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:

	Three Months Ended March 31, 2013
	Shares		Weighted Average Exercise Price
Outstanding, beginning of year	433,132		$	13.06
Granted	2,500		14.24
Exercised	(15,000	)	7.40
Forfeited or expired	(1,000	)	11.85
Outstanding, period end	419,632		$	13.27
Options exercisable at period end	329,622		$	13.81
Fully vested and expected to vest	411,602		$	13.30

The following table details stock options outstanding:

	March 31, 2013		December 31, 2012
Stock options vested and currently exercisable:
Number	329,622		344,722
Weighted average exercise price	$	13.81	$	13.53
Aggregate intrinsic value	$	931	$	826
Weighted average remaining life (in years)	3.8		4.1

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 $36 in stock compensation expense during the three month ended March 31, 2013 and $17 in stock compensation expense during the three months ended March 31, 2012 to salaries and employee benefits. There were 2,500 options granted in the first quarter of 2013. In order to calculate the fair value of the options granted in 2013, the following weighted-average assumptions were used as of the grant dates: risk free interest rate of 1.26%, expected option life 7.0 years, expected price volatility 34.5%, and dividend yield of 1.69%. 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 2013 and beyond is estimated as follows:

Year	(in thousands)
April 2013 - December 2013	$	108
2014	120
2015	113
2016	3

During the second quarters of 2011 and 2012, the Compensation Committee of the Board of Directors of the Company granted restricted stock awards in lieu of cash awards to certain executive officers pursuant to the Company’s annual performance-based incentive bonus plan. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the issue date. The value of the awards was determined by multiplying the award amount by the closing price of a share of Company common stock on the grant date, April 25, 2012 ($11.85) and April 8, 2011 ($9.68). The stock awards vest as follows — 80% on the second anniversary of the date of grant and 20% on the third anniversary of the date of grant. A total of 48,061 shares of common stock of the Company were granted in 2012. Total compensation expense for the restricted stock grants was $105 and $35 for the first three months of 2013 and 2012 respectively.

A summary of changes in the Company’s nonvested shares for the first quarter of 2013 follows:

	Shares	Weighted Average Grant Date Fair Value

Nonvested at January 1, 2013	94,305	10.79

Granted	0	$	0

Vested	0	0

Forfeited	0	0

Nonvested at March 31, 2013	94,305	$	10.79

As of March 31, 2013, there were $640 of total unrecognized compensation costs related to nonvested restricted stock awards granted under the 2007 Plan that will be recognized over the remaining vesting period of approximately 1.5 years.

During the second quarter of 2011, members of the Board of Directors of the Company were given the option of having their retainer paid in cash, Company stock, or a combination of cash and stock. The retainer is paid quarterly, on May 1, August 1, November 1, and February 1, 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 paid in stock were 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. The shares issued vest immediately. Shares awarded by quarter were as follows:

Quarter	Year	Shares	Price Per Share
2 Q	2011	6,750	$	9.53
3 Q	2011	7,902	$	8.80
4 Q	2011	9,130	$	9.44
1Q	2012	8,750	$	9.29
2Q	2012	7,200	$	11.83
3Q	2012	7,200	$	11.58
4Q	2012	7,200	$	12.25
1Q	2013	7,200	$	13.38