| MAINSOURCE FINANCIAL GROUP ITEM 1A RISK FACTORS 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 |
| Our historical growth and financial performance trends may not continue if our acquisition strategy is not successful |
| Growth in asset size and earnings through acquisitions is an important and continuing part of our business strategy |
| As consolidation of the banking industry continues, the competition for suitable acquisition candidates may increase |
| We compete with other banking companies for acquisition opportunities, and many of these competitors have greater financial resources and acquisition experience than we do and may be able to pay more for an acquisition than we are able or willing to pay |
| We also may need additional debt or equity financing in the future to fund acquisitions |
| We may not be able to obtain additional financing or, if available, it may not be in amounts and on terms acceptable to us |
| We may use our common stock as the consideration for an acquisition or we may issue additional common stock and use the proceeds for the acquisition |
| Our issuance of additional securities will dilute your equity interest in us and may have a dilutive effect on our earnings per share |
| If we are unable to locate suitable acquisition candidates willing to sell on terms acceptable to us, or we are otherwise unable to obtain additional debt or equity financing necessary for us to continue our acquisition strategy, we would be required to find other methods to grow our business and we may not grow at the same rate we have in the past, or at all |
| 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 management’s 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; and • 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 acquisition strategy could reduce MainSource’s future earnings per share |
| MainSource believes it has reasonably estimated the likely costs of integrating the operations of the banks it acquires into MainSource 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 MainSource’s earnings per share |
| In other words, if MainSource incurs such unexpected costs and expenses as a result of its acquisitions, MainSource believes that the earnings per share of MainSource common stock could be less than they would have been if those acquisitions had not been completed |
| MainSource may be unable to successfully integrate the operations of the banks it is acquiring and retain employees of such banks |
| 7 ______________________________________________________________________ MainSource’s acquisition strategy involves the integration of the banks MainSource is acquiring 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; and • 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 MainSource, its subsidiary banks and the banks MainSource is acquiring and the loss of key personnel |
| The integration of such banks as MainSource subsidiary banks will require the experience and expertise of certain key employees of such banks who are expected to be retained by MainSource |
| We cannot be sure, however, that MainSource 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 management’s 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 the business and results of operation of MainSource |
| Like most banking organizations, our business is highly susceptible to credit risk |
| 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, 2005, our total loan portfolio was approximately dlra958 million or 58prca of our total assets |
| Three major components of the loan portfolio are loans principally secured by real estate, approximately dlra662 million or 68prca of total loans, other commercial loans, approximately dlra149 million or 16prca of total loans, and consumer loans, approximately dlra123 million or 13prca 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 |
| 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 in an attempt to cover loan losses inherent in our loan portfolio |
| Additional 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 collectibility of our loan portfolio, including the diversification by industry of our commercial loan portfolio, the effect of changes in the local real estate market 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 |
| 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 |
| 8 ______________________________________________________________________ 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, including James L Saner, Sr, our President and Chief Executive Officer, James M Anderson, our Senior Vice President and Chief Financial Officer, the presidents of our subsidiary banks and our other senior managers |
| Saner or Mr |
| Anderson, or any of our other 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 |
| Significant interest rate volatility could reduce our profitability |
| Our results of operations are affected principally by net interest income, which is the difference between interest earned on loans and investments and interest expense paid on deposits and other borrowings |
| We cannot predict or control changes in interest rates |
| National, regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Board of Governors of the Federal Reserve System, affect market interest rates |
| While we have instituted policies and procedures designed to manage the risks from changes in market interest rates, at any given time our assets and liabilities will likely be affected differently by a given change in interest rates, principally because we do not match the maturities of our loans and investments precisely with our deposits and other funding sources |
| Changes in interest rates may also affect the level of voluntary prepayments on our loans and the level of financing or refinancing by customers |
| As of December 31, 2005, we had a negative interest rate gap of 23prca of interest earning assets in the one-year time frame |
| Although this is within our internal policy limits, our earnings will be adversely affected in periods of rising interest rates because, during such periods, the interest expense paid on deposits and borrowings will generally increase more rapidly than the interest income earned on loans and investments |
| If such an interest rate increase occurred gradually, we would use our established procedures to attempt to mitigate the effects over time |
| However, if such an interest rate increase occurred rapidly, or interest rates exhibited volatile increases and decreases, we might be unable to mitigate the effects, and our net interest income could suffer significant adverse effects |
| While management intends to continue to take measures to mitigate interest rate risk, we cannot assure you that such measures will be entirely effective in minimizing our exposure to the risk of rapid changes in interest rates |
| 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 govern 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 |
| Our strategy to minimize Indiana state taxes on our investment portfolio may be unsuccessful |
| Since 2002, our Indiana state financial institutions taxes have been reduced by our use of subsidiaries we formed in the State of Nevada to hold the investment portfolios of two of our bank subsidiaries |
| Nevada has no state or local income tax, and we take the position that none of this income is subject to the Indiana financial institutions tax |
| For the year ended December 31, 2005, our net savings in Indiana tax from this arrangement (after federal tax) was approximately dlra600cmam000 |
| Although management believes that this arrangement is permitted under Indiana law, and Indiana tax authorities have not challenged our tax returns in this regard, we understand that Indiana tax authorities have recently challenged a similar arrangement implemented by at least one other Indiana-based bank holding company |
| If we were not permitted to realize state tax savings from this arrangement, it would cause our net income after taxes to be lower in the future, and if Indiana tax authorities challenged our arrangement and were successful in assessing additional taxes, interest and penalties for prior years, we might be forced to take a special charge to our earnings in the amount of the assessment |
| 9 ______________________________________________________________________ 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 22 counties in Indiana and three counties in Illinois |
| As a result of this geographic concentration in two fairly contiguous markets, our financial results depend largely upon economic conditions in these market areas |
| A deterioration in economic conditions in one or both 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; and • 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 our banks |
| 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 |