10-K 1 msfg-20151231x10k.htm 10-K msfg_Current folio_10K





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

Securities Exchange Act of 1934

For the fiscal year ended December 31, 2015

Commission file number 0‑12422


(Exact name of registrant as specified in its charter)



(State or other jurisdiction
of incorporation or organization)

(I.R.S. Employer
Identification No.)

2105 North State Road 3 Bypass
Greensburg, Indiana 47240
(Address of principal executive offices) (Zip code)

Registrants telephone number, including area code: (812) 663‑6734

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Common shares, no par value

Name of each exchange on which registered
The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:


Indicate by check mark if the registrant is a well‑known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes   No 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes   No 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   No 

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S‑K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10‑K or any amendment to this Form 10‑K. 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non‑accelerated filer, or a smaller reporting company. See definitions of large accelerated filer,  accelerated filer, and smaller reporting company in Rule 12b‑2 of the Exchange Act.





Large accelerated filer

Accelerated filer

Non-accelerated filer
(Do not check if a smaller
reporting company)

Smaller reporting company


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Act). Yes   No 

The aggregate market value (not necessarily a reliable indication of the price at which more than a limited number of shares would trade) of the voting stock held by non‑affiliates of the registrant was $474,661,814 as of June 30, 2015.

As of March 11, 2016, there were outstanding 21,626,196 common shares, without par value, of the registrant.




Part of Form 10-K
Into Which Incorporated

Definitive Proxy Statement for Annual
Meeting of Shareholders to be held
April 27, 2016


Part III (Items 10 through 14)
















Item 1 



Item 1A 

Risk Factors


Item 1B 

Unresolved Staff Comments


Item 2 



Item 3 

Legal Proceedings


Item 4 

Mine Safety Disclosures










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










Item 10

Directors, Executive Officers and Corporate Governance

See below

Item 11

Executive Compensation

See below

Item 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

See below

Item 13

Certain Relationships and Related Transactions and Director Independence

See below

Item 14

Principal Accounting Fees and Services

See below









Item 15 

Exhibits, Financial Statement Schedules


Pursuant to General Instruction G, the information called for by Items 10‑14 is omitted by MainSource Financial Group, Inc. since MainSource Financial Group, Inc. will file with the Commission a definitive proxy statement for its 2016 Annual Meeting of Shareholders pursuant to Regulation 14A not later than 120 days after the close of the fiscal year containing the information required by Items 10‑14.





(Dollar amounts in thousands except per share data)

Cautionary Note Regarding Forward‑Looking Statements

Except for historical information contained herein, the discussion in this Annual Report includes certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Any statement that does not describe historical or current facts is a forward looking statement. These statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “goals,” “targets,” “initiatives,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future conditional verbs such as “may,” “will,” “should,” “would,” and “could.” Actual results and experience could differ materially from the anticipated results or other expectations expressed in the Company’s forward looking statements. The Company disclaims any intent or obligation to update such forward looking statements. Factors which could cause future results to differ from these expectations include the following: general economic conditions; legislative and regulatory initiatives; monetary and fiscal policies of the federal government; deposit flows; the cost of funds; general market rates of interest; interest rates on competing investments; demand for loan products; demand for financial services; changes in accounting policies or guidelines; changes in the quality or composition of the Company’s loan and investment portfolios; the Company’s ability to integrate acquisitions, and other factors, including the risk factors set forth in Item 1A of this Annual Report on Form 10 K and in other reports we file from time to time with the Securities and Exchange Commission. The Company intends the forward looking statements set forth herein to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995.



MainSource Financial Group, Inc. (MainSource or the Company) is an Indiana corporation and bank holding company, within the meaning of the Bank Holding Company Act of 1956, as amended (the BHC Act), that has elected to become a financial holding company (FHC). The Company is based in Greensburg, Indiana. As of December 31, 2015, the Company operated one banking subsidiary: MainSource Bank (the Bank), an Indiana state chartered bank. Through its non‑bank affiliates, the Company provides services incidental to the business of banking. Since its formation in 1982, the Company has acquired and established various institutions and financial services companies and may acquire additional financial institutions and financial services companies in the future. For further discussion of the business of the Company see Managements Discussion and Analysis in Part II, Item 7.

As of December 31, 2015, the Company operated 85 branch banking offices in Indiana, Illinois, Ohio and Kentucky. As of December 31, 2015, the Company had consolidated assets of $3,385,408, consolidated deposits of $2,650,775 and shareholders equity of $381,360.

Through the Bank, the Company offers a broad range of financial services, including: accepting time and transaction deposits; making consumer, commercial, agribusiness and real estate mortgage loans; renting safe deposit facilities; providing personal and corporate trust services; and providing other corporate services such as letters of credit and repurchase agreements.

The lending activities of the Bank are separated into primarily the categories of commercial, commercial real estate, residential, and consumer. Loans are originated by the lending officers of the Bank subject to limitations set forth in lending policies. The Board of Directors of the Bank monitors concentrations of credit, problem and past due loans and charge‑offs of uncollectible loans and approves loan policy. The Bank maintains conservative loan policies and underwriting practices in order to address and manage loan risks. These policies and practices include granting loans on a sound and collectible basis, serving the legitimate needs of the community and the general market area while obtaining a balance between maximum yield and minimum risk, ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan, developing and maintaining adequate diversification of the loan portfolio as a whole and of the loans within each category and developing and applying adequate collection policies.



Commercial loans include secured and unsecured loans, including real estate loans, to individuals and companies and to governmental units predominantly within the market area of the Bank 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 are also made for agricultural production and such loans are generally reviewed annually.

Residential real estate lending has been the largest component of the loan portfolio for many years. The Bank generates residential mortgages for its own portfolio. However, the Company elects to sell the majority of its fixed rate mortgages into the secondary market while maintaining the servicing of such loans. At December 31, 2015,  the Company was servicing a $925 million residential real estate loan portfolio. By originating loans for sale in the secondary market, the Company can more fully satisfy customer demand for fixed rate residential mortgages and increase fee income, while reducing the risk of loss caused by rising interest rates.

The principal source of revenues for the Company is interest and fees on loans, which accounted for 53.9% of total revenues in 2015, 53.9% in 2014 and 53.4% in 2013. While the Companys chief decision makers monitor the revenue streams of the various Company products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company‑wide basis. Accordingly, all of the Companys financial service operations are considered by management to be aggregated in one reportable operating segment.

The Companys investment securities portfolio is primarily comprised of state and municipal bonds; U.S. government sponsored entities mortgage‑backed securities and collateralized mortgage obligations; and corporate securities. The Company has classified its entire investment portfolio as available for sale, with fair value changes reported separately in shareholders equity. Funds invested in the investment portfolio generally represent funds not immediately required to meet loan demand. Income related to the Companys investment portfolio accounted for 14.9% of total revenues in 2015, 16.6% in 2014 and 16.7% in 2013. As of December 31, 2015, the Company had not identified any securities as being high risk as defined by the FFIEC Supervisory Policy Statement on Securities Activities.

The primary source of funds for the Bank is deposits generated in local market areas. To attract and retain stable depositors, the Bank markets various programs for demand, savings and time deposit accounts. These programs include interest and non‑interest bearing demand and individual retirement accounts.

Currently, national retailing and manufacturing subsidiaries, brokerage and insurance firms and credit unions are fierce competitors within the financial services industry. Mergers between financial institutions within Indiana and neighboring states, which became permissible under the Interstate Banking and Branching Efficiency Act of 1994, have also added competitive pressure.

The branches of the Bank are predominantly located in non‑metropolitan areas and the Banks business is centered in loans and deposits generated within markets considered largely rural in nature. In addition to competing vigorously with other banks, thrift institutions, credit unions and finance companies located within their service areas, we also compete, directly and indirectly, with all providers of financial services.


As of December 31, 2015, the Company and its subsidiaries had 841 fulltime equivalent employees to whom they provide a variety of benefits and with whom they enjoy excellent relations. None of our employees are subject to collective bargaining agreements.

Available Information

We make available free of charge on or through our Internet web site, www.mainsourcebank.com, our Annual Report on Form 10‑K, Quarterly Reports on Form 10‑Q and Current Reports on Form 8‑K and all amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). Such materials are also available free of charge on the SEC website,



www.sec.gov. We have included our and the SECs Internet website addresses throughout this Annual Report on Form 10‑K as textual references only. The information contained on these websites is not incorporated into this Annual Report on Form 10‑K.

Regulation and Supervision

The Company is a financial holding company within the meaning of the Bank Holding Company Act of 1956, as amended. As a FHC, the Company is subject to regulation by the Federal Reserve Board (FRB). The Bank is an Indiana state chartered bank subject to supervision and regulation by the Federal Deposit Insurance Corporation (FDIC) and the Indiana Department of Financial Institutions. The following is a discussion of material statutes and regulations affecting the Company and the Bank. The discussion is qualified in its entirety by reference to such statutes and regulations.

Bank Holding Company Act of 1956

Generally, the BHC Act governs the acquisition and control of banks and nonbanking companies by bank holding companies. A bank holding company is subject to regulation by and is required to register with the FRB under the BHC Act. The BHC Act requires a bank holding company to file an annual report of its operations and such additional information as the FRB may require. The FRB has issued regulations under the BHC Act requiring a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. It is the policy of the FRB that, pursuant to this requirement, a bank holding company should stand ready to use its resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity.

The acquisition of 5% or more of the voting shares of any bank or bank holding company generally requires the prior approval of the FRB and is subject to applicable federal and state law, including the Riegle‑Neal Interstate Banking and Branching Efficiency Act of 1994 (Riegle‑Neal) for interstate transactions. The FRB evaluates acquisition applications based on, among other things, competitive factors, supervisory factors, adequacy of financial and managerial resources, and banking and community needs considerations.

The BHC Act also prohibits, with certain exceptions, a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any nonbanking company unless the nonbanking activities are found by the FRB to be so closely related to banking...as to be a proper incident thereto. Under current regulations of the FRB, a bank holding company and its nonbank subsidiaries are permitted, among other activities, to engage in such banking‑related business ventures as consumer finance, equipment leasing, data processing, mortgage banking, financial and investment advice, and securities brokerage services. The BHC Act does not place territorial restrictions on the activities of a bank holding company or its nonbank subsidiaries.

Federal law prohibits acquisition of control of a bank or bank holding company without prior notice to certain federal bank regulators. Control is defined in certain cases as the acquisition of as little as 10% of the outstanding shares of any class of voting stock. Furthermore, under certain circumstances, a bank holding company may not be able to purchase its own stock, where the gross consideration will equal 10% or more of the companys net worth, without obtaining approval of the FRB. Under the Federal Reserve Act, banks and their affiliates are subject to certain requirements and restrictions when dealing with each other (affiliate transactions include transactions between a bank and its bank holding company).

Gramm‑Leach‑Bliley Financial Modernization Act of 1999

The Gramm‑Leach‑Bliley Financial Modernization Act of 1999 (the Modernization Act) was enacted on November 12, 1999. The Modernization Act, which amended the BHC Act,


allows bank holding companies that qualify as financial holding companies to engage in a broad range of financial and related activities;


allows insurers and other financial services companies to acquire banks;




removes various restrictions that applied to bank holding company ownership of securities firms and mutual fund advisory companies; and


establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations.

The Company initially qualified as a financial holding company in December, 2004. Thus the Company is authorized to operate as a financial holding company and is eligible to engage in, or acquire companies engaged in, the broader range of activities that are permitted by the Modernization Act. These activities include those that are determined to be financial in nature, including insurance underwriting, securities underwriting and dealing, and making merchant banking investments in commercial and financial companies. If a banking subsidiary ceases to be well capitalized or well managed under applicable regulatory standards, the FRB may, among other things, place limitations on our ability to conduct these broader financial activities or, if the deficiencies persist, require us to divest the banking subsidiary. In addition, if a banking subsidiary receives a rating of less than satisfactory under the Community Reinvestment Act of 1977 (CRA), we would be prohibited from engaging in any additional activities other than those permissible for bank holding companies that are not financial holding companies.

Bank Secrecy Act and USA Patriot Act

In 1970, Congress enacted the Currency and Foreign Transactions Reporting Act, commonly known as the Bank Secrecy Act (the BSA). The BSA requires financial institutions to maintain records of certain customers and currency transactions and to report certain domestic and foreign currency transactions, which may have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings. Under this law, financial institutions are required to develop a BSA compliance program.

In 2001, the President signed into law comprehensive anti‑terrorism legislation known as the USA Patriot Act. Title III of the USA Patriot Act requires financial institutions, including the Company and the Bank, to help prevent and detect international money laundering and the financing of terrorism and prosecute those involved in such activities. The Department of the Treasury has adopted additional requirements to further implement Title III.

Under these regulations, a mechanism has been established for law enforcement officials to communicate names of suspected terrorists and money launderers to financial institutions to enable financial institutions to promptly locate accounts and transactions involving those suspects. Financial institutions receiving names of suspects must search their account and transaction records for potential matches and report positive results to the U.S. Department of the Treasury Financial Crimes Enforcement Network (FinCEN). Each financial institution must designate a point of contact to receive information requests. These regulations outline how financial institutions can share information concerning suspected terrorist and money laundering activity with other financial institutions under the protection of a statutory safe harbor if each financial institution notifies FinCEN of its intent to share information. The Department of the Treasury has also adopted regulations intended to prevent money laundering and terrorist financing through correspondent accounts maintained by U.S. financial institutions on behalf of foreign banks. Financial institutions are required to take reasonable steps to ensure that they are not providing banking services directly or indirectly to foreign shell banks. In addition, banks must have procedures in place to verify the identity of the persons with whom they deal.

FDIC Improvement Act of 1991

The Federal Deposit Insurance Act, as amended (FDIA), requires among other things, the federal banking agencies to take prompt corrective action in respect of depository institutions that do not meet minimum capital requirements. The FDIA includes the following five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institutions capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The relevant capital measures are the total risk‑based capital ratio, the Tier 1 risk‑based capital ratio, the common equity Tier 1 risk‑based capital ratio, and the leverage ratio.

A bank will be (i) well capitalized if the institution has a total risk‑based capital ratio of 10.0% or greater, a Tier 1 risk‑based capital ratio of 8.0% or greater, a common equity Tier 1 risk‑based capital ratio of 6.5% or greater, and



a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) adequately capitalized if the institution has a total risk‑based capital ratio of 8.0% or greater, a Tier 1 risk‑based capital ratio of 6.0% or greater, a common equity Tier 1 risk‑based capital ratio of 4.5% or greater, and a leverage ratio of 4.0% or greater and is not well capitalized; (iii) undercapitalized if the institution has a total risk‑based capital ratio that is less than 8.0%, a Tier 1 risk‑based capital ratio of less than 6.0%, a common equity Tier 1 risk‑based capital ratio of less than 4.5%, or a leverage ratio of less than 4.0%; (iv) significantly undercapitalized if the institution has a total risk‑based capital ratio of less than 6.0%, a Tier 1 risk‑based capital ratio of less than 4.0%, a common equity Tier 1 risk‑based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%; and (v) critically undercapitalized if the institutions tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A banks capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the banks overall financial condition or prospects for other purposes.

The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be undercapitalized. Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institutions capital. In addition, for a capital restoration plan to be acceptable, the depository institutions parent holding company must guarantee that the institution will comply with such capital restoration plan. The bank holding company must also provide appropriate assurances of performance. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5.0% of the depository institutions total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator.

The appropriate federal banking agency may, under certain circumstances, reclassify a well‑capitalized insured depository institution as adequately capitalized. The FDIA provides that an institution may be reclassified if the appropriate federal banking agency determines (after notice and opportunity for hearing) that the institution is in an unsafe or unsound condition or deems the institution to be engaging in an unsafe or unsound practice. The appropriate agency is also permitted to require an adequately capitalized or undercapitalized institution to comply with the supervisory provisions as if the institution were in the next lower category (but not treat a significantly undercapitalized institution as critically undercapitalized) based on supervisory information other than the capital levels of the institution.

The Company believes that, as of December 31, 2015, the Company and the Bank were each well capitalized based on the aforementioned ratios.

The Sarbanes‑Oxley Act

The Sarbanes‑Oxley Act of 2002 (the Sarbanes‑Oxley Act) represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. Among other requirements, the Sarbanes‑ Oxley Act established: (i) requirements for audit committees of public companies, including independence and expertise standards; (ii) additional responsibilities regarding financial statements for the chief executive officers and chief financial officers of reporting companies; (iii) standards for auditors and regulation of audits; (iv) increased disclosure and reporting obligations for reporting companies regarding various matters relating to corporate governance, and (v) new and increased civil and criminal penalties for violation of the securities laws.



Deposit Insurance Fund

The deposits of the Bank are insured 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 Bank Insurance Fund and the Savings Association Insurance Fund in accordance with the Federal Deposit Insurance Reform Act of 2005 (the FDI Act). The FDIC maintains the DIF by assessing depository institutions an insurance premium. Pursuant to the Dodd‑Frank Act, the FDIC is required to set a DIF reserve ratio of 1.35% of estimated insured deposits and is required to achieve this ratio by September 30, 2020.

Under the FDICs risk‑based assessment system, insured institutions are required to pay deposit insurance premiums based on the risk that each institution poses to the DIF. An institutions risk to the DIF is measured by its regulatory capital levels, supervisory evaluations, and certain other factors. An institutions assessment rate depends upon the risk category to which it is assigned. As noted above, pursuant to the Dodd‑Frank Act, the FDIC will calculate an institutions assessment level based on its total average consolidated assets during the assessment period less average tangible equity (i.e., Tier 1 capital) as opposed to an institutions deposit level which was the previous basis for calculating insurance assessments. Pursuant to the Dodd‑Frank Act, institutions will be placed into one of four risk categories for purposes of determining the institutions actual assessment rate. The FDIC will determine the risk category based on the institutions capital position (well capitalized, adequately capitalized, or undercapitalized) and supervisory condition (based on exam reports and related information provided by the institutions primary federal regulator).


The Company is a legal entity separate and distinct from the Bank. There are various legal limitations on the extent to which the Bank can supply funds to the Company. The principal source of the Companys funds consists of dividends from the Bank. State and Federal law restricts the amount of dividends that may be paid by banks. The specific limits depend on a number of factors, including the banks type of charter, recent earnings, recent dividends, level of capital and regulatory status. The regulators are authorized, and under certain circumstances are required, to determine that the payment of dividends or other distributions by a bank would be an unsafe or unsound practice and to prohibit that payment. For example, the FDI Act generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be undercapitalized.

The Dodd‑Frank Act and its accompanying regulations also limit a depository institutions ability to make capital distributions if it does not hold a 2.5% capital buffer above the required minimum risk‑based capital ratios. Regulators also review and limit proposed dividend payments as part of the supervisory process and review of an institutions capital planning. In addition to dividend limitations, the Bank is subject to certain restrictions on extensions of credit to the Company, on investments in the stock or other securities of the Company and in taking such stock or securities as collateral for loans.

Community Reinvestment Act

The Community Reinvestment Act requires that the federal banking regulators evaluate the records of a financial institution in meeting the credit needs of its local community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could result in the imposition of additional requirements and limitations on the Bank.

The Dodd‑Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, President Obama signed into law the sweeping financial regulatory reform act entitled the Dodd‑Frank Wall Street Reform and Consumer Protection Act  (the “Dodd‑Frank Act). This significant law affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. Various federal agencies are given significant discretion in drafting and implementing a broad range of new rules and regulations, and consequently, while many new rules and regulation have been adopted, many more remain to be adopted.



Certain provisions of Dodd‑Frank are now effective and have been fully implemented, including the revisions in the deposit insurance assessment base for FDIC insurance and the permanent increase in coverage to $250,000; the permissibility of paying interest on business checking accounts; the removal of barriers to interstate branching and required disclosure and shareholder advisory votes on executive compensation. Recent action to implement the final Dodd‑Frank provisions included (i) final new capital rules, (ii) a final rule to implement the so called Volcker rule restrictions on certain proprietary trading and investment activities and (iii) final rules and increased enforcement action by the Consumer Finance Protection Bureau (CFPB).

Key provisions of the Dodd‑Frank Act are as follows:


eliminated the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts.


broadened the base for Federal Deposit Insurance Corporation insurance assessments.


required publicly traded companies to give stockholders a nonbinding vote on executive compensation and so‑called golden parachute payments.


broadened the scope of derivative instruments, and subjected covered institutions to increased regulation of their derivative businesses, including margin requirements, record keeping and reporting requirements, and heightened supervision.


created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. Banks and savings institutions with $10 billion or less in assets will continue to be examined for compliance with consumer laws by their primary bank regulators. The CFPB, along with the Department of Justice and bank regulatory authorities also seek to enforce discriminatory lending laws. In such actions, the CFPB and others have used a disparate impact analysis, which measures discriminatory results without regard to intent.


mandated that debit card and interchange fees be reasonable and proportional to the issuers cost for processing the transaction. The Federal Reserve Board has approved a debit card interchange regulation which caps an issuers base fee at $0.21 per transaction plus an additional fee computed at five basis‑points of the transaction value. These standards apply to issuers that, together with their affiliates, have assets of $10 billion or more. The Companys assets are under $10 billion and therefore it is not directly impacted by these provisions.

S.A.F.E. Act Requirements

Regulations issued under the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (the S.A.F.E. Act) require residential mortgage loan originators who are employees of institutions regulated by the foregoing agencies, including national banks, to meet the registration requirements of the S.A.F.E. Act. The S.A.F.E. Act requires residential mortgage loan originators who are employees of regulated financial institutions to be registered with the Nationwide Mortgage Licensing System and Registry, a database created by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators to support the licensing of mortgage loan originators by the states. Employees of regulated financial institutions are generally prohibited from originating residential mortgage loans unless they are registered.

Regulatory Capital Requirements

In July 2013, the federal banking agencies published the Basel III Capital Rules establishing a new comprehensive capital framework for U.S. banking organizations.  The rules implement the Basel Committee’s December 2010 framework known as “Basel III” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. 




The Basel III Capital Rules became effective on January 1, 2015 (subject to a phase-in period) and, among other things, introduced a new capital measure known as “Common Equity Tier 1” (“CET1”), which generally consists of common equity Tier 1 capital instruments and related surplus, retained earnings, and common equity Tier 1 minority interests (minus certain adjustments and deductions, as discussed below).


The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.  Under the former capital standards, the effects of accumulated other comprehensive income items included in capital were excluded for the purposes of determining regulatory capital ratios.  Under the Basel III Capital Rules, the effects of certain accumulated other comprehensive items are not excluded; however, non-advanced approaches banking organizations, including the Company, may make a one-time permanent election to continue to exclude these items.  The Company and the Bank both made this election in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of the Company’s available-for-sale securities portfolio.  The Basel III Capital Rules also preclude certain hybrid securities, such as trust preferred securities, as Tier 1 capital of bank holding companies, subject to phase-out.  The Company has some trust preferred securities. Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a four-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). 


The Basel III Capital Rules prescribe a standardized approach for risk weightings depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures. Specifics risk-weights impacting the Company’s determination of risk-weighted assets include, among other things:



Applying a 150% risk weight for certain high volatility commercial real estate acquisition, development and construction loans;



Assigning a 150% risk weight to exposures (other than residential mortgage exposures) that are 90 days past due;



Providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; and



Providing for a risk weight, generally not less than 20% with certain exceptions, for securities lending transactions based on the risk weight category of the underlying collateral securing the transaction.


When fully phased in on January 1, 2019, the Basel III Capital Rules will require the Company and its banking subsidiaries to maintain:



a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7% upon full implementation);



a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation);



a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and



a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.


The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be



phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).  The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.


Under the Basel III Capital Rules, the minimum capital ratios, with the capital conversation buffer, as of January 1, 2016 are as follows:



5.125% CET1 to risk-weighted assets;



6.625% Tier 1 capital to risk-weighted assets; and



8.625% Total capital to risk-weighted assets.


Certain regulatory capital ratios for the Company as of December 31, 2015, are shown below:



12.7% CET1 to risk-weighted assets;



14.5% Tier 1 capital to risk-weighted assets;



15.5% Total capital to risk-weighted assets; and



10.2% leverage ratio.


Certain regulatory capital ratios for the Bank as of December 31, 2015, are shown below:



13.6% CET1 to risk-weighted assets;



13.6% Tier 1 capital to risk-weighted assets;



14.5% Total capital to risk-weighted assets; and



9.6% leverage ratio.


Volcker Rule

On December 10, 2013, the Federal Reserve, the Office of the Comptroller of the Currency, the FDIC, the U.S. Commodities Futures Trading Commission and the SEC issued final rules to implement the Volcker Rule contained in section 619 of the Dodd‑Frank Act. On December 15, 2014, the FRB granted a one‑year extension to July 21, 2016, and signaled an intention to grant another one year extension to July 21, 2017 to confirm investments in and relationships with covered funds that were in place prior to December 31, 2013 (“Legacy Convered Funds”).  With respect to all other investments in and relationships with convered funds other than Legacy Covered Funds, the Volcker Rule became effective July 21, 2015.

The Volcker Rule prohibits an insured depository institution and its affiliates from: (i) engaging in proprietary trading and (ii) investing in or sponsoring certain types of funds (covered funds) subject to certain limited exceptions. The rule also effectively prohibits short‑term trading strategies by any U.S. banking entity if those strategies involve instruments other than those specifically permitted for trading and prohibits the use of some hedging strategies.

Under these rules and subject to certain exceptions, banking entities, including the Company and the Bank, will be restricted from engaging in activities that are considered proprietary trading and from sponsoring or investing in certain



entities, including hedge or private equity funds that are considered covered funds. Certain collateralized debt obligations (CDO) securities backed by trust preferred securities were initially defined as covered funds subject to the investment prohibitions of the final rule. Action taken by the Federal Reserve in January 2014 exempted many such securities to address the concern that community banks holding such CDO securities may have been required to recognize losses on those securities. Banks with less than $10 billion in total consolidated assets, such as the Bank, that do not engage in any covered activities, other than trading in certain government agency, state or municipal obligations, do not have any significant compliance obligations under the rules implementing the Volcker Rule.

Office of Foreign Assets Control Regulation

The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others which are administered by the U.S. Treasury Department Office of Foreign Assets Control. Failure to comply with these sanctions could have serious legal and reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.

Incentive Compensation

The Dodd‑Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive‑based payment arrangements at specified regulated entities having at least $1 billion in total assets that encourage inappropriate risks by providing an executive officer, employee, director or principal stockholder with excessive compensation, fees, or benefits that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure of incentive‑based compensation arrangements to regulators. The agencies proposed such regulations in April 2011, but these regulations have not yet been finalized.

In June 2010, the FRB and the FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk‑taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organizations incentive compensation arrangements should (i) provide incentives that do not encourage risk‑taking beyond the organizations ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organizations board of directors. These three principles are incorporated into the proposed joint compensation regulations under The Dodd‑Frank Act, discussed above. The FRB will review, as part of its regular, risk‑focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not large, complex banking organizations. These reviews will be tailored to each organization based on the scope and complexity of the organizations activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organizations supervisory ratings, which can affect the organizations ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk‑management control or governance processes, pose a risk to the organizations safety and soundness and the organization is not taking prompt and effective measures to correct the deficiency.

Future Legislation

In addition to the specific legislation described above, various additional legislation is currently being considered by Congress. This legislation may change banking statutes and the Companys operating environment in substantial and unpredictable ways and may increase reporting requirements and governance. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any potential legislation will be enacted and, if enacted, the effect that it, or any implementing regulations, would have on its business, results of operations, or financial condition.




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

Risks Related to Our Business.

A significant portion of our assets consists of loans, which if not repaid could result in losses to the Company.

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

As of December 31, 2015, our total loan portfolio was approximately $2,155 million or 64% of our total assets. Three major components of the loan portfolio are loans principally secured by real estate, approximately $1,653 million or 77% of total loans; other commercial loans, approximately $445 million or 21% of total loans; and consumer loans, approximately $57 million or 2% of total loans. Our credit risk with respect to our consumer installment loan portfolio and commercial loan portfolio relates principally to the general creditworthiness of individuals and businesses within our local market area. Our credit risk with respect to our residential and commercial real estate mortgage and construction loan portfolio relates principally to the general creditworthiness of individuals and businesses and the value of real estate serving as security for the repayment of the loans. A related risk in connection with loans secured by commercial real estate is the effect of unknown or unexpected environmental contamination, which could make the real estate effectively unmarketable or otherwise significantly reduce its value as security. Continued or worsening declines in the economy could cause additional credit issues, particularly within our residential and commercial real estate mortgage and construction loan portfolio.

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

We maintain an allowance for loan losses at a level estimated by management to be sufficient to cover probable incurred loan losses in our loan portfolio. Loan losses will likely occur in the future and may occur at a rate greater than we have experienced to date. In determining the size of the allowance, our management makes various assumptions and judgments about the collectability of our loan portfolio, including the diversification by industry of our commercial loan portfolio, the effect of changes in the local real estate markets on collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers, the amount of charge‑offs for the period, the amount of nonperforming loans and related collateral security, and the evaluation of our loan portfolio by an external loan review. If our assumptions and judgments prove to be incorrect, our current allowance may not be sufficient and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Additionally, continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside the Companys control, may require an increase in the allowance for loan losses. Federal and state regulators also periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge‑offs, based on judgments different than those of our management. Any increase in our allowance for loan losses or loan charge‑offs could have an adverse effect on our operating results and financial condition. There can be no assurance that our monitoring procedures and policies will reduce certain lending risks or that our allowance for loan losses will be adequate to cover actual losses.

If we foreclose on collateral property, we may be subject to the increased costs associated with ownership of real property, resulting in reduced revenues and earnings.

We may have to foreclose on collateral property to protect our investment and may thereafter own and operate such property, in which case we will be exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to: (i) general or local economic conditions; (ii) neighborhood values; (iii) interest rates; (iv) real estate tax rates; (v) operating expenses of the mortgaged properties; (vi) environmental remediation liabilities; (vii) ability to obtain and maintain



adequate occupancy of the properties; (viii) zoning laws; (ix) governmental rules, regulations and fiscal policies; and (x) acts of God. Certain expenditures associated with the ownership of real estate, principally real estate taxes, insurance, and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of operating real property may exceed the income earned from such property, and we may have to advance funds in order to protect our investment, or we may be required to dispose of the real property at a loss. The foregoing expenditures and costs could adversely affect our ability to generate revenues, resulting in reduced levels of profitability.

Fluctuating interest rates could adversely affect our profitability.

Our profitability is dependent to a large extent upon our net interest income, which is the difference between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities.  Because of the differences in maturities and re-pricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities.  Accordingly, fluctuations in interest rates could adversely affect our net interest margin, and, in turn, our profitability. We manage our interest rate risk within established guidelines and generally seek an asset and liability structure that insulates net interest income from large deviations attributable to changes in market rates. However, our interest rate risk management practices may not be effective in a highly volatile rate environment.


The current unusual interest rate environment poses particular challenges.  Market rates are extremely low right now and the Federal Reserve Board has indicated that it will likely maintain low short-term interest rates for the foreseeable future. The Federal Reserve is also purchasing significant amounts of Treasury and Agency bonds in the public market, lowering yields on these instruments and on most other longer-term fixed income instruments as well.  This extended period of low rates, when combined with keen competition for high-quality borrowers, may cause additional downward pressure on the yield on the Company's loan and investment portfolios. In addition, low rates accelerate prepayment rates on our mortgage-backed securities, which also negatively impacts yields. Since the Company's cost of interest-bearing liabilities is already at record lows, the impact of decreasing asset yields may have a more adverse impact on the Company's net interest income.


New mortgage regulations may adversely impact our business.

Revisions made pursuant to Dodd‑Frank to Regulation Z, which implements the Truth in Lending Act (the “TILA), effective in January 2014, apply to all consumer mortgages (except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans), and mandate specific underwriting criteria and ability to repay requirements for home loans. This may impact our offering and underwriting of single family residential loans in our residential mortgage lending operation and could have a resulting unknown effect on potential delinquencies. In addition, the relatively uniform requirements may make it difficult for regional and community banks to compete against the larger national banks for single family residential loan originations.

We may be required to pay significantly higher Federal Deposit Insurance Corporation (FDIC) premiums in the future.

Insured institution failures during the past several years have significantly increased FDIC loss provisions, resulting in a decline in the designated reserve ratio to historical lows. In addition the Dodd‑Frank Act permanently implemented FDIC insurance coverage for all deposit accounts up to $250,000 and revised the insurance premium assessment base from all domestic deposits to the average of total assets less tangible equity. The minimum reserve ratio of the deposit insurance fund has been increased from 1.15% to 1.35%, with the increase to be covered by assessments on insured institutions with assets over $10 billion until the new reserve ratio is reached.

We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels. Additionally, the FDIC may make material changes to the calculation of the prepaid assessment from the current proposal. Any future changes in the calculation or assessment of FDIC insurance premiums may have a material adverse effect on our results of operations, financial condition and our ability to continue to pay dividends on our common shares at the current rate or at all.



Future growth or operating results may require the Company to raise additional capital but that capital may not be available or it may be dilutive.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. To the extent our future operating results erode capital or we elect to expand through loan growth or acquisition we may be required to raise capital. Our ability to raise capital will depend on conditions in the capital markets, which are outside of our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise capital if needed or on favorable terms. If we cannot raise additional capital when needed, we will be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These could negatively impact our ability to operate or further expand our operations through acquisitions or the establishment of additional branches and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our financial condition and results of operations.

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

We are and will continue to be dependent upon the services of our management team. The loss of any of our senior managers could have an adverse effect on our growth and performance because of their skills, knowledge of the markets in which we operate and years of industry experience and the difficulty of promptly finding qualified replacement personnel. The loss of key personnel in a particular market could have an adverse effect on our performance in that market because it may be difficult to find qualified replacement personnel who are already located in or would be willing to relocate to a non‑metropolitan market. Additionally, recent regulations issued by banking regulators regarding executive compensation may impact our ability to compensate executives and, as a result, to attract and retain qualified personnel.

The geographic concentration of our markets makes our business highly susceptible to local economic conditions.

Unlike larger banking organizations that are more geographically diversified, our operations are currently concentrated in 31 counties in Indiana, three counties in Illinois, four counties in Ohio, and five counties in Kentucky. As a result of this geographic concentration in four fairly contiguous markets, our financial results depend largely upon economic conditions in these market areas. A deterioration in economic conditions in one or all of these markets could result in one or more of the following:


an increase in loan delinquencies;


an increase in problem assets and foreclosures;


a decrease in the demand for our products and services; or


a decrease in the value of collateral for loans, especially real estate, in turn reducing customers borrowing power, the value of assets associated with problem loans and collateral coverage.

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

We face substantial competition for deposit, credit and trust relationships, as well as other sources of funding in the communities we serve. Competing providers include other banks, thrifts and trust companies, insurance companies, mortgage banking operations, credit unions, finance companies, money market funds and other financial and nonfinancial companies which may offer products functionally equivalent to those offered by the Bank. Competing providers may have greater financial resources than we do and offer services within and outside the market areas we serve. In addition to this challenge of attracting and retaining customers for traditional banking services, our competitors now include securities dealers, brokers, mortgage bankers, investment advisors and finance and insurance companies who seek to offer one‑stop financial services to their customers that may include services that banks have not been able or allowed to offer to their customers in the past. The increasingly competitive environment is primarily a result of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial service providers. If



we are unable to adjust both to increased competition for traditional banking services and changing customer needs and preferences, it could adversely affect our financial performance and your investment in our common stock.

The operations of our business, including our interaction with customers, are increasingly done via electronic means, and this has increased our risks related to cybersecurity and data security. 


The Company relies heavily on internal and outsourced digital technologies, communications, and information systems to conduct its business. As the Company's reliance on technology systems increases, the potential risks of technology-related operation interruptions in the Company's customer relationship management, general ledger, deposit, loan, or other systems or the occurrence of cyber and data security incidents also increases. Cyber and data security incidents can result from deliberate attacks or unintentional events including, among other things, (i) gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing potentially debilitating operational disruptions; (ii) causing denial-of-service attacks on websites; or (iii) intelligence gathering and social engineering aimed at obtaining information. The occurrence of an operational interruption, cyber incident, data security breach or other deficiency in the security of the Company's technology systems (internal or outsourced) could negatively impact the Company's financial condition or results of operations.


The Company has policies and procedures expressly designed to prevent or limit the effect of a failure, interruption, or security breach of its systems and maintains cyber security insurance. Significant interruptions to the Company's business from technology issues could result in expensive remediation efforts and distraction of management. The Company invests in security and controls to prevent and mitigate incidents. Although the Company has not experienced any material losses related to a technology-related operational interruption, cyber-attack, or data security breach, there can be no assurance that such failures, interruptions, or security breaches will not occur in the future or, if they do occur, that the impact will not be substantial.


The occurrence of any failures, interruptions, or security breaches of the Company's technology systems could damage the Company's reputation, result in a loss of customer business, result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of proprietary information, subject the Company to additional regulatory scrutiny, or expose the Company to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company's business, financial condition, and results of operations, as well as its reputation or stock price. As cyber and data security threats continue to evolve, the Company expects it will be required to spend significant resources on an ongoing basis to continue to modify and enhance its protective measures and to investigate and remediate any information security vulnerabilities.

Negative perception of the Company through social media may adversely affect the Company’s reputation and business. 

The Company’s reputation is critical to the success of its business. The Company believes that its brand image has been well received by customers, reflecting the fact that the brand image, like the Company’s business, is based in part on trust and confidence. The Company’s reputation and brand image could be negatively affected by rapid and widespread distribution of publicity through social media channels. The Company’s reputation could also be affected by the Company’s association with clients affected negatively through social media distribution, or other third parties, or by circumstances outside of the Company’s control. Negative publicity, whether true or untrue, could affect the Company’s ability to attract or retain customers, or cause the Company to incur additional liabilities or costs, or result in additional regulatory scrutiny.

Acquisitions entail risks which could negatively affect our operations.

Acquisitions involve numerous risks, including:


exposure to asset quality problems of the acquired institution;


maintaining adequate regulatory capital;


diversion of managements attention from other business concerns;




risks and expenses of entering new geographic markets;


potential significant loss of depositors or loan customers from the acquired institution; or


exposure to undisclosed or unknown liabilities of an acquired institution.

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

Unanticipated costs related to our acquisitions could reduce our future earnings per share.

We believe we have reasonably estimated the likely costs of integrating the operations of the banks we acquire into the Company and the incremental costs of operating such banks as a part of the MainSource family. However, it is possible that unexpected transaction costs such as taxes, fees or professional expenses or unexpected future operating expenses, such as increased personnel costs or increased taxes, as well as other types of unanticipated adverse developments, could have a material adverse effect on the results of operations and financial condition of MainSource. If unexpected costs are incurred, acquisitions could have a dilutive effect on our earnings per share. Current accounting guidance requires expensing of acquisition costs. In prior years, these costs could be capitalized. In other words, if we incur such unexpected costs and expenses as a result of our acquisitions, we believe that the earnings per share of our common stock could be less than they would have been if those acquisitions had not been completed.

We may be unable to successfully integrate the operations of the banks we have acquired and may acquire in the future and retain employees of such banks.

Our acquisition strategy involves the integration of the banks we have acquired and may acquire in the future as MainSource subsidiary banks. The difficulties of integrating the operations of such banks with MainSource and its other subsidiary banks include:


coordinating geographically separated organizations;


integrating personnel with diverse business backgrounds;


combining different corporate cultures; or


retaining key employees.

The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of one or more of the Company, our subsidiary banks and the banks we have acquired and may acquire in the future and the loss of key personnel. The integration of such banks as MainSource subsidiary banks requires the experience and expertise of certain key employees of such banks who we expect to retain. We cannot be sure, however, that we will be successful in retaining these employees for the time period necessary to successfully integrate such banks operations as subsidiary banks of MainSource. The diversion of managements attention and any delays or difficulties encountered in connection with the mergers, along with the integration of the banks as MainSource subsidiary banks, could have an adverse effect on our business and results of operation.

Risks Relating to the Banking Industry

Changes in governmental regulation and legislation could limit our future performance and growth.

We are subject to extensive state and federal regulation, supervision and legislation that governs almost all aspects of our operations, as well as any acquisitions we may propose to make. Any change in applicable federal or state laws or regulations could have a substantial impact on us, our subsidiary banks and our operations. While we cannot predict what



effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could reduce the value of your investment.

The implementation of final rules under the many provisions of Dodd‑ Frank Act could adversely affect us.

Regulation of the financial services industry is undergoing major changes from the enactment and ongoing implementation of Dodd‑Frank. Certain provisions of Dodd‑Frank are effective and have been fully implemented, including the revisions in the deposit insurance assessment base for FDIC insurance and the permanent increase in FDIC coverage to $250,000; the permissibility of paying interest on business checking accounts; the removal of remaining barriers to interstate branching and required disclosure and shareholder advisory votes on executive compensation. Other recent actions to implement the final Dodd‑ Frank provisions include (i) final new capital rules; (ii) a final rule to implement the Volcker Rule restrictions on certain proprietary trading and investment activities; and (iii) the promulgation of final rules and increased enforcement action by the CFPB. The full implementation of certain final rules is delayed or phased in over several years; therefore, as yet we cannot definitively assess what may be the short or longer term specific or aggregate effect of the full implementation of Dodd‑Frank on us.

Changes in regulation or oversight may have a material adverse impact on our operations.

We are subject to extensive regulation, supervision and examination by the Indiana Department of Financial Institutions, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, the Securities and Exchange Commission and other regulatory bodies. Such regulation and supervision governs the activities in which we may engage. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, investigations and limitations related to our securities, the classification of our assets and determination of the level of our allowance for loan losses. In light of the recent conditions in the U.S. financial markets and economy, Congress and regulators have increased their focus on the regulation of the financial services industry. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material adverse impact on our business, financial condition or results of operations.

Difficult conditions in the capital markets and the economy generally have affected and may continue to materially adversely affect our business and results of operations.

From 2007 through 2009, the U.S. economy was in recession. Business activity across a wide range of industries and regions in the U.S. was greatly reduced. Although economic conditions have improved, certain sectors, such as real estate, remain weak and unemployment remains high. Local governments and many businesses are still in serious difficulty due to lower consumer spending and the lack of liquidity in the credit markets. The Companys financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services that the Company offers, is highly dependent upon the business environment in the markets where the Company operates and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters, or a combination of these or other factors.

During 2014 and 2015, the business environment continued to be adverse for many households and businesses in the United States and worldwide. While economic conditions in the United States and worldwide have begun to improve, there can be no assurance that this improvement will continue. Such conditions have affected, and could continue to adversely affect, the credit quality of the Companys loans, results of operations and financial condition.



Changes in consumer use of banks and changes in consumer spending and savings habits could adversely affect our financial results.

Technology and other changes now allow many customers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and savings habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.

Our earnings could be adversely impacted by incidences of fraud and compliance failure.

Financial institutions are inherently exposed to fraud risk and compliance risk. A fraud can be perpetrated by a customer of MainSource, an employee, a vendor, or members of the general public. We are most subject to fraud and compliance risk in connection with the origination of loans, ACH transactions, ATM transactions and checking transactions. Our largest fraud risk, associated with the origination of loans, includes the intentional misstatement of information in property appraisals or other underwriting documentation provided to us by third parties. Compliance risk is the risk to earnings or capital from noncompliance with laws, rules, and regulations. We face risk of noncompliance and enforcement actions under the BSA and other anti-money laundering statutes and regulations. The BSA requires banks and other financial institutions to, among other things, develop and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. If our policies, procedures and internal controls are deemed deficient, we could face money penalties as well as serious reputational consequences. There can be no assurance that we can prevent or detect acts of fraud or violation of law or our compliance standards by our employees or the other parties with whom we conduct business. Repeated incidences of fraud or compliance failures would adversely impact our reputation, the performance of our loan portfolio, and our earnings.

Risks Related to the Companys Stock

We may not be able to pay dividends in the future in accordance with past practice.

The Company has traditionally paid a quarterly dividend to common stockholders. The Company is a separate legal entity from the Bank and receives substantially all of its revenue and cash flow from dividends paid by the Bank to the Company. Indiana state law and agreements between the Bank and its federal and state regulators may limit the amount of dividends that the Bank may pay to the Company. In the event that the Bank is unable to pay dividends to the Company for an extended period of time, the Company may not be able to service its debt obligations or pay dividends on its common stock. Additionally, any payment of dividends in the future will depend, in large part, on the Banks earnings, capital requirements, financial condition and other factors considered relevant by the Companys Board of Directors. Starting in the second quarter of 2009 and continuing to the second quarter of 2012, the Company reduced the amount of cash dividends paid. This reduction was made to preserve capital levels at the Company. Beginning in the third quarter of 2012, the Company has steadily raised the dividend, including an increase to $0.11 per common share in the third quarter of 2014,  $0.13 per common share in the first quarter of 2015, $0.14 per common share in the third quarter of 2015, and announced a $0.15 per common share dividend in the first quarter of 2016.  There can be no assurance that the Company will continue to raise the amount of the dividend or that it will not decrease or eliminate the dividend in the future.

The price of the Companys common stock may be volatile, which may result in losses for investors.

General market price declines or market volatility in the future could adversely affect the price of the Companys common stock. In addition, the following factors may cause the market price for shares of the Companys common stock to fluctuate:


announcements of developments related to the Companys business;


fluctuations in the Companys results of operations;




sales or purchases of substantial amounts of the Companys securities in the marketplace;


general conditions in the Companys banking niche or the worldwide economy;


a shortfall or excess in revenues or earnings compared to securities analysts expectations;


changes in analysts recommendations or projections; and


the Companys announcement of new acquisitions or other projects.

The Companys charter documents and federal regulations may inhibit a takeover, or prevent a transaction that may favor or otherwise limit the Companys growth opportunities, which could cause the market price of the Companys common stock to decline.

Certain provisions of the Companys charter documents and federal regulations could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. In addition, the Company must obtain approval from regulatory authorities before acquiring control of any other company.




As of December 31, 2015, the Company leased an office building located in Greensburg, Indiana, from one of its subsidiaries for use as its corporate headquarters. The Companys subsidiaries own, or lease, all of the facilities from which they conduct business. All leases are comparable to other leases in the respective market areas and do not contain provisions materially detrimental to the Company or its subsidiaries. As of December 31, 2015 the Company had 85 banking locations. At December 31, 2015, the Company had approximately $62,973 invested in premises and equipment.


The Company and its subsidiaries may be parties (both plaintiff and defendant) to ordinary litigation incidental to the conduct of business. A putative stockholder class action lawsuit has been filed against Cheviot, the directors of Cheviot and MainSource in the Court of Common Pleas, Hamilton County, Ohio, Civil Division (the "Ohio Action"). In the Ohio Action, the plaintiff alleges that the directors of Cheviot breached their fiduciary duties of due care, independence, good faith and fair dealing to the stockholders of Cheviot, that the consideration to be received by the stockholders is inadequate and undervalues Cheviot, that the Merger Agreement includes improper deal-protection devices that purportedly lock up the Merger and may operate to prevent other bidders from making successful competing offers for Cheviot, and that the deal protection devices unreasonably inhibit the ability of the directors of Cheviot to act with respect to investigating and pursuing superior proposals and alternatives. The complaint further alleges that Cheviot and MainSource aided and abetted the alleged breaches of fiduciary duty by the directors of Cheviot. The plaintiff seeks an order that the matter may be maintained as a class action, preliminary and permanent injunctive relief, including enjoining or rescinding the Merger, and an award of unspecified damages, attorneys' fees and other relief.


Not applicable.






Market Information

The Companys Common Stock is traded on the NASDAQ Global Select Market under the symbol MSFG. The Common Stock was held by approximately 6,000 shareholders at March 11, 2016. The quarterly high and low closing prices for the Companys common stock as reported by NASDAQ and quarterly cash dividends declared and paid are set forth in the tables below. All per share data is retroactively restated for all stock dividends and splits.

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

















Market Prices
















































































































Cash Dividends








































































It is expected that the Company will continue to consider the Companys results of operations, capital levels and other external factors beyond managements control in making the decision to maintain or further raise the dividend.

Issuer Purchases of Equity Securities

The Company purchased the following equity securities of the Company during the quarter ended December 31, 2015:

















Total Number of Shares


Maximum Number (or








(or Units) Purchased as


Approximate Dollar Value)




Total Number




Part of Publicly


of Shares (or Units) That




of Shares (or


Average Price Paid Per


Announced Plans or


May Yet Be Purchased




Units) Purchased


Share (or Unit)


Programs (1)


Under the Plans or Programs


October 131, 2015










November 130, 2015







December 131, 2015


















On December 19, 2014, the Company announced that its Board of Directors authorized a stock repurchase program effective January 1, 2015, pursuant to which up to 5.0% of the Corporations outstanding shares of common stock, or approximately 1,085,000 shares, could be repurchased. The stock repurchase plan expired on December 31, 2015.  



Stock Performance Graph

The following performance graph compares the performance of our common shares to the performance of the NASDAQ Market Index (U.S.) and the NASDAQ Bank Stocks Index for the 60 months ended December 31, 2015. The graph assumes an investment of $100 in each of the Companys common shares, the NASDAQ Market Index (U.S.) and the NASDAQ Bank Stocks Index on December 31, 2010.

Picture 2





























MainSource Financial Group




























NASDAQ Bank Stocks Index




















Selected Financial Data

(Dollar amounts in thousands except per share data)






























Results of Operations

















Net interest income

















Provision for loan losses

















Noninterest income

















Noninterest expense

















Income before income tax

















Income tax

















Net income

















Preferred dividends and accretion

















Net income available to common shareholders

















Dividends paid on common stock

















Per Common Share*

















Earnings per share (basic)

















Earnings per share (diluted)

















Dividends paid

















Book value — end of period

















Tangible book value — end of period

















Market price — end of period

















At Year End

















Total assets


































Loans, excluding held for sale

















Allowance for loan losses

















Total deposits

















Federal Home Loan Bank advances

















Subordinated debentures

















Shareholders’ equity

















Financial Ratios

















Return on average assets

















Return on average common shareholders’ equity

















Allowance for loan losses to total loans (year end, excluding held for sale)

















Allowance for loan losses to total non-performing loans (year end)

















Shareholders’ equity to total assets (year end)

















Average equity to average total assets

















Dividend payout ratio


















*   Adjusted for stock split and dividends


Tangible book value per share is a non-GAAP financial measure calculated using GAAP amounts.  Tangible book value per share is calculated by dividing tangible common equity by the number of shares outstanding.  Tangible common equity is calculated by excluding the balance of preferred stock, goodwill, and other intangible assets from the calculation



of stockholders' equity.  The Company believes that this non-GAAP financial measure provides more information to investors that is useful in understanding its financial condition.  Because not all companies use the same calculation of tangible common  equity, this presentation may not be comparable to other similarly titled measures calculated by other companies.

A reconciliation of this non-GAAP financial measures is provided below.






























Shareholders' Equity

















Less: Preferred Stock

















Intangible Assets

















Tangible Common Equity


































Ending Shares Outstanding


































Tangible Book Value Per Common Share


















The allowance for loan losses to total loans ratio at December 31, 2015 includes The Merchants Bank and Trust Company and Old National Bank loans brought over at fair value with no associated allowance.    The allowance for loan losses to total loans ratio at December 31, 2014 includes The Merchants Bank and Trust Company loans brought over at fair value with no associated allowance. See Note 26 to the Consolidated Financial Statements for additional information concerning acquisitions by the Company.




Management’s Discussion and Analysis

(Dollar amounts in thousands except per share data)


MainSource Financial Group, Inc. is a financial holding company whose principal activity is the ownership and management of its wholly owned subsidiary bank: MainSource Bank headquartered in Greensburg, Indiana.  The Bank operates under an Indiana state charter and is subject to regulation by the Indiana Department of Financial Institutions and the Federal Deposit Insurance Corporation. Non banking subsidiaries include MainSource Insurance, LLC, Insurance Services Marketing, LLC, MainSource Title, LLC, MainSource Risk Management, Inc., and New American Real Estate, LLC. The first three subsidiaries are subject to regulation by the Indiana Department of Insurance.

Business Strategy

The Company operates under the broad tenets of a long‑term strategic plan (“Plan”) designed to improve the Company’s financial performance, expand its competitive position and enhance long‑term shareholder value. The Plan is premised on the belief of the Company’s Board of Directors that it can best promote long‑term shareholder interests by pursuing strategies which will continue to preserve its community‑focused philosophy. The dynamics of the Plan assure continually evolving goals, with the enhancement of shareholder value being the constant, overriding objective. The extent of the Company’s success will depend upon how well it anticipates and responds to competitive changes within its markets, the interest rate environment and other external forces.



Results of Operations

Net income attributable to common shareholders was $35,542 in 2015, $28,996 in 2014, and $25,693 in 2013. Earnings per common share on a fully diluted basis were $1.62 in 2015,  $1.39 in 2014, and $1.26 in 2013. The primary drivers that led to the increase in net income in 2015 versus 2014 were an increase in net interest income of $8,237,  increases in mortgage banking of $1,601, interchange income of $1,649, service charge income of $1,341, swap fee income of $674, and securities gains of $362 as well as reductions in acquisition related expenses of $2,388 and consultant expenses of $294. An increase in earning assets (primarily loans) and a continued slight reduction in interest costs resulted in higher net interest income. Continued emphasis on new deposit generation as well as a full year effect of the MBT Bancorp acquisition and partial year effect of the Old National Branch branch acquisitions led to increased service charge and interchange income. The low interest rate environment spurred new home sales as well as refinancing activity.  Favorable pricing in 2015 allowed the Company to realize higher securities gain.  The Company started offering derivative products to some of its commercial customers in 2015 that generated fee income.  The costs incurred in acquiring the five Old National branches in 2015 were siginificantly less than the costs incurred for the MBT Bancorp acquisition in 2014. Offsetting these increases were increases in salaries and employee benefits of $3,609, net occupancy expenses of $698, equipment expenses of $1,023, FHLB advance prepayment penalty of $2,364, and interchange expenses of $332.  The full year effect of the MBT Bancorp acquisition and the partial year effect of the Old National branch acquisition led to increases in salaries and employee benefits, net occupancy, and equipment expenses.  The increase in interchange expense is a direct result of higher interchange income in 2015.

The primary drivers that led to the increase in net income in 2014 versus 2013 were an increase in net interest income of $3,188, a smaller provision for loan losses of $3,034, an increase in service charge income of $271, an increase in interchange income of $534, reduced losses on OREO sales of $386, a reduction in marketing expenses of $473, a reduction in collection expenses of $1,970 and a prepayment penalty of $2,239 on a FHLB advance that was incurred in 2013. An increase in earning assets (primarily loans) and a continued reduction in interest costs resulted in higher net interest income. Improvements in collection efforts led to a reduction in problem credits which resulted in lower loan loss provision expense needed, a reduction in collection expenses, and lower losses on the sale of OREO properties. Continued emphasis on new deposit generation led to increased service charge and interchange income. The reduction in marketing costs was due to fewer initiatives undertaken in 2014. Offsetting these increases were lower securities gains in 2014 of $811, higher salary and employee benefit costs of $1,967, higher occupancy costs of $489, higher equipment expenses of $406, higher interchange expenses of $369, and conversion costs incurred in 2014 as a result of the acquisition of MBT Bancorp of $3,119. The higher salary and employee benefit costs, occupancy expenses, and equipment expenses were related to the Company’s entry into new markets in 2014. The increase in interchange expenses is a direct result of higher interchange income in 2014.

Net Interest Income

Net interest income and net interest margin are influenced by the volume and yield or cost of earning assets and interest‑bearing liabilities. Tax equivalent net interest income of $109,939 in 2015 increased from $101,224 in 2014. Net interest margin, on a fully‑taxable equivalent basis, was 3.74% for 2015 compared to 3.82% for the same period a year ago. The Company was unable to match reductions in its yield on earning assets with a corresponding reduction in its cost of funds, as the cost of funds has essentially floored. The Company experienced loan growth in 2015 which partially offset the reduction in its yield. The Company was also able to slightly lower the interest paid on deposit accounts.



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

Average Balance Sheet and Net Interest Analysis (Taxable Equivalent Basis)*





































































































Short-term investments


























Federal funds sold and money market accounts








































































































Total securities














































































Residential real estate




















































Total loans


























Total earning assets


























Cash and due from banks


























Unrealized gains (losses) on securities


























Allowance for loan losses


























Premises and equipment, net


























Intangible assets


























Accrued interest receivable and other assets


























Total assets




















































Interest-bearing deposits DDA, savings, and money market accounts


























Certificates of deposit


























Total interest-bearing deposits


























Short-term borrowings


























Subordinated debentures


























Notes payable and FHLB borrowings


























Total interest-bearing liabilities


























Demand deposits


























Other liabilities


























Total liabilities


























Shareholders’ equity


























Total liabilities and shareholders’ equity


























Net interest income


























Conversion of tax exempt income to a fully taxable equivalent basis using a marginal rate of 35%


























Security yields are calculated based on amortized cost.

*Adjusted to reflect income related to securities and loans exempt from Federal income taxes.

**          Non-accruing loans have been included in the average balances.

***        Total interest expense divided by total earning assets.

****      Net interest income divided by total earning assets.