STOCK PLANS AND STOCK BASED COMPENSATION

6 Months Ended

Jun. 30, 2012

STOCK PLANS AND STOCK BASED COMPENSATION

STOCK PLANS AND STOCK BASED COMPENSATION

NOTE 2 - STOCK PLANS AND STOCK BASED COMPENSATION

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

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

The following table summarizes stock option activity:

	Six Months Ended June 30, 2012
	Shares		Weighted Average Exercise Price
Outstanding, beginning of year	403,223		$	13.15
Granted	66,000		11.73
Exercised	(10,000	)	(5.40		)
Forfeited or expired	(9,681	)	(13.02		)
Outstanding, period end	449,542		$	13.12
Options exercisable at period end	300,302		$	14.27
Fully vested and expected to vest	439,343		$	13.17

The following table details stock options outstanding:

	June 30, 2012		December 31, 2011
Stock options vested and currently exercisable:
Number	300,302		311,154
Weighted average exercise price	$	14.27	$	14.19
Aggregate intrinsic value	$	549	$	294
Weighted average remaining life (in years)	3.8		4.5

The intrinsic value for stock options is calculated based on the exercise price of the underlying awards and the market price of our common stock as of the reporting date. The Company recorded $31 and $48 in stock compensation expense during the three and six months ended June 30, 2012 and $16 and $33 in stock compensation expense during the three and six months ended June 30, 2011 to salaries and employee benefits. There were 66,000 options granted in the second quarter of 2012.  In order to calculate the fair value of the options granted in 2012, the following weighted-average assumptions were used as of the grant dates:  risk free interest rate of 1.34%, expected option life 7.0 years, expected price volatility 40.5%, and dividend yield of 0.34%.  The weighted average fair value of the options issued in 2012 was $4.91.  There were 6,000 options granted in the first quarter of 2011, 3,500 options in the second quarter of 2011, and 5,000 in the third quarter of 2011.  In order to calculate the fair value of the options granted in 2011, the following weighted-average assumptions were used as of the grant dates:  risk free interest rate of 2.36%, expected option life 7.0 years, expected price volatility 61.4%, and dividend yield of 0.46%.  The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes based stock option valuation model. This model requires the input of subjective assumptions that will usually have a significant impact on the fair value estimate. Expected volatilities are based on historical volatility of the Company’s stock, and other factors. Expected dividends are based on dividend trends and the market price of the Company’s stock price at grant. The Company uses historical data to estimate option exercises within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

Unrecognized stock option compensation expense related to unvested awards for the remainder of 2012 and beyond is estimated as follows:

Year	(in thousands)
July 2012 - December 2012	$	86
2013	105
2014	111
2015	93

During the second quarter of 2012, the Compensation Committee of the Board of Directors of the Company granted restricted stock awards to certain executive officers pursuant to the Company’s annual performance-based incentive bonus plan.  Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the issue date.  The value of the awards was determined by multiplying the award amount by the closing price of a share of Company common stock on the grant date, April 25, 2012 ($11.85).  The stock awards vest as follows — 80% on the second anniversary of the date of grant and 20% on the third anniversary of the date of grant.  A total of 48,061 shares of common stock of the Company were granted.  Total compensation expense for the restricted stock grants was $94 and $129 for the three and six month periods ended June 30, 2012.  The compensation expense for the three and six month periods ended June 30, 2011 was $47 and $47.

During the second quarter of 2011, the Compensation Committee of the Board of Directors of the Company granted restricted stock awards to certain executive officers pursuant to the Company’s annual performance-based incentive bonus plan.  Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the issue date.  The value of the awards was determined by multiplying the award amount by the closing price of a share of Company common stock on the grant date, April 8, 2011 ($9.68).  The stock awards vest as follows — 80% on the second anniversary of the date of grant and 20% on the third anniversary of the date of grant.  A total of 46,244 shares of common stock of the Company were granted.

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

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

As of June 30, 2012, there was $840 of total unrecognized compensation costs related to nonvested restricted stock awards granted under this plan that will be recognized over the remaining vesting period of approximately 2.3 years.  The recognized compensation costs related to this plan were $129 and $37 for the first six months of 2012 and 2011 respectively.

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

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

The expense associated with the directors’ shares was $85 and $166 for the three and six month periods ended June 30, 2012.  For the three and six month periods ended June 30, 2011, the expense was $64 and $64.