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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED SEPTEMBER 30, 2002
COMMISSION FILE NUMBER 0-12422
MAINSOURCE FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
INDIANA 35-1562245
------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
201 NORTH BROADWAY GREENSBURG, INDIANA 47240
---------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(812) 663-0157
--------------
(Registrant's telephone number, including area code)
-------------------------------------------------------
(Former name, former address and former fiscal year, if
changed since last report.)
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 X No
--- ---
As of November 8, 2002 there were outstanding 6,469,873 shares, without par
value of the registrant.
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
INDEX
- ------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Condensed Balance Sheets 3
Consolidated Condensed Statements of Income and Comprehensive Income 4
Consolidated Condensed Statements of Cash Flows 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial 10
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
2
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in thousands except per share data)
(Unaudited)
September 30, December 31,
2002 2001
------------ -----------
Assets
Cash and due from banks $ 45,630 $ 54,068
Money market fund 9,264 5,351
----------- -----------
Cash and cash equivalents 54,894 59,419
Interest-bearing time deposits -- 599
Securities
Available for sale 331,016 268,136
Held to maturity (fair value of $6,075 and $8,292) 5,775 8,168
Loans held for sale 16,474 23,256
Loans, net of allowance for loan losses of $10,050 and $8,894 753,113 751,891
Premises and equipment (net) 19,097 16,840
Restricted stock, at cost 6,494 5,109
Goodwill 2,673 2,673
Intangible assets 21,929 20,142
Other assets 23,173 22,159
----------- -----------
Total assets $ 1,234,638 $ 1,178,392
=========== ===========
Liabilities
Deposits
Noninterest-bearing $ 106,507 $ 103,391
Interest-bearing 914,002 911,296
----------- -----------
Total deposits 1,020,509 1,014,687
Short-term borrowings 24,706 15,478
Federal Home Loan Bank advances 50,252 20,346
Notes payable 3,231 4,062
Other liabilities 15,840 13,522
----------- -----------
Subtotal 1,114,538 1,068,095
Guaranteed preferred beneficial interests in
company's subordinated debentures 22,425 22,425
Shareholders' equity
Preferred stock no par value
Authorized shares - 400,000
Issued and outstanding shares - none -- --
Common stock $.50 stated value:
Authorized shares - 10,000,000
Issued shares - 6,500,084 and 6,191,232
Outstanding shares - 6,469,873 and 6,191,232 3,251 3,096
Common stock to be distributed, 0 and 309,532 shares -- 155
Treasury stock - 30,211 and 0 shares (694) --
Additional paid-in capital 35,385 35,385
Retained earnings 54,559 47,806
Accumulated other comprehensive income (loss) 5,174 1,430
----------- -----------
Total shareholders' equity 97,675 87,872
----------- -----------
Total liabilities and shareholders' equity $ 1,234,638 $ 1,178,392
=========== ===========
See notes to consolidated condensed financial statements.
3
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands except per share data)
Three months ended Nine months ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Interest income:
Loans, including fees $ 14,370 $ 16,507 $ 42,823 $ 50,657
Investment securities 3,870 3,872 11,491 11,829
Other 52 396 470 2,008
-------- -------- -------- --------
Total interest income 18,292 20,775 54,784 64,494
-------- -------- -------- --------
Interest expense:
Deposits 5,439 9,220 17,553 30,919
Trust preferred securities 506 506 1,517 1,517
Other borrowings 654 573 1,789 1,825
-------- -------- -------- --------
Total interest expense 6,599 10,299 20,859 34,261
-------- -------- -------- --------
Net interest income 11,693 10,476 33,925 30,233
Provision for loan losses 810 409 1,925 1,147
-------- -------- -------- --------
Net interest income after
provision for loan losses 10,883 10,067 32,000 29,086
Non-interest income:
Securities gains/(losses) 26 (4) 340 (128)
Other income 3,456 2,890 9,950 8,466
-------- -------- -------- --------
Total non-interest income 3,482 2,886 10,290 8,338
Non-interest expense 9,363 8,678 27,256 25,179
-------- -------- -------- --------
Income before income tax 5,002 4,275 15,034 12,245
Income tax expense 1,583 1,432 4,961 4,042
-------- -------- -------- --------
Net income $ 3,419 $ 2,843 $ 10,073 $ 8,203
======== ======== ======== ========
Comprehensive income $ 4,681 $ 4,635 $ 13,817 $ 12,669
======== ======== ======== ========
Net income per share (basic and diluted) $ 0.53 $ 0.44 $ 1.55 $ 1.26
Cash dividends declared 0.170 0.157 0.510 0.471
See notes to consolidated condensed financial statements.
4
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Nine months ended
September 30,
-------------
2002 2001
--------- ---------
Operating Activities
Net income $ 10,073 $ 8,203
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,925 1,147
Depreciation and amortization 2,386 1,821
Amortization of intangibles 1,348 1,472
Investment securities (gains)/losses (340) 128
Change in loans held for sale 6,782 (12,638)
Change in other assets and liabilities (731) 2,859
--------- ---------
Net cash provided by operating activities 21,443 2,992
Investing Activities
Net change in short term investments 599 (302)
Proceeds from maturities and payments
on securities held to maturity 2,422 4,171
Purchases of securities available for sale (170,546) (145,536)
Proceeds from maturities and payments
on securities available for sale 83,602 167,760
Proceeds from sales of securities available for sale 29,525 9,240
Loan originations and payments, net 18,758 3,277
Cash paid for acquisitions -- (655)
Purchases of restricted stock (1,385) (1,339)
Purchases of premises and equipment (2,598) (1,158)
--------- ---------
Net cash provided (used) by investing activities (39,623) 35,458
Financing Activities
Net change in deposits (57,507) (44,551)
Short-term borrowings 9,228 6,711
Repayment of notes payable (831) (1,634)
Repayment of FHLB advances (10,094) (2,099)
Proceeds from FHLB borrowings 40,000 --
Purchase of treasury shares (694) --
Cash received from Branch acquisitions 36,873 --
Cash dividends and fractional shares (3,320) (3,061)
--------- ---------
Net cash provided (used) by financing activities 13,655 (44,634)
--------- ---------
Net change in cash and cash equivalents (4,525) (6,184)
Cash and cash equivalents, beginning of period 59,419 70,088
--------- ---------
Cash and cash equivalents, end of period $ 54,894 $ 63,904
========= =========
See notes to consolidated condensed financial statements.
5
NOTE 1 SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by MainSource Financial Group,
Inc., formerly known as Indiana United Bancorp, ("Company") for interim
financial reporting are consistent with the accounting policies followed for
annual financial reporting. All adjustments which are, in the opinion of
management, necessary for a fair presentation of the results for the periods
reported have been included in the accompanying unaudited consolidated financial
statements and all such adjustments are of a normal recurring nature.
NOTE 2 ACQUISITIONS
During 2002, three branch acquisitions were closed, for a total cost of $3,132.
The results of operations for each acquisition have been included since the
transaction date. Below is a summary of the acquisitions:
o In August 2002, one branch located in Lynn, Indiana was acquired and merged
into People's Trust.
o In July 2002, three branches in Vermillion County, Illinois were acquired
and merged into Capstone Bank. As of the date of acquisition one of the
three branches acquired was closed.
o In February 2002, one branch located in Grant Park, Illinois was acquired
and merged into Capstone Bank.
The branch acquisitions were made to further solidify the Company's market share
in existing markets and to expand its customer base into new markets, thereby
enhancing deposit fee income and providing an opportunity to market additional
products and services to new customers. The acquisition also helped to prevent
another financial institution from entering these markets, and it allowed the
Company to establish additional branch locations to improve customer
convenience.
The following is a summary of assets acquired and liabilities assumed (in
millions):
Grant Vermillion Lynn Total
----- ---------- ---- -----
Cash and cash equivalents $15.7 $20.1 $1.0 $36.8
Loans 3.2 9.0 9.7 21.9
Fixed and other assets .9 .3 .3 1.3
Intangibles .5 1.6 .9 3.0
Deposits (20.1) (31.2) (12.0) (63.3)
Other liabilities ( .1) ( .1) -- ( .2)
The Company is in the process of obtaining third party valuations for assets
acquired and the allocation of the purchase price is subject to refinement.
The intangible assets, which include $537 of core deposit, will be amortized
over periods ranging from 8 to 10 years using a straight-line amortization
method. At September 30, 2002, no goodwill has been recorded; however, the
Company will be evaluating new accounting standards effective October 1, 2002
and anticipates reclassifying a majority of the intangibles. See Note 8.
The following table presents pro forma information for the periods ended
September 30 as if the acquisition of the branches had occurred at the beginning
of 2002 and 2001. The pro forma information includes adjustments for the
amortization of intangibles arising from the transaction, depreciation expense
on property acquired, interest income and expense on loans acquired and deposits
assumed, and the related income tax effects. The pro forma financial information
presented below does not reflect earnings on cash acquired, fees that could be
earned on deposits, or operating expenses related to the new branch. The pro
forma financial information is not necessarily indicative of the results of
operations as they would have been had the transactions been effected on the
assumed dates.
2002 2001
---- ----
Interest income $ 55,823 $ 65,849
Interest expense 21,989 36,930
-------- --------
Net interest income 33,834 28,919
Provision for loan losses 1,925 1,147
-------- --------
Net interest income after provision for loan losses 31,909 27,772
Noninterest income 10,290 8,338
Noninterest expense 27,692 25,892
-------- --------
Income before federal income tax expense 14,507 10,218
Federal income tax expense 4,750 3,231
-------- --------
Net income $ 9,757 $ 6,987
======== ========
Earnings per share $ 1.50 $ 1.08
======== ========
6
Effective April 1, 2001, the Company consummated its acquisition of the
insurance agencies of Vollmer & Associates, Inc. The transaction was accounted
for using the purchase method of accounting, and the results of operations have
been included since the transaction date. The purchase price consisted of $0.7
million cash and 25,393 shares of Company stock.
NOTE 3 - SECURITIES
The fair value of securities available for sale and related gains/losses
recognized in accumulated other comprehensive income (loss) were as follows:
Gross Gross
Fair Unrealized Unrealized
As of September 30, 2002 Value Gains Losses
- -------------------------------------------------------------------------------
Available for Sale
Federal agencies $81,046 $2,990 $-
State and municipal 50,067 2,066 -
Mortgage-backed securities 175,224 2,486 (50)
Equity and other securities 24,679 1,198 (503)
- -------------------------------------------------------------------------------
Total available for sale $331,016 $8,740 ($553)
- -------------------------------------------------------------------------------
As of December 31, 2001
- -----------------------
Available for Sale
Federal agencies $97,654 $2,205 ($113)
State and municipal 41,920 558 (600)
Mortgage-backed securities 102,086 970 (505)
Equity and other securities 26,476 565 (852)
- -------------------------------------------------------------------------------
Total available for sale $268,136 $4,298 ($2,070)
- -------------------------------------------------------------------------------
The carrying amount, unrecognized gains and losses, and fair value of securities
held to maturity were as follows:
Gross Gross
Carrying Unrecognized Unrecognized Fair
As of September 30, 2002 Amount Gains Losses Value
- --------------------------------------------------------------------------------
Held to Maturity
State and municipal $4,589 $149 $- $4,738
Other securities 1,186 151 - 1,337
- --------------------------------------------------------------------------------
Total held to maturity $5,775 $300 $- $6,075
- --------------------------------------------------------------------------------
As of December 31, 2001
- -----------------------
Held to Maturity
State and municipal $7,018 $68 ($38) $7,048
Other securities 1,150 94 - 1,244
- --------------------------------------------------------------------------------
Total held to maturity $8,168 $162 ($38) $8,292
- --------------------------------------------------------------------------------
7
NOTE 4 - LOANS
September 30 December 31
2002 2001
- ------------------------------------------------------------------------------
Commercial and industrial loans $ 104,789 $ 89,706
Agricultural real estate and production 71,929 67,250
Commercial real estate 94,410 106,522
Hotel 69,072 74,888
Residential real estate 316,698 318,332
Construction and development 30,626 34,130
Consumer 75,639 69,957
-----------------------------
Total loans 763,163 760,785
Allowance for loan lossess (10,050) (8,894)
- ------------------------------------------------------------------------------
Net loans $ 753,113 $ 751,891
- ------------------------------------------------------------------------------
NOTE 5 - DEPOSITS
September 30, December 31,
2002 2001
---- ----
Non-interest-bearing demand $ 106,507 $ 103,391
Interest-bearing demand 224,340 212,812
Savings 211,716 223,640
Certificates of deposit of $100 or more 96,660 87,480
Other certificates and time deposits 381,286 387,364
------------- --------------
Total deposits $ 1,020,509 $ 1,014,687
============= ==============
NOTE 6 - SHORT-TERM BORROWINGS
September 30, December 31,
2002 2001
---- ----
Short-term borrowings:
Federal funds purchased $ 8,150 $ -
Securities sold under agreement to repurchase 16,556 15,478
--------- ---------
Total short-term borrowings $24,706 $15,478
========= =========
NOTE 7 - EARNINGS PER SHARE
Earnings per share (EPS) were computed as follows:
For the three months ended September 30, 2002 September 30, 2001
------------------------------------ ------------------------------------
Weighted Per Weighted Per
Net Average Share Net Average Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic earnings per share:
Income available to
common shareholders $3,419 6,471,808 $0.53 $2,843 6,500,794 $0.44
------- ----- ------ --------- -----
Effect of dilutive shares - -
--------- ---------
Diluted earnings per share $3,419 6,471,808 $0.53 $2,843 6,500,794 $0.44
====== ========= ===== ====== ========= =====
For the nine months ended September 30, 2002 September 30, 2001
------------------------------------ ------------------------------------
Weighted Per Weighted Per
Net Average Share Net Average Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic earnings per share:
Income available to
common shareholders $10,073 6,486,071 $1.55 $8,203 6,492,422 $1.26
------- ----- ------ --------- -----
Effect of dilutive shares - -
--------- ---------
Diluted earnings per share $10,073 6,486,071 $1.55 $8,203 6,492,422 $1.26
======= ========= ===== ====== ========= =====
8
NOTE 8 NEW ACCOUNTING PRONOUNCEMENTS
New accounting standards require all business combinations to be recorded using
the purchase method of accounting. Under the purchase method, all identifiable
tangible and intangible assets and liabilities of the acquired company must be
recorded at fair value at date of acquisition, and the excess cost over fair
value of net assets acquired is recorded as goodwill. Identifiable intangible
assets with finite useful lives will continue to amortize under the new
standard, whereas goodwill ceased being amortized starting in 2002. Annual
impairment testing will be required for goodwill with impairment being recorded
if the carrying amount of goodwill exceeds its implied fair value. Amounts
previously recorded as goodwill from depository institution branch acquisitions
were not initially considered to be goodwill under the new standards and these
amounts continued to be amortized through September 30, 2002.
Goodwill is not being amortized in 2002, but was amortized in 2001. If goodwill
had not been amortized in 2001, the effect on third quarter net income would
have been a net increase of $53, consisting of reduced amortization expense of
$71 and increased income tax expense of $18, and earnings per share would have
been increased by $.01. The effect on the first nine months net income in 2001
of not amortizing goodwill would have been a net increase of $149, consisting of
reduced amortization expense of $195 and increased income tax expense of $46,
and earnings per share would have been increased by $.02.
The Company completed its annual impairment testing of goodwill as of June 30,
2002 and determined that no impairment adjustment was needed.
All intangible assets with finite useful lives are subject to amortization, and
amortization expense was $479 and $496 for the third quarter of 2002 and 2001.
For the first nine months of 2002, amortization expense was $1,348 compared to
$1,472 for the same period a year ago. Estimated amortization expense for the
next five years is as follows: 2002 $1,918, 2003 $1,864, 2004 $1,832, 2005
$1,832, 2006 $1,832. Intangible assets subject to amortization are as follows:
Gross Accumulated
Amount Amortization
September 30, 2002:
Core deposit intangible $ 9,597 $ 3,562
Unidentified branch acquisition intangible 18,953 3,059
-------- --------
Total $ 28,550 $ 6,621
December 31, 2001:
Core deposit intangible $ 9,059 $ 2,879
Unidentified branch acquisition intangible 16,358 2,396
-------- --------
Total $ 25,417 $ 5,275
Effective October 1, 2002, a new accounting standard clarifies the accounting
for unidentified financial institution branch acquisition intangibles. If
certain criteria are met, unidentified intangibles from previous financial
institution branch acquisitions are to be reclassified to goodwill upon
adoption of this new standard, with amortization expense recognized in 2002 on
reclassified amounts reversed retroactive to January 1, 2002. The Company is
evaluating the impact of this standard and expects to reclassify the majority of
its unidentified branch acquisitions intangible to goodwill in the fourth
quarter. As a result of this reclassification, the Company expects to reverse
the majority of 2002 amortization expense recognized on unidentified branch
acquisition intangibles. Amortization expense on unidentified branch acquisition
intangibles totaled $247 and $663 for the three and nine months ended September
30, 2002.
Effective January 1, 2002, the Corporation adopted a new accounting standard on
impairment and disposal of long-lived assets. The effect of this new standard
was not material to the financial statements.
New accounting standards will apply for 2003 regarding asset retirement
obligations, debt extinguishment and certain lease modifications, and activity
exit costs. Management does not believe these standards will have a material
effect on the Company's financial statements, but the effects will depend on the
existence of applicable activities at the effective date of the standards.
9
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Overview
MainSource Financial Group, Inc. until May 1, 2002 known as Indiana United
Bancorp, ("Company") is a multi-bank, bank holding company that provides an
array of financial services and is headquartered in Greensburg, Indiana. The
Company's shares trade on the NASDAQ national market under the symbol MSFG. On
September 30, 2002, the Company controlled four bank subsidiaries, People's
Trust Company ("People's"), Union Bank and Trust Company of Indiana ("Union"),
Regional Bank ("Regional"), and Capstone Bank, N.A. ("Capstone"). In addition to
the banking subsidiaries, the Company owned, either directly or indirectly, the
following subsidiaries: MainSource Insurance, Inc., IUB Capital Trust, IUB
Reinsurance Company, Ltd., People's Investment Company, Ltd., PTC Investments,
Inc., RB Investments, Inc. and Union Investment Company, Ltd.
During the first week of October 2002, the Company completed the merger of
People's and Union with the newly formed bank being named MainSource Bank.
The Company continues to explore various acquisition targets including branches,
whole banks, and other financial service providers. In order to fund these
acquisitions, the Company may assume additional debt or issue additional shares.
Forward-Looking Statements
Except for historical information contained herein, the discussion in this Form
10-Q quarterly report includes certain forward-looking statements based upon
management expectations. 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 costs 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; and
changes in the quality or composition of the Company's loan and investment
portfolios.
The forward-looking statements included in the Management's Discussion and
Analysis ("MD&A") relating to certain matters involve risks and uncertainties,
including anticipated financial performance, business prospects, and other
similar matters, which reflect management's best judgment based on factors
currently known. Actual results and experience could differ materially from the
anticipated results or other expectations expressed in the Company's forward-
looking statements as a result of a number of factors, including but not limited
to those discussed in the MD&A.
Results of Operations
Net income for the third quarter of 2002 increased $576 to $3,419, or 20.3%,
compared to the third quarter of 2001, due primarily to an increase in the
Company's non-interest income and an improvement in net interest income.
Earnings per share for the third quarter equaled $.53 in 2002, compared to $.44
in 2001, an increase of 20.5%. The Company's return on average total assets for
the third quarter was 1.13% in 2002 compared to .94% in 2001. Return on average
shareholders' equity for the third quarter was 14.30% in 2002 and 13.39% in
2001.
For the nine months ended September 30, 2002, earnings per share were $1.55
versus $1.26 for the same period in 2001. In the first two quarters of 2002, the
Company realized non-operating gains related to the sale of investment
securities and the sale of the Company's merchant credit card portfolio. These
non-operating items resulted in a $.04 increase in earnings per share. As a
result, the Company's operating earnings per share were $1.51 for the nine
months ended September 30, 2002.
10
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Net Interest Income
The volume and yield of earning assets and interest-bearing liabilities
influence net interest income. Net interest income reflects the mix of
interest-bearing and non-interest-bearing liabilities that fund earning assets,
as well as interest spreads between the rates earned on these assets and the
rates paid on interest-bearing liabilities. Third quarter net interest income of
$11,693 in 2002 was an increase of 11.6% over the third quarter of 2001. Net
interest income on a tax equivalent basis, reflected as a percentage of average
earning assets (net interest margin), was 4.12% for the third quarter of 2002
and 3.85% for the same time frame in 2001. The increase in the Company's net
interest margin was primarily due to the repricing and runoff of higher priced
CDs and the repricing of core deposits at market rates.
Provision for Loan Losses
This topic is discussed under the heading "Loans, Credit Risk and the Allowance
and Provision for Probable Loan Losses".
Non-interest Income
Third quarter non-interest income for 2002 was $3,482, which was an increase
over the same period a year ago of $596 or 20.7%. The increase was primarily due
to an increase in mortgage banking activity.
For the first nine months of 2002, the Company's non-interest income was $10,290
versus $8,338 for the comparable period a year ago. The increase of 23.4% was
primarily related to realized gains on sales of investment securities during the
first half of 2002, increases in mortgage banking income, and increases in
insurance commissions related to the April 2001 acquisition of the Vollmer
agencies. Mortgage banking income consists of gains and losses on loan sales to
the secondary market and loan servicing fee income. Income for this line of
business has been strong, as origination volumes have increased in light of
declining interest rates.
Non-interest Income
Three months ended Nine months ended
September 30, September 30,
------------------- -------------------
2002 2001 2002 2001
------- ------- ------- -------
Service charges on deposit accounts $ 1,073 $ 986 $ 2,948 $ 2,861
Mortgage banking income 1,073 724 2,876 1,780
Insurance commissions 522 499 1,642 1,445
Trust fees 148 100 513 379
Gain (loss) on sales of securities 26 (4) 340 (128)
Other income* 640 581 1,971 2,001
------- ------- ------- -------
Total $ 3,482 $ 2,886 $10,290 $ 8,338
======= ======= ======= =======
* Other Income consists of interchange fees related to debit and credit card
activity, customer service fees, rental fees on safe deposit boxes, gains on
sales of assets other than securities, and other miscellaneous fees.
11
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Non-interest expense
Total non-interest expense was $9,363 for the third quarter of 2002, which
represented an increase of $685 from the third quarter of 2001. The largest
component of non-interest expense is personnel expense. Personnel expenses
increased in the third quarter of 2002 by $538, or 11.2% compared to the prior
year period. Normal staff salary increases and increased benefit costs were
incurred in 2002. Included in the 11.2% increase are the personnel costs related
to the addition of four branches in 2002.
For the first nine months of 2002, non-interest expense was $27,256 compared to
$25,179 for the same period in 2001. The increase of 8.2% was attributable to
the acquisition of four branches and the Vollmer insurance agencies, an increase
in employee benefit expense, and expenses related to the name change of the
holding company. As discussed in Note 8 to the financial statements, intangible
amortization expense is expected to decline significantly in future periods as a
large portion of the Company's intangibles are expected to be reclassified to
non-amortizing goodwill in the fourth quarter of 2002.
A ratio frequently used to measure the efficiency of a financial institution is
computed by dividing non-interest expense by the total of tax-effected net
interest income plus non-interest income excluding securities gains or losses.
The lower the ratio, the more efficient the Company is in managing net interest
margin, non-interest income and non-interest expense. The Company's efficiency
ratios were 60.7% for the third quarter of 2002 compared to 64.2% for the same
period in 2001.
Non-interest Expense
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
------- ------- ------- -------
Salaries and employee benefits $ 5,322 $ 4,784 $15,483 $14,158
Net occupancy 632 557 1,800 1,610
Equipment expense 688 784 2,017 2,007
Intangible amortization 479 496 1,348 1,472
Stationary, printing, and supplies 262 214 747 648
Other expenses* 1,980 1,843 5,861 5,284
------- ------- ------- -------
Total non-interest expense $ 9,363 $ 8,678 $27,256 $25,179
======= ======= ======= =======
* Other Expenses consists of professional fees, directors' fees, marketing,
postage, travel, communications, regulatory fees, and other miscellaneous items.
Income Taxes
The effective tax rate for the first nine months was 33.0% for 2002 and 2001.
The Company and its subsidiaries file consolidated income tax returns.
12
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Financial Condition
Total assets at September 30, 2002 were $1,234,638 compared to $1,178,392 as of
December 31, 2001. Average earning assets represented 92.7% of average total
assets for the first nine months of 2002 and 92.8% for the same period in 2001.
Average loans represented 76.0% of average deposits in the first nine months of
2002 and 76.6% for the comparable period in 2001. Management continues to
emphasize quality loan growth to increase these averages. Average loans as a
percent of average assets were 64.0% and 66.0% for the nine-month period ended
September 30, 2002 and 2001 respectively.
The increase in deposits of $5,822 from December 31, 2001 to September 30, 2002
was due primarily to the acquisition of four branches involving the assumption
of $63,329 of deposits.
Shareholders' equity was $97,675 on September 30, 2002 compared to $87,872 on
December 31, 2001. Book value per common share was $15.10 at September 30, 2002
versus $13.52 at year-end 2001. The unrealized gain on securities available for
sale, net of taxes, totaled $5,174 or $.80 per share at September 30, 2002
compared to $1,430 or $.22 per share at December 31, 2001. Excluding the net
unrealized gains and losses on securities available for sale, book value per
share would have been $14.30 at September 30, 2002 or an increase of 7.5% over
the comparable book value at year-end 2001.
Loans, Credit Risk and the Allowance and Provision for Probable Loan Losses
Loans remain the Company's largest concentration of assets and, by their nature,
carry a higher degree of risk. The loan underwriting standards observed by the
Company's subsidiaries are viewed by management as a means of controlling
problem loans and the resulting charge-offs.
The Company's loan underwriting standards have historically resulted in lower
levels of net charge-offs than peer bank averages. The Company believes credit
risks may be elevated if undue concentrations of loans in specific industry
segments and to out-of-area borrowers are incurred. Accordingly, the Company's
Board of Directors regularly monitors such concentrations to determine
compliance with its loan allocation policy. The Company believes it has no undue
concentrations of loans.
13
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Residential real estate loans continue to represent a significant portion of the
total loan portfolio. Such loans represented 41.5% of total loans at September
30,2002 and 41.8% at December 31, 2001.
On September 30, 2002, the Company had $16,474 of residential real estate loans
held for sale, which was a decrease from the year-end balance of $23,256. The
Company generally retains the servicing rights on mortgages sold.
Total non-performing assets were $13.9 million as of September 30, 2002 compared
to $10.7 million as of September 30, 2001 and represented 1.13% of total assets
at September 30, 2002 versus 0.93% one year ago. One commercial credit
represents $4.0 million of the total. Excluding this credit, the Company's
non-performing assets would have been $9.9 million. In October 2002, the Company
sold certain properties collateralizing this credit. After the sale, the
remaining balance of the loan was $2.6 million, of which $0.9 million was taken
as a charge-off. The Company expects to reclassify the remaining $1.7 million
loan balance to OREO in the fourth quarter of 2002.
The provision for loan losses was $810 in the third quarter of 2002 compared to
$409 for the same period in 2001 and $1,925 for the first nine months of 2002
compared to $1,147 for the same period in 2001. Net charge-offs were $769 for
the first nine months of 2002 compared to $466 for the comparable period in
2001. On an annualized basis as a percentage of average loans, net charge-offs
equaled .13% for the nine-month period ended September 30, 2002, compared to
..08% for the comparable period in 2001.
Foreclosed real estate and repossessions held by the Company at September 30,
2002 were $1,035 and $733 at December 31, 2001.
The adequacy of the allowance for loan losses in each subsidiary is reviewed at
least quarterly. The determination of the provision amount in any period is
based on management's continuing review and evaluation of loan loss experience,
changes in the composition of the loan portfolio, current economic conditions,
the amount of loans presently outstanding, and information about specific
borrower situations. The allowance for loan losses as of September 30, 2002 is
considered adequate by management.
Investment Securities
Investment securities offer flexibility in the Company's management of interest
rate risk, and are an important source of liquidity as a response to changing
characteristics of assets and
14
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
liabilities. The Company's investment policy prohibits trading activities and
does not allow investment in high-risk derivative products, junk bonds or
foreign investments.
As of September 30, 2002, $331,016 of investment securities are classified as
"available for sale" ("AFS") and are carried at fair value with unrealized gains
and losses, net of taxes, reported as a separate component of shareholders'
equity. An unrealized pre-tax gain of $8,187 was recorded to adjust the AFS
portfolio to current market value at September 30, 2002, compared to an
unrealized pre-tax gain of $2,228 at December 31, 2001. AFS securities increased
$62,880 from December 31, 2001 to September 30, 2002. With favorable interest
rates, the Company determined that it would have a favorable impact on net
interest income by increasing FHLB borrowings and investing in AFS securities.
Much of the increase in AFS securities and FHLB advances is attributable to this
activity.
In September 2000, the Company formed two investment subsidiaries, People's
Investment Company, Ltd. and Union Investment Company, Ltd., which are
incorporated in Bermuda. Effective January 1, 2002 the Company formed two
additional investment subsidiaries, PTC Investments, Inc. and RB Investments,
Inc., which are incorporated in Nevada. These subsidiaries, which are 100% owned
by and fully consolidated in the Company's financial statements, hold a large
portion of the Company's investment portfolios and were formed with the intent
to enhance the management and profitablity of the investment portfolios.
Sources of Funds
The Company relies primarily on customer deposits, securities sold under
agreement to repurchase ("agreements") and shareholders' equity to fund earning
assets. FHLB advances are also used to provide additional funding.
Deposits generated within local markets provide the major source of funding for
earning assets. Total deposits funded 90.0% and 93.8% of total earning assets at
September 30, 2002 and December 31, 2001. Total interest-bearing deposits
averaged 90.8% and 91.7% of average total deposits for the periods ending
September 30, 2002 and December 31, 2001, respectively. Management constantly
strives to increase the percentage of transaction-related deposits to total
deposits due to the positive effect on earnings.
Short-term borrowings increased $9,228 from year-end 2001 as higher-rate
certificates of deposit matured and were not aggressively pursued. The Company
had FHLB advances of $50,252 outstanding at September 30, 2002. These advances
have interest rates ranging from 2.26% to 6.95% with $10,000 maturing in the
first quarter of 2004. Approximately $40,000 of these advances mature in 2005 or
later.
Capital Resources
Total shareholders' equity increased $9,803 to $97,675 at September 30, 2002 as
compared to December 31, 2001.
The Federal Reserve Board and other regulatory agencies have adopted risk-based
capital guidelines that assign risk weightings to assets and off-balance sheet
items. The Company's core capital consists of shareholders' equity, excluding
accumulated other comprehensive income, while Tier 1 consists of core capital
less goodwill and intangibles. Trust preferred securities qualify as Tier 1
capital or core capital with respect to the Company under the risk-based capital
guidelines established by the Federal Reserve. Under such guidelines, capital
received from the proceeds of the sale of trust preferred securities cannot
constitute more than 25% of the total core capital of the Company. Consequently,
the amount of trust preferred securities in excess of the 25% limitation
constitutes Tier 2 capital of the Company. Total regulatory capital consists of
Tier 1, certain debt instruments and a portion of the allowance for credit
losses. At September 30, 2002, Tier 1 capital to total average assets was 7.60%.
Tier 1
15
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
capital to risk-adjusted assets was 11.69%. Total capital to risk-adjusted
assets was 12.94%. All three ratios exceed all required ratios established for
bank holding companies. Risk-adjusted capital levels of the Company's subsidiary
banks exceed regulatory definitions of well-capitalized institutions.
The Company declared and paid common dividends of $.17 per share in the third
quarter of 2002 versus $.157 for the third quarter of 2001. For the nine months
ended September 30, 2002, the Company paid common dividends of $.51 per share
versus $.471 for the same period in 2001.
Liquidity
Liquidity management involves maintaining sufficient cash levels to fund
operations and to meet the requirements of borrowers, depositors, and creditors.
Higher levels of liquidity bear higher corresponding costs, measured in terms of
lower yields on short-term, more liquid earning assets, and higher interest
expense involved in extending liability maturities. Liquid assets include cash
and cash equivalents, loans and securities maturing within one year, and money
market instruments. In addition, the Company holds AFS securities maturing after
one year, which can be sold to meet liquidity needs.
Maintaining a relatively stable funding base, which is achieved by diversifying
funding sources and extending the contractual maturity of liabilities, supports
liquidity and limits reliance on volatile short-term purchased funds. Short-term
funding needs arise from declines in deposits or other funding sources, funding
of loan commitments and requests for new loans. The Company's strategy is to
fund assets to the maximum extent possible with core deposits that provide a
sizable source of relatively stable and low-cost funds. Average core deposits
funded approximately 82.1% of total earning assets for the nine months ended
September 30, 2002 and 82.9% for the same period in 2001.
Management believes the Company has sufficient liquidity to meet all reasonable
borrower, depositor, and creditor needs in the present economic environment. In
addition, the affiliates have access to the Federal Home Loan Bank for borrowing
purposes. The Company has not received any recommendations from regulatory
authorities that would materially affect liquidity, capital resources or
operations.
Interest Rate Risk
Asset/liability management strategies are developed by the Company to manage
market risk. Market risk is the risk of loss in financial instruments including
investments, loans, deposits and borrowings arising from adverse changes in
prices/rates. Interest rate risk is the Company's primary market risk exposure,
and represents the sensitivity of earnings to changes in market interest rates.
Strategies are developed that impact asset/liability committee activities based
on interest rate risk sensitivity, board policy limits, desired sensitivity gaps
and interest rate trends.
Effective asset/liability management requires the maintenance of a proper ratio
between maturing or repriceable interest-earning assets and interest-bearing
liabilities. It is the policy of the Company that the cumulative GAP divided by
total assets shall be plus or minus 20% at the 3-month, 6-month, and 1-year time
horizons.
16
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
At September 30, 2002, the Company held approximately $366,305 in assets
comprised of securities, loans, short-term investments, and federal funds sold,
which were interest sensitive in one year or less time horizons.
Other
The Securities and Exchange Commission ("Commission") maintains a Web site that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission, including
the Company. That address is http://www.sec.gov.
17
MAINSOURCE FINANCIAL GROUP, INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
(Dollar amounts in thousands except per share data)
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk of the Corporation encompasses exposure to both liquidity and
interest rate risk and is reviewed monthly by the Asset/Liability Committee and
the Board of Directors. There have been no material changes in the quantitative
and qualitative disclosures about market risks as of September 30, 2002 from the
analysis and disclosures provided in the Corporation's Form 10-K for the year
ended December 31, 2001.
18
Item 4. Controls and Procedures
Within the 90-day period prior to the filing date of this report, an evaluation
was carried out under the supervision and with the participation of the
Company's management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of our disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934). Based on their evaluation, our Chief Executive Officer
and Chief Financial Officer have concluded that the Company's disclosure
controls and procedures are, to the best of their knowledge, effective to ensure
that information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission
rules and forms. Subsequent to the date of their evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that there were no
significant changes in the Company's internal controls or in other factors that
could significantly affect its internal controls, including any corrective
actions with regard to significant deficiencies and material weaknesses.
19
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are furnished in accordance with the
provisions of Item 601 of Regulation S-K.
The following exhibits accompany this periodic report pursuant
to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (the "2002 Act"). These exhibits shall be
deemed only to accompany this periodic report are not part of this
periodic report, shall not be deemed filed for purposes of the
Securities Exchange Act of 1934, and may not be used for any purpose
other than compliance with the 2002 Act.
99.1 Certification Pursuant to 18 U.S.C Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by
Chief Executive Officer
99.2 Certification Pursuant to 18 U.S.C Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by
Chief Financial Officer
b) Reports on Form 8-K
No other information is required to be filed under Part II of this form.
20
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MAINSOURCE FINANCIAL GROUP, INC.
November 12, 2002
/s/ James L. Saner, Sr.
-------------------------------------------------
James L. Saner Sr
President and Chief Executive Officer
November 12, 2002
/s/ Donald A. Benziger
-------------------------------------------------
Donald A. Benziger
Senior Vice President & Chief Financial Officer
November 12, 2002
/s/ James M. Anderson
-------------------------------------------------
James M. Anderson
Controller & Principal Accounting Officer
21
Certification of Principal Executive Officer
CERTIFICATIONS FOR QUARTERLY REPORT ON FORM 10-Q
I, James L. Saner, Sr. certify that:
1) I have reviewed this quarterly report on Form 10-Q of MainSource Financial
Group, Inc.;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
--------------------
/s/ James L. Saner, Sr.
- -------------------------------------
[Signature]
President and Chief Executive Officer
- -------------------------------------
[Title]
Certification of Principal Financial Officer
CERTIFICATIONS FOR QUARTERLY REPORT ON FORM 10-Q
I, Donald A. Benziger, certify that:
1) I have reviewed this quarterly report on Form 10-Q of MainSource Financial
Group, Inc.;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
--------------------
/s/ Donald A. Benziger
- -------------------------------------
[Signature]
Senior Vice President &
Chief Financial Officer
- -------------------------------------
[Title]