regulations, ranging from wellcapitalized to critically undercapitalized. Classification in any of theundercapitalized categories can result in actions by regulators that could havea material effect on operations. At December 31, 2006 and 2005, the mostrecent regulatory notifications categorized the banks as well capitalized underthe regulatory framework for prompt corrective actions. There are no conditionsor events since that notification that management believes have changed theinstitutions’ category.

Actual and requiredcapital amounts and ratios are presented below.
| ** **                               | ** ** | ** ** | ** ** | ** **                | ** ** | **Required for** | ** ** | **To Be Well** | ** ** |
|------------------------------------------|------------|------------|------------|---------------------------|------------|-----------------------|------------|--------------------------|------------|
| ** **                               | ** ** | **Actual** | ** ** | **Adequate Capital** | ** ** | **Capitalized**       | ** ** |
| **December 31, 2006**          | ** ** | **Amount** | ** ** | **Ratio**                 | ** ** | **Amount**            | ** ** | **Ratio**                | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
|                                     |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| MainSource  Financial Group              |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 170,950    |                      | 11.2       | %                     | $          | 122,400                  |       | 8.0 | % | N/A |   | N/A |   |
| Tier 1 capital (to risk-weighted assets) |       | 158,158    |       | 10.3                      |       | 61,200                |       | 4.0                      |       | N/A |   | N/A |   |
| Tier 1 capital (to average assets)       |       | 158,158    |       | 7.0                       |       | 90,130                |       | 4.0                      |       | N/A |   | N/A |   |
|                                     |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| MainSource Bank                          |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 110,786    |                      | 11.2       | %                     | $          | 78,874                   |       | 8.0 | % | $ | 98,593 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |       | 102,770    |       | 10.4                      |       | 39,437                |       | 4.0                      |       | 59,156 |   | 6.0 |   |
| Tier 1 capital (to average assets)       |       | 102,770    |       | 7.2                       |       | 57,200                |       | 4.0                      |       | 71,500 |   | 5.0 |   |
|                                     |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| MainSource Bank  of Illinois             |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 13,998     |                      | 12.9       | %                     | $          | 8,656                    |       | 8.0 | % | $ | 10,820 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |       | 13,090     |       | 12.1                      |       | 4,328                 |       | 4.0                      |       | 6,492 |   | 6.0 |   |
| Tier 1 capital (to average assets)       |       | 13,090     |       | 7.3                       |       | 7,151                 |       | 4.0                      |       | 8,939 |   | 5.0 |   |
| ** **                               |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| MainSource Bank  - Crawfordsville        |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 17,170     |                      | 10.3       | %                     | $          | 13,325                   |       | 8.0 | % | $ | 16,656 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |       | 15,551     |       | 9.3                       |       | 6,662                 |       | 4.0                      |       | 9,993 |   | 6.0 |   |
| Tier 1 capital (to average assets)       |       | 15,551     |       | 6.4                       |       | 9,689                 |       | 4.0                      |       | 12,111 |   | 5.0 |   |
|                                     |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| MainSource Bank  - Hobart                |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 17,578     |                      | 13.5       | %                     | $          | 10,400                   |       | 8.0 | % | $ | 13,001 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |       | 16,208     |       | 12.5                      |       | 5,200                 |       | 4.0                      |       | 7,800 |   | 6.0 |   |
| Tier 1 capital (to average assets)       |       | 16,208     |       | 7.6                       |       | 8,525                 |       | 4.0                      |       | 10,657 |   | 5.0 |   |
|                                     |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| MainSource Bank  - Ohio                  |       |       |       |                      |       |                  |       |                     |       |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 17,479     |                      | 13.0       | %                     | $          | 10,745                   |       | 8.0 | % | $ | 13,431 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |       | 16,019     |       | 11.9                      |       | 5,372                 |       | 4.0                      |       | 8,059 |   | 6.0 |   |
| Tier 1 capital  (to average assets)      |       | 16,019     |       | 7.9                       |       | 8,071                 |       | 4.0                      |       | 10,089 |   | 5.0 |   |

 
| ** **                               | ** ** | **Actual** | ** ** | **Required for  Adequate Capital** | ** ** | **To Be Well  Capitalized** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------------------------|------------|---------------------------------------|------------|
| **December 31, 2005**          | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                            | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
|                                     |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| MainSource  Financial Group              |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 143,068    |                                         | 13.5       | %                                     | $          | 84,537 |   | 8.0 | % | N/A |   | N/A |   |
| Tier 1 capital (to risk-weighted assets) |       | 132,627    |       | 12.6                                         |       | 42,268                                |       | 4.0 |   | N/A |   | N/A |   |
| Tier 1 capital (to average assets)       |       | 132,627    |       | 8.4                                          |       | 63,284                                |       | 4.0 |   | N/A |   | N/A |   |
|                                     |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| MainSource Bank                          |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 112,673    |                                         | 12.0       | %                                     | $          | 75,301 |   | 8.0 | % | $ | 94,126 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |       | 102,969    |       | 10.9                                         |       | 37,650                                |       | 4.0 |   | 56,475 |   | 6.0 |   |
| Tier 1 capital (to average assets)       |       | 102,969    |       | 7.5                                          |       | 55,194                                |       | 4.0 |   | 68,993 |   | 5.0 |   |
|                                     |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| MainSource Bank  of Illinois             |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 13,166     |                                         | 12.3       | %                                     | $          | 8,596 |   | 8.0 | % | $ | 10,745 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |       | 12,429     |       | 11.6                                         |       | 4,298                                 |       | 4.0 |   | 6,447 |   | 6.0 |   |
| Tier 1 capital  (to average assets)      |       | 12,429     |       | 6.8                                          |       | 7,370                                 |       | 4.0 |   | 9,212 |   | 5.0 |   |

 

55

----

**NOTE 20 –EMPLOYEE BENEFIT PLANS**

The Company has adefined-contribution retirement plan in which substantially all employees mayparticipate. The Company matches a portion of employees’ contributions andmakes additional contributions based on employee compensation and the overallprofitability of the Company. Expense was $1,293 in 2006, $1,309 in 2005, and$1,621 in 2004.

The Company acquired adefined benefit retirement plan upon purchase of Peoples. Per the mergeragreement, the plan was curtailed prior to the merger and an application wasfiled with the IRS to settle this plan. The Company expects to settle this planin the first half of 2007. Plan assets of $1.1 million are invested in a moneymarket fund in a trust and the projected termination liability is $1.6 million.The Company has a $0.5 million liability included in other liabilities on thebalance sheet.

56

----

**NOTE 21 - RELATED PARTY TRANSACTIONS**

TheCompany has entered into transactions with certain directors, executiveofficers, significant stockholders and their affiliates or associates (relatedparties). Such transactions were made in the ordinary course of business anddid not, in the opinion of management, involve more than normal credit risk orpresent other unfavorable features.

Theaggregate amount of loans, as defined, to such related parties were as follows:
| Balances,  January 1, 2006             |   | $       | 10,808 |   |
|---------------------------------------------|--------|---------|--------|--------|
| Changes in composition  of related parties  |   | 6,845   |   |
| New loans, including  renewals and advances |   | 10,856  |   |
| Payments, including  renewals               |   | (10,067 | )      |
| Balances, December 31, 2006            |   | $       | 18,442 |   |

 

Depositsfrom related parties held by the Company at December 31, 2006 and 2005totaled $8,288 and $2,847.

57

----

**NOTE 22 - STOCK OPTION PLANS**

Options to buy stock weregranted to directors and officers of the Company under the Company’s StockOption Plan (the “Plan”), which was adopted in 2003 and provides for the issueof up to 607,754 options. The Company believes that such awards better alignthe interests of its employees with those of its shareholders. Option awardsare granted with an exercise price equal to the market price of the Company’s commonstock at the date of grant. The maximum option term is ten years, and optionawards have vesting periods ranging from immediate vesting for directors of theCompany to four years for management awards. The Company has a policy of usingshares held in treasury stock to satisfy share option exercises. Currently, theCompany has a sufficient number of treasury shares to satisfy expected shareoption exercises.

The fair value of eachoption award is estimated on the date of grant using a closed form optionvaluation (Black-Scholes) model that uses the assumptions noted in the tablebelow. Expected volatilities are based on historical volatilities of theCompany’s common stock. The Company uses historical data to estimate optionexercise and post-vesting termination behavior. Employee and management optionsare tracked separately. The expected term of options granted is based onhistorical data and represents the period of time that options granted areexpected to be outstanding, which takes into account that the options are nottransferable. The risk-free interest rate for the expected term of the optionis based on the U.S. Treasury yield curve in effect at the time of the grant.

As part of the mergeragreement with Peoples Ohio Financial Corp, certain options of Peoples were convertedinto options of MainSource at the same conversion ratio as the shares wereexchanged. All options were fully vested prior to merger.

The fair value of optionsgranted was determined using the following weighted average assumptions as ofgrant date.
|                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Risk-free  interest rate         |       | 4.56     | %          | 4.08     | %          | 3.48     | %          |
| Expected term  (years)           |       | 6.82     |       | 6.83     |       | 6.69     |       |
| Expected stock  price volatility |       | 21.11    | %          | 21.64    | %          | 20.34    | %          |
| Dividend yield                   |       | 2.78     | %          | 2.50     | %          | 2.75     | %          |

 

A summary of the activityin the stock option plan for 2006 follows:
| ** **                                                                          | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**          | ** ** | ** **    | ** ** |
|-------------------------------------------------------------------------------------|------------|------------|------------|--------------|------------|-----------------------|------------|---------------|------------|
| ** **                                                                          | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average**           | ** ** | ** **    | ** ** |
| ** **                                                                          | ** ** | ** ** | ** ** | **Average**  | ** ** | **Remaining**         | ** ** | **Aggregate** | ** ** |
| ** **                                                                          | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual**       | ** ** | **Intrinsic** | ** ** |
| **Options (restated for stock dividends and splits)** | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Term (years)** | ** ** | **Value**     | ** ** |
| Outstanding,  beginning of year                                                     |       | 182,601    |       | $            | 18.77      |                  |       |          |       |   |
| Granted                                                                             |       | 41,475     |       | 18.01        |       |                  |       |          |       |
| Additions  related to acquisition                                                   |       | 91,803     |       | 12.99        |       |                  |       |          |       |
| Exercised                                                                           |       | (33,239    | )          | 7.41         |       |                  |       |          |       |
| Forfeited or  expired                                                               |       | (19,295    | )          | 20.66        |       |                  |       |          |       |
| Outstanding at  end of year                                                         |       | 263,345    |       | $            | 17.93      |                  | 6.9        |          | 352        |   |
| Exercisable at year end                                                             |       | 228,806    |       | $            | 17.92      |                  | 6.5        |          | 352        |   |

 

Information related tothe stock option plan during each year follows:
|                                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Intrinsic value  of options exercised                       |       | $        | 314        |     | $          | 17       |       | $ | 14 |   |
| Cash received  from option exercises                        |       | 246      |       | 43       |       | 23       |       |
| Tax benefit  realized from option exercises                 |       | —   |       | 5        |       | 5        |       |
| Weighted average (per  share) fair value of options granted |       | 3.97     |       | 4.58     |       | 4.01     |       |
|                                                             |            |          |            |          |            |          |            |  |  |  |

 

As of December 31, 2006,there was $143 of total unrecognized compensation cost related to nonvestedstock options granted under the Plan. The cost is expected to be recognizedover a weighted-average period of 1.7 years.

58

----

**NOTE 23 - EARNINGS PER SHARE**

Earningsper share were computed as follows:
| ** **                                                           | ** ** | **Net  Income** | ** ** | **Weighted  Average  Shares** | ** ** | **Per Share  Amount** | ** ** |
|----------------------------------------------------------------------|------------|-----------------|------------|-------------------------------|------------|----------------------------|------------|
| **Year  Ended December 31, 2006**                               |       |            |       |                          |       |                       |       |
| **Basic  Earnings Per Share**                                        |       |            |       |                          |       |                       |       |
| Net income  available to common shareholders                         |       | $               | 22,241     |                          | 17,174,478 |                       | $          | 1.30 |   |
| Effect of  dilutive stock options                                    |       |            |       | 13,763                        |       |                       |       |
|                                                                 |       |            |       |                          |       |                       |       |
| **Diluted  Earnings Per Share**                                      |       |            |       |                          |       |                       |       |
| Net income  available to common shareholders and assumed conversions |       | $               | 22,241     |                          | 17,188,241 |                       | $          | 1.29 |   |
|                                                                 |       |            |       |                          |       |                       |       |
| **Year  Ended December 31, 2005**                               |       |            |       |                          |       |                       |       |
| **Basic  Earnings Per Share**                                        |       |            |       |                          |       |                       |       |
| Net income  available to common shareholders                         |       | $               | 16,192     |                          | 13,177,462 |                       | $          | 1.23 |   |
| Effect of  dilutive stock options                                    |       |            |       | 14,171                        |       |                       |       |
|                                                                 |       |            |       |                          |       |                       |       |
| **Diluted  Earnings Per Share**                                      |       |            |       |                          |       |                       |       |
| Net income  available to common shareholders and assumed conversions |       | $               | 16,192     |                          | 13,191,633 |                       | $          | 1.23 |   |
|                                                                 |       |            |       |                          |       |                       |       |
| **Year  Ended December 31, 2004**                               |       |            |       |                          |       |                       |       |
| **Basic  Earnings Per Share**                                        |       |            |       |                          |       |                       |       |
| Net income  available to common shareholders                         |       | $               | 16,793     |                          | 11,923,448 |                       | $          | 1.41 |   |
| Effect of  dilutive stock options                                    |       |            |       | 17,145                        |       |                       |       |
|                                                                 |       |            |       |                          |       |                       |       |
| **Diluted  Earnings Per Share**                                      |       |            |       |                          |       |                       |       |
| Net income available to  common shareholders and assumed conversions |       | $               | 16,793     |                          | 11,940,593 |                       | $          | 1.41 |   |

 

Stockoptions for 182,995, 129,964, and 64,496 shares of common stock were notconsidered in computing diluted earnings per common share for 2006, 2005 and2004 because they were antidilutive.

59

----

**NOTE 24 - FAIR VALUES OF FINANCIAL INSTRUMENTS**
| ** **                                | ** ** | **2006**             | ** ** | **2005**        | ** ** |
|-------------------------------------------|------------|----------------------|------------|-----------------|------------|
| **December 31**                      | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| Assets                                    |       |                 |       |            |       |   |   |   |   |
| Cash and cash  equivalents                |       | $                    | 104,155    |            | $          | 104,155 |   | $ | 86,205 |   | $ | 86,205 |   |
| Interest-bearing time  deposits           |       | 116                  |       | 116             |       | 210 |   | 210 |   |
| Securities available  for sale            |       | 485,259              |       | 485,259         |       | 450,814 |   | 450,814 |   |
| Loans including loans  held for sale, net |       | 1,563,754            |       | 1,582,951       |       | 950,120 |   | 948,150 |   |
| Restricted stock                          |       | 22,947               |       | 22,947          |       | 10,940 |   | 10,940 |   |
| Interest receivable                       |       | 12,364               |       | 12,364          |       | 8,400 |   | 8,400 |   |
| Interest rate swap and  cap               |       | —               |       | —          |       | 426 |   | 426 |   |
|                                      |       |                 |       |            |       |   |   |   |   |
| Liabilities                               |       |                 |       |            |       |   |   |   |   |
| Deposits                                  |       | (1,859,689           | )          | (1,801,452      | )          | (1,352,697 | ) | (1,340,150 | ) |
| Borrowings                                |       |                 |       |            |       |   |   |   |   |
| Other                                     |       | (42,306              | )          | (42,306         | )          | (26,516 | ) | (26,516 | ) |
| FHLB advances                             |       | (208,443             | )          | (200,609        | )          | (41,547 | ) | (40,951 | ) |
| Interest payable                          |       | (8,032               | )          | (8,032          | )          | (3,373 | ) | (3,373 | ) |
| Subordinated debentures                   |       | (41,239              | )          | (41,473         | )          | (29,898 | ) | (31,090 | ) |
|                                           |            |                      |            |                 |            |  |  |  |  |  |  |  |  |

 

Themethods and assumptions used to estimate fair value are described as follows.

Carryingamount is the estimated fair value of cash and cash equivalents,interest-bearing time deposits, restricted stock, accrued interest receivableand payable, demand and all other transactional deposits, short-termborrowings, variable rate notes payable, and variable rate loans or depositsthat reprice frequently and fully.  Security fair values are based on market prices or dealer quotes, and ifno such information is available, on the rate and term of the security andinformation about the issuer.  For fixedrate loans or deposits and for variable rate loans or deposits with infrequentrepricing or repricing limits, fair value is based on discounted cash flowsusing current market rates applied to the estimated life and credit risk.  Fair values for impaired loans are estimatedusing discounted cash flow analysis or underlying collateral values.  Fair value of loans held for sale is based onmarket quotes.  Fair value of FHLBadvances and subordinated debentures is based on current rates for similarfinancing. The fair value of off-balance-sheet items is based on the currentfees or cost that would be charged to enter into or terminate sucharrangements, and are not considered significant.  The fair value of interest rate swaps isbased on market prices or dealer quotes.

60

----

**NOTE 25 - QUARTERLY FINANCIAL DATA (UNAUDITED)**
| ** **     | ** ** | **Interest** | ** ** | **Net Interest** | ** ** | **Net**    | ** ** | **Earnings per Share** | ** ** |
|----------------|------------|--------------|------------|-----------------------|------------|------------|------------|----------------------------------|------------|
| ** **     | ** ** | **Income**   | ** ** | **Income**            | ** ** | **Income** | ** ** | **Basic**                        | ** ** | **Fully Diluted** | ** ** |
| 2006           |       |         |       |                  |       |       |       |                             |       |   |   |
| First quarter  |       | $            | 22,655     |                  | $          | 14,234     |       | $                                | 4,786      |   | $ | .33 |   | $ | .33 |   |
| Second quarter |       | 28,582       |       | 16,408                |       | 5,482      |       | .33                              |       | .33 |   |
| Third quarter  |       | 34,431       |       | 18,825                |       | 5,934      |       | .32                              |       | .31 |   |
| Fourth quarter |       | 35,063       |       | 18,801                |       | 6,039      |       | .32                              |       | .32 |   |
|           |       |         |       |                  |       |       |       |                             |       |   |   |
| 2005           |       |         |       |                  |       |       |       |                             |       |   |   |
| First quarter  |       | $            | 18,693     |                  | $          | 12,705     |       | $                                | 3,790      |   | $ | 0.31 |   | $ | 0.31 |   |
| Second quarter |       | 19,533       |       | 13,185                |       | 4,326      |       | 0.35                             |       | 0.35 |   |
| Third quarter  |       | 20,598       |       | 13,629                |       | 4,532      |       | 0.32                             |       | 0.32 |   |
| Fourth quarter |       | 21,651       |       | 14,129                |       | 3,544      |       | 0.25                             |       | 0.25 |   |

 

61

----

**NOTE 26 - PARENT ONLY CONDENSED FINANCIAL STATEMENTS**

**Parent Only Condensed Balance Sheets**
| **December 31**                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Assets                                           |       |     |       |     |       |
| Cash and cash equivalents                        |       | $        | 1,666      |     | $          | 9,457 |   |
| Securities available for sale                    |       | 1,106    |       | 3,111    |       |
| Investment in subsidiaries                       |       | 300,626  |       | 174,471  |       |
| Other assets                                     |       | 6,620    |       | 5,713    |       |
| Total assets                                     |       | $        | 310,018    |     | $          | 192,752 |   |
|                                             |       |     |       |     |       |
| Liabilities                                      |       |     |       |     |       |
| Subordinated debentures                          |       | $        | 41,239     |     | $          | 29,898 |   |
| Other borrowings                                 |       | 13,000   |       | —   |       |
| Other liabilities                                |       | 2,532    |       | 1,785    |       |
| Total liabilities                                |       | 56,771   |       | 31,683   |       |
| Shareholders’  equity                       |       | 253,247  |       | 161,069  |       |
| Total  liabilities and shareholders’ equity |       | $        | 310,018    |     | $          | 192,752 |   |

 

62

----

**Parent Only Condensed Statements of Income**
| **Year Ended December 31**                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income                                                                         |       |     |       |     |       |     |       |
| Dividends from subsidiaries                                                    |       | $        | 37,785     |     | $          | 27,797   |       | $ | 17,850 |   |
| Fees from subsidiaries                                                         |       | 10,811   |       | 10,345   |       | 9,197    |       |
| Other Income                                                                   |       | 959      |       | 132      |       | 95       |       |
| Total income                                                                   |       | 49,555   |       | 38,274   |       | 27,142   |       |
| Expenses                                                                       |       |     |       |     |       |     |       |
| Interest expense                                                               |       | 3,150    |       | 2,192    |       | 1,993    |       |
| Salaries and benefits                                                          |       | 6,601    |       | 6,115    |       | 5,280    |       |
| Professional fees                                                              |       | 934      |       | 932      |       | 689      |       |
| Other expenses                                                                 |       | 6,696    |       | 5,805    |       | 4,962    |       |
| Total expenses                                                                 |       | 17,381   |       | 15,044   |       | 12,924   |       |
| Income before  income taxes and equity in undistributed income of subsidiaries |       | 32,174   |       | 23,230   |       | 14,218   |       |
| Income tax expense (benefit)                                                   |       | (2,441   | )          | (1,980   | )          | (1,588   | )          |
| Income before  equity in undistributed income of subsidiaries                  |       | 34,615   |       | 25,210   |       | 15,806   |       |
| Equity in  undistributed income of subsidiaries                                |       | (12,374  | )          | (9,018   | )          | 987      |       |
| Net income                                                                     |       | $        | 22,241     |     | $          | 16,192   |       | $ | 16,793 |   |

 

63

----

**Condensed Statements of Cash Flows Parent Only**
| **Year Ended December 31**            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Operating  Activities**                            |       |     |       |     |       |     |       |
| Net income                                           |       | $        | 22,241     |     | $          | 16,192   |       | $ | 16,793 |   |
| Undistributed income of subsidiaries                 |       | 12,374   |       | 9,018    |       | (987     | )          |
| Changes in other assets and liabilities              |       | 1,961    |       | 1,172    |       | 183      |       |
| Net cash provided by operating activities            |       | 36,576   |       | 26,382   |       | 15,989   |       |
|                                                 |       |     |       |     |       |     |       |
| **Investing  Activities**                            |       |     |       |     |       |     |       |
| Capital contributed to subsidiary                    |       | (6,408   | )          | (735     | )          | (1,300   | )          |
| Cash paid for acquisitions                           |       | (51,873  | )          | (30,267  | )          | (4,662   | )          |
| Purchases of equipment                               |       | (1,184   | )          | (1,777   | )          | (948     | )          |
| Proceeds from sales of securities available for sale |       | 2,112    |       | —   |       | 165      |       |
| Purchase of securities available for sale            |       | (26      | )          | —   |       | (2,096   | )          |
| Net cash used by investing activities                |       | (57,379  | )          | (32,779  | )          | (8,841   | )          |
|                                                 |       |     |       |     |       |     |       |
| **Financing  Activities**                            |       |     |       |     |       |     |       |
| Payments on note payable                             |       | —   |       | (9,100   | )          | (3,400   | )          |
| Proceeds from issuance of subordinated debentures    |       | 11,000   |       | —   |       | —   |       |
| Net change in other borrowings                       |       | 13,000   |       | (3,000   | )          | 3,000    |       |
| Purchase of treasury shares                          |       | (2,290   | )          | (27      | )          | (1,312   | )          |
| Proceeds from exercise of stock options              |       | 246      |       | 48       |       | 28       |       |
| Proceeds from stock issuance                         |       | —   |       | 32,660   |       | —   |       |
| Cash dividends and fractional shares                 |       | (8,944   | )          | (6,514   | )          | (5,421   | )          |
| Net cash provided (used) by financing activities     |       | 13,012   |       | 14,067   |       | (7,105   | )          |
| Net change in  cash and cash equivalents             |       | (7,791   | )          | 7,670    |       | 43       |       |
| Cash and cash  equivalents, beginning of year        |       | 9,457    |       | 1,787    |       | 1,744    |       |
| Cash and cash  equivalents, end of year              |       | $        | 1,666      |     | $          | 9,457    |       | $ | 1,787 |   |

 

64

----

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

Inconnection with its audits for the three most recent fiscal years endedDecember 31, 2006, there have been no disagreements with the Company’sindependent registered public accounting firm on any matter of accountingprinciples or practices, financial statement disclosure or auditing scope orprocedure.

**ITEM 9A.****CONTROLS & PROCEDURES**

**DisclosureControls and Procedures**

As ofthe end of the period covered by this report, an evaluation was carried outunder the supervision and with the participation of the Company’s management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of our disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e) under the Securities ExchangeAct of 1934). Based on their evaluation, our Chief Executive Officer and ChiefFinancial Officer have concluded that the Company’s disclosure controls andprocedures are, to the best of their knowledge, effective to ensure thatinformation required to be disclosed by the Company in reports that it files orsubmits under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commissionrules and forms as of such date.

Ourmanagement has evaluated our internal control over financial reporting andthere were no changes in our internal control over financial reporting thatoccurred during the most recent fiscal quarter that have materially affected,or are reasonably likely to materially affect, the Company’s internal controlover financial reporting.

**Management’s Report on InternalControl Over Financial Reporting**

MainSource FinancialGroup, Inc. (the “Corporation”) is responsible for the preparation, integrity,and fair presentation of the consolidated financial statements included in thisannual report.  The consolidatedfinancial statements and notes included in this annual report have beenprepared in conformity with United States generally accepted accountingprinciples and necessarily include some amounts that are based on management’sbest estimates and judgments.

We, as management ofMainSource Financial Group Inc., are responsible for establishing and maintainingeffective internal control over financial reporting that is designed to producereliable financial statements in conformity with Untied States generallyaccepted accounting principles.  Thesystem of internal control over financial reporting as it relates to thefinancial statements is evaluated for effectiveness by management and testedfor reliability through a program of internal audits and other managementtesting. Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Management assessed theCorporation’s system of internal control over financial reporting as ofDecember 31, 2006, in relation to criteria for effective internal control overfinancial reporting as described in “Internal Control—Integrated Framework”issued by the Committee of Sponsoring Organizations of the TreadwayCommission.  This assessment excludedinternal control over financial reporting for MainSource Bank — Crawfordsville(MSB-C), MainSource Bank — Hobart (MSB-H), and MainSource Bank — Ohio (MSB-OH)as allowed by the SEC for current year acquisitions.  MSB-C was acquired on March 17, 2006 andrepresented 11.1% of assets at December 31, 2006 and 7.2% of net income for2006; MSB-H was acquired on May 24, 2006 and represented 9.6% of assets atDecember 31, 2006 and 6.6% of net income for 2006; and MSB-OH was acquired onJune 16, 2006 and represented 9.2% of assets at December 31, 2006 and 5.5% ofnet income for 2006. Based on this assessment, management concludes that as ofDecember 31, 2006, its system of internal controls over financial reporting iseffective and meets the criteria of the “Internal Control—Integrated Framework”.    Crowe Chizek and Company LLC, independentregistered public accounting firm, has issued an attestation report dated March6, 2007 on management’s assessment of the Corporation’s internal control overfinancial reporting.

James L. Saner, Sr.

President and ChiefExecutive Officer

James M. Anderson

Senior Vice President andChief Financial Officer

65

----

**Report Of Independent Registered Public AccountingFirm On Internal Controls**
|   |
|--------|
|   | **Crowe Chizek and Company LLC****Member Horwath International** |

 

REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROLS

 

 

We have audited management's assessment, included in theaccompanying *Report on Management’sReport on Internal Control Over Financial Reporting*, that  MainSource FinancialGroup, Inc. maintained effective internal control over**financial reporting as of December 31, 2006,based on criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).  MainSourceFinancial Group, Inc.’s managementis responsible for maintaining effective internal control over financialreporting and for its assessment of the effectiveness of internal control overfinancial reporting.  Our responsibilityis to express an opinion on management's assessment and an opinion on theeffectiveness of the Company's internal control over financial reporting basedon our audit. 

 

We conducted our audit in accordance with the standards of thePublic Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects.  Our audit included obtainingan understanding of internal control over financial reporting, evaluatingmanagement's assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. 

 

A company's internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with U.S. generally accepted accounting principles.  A company's internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2)provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with U. S. generallyaccepted accounting principles, and that receipts and expenditures of thecompany are being made only in accordance with authorizations of management anddirectors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company's assets that could have a material effect on the financialstatements. 

 

Because of its inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate. 

 

As permitted, the Company excluded the three financialinstitutions acquired during 2006 (Union Community Bancorp, HFS Bank, F.S.B.,and Peoples Ohio Financial Corporation) from the scope of management’s reporton internal control over financial reporting. As such, these entities have also been excluded from the scope of ouraudit of internal control over financial reporting.  

 

In our opinion, management's assessment that MainSource FinancialGroup, Inc. maintained effective internal control over financial reporting asof December 31, 2006, is fairly stated, in all material respects, based on criteria established in  *Internal Control—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).  

 

Also in our opinion, MainSource Financial Group, Inc. maintained,in all material respects, effective internal control over financial reportingas of December 31, 2006, based on criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO). 

 

We have also audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States), the consolidatedbalance sheets as of December 31, 2006 and 2005, and the related consolidatedstatements of income, shareholders' equity, and cash flows for each of thethree years in the period ended December 31, 2006 of MainSource FinancialGroup, Inc. and our report dated March 6, 2007 expressed an unqualifiedopinion.

 

 

 

                                                                                                      

                                                                                                      CroweChizek and Company LLC

 

 

Louisville, Kentucky

March 6, 2007

 

 

**ITEM 9B. OTHER INFORMATION**

 

None

66

----

**Part IV**

**ITEM15—EXHIBITS, FINANCIAL STATEMENT SCHEDULES**

(a)(1)  Financial Statements.

FinancialStatements filed as part of this Form 10-K are included under Part II, Item 8,above.

(a)(2)  Financial statement schedules

All schedules are omitted because they are not applicable or notrequired, or because the required information is included in the consolidatedfinancial statements or related notes in Part II, Item 8 above.

(a)(3)  Exhibits:

3.1                               RestatedArticles of Incorporation (incorporated by reference to Exhibit 3.1 to theAnnual Report on Form 10-K of the registrant for the fiscal year ended December31, 2003 filed March 12, 2004 with the Commission (Commission File No.0-12422)).

3.2                               Bylawsof MainSource Financial Group, Inc. dated September 19, 2005 (incorporatedby reference to Exhibit 3 to the Report on Form 8-K of the registrant filedSeptember 22, 2005 with the Commission (Commission File No. 0-12422)).

4.1                               Indenturedated as of December 19, 2002 between the Registrant, as issuer, and StateStreet Bank and Trust Company of Connecticut, N.A., as trustee, re: floatingrate junior subordinated deferrable interest debentures due 2032 (incorporatedby reference to Exhibit 4.6 to the Annual Report on Form 10-K of the registrantfor the fiscal year ended December 31, 2002 filed March 28, 2003 with theCommission (Commission File No. 0-12422)).

4.2                               Amendedand Restated Declaration of Trust dated as of December 19, 2002 among StateStreet Bank and Trust Company of Connecticut, N.A., as institutional trustee,the Registrant, as sponsor, and James L. Saner Sr., Donald A. Benziger andJames M. Anderson, as administrators (incorporated by reference to Exhibit 4.7to the Annual Report on Form 10-K of the registrant for the fiscal year endedDecember 31, 2002 filed March 28, 2003 with the Commission (Commission File No.0-12422)).

4.3                               GuaranteeAgreement dated as of December 19, 2002 between the Registrant, and StateStreet Bank and Trust Company of Connecticut, N.A (incorporated by reference toExhibit 4.8 to the Annual Report on Form 10-K of the registrant for the fiscalyear ended December 31, 2002 filed March 28, 2003 with the Commission(Commission File No. 0-12422)).

4.4                               Indenturedated as of April 1, 2003 between the Registrant, as issuer, and U.S. Bank,N.A., as trustee, re: floating rate junior subordinated deferrable interestdebentures due 2033 (incorporated by reference to Exhibit 4.1 to the QuarterlyReport on Form 10-Q of the registrant for the quarter ended June 30, 2003 filedAugust 14, 2003 with the Commission (Commission File No. 0-12422)).

67

----

4.5                               Amendedand Restated Declaration of Trust dated as of April 1, 2003 among U.S. Bank,N.A., as institutional trustee, the Registrant, as sponsor, and James L. SanerSr., Donald A. Benziger and James M. Anderson, as administrators (incorporatedby reference to Exhibit 4.2 to the Quarterly Report on Form 10-Q of theregistrant for the quarter ended June 30, 2003 filed August 14, 2003 with theCommission (Commission File No. 0-12422)).

4.6                               GuaranteeAgreement dated as of April 1, 2003 between the Registrant, and U.S. Bank, N.A(incorporated by reference to Exhibit 4.3 to the Quarterly Report on Form 10-Qof the registrant for the quarter ended June 30, 2003 filed August 14, 2003 withthe Commission (Commission File No. 0-12422)).

4.7                               Indenturedated as of June 12, 2003 between the Registrant, as issuer, and The Bank ofNew York, as trustee, re: rate junior subordinated deferrable interestdebentures due (incorporated by reference to Exhibit 4.4 to the QuarterlyReport on Form 10-Q of the registrant for the quarter ended June 30, 2003 filedAugust 14, 2003 with the Commission (Commission File No. 0-12422)).

4.8                               Amendedand Restated Declaration of Trust dated as of June 12, 2003 among The Bank ofNew York, as institutional trustee, the Registrant, as sponsor, and James L.Saner Sr., Donald A. Benziger and James M. Anderson, as administrators(incorporated by reference to Exhibit 4.5 to the Quarterly Report on Form 10-Qof the registrant for the quarter ended June 30, 2003 filed August 14, 2003with the Commission (Commission File No. 0-12422)).

4.9                               GuaranteeAgreement dated as of June 12, 2003 between the Registrant, and The Bank of NewYork (incorporated by reference to Exhibit 4.6 to the Quarterly Report on Form10-Q of the registrant for the quarter ended June 30, 2003 filed August 14,2003 with the Commission (Commission File No. 0-12422)).

4.10                         Form of Amended and RestatedDeclaration of Trust dated as of October 13, 2006, of MainSource StatutoryTrust  IV, among MainSource FinancialGroup, Inc. as sponsor, Wells Fargo Delaware Trust Company as Delaware trusteeand Wells Fargo Bank, National Association, as institutional trustee (incorporatedby reference to Exhibit 10.1 to the periodic report on Form 8-K of theregistrant filed October 17, 2006 with the Commission (Commission File No.0-12422)).

4.11                         Form of Indenture dated as ofOctober 13, 2006, between MainSource Financial Group, Inc. and Wells FargoBank, National Association, as trustee (incorporated by reference to Exhibit10.2 to the periodic report on Form 8-K of the registrant filed October 17,2006 with the Commission (Commission File No. 0-12422)).

4.12                         Form of Guarantee Agreementdated as of October 13, 2006, between MainSource Financial Group, Inc., asguarantor, and Wells Fargo Bank, National Association, as guarantee trustee(incorporated by reference to Exhibit 10.3 to the periodic report on Form 8-Kof the registrant filed October 17, 2006 with the Commission (Commission FileNo. 0-12422)).

10.1                         Registrant’s 2003 Stock OptionPlan (incorporated by reference to Exhibit 10.1 to the Annual Report on Form10-K of the registrant for the fiscal year ended December 31, 2003 filed March12, 2004 with the Commission (Commission File No. 0-12422)).*

10.2                         Form of Stock Option AgreementUnder 2003 Stock Option Plan for Directors of Registrant dated May 19, 2003(incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K ofthe registrant for the fiscal year ended December 31, 2003 filed March 12, 2004with the Commission (Commission File No. 0-12422)).*

10.3                         Form of Stock Option AgreementUnder 2003 Stock Option Plan for Officers of Registrant (incorporated byreference to Exhibit 10.1 to the Report on Form 8-K of the registrant filedFebruary 24, 2005 with the Commission (Commission File No. 0-12422)).*

10.4                         Form of Executive SeveranceAgreement dated January 16, 2001 between the Registrant and James L. Saner, Sr.(incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K ofthe registrant for the fiscal year ended December 31, 2000 filed March 30, 2001with the Commission (Commission File No. 0-12422)).*

68

----

10.5                         Form of Executive SeveranceAgreement dated January 16, 2001 between the Registrant and John C. Parker(incorporated by reference to Exhibit 10.4 to the Annual Report on Form 10-K ofthe registrant for the fiscal year ended December 31, 2002 filed March 28, 2003with the Commission (Commission File No. 0-12422)).*

10.6                           Formof Executive Severance Agreement dated January 16, 2001 between Registrantand Daryl R. Tressler.*

10.7                           Formof Change-In-Control Agreement dated February 20, 2007 to be effective January1, 2006, between Registrant and James M. Anderson.*

10.8                         Form of IndemnificationAgreement for Directors and Certain Officers of Registrant (incorporated byreference to Exhibit 10.1 to the Report on Form 8-K of the registrant filedFebruary 24, 2005 with the Commission (Commission File No. 0-12422)).

14                                  Codeof Ethical Conduct (incorporated by reference to Exhibit 14 to the AnnualReport on Form 10-K of the registrant for the fiscal year ended December 31,2003 filed March 12, 2004 with the Commission (Commission File No. 0-12422)).

21            List of subsidiaries of theRegistrant.

23.1         Consent of Crowe Chizek and Company LLC

31.1         Certification pursuant to Section 302 ofSarbanes-Oxley Act of 2002 by Chief Executive Officer

31.2         Certification pursuant to Section 302 ofSarbanes-Oxley Act of 2002 by Chief Financial Officer

The followingexhibits accompany this periodic report pursuant to Section 906 of theSarbanes-Oxley Act of 2002 (the “2002 Act”). These exhibits shall be deemedonly to accompany this periodic report and are not part of this periodicreport, shall not be deemed filed for purposes of the Securities Exchange Actof 1934, and may not be for any purpose other than compliance with the 2002Act.

32.1         Certification pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002, by Chief Executive Officer

32.2         Certification pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002, by Chief Financial Officer

----

* A management contractor compensatory plan or agreement.

(b) Exhibits

Reference is madeto Item 15(a)(3) above.

(c) Schedules

None required

69

----

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned; thereunto duly authorized, on the 12th day of March,2007.
|        | MAINSOURCE FINANCIAL GROUP, INC.    |
|--------|-------------------------------------|
|   |                                |
|   | /s/ James L. Saner, Sr.        |
|   | James L. Saner, Sr., President |
|   | and Chief Executive Officer         |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report onForm 10-K has been signed by the following persons on behalf of theregistrant and in the capacities with the Company and on the dates indicated.
| Signature                     | ** ** | **Capacity**                                                | ** ** | **Date**            |
|-------------------------------|------------|-------------------------------------------------------------|------------|---------------------|
|                          |       |                                                        |       |                |
| /s/ William G.  Barron        |       |                                                        |       |                |
| William G.  Barron            |       | Director                                                    |       | March 12, 2007 |
|                          |       |                                                        |       |                |
| /s/ Brian J.  Crall           |       |                                                        |       |                |
| Brian J. Crall                |       | Director                                                    |       | March 12, 2007 |
|                          |       |                                                        |       |                |
| /s/ Douglas I.  Kunkel        |       |                                                        |       |                |
| Douglas I.  Kunkel            |       | Director                                                    |       | March 12, 2007 |
|                          |       |                                                        |       |                |
| /s/ Philip A.  Frantz         |       |                                                        |       |                |
| Philip A. Frantz              |       | Director                                                    |       | March 12, 2007 |
|                          |       |                                                        |       |                |
| /s/ Rick S.  Hartman          |       |                                                        |       |                |
| Rick S. Hartman               |       | Director                                                    |       | March 12, 2007 |
|                          |       |                                                        |       |                |
| /s/ D.J. Hines                |       |                                                        |       |                |
| D.J. Hines                    |       | Director                                                    |       | March 12, 2007 |
|                          |       |                                                        |       |                |
| /s/ Robert E.  Hoptry         |       |                                                        |       |                |
| Robert E. Hoptry              |       | Director                                                    |       | March 12, 2007 |
|                          |       | Chairman of the Board                                       |       |                |
|                          |       |                                                        |       |                |
| /s/ James M.  Anderson        |       |                                                        |       |                |
| James M.  Anderson            |       | Senior Vice  President &  Chief Financial  Officer |       | March 12, 2007 |
|                          |       |                                                        |       |                |
| /s/ James L.  Saner, Sr. |       |                                                        |       |                |
| James L.  Saner, Sr.     |       | Director                                                    |       | March 12, 2007 |
|                          |       | President & Chief   Executive Officer              |       |                |

 

70

----