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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, 2003
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
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes X No
--- ---
As of November 10, 2003 there were outstanding 6,729,256 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 9
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Item 4. Controls and Procedures 18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
2
MAINSOURCE FINANCIAL GROUP
FORM 10-Q
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in thousands except per share data)
(Unaudited)
September 30, December 31,
2003 2002
------------ ------------
Assets
Cash and due from banks $ 50,939 $ 54,548
Money market fund 6,498 22,869
Federal funds sold -- 500
----------- -----------
Cash and cash equivalents 57,437 77,917
Investment securities
Available for sale 396,774 346,468
Held to maturity (fair value of $3,681 and $4,939) 3,420 4,675
Loans held for sale 4,443 15,715
Loans, net of allowance for loan losses of $12,165 and $9,517 828,075 730,650
Restricted stock, at cost 6,871 5,690
Premises and equipment, net 23,178 19,258
Goodwill 36,476 20,708
Intangible assets 5,585 5,005
Cash surrender value of life insurance 21,781 3,892
Other assets 20,024 21,782
----------- -----------
Total assets $ 1,404,064 $ 1,251,760
=========== ===========
Liabilities
Deposits
Noninterest bearing $ 122,391 $ 104,282
Interest bearing 1,017,771 930,025
----------- -----------
Total deposits 1,140,162 1,034,307
Short-term borrowings 42,019 19,529
Federal Home Loan Bank advances 63,847 50,235
Trust preferred securities 29,000 30,425
Notes payable 14,600 2,400
Other liabilities 12,526 15,093
----------- -----------
Total liabilities 1,302,154 1,151,989
Shareholders' equity
Preferred stock - no par value
Authorized - 400,000
Issued and outstanding - none -- --
Common stock $.50 stated value:
Authorized - 25,000,000 shares,
Issued shares - 6,824,405 and 6,500,084
Outstanding shares - 6,729,256 and 6,469,873 3,414 3,251
Common stock to be distributed, 0 and 325,004 shares -- 163
Treasury stock, 95,149 and 30,211 shares (2,190) (694)
Additional paid-in capital 43,009 43,025
Retained earnings 56,971 49,529
Accumulated other comprehensive income 706 4,497
----------- -----------
Total shareholders' equity 101,910 99,771
----------- -----------
Total liabilities and shareholders' equity $ 1,404,064 $ 1,251,760
=========== ===========
See notes to consolidated condensed financial statements.
3
MAINSOURCE FINANCIAL GROUP
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,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
Interest income:
Loans, including fees $14,107 $14,370 $40,131 $42,823
Investment securities 3,036 3,870 10,157 11,491
Other 73 52 184 470
------- ------- ------- -------
Total interest income 17,216 18,292 50,472 54,784
------- ------- ------- -------
Interest expense:
Deposits 4,623 5,439 14,176 17,553
Trust preferred securities 399 506 1,235 1,517
Other borrowings 890 654 2,323 1,789
------- ------- ------- -------
Total interest expense 5,912 6,599 17,734 20,859
------- ------- ------- -------
Net interest income 11,304 11,693 32,738 33,925
Provision for loan losses 815 810 1,550 1,925
------- ------- ------- -------
Net interest income after
provision for loan losses 10,489 10,883 31,188 32,000
Non-interest income:
Securities gains 466 26 1,301 340
Other income 5,058 3,456 13,468 9,950
------- ------- ------- -------
Total non-interest income 5,524 3,482 14,769 10,290
Non-interest expense 10,549 9,363 30,266 27,256
------- ------- ------- -------
Income before income tax 5,464 5,002 15,691 15,034
Income tax expense 1,615 1,583 4,603 4,961
------- ------- ------- -------
Net income $ 3,849 $ 3,419 $11,088 $10,073
======= ======= ======= =======
Comprehensive income $ 1,662 $ 4,681 $ 7,297 $13,817
======= ======= ======= =======
Net income per share (basic and diluted) $ 0.57 $ 0.50 $ 1.64 $ 1.48
Cash dividends declared 0.180 0.162 0.540 0.486
See notes to consolidated condensed financial statements.
4
MAINSOURCE FINANCIAL GROUP
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW
(Unaudited)
(Dollars in thousands)
Nine months ended
September 30,
-------------
2003 2002
--------- ---------
Operating Activities
Net income $ 11,088 $ 10,073
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,550 1,925
Depreciation and amortization 1,945 1,557
Securities amortization, net 3,256 829
Amortization of intangibles 675 1,348
Investment securities gains (1,301) (340)
Change in loans held for sale 11,788 6,782
Change in other assets and liabilities 959 (731)
--------- ---------
Net cash provided by operating activities 29,960 21,443
Investing Activities
Net change in short term investments -- 599
Proceeds from maturities and payments
on securities held to maturity 1,288 2,422
Purchases of securities available for sale (333,037) (170,546)
Proceeds from maturities and payments
on securities available for sale 161,597 83,602
Proceeds from sales of securities available for sale 117,383 29,525
Loan originations and payments, net 21,755 18,758
Purchases of restricted stock (142) (1,385)
Cash received from branch acquisitions 12,203 36,873
Cash paid for bank acquisition (12,795) --
Cash paid for life insurance policies (15,000) --
Purchases of premises and equipment (1,604) (2,598)
--------- ---------
Net cash provided (used) by investing activities (48,352) (2,750)
Financing Activities
Net change in deposits (29,279) (57,507)
Short-term borrowings 21,740 9,228
Proceeds from issuance of long-term debt 13,000 --
Repayment of notes payable (800) (831)
Repayment of FHLB advances (166) (10,094)
Proceeds from FHLB borrowings -- 40,000
Proceeds from issuance of trust preferred securities 21,000 --
Redemption of trust preferred securities (22,425) --
Purchase of shares for treasury (1,496) (694)
Cash dividends and fractional shares (3,662) (3,320)
--------- ---------
Net cash provided (used) by financing activities (2,088) (23,218)
--------- ---------
Net change in cash and cash equivalents (20,480) (4,525)
Cash and cash equivalents, beginning of period 77,917 59,419
--------- ---------
Cash and cash equivalents, end of period $ 57,437 $ 54,894
========= =========
See notes to consolidated condensed financial statements.
NOTES to CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)
NOTE 1 SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by MainSource Financial Group,
Inc., ("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.
STOCK OPTION PLAN
Options to buy stock are granted to directors, officers and employees under the
MainSource Financial Group, Inc. 2003 Stock Option Plan approved on April 23,
2003, which provides for issue of up to 350,000 options. Exercise price is the
market price at date of grant. The maximum option term is ten years, and options
vest over four years for incentive stock options and immediately for
non-qualified options. A total of 34,500 options, 8,000 non-qualified and 26,500
incentive stock options, were granted on May 19, 2003 at an exercise price of
$23.20 all with a ten-year life.
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The following
table illustrates the effect on net income and earnings per share if expense was
measured using the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation.
For the three months ended For the nine months ended
-------------------------- -------------------------
Sept. 30, 2003 Sept. 30, 2002 Sept. 30, 2003 Sept. 30, 2002
-------------- -------------- -------------- --------------
Net income as reported $3,849 $3,419 $11,088 $10,073
Deduct: Stock-based compensation expense 6 -- 23 --
determined under fair value based method ------ ------ ------- -------
Pro forma net income $3,843 $3,419 $11,065 $10,073
Basic earnings per share as reported $0.57 $0.50 $1.64 $1.48
Pro forma basic earnings per share $0.57 $0.50 $1.64 $1.48
Diluted earnings per share as reported $0.57 $0.50 $1.64 $1.48
Pro forma diluted earnings per share $0.57 $0.50 $1.64 $1.48
The pro forma effects are computed utilizing option pricing models using the
following weighted-average assumptions for 2003 as of grant date: risk-free
interest rate 2.80%, expected option life 6.54 years, expected stock price
volatility 18.60% and dividend yield 2.90%.
NOTE 2 ACQUISITIONS
In June 2003, the Company consummated its acquisition of First Community
Bancshares, Inc. which has 10 branches located in the south central area of
Indiana. As of the date of acquisition, the acquired company had $11,448 of
cash, $114,303 of net loans, and $115,481 of deposits. A core deposit intangible
of $1,080 and goodwill of $14,950 were also recorded. The results of operations
for this acquisition have been included since the transaction date which was
June 12, 2003. The Company funded the cash purchase price of $24,243 by issuing
$7,000 of floating rate trust preferred securities and securing a long-term note
of $13,000. The additional amount was obtained from internal sources.
The following table presents proforma information for the periods ended
September 30 as if the acquisition had occurred at the beginning of 2003 and
2002. The proforma information includes adjustments for the amortization of
intangibles arising from the transaction. The pro forma financial information is
not necessarily indicative of the results of operations as they would have been
had the transaction been effected on the assumed dates.
For the three months ended For the nine months ended
-------------------------- -------------------------
Sept. 30, 2003 Sept. 30, 2002 Sept. 30, 2003 Sept. 30, 2002
-------------- -------------- -------------- --------------
Net interest income 11,304 13,243 35,220 38,335
Net income 3,849 3,674 10,039 10,683
Earnings per share 0.57 0.54 1.49 1.57
In February 2003, the Company acquired one branch in Illinois. The acquired
branch consisted of $12,203 of cash, $6,427 of loans, and $19,653 of deposits. A
core deposit intangible of $166 and goodwill of $818 were also recorded. The
results of operations for this acquisition have been included since the
transaction date.
These 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 acquistions also helped to prevent
another financial institution from entering these markets.
6
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, 2003 Value Gains Losses
- --------------------------------------------------------------------------------------------
Available for Sale
Federal agencies $76,907 $1,475 ($56)
State and municipal 60,840 1,858 (194)
Mortgage-backed securities 247,779 1,074 (1,917)
Equity and other securities 11,248 91 (749)
- --------------------------------------------------------------------------------------------
Total available for sale $396,774 $4,498 ($2,916)
- --------------------------------------------------------------------------------------------
As of December 31, 2002
- --------------------------------------------------------------------------------------------
Available for Sale
Federal agencies $80,483 $2,928 $0
State and municipal 49,027 1,682 (5)
Mortgage-backed securities 194,490 2,901 (54)
Equity and other securities 22,468 227 (614)
- --------------------------------------------------------------------------------------------
Total available for sale $346,468 $7,738 ($673)
- --------------------------------------------------------------------------------------------
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, 2003 Amount Gains Losses Value
- --------------------------------------------------------------------------------------
Held to Maturity
State and municipal $2,684 $124 $0 $2,808
Other securities 736 137 - 873
- --------------------------------------------------------------------------------------
Total held to maturity $3,420 $261 $0 $3,681
- --------------------------------------------------------------------------------------
As of December 31, 2002
- --------------------------------------------------------------------------------------
Held to Maturity
State and municipal $3,977 $119 $0 $4,096
Other securities 698 145 - 843
- --------------------------------------------------------------------------------------
Total held to maturity $4,675 $264 $0 $4,939
- --------------------------------------------------------------------------------------
NOTE 4 - LOANS
September 30, December 31,
2003 2002
- -----------------------------------------------------------------------------
Commercial and industrial loans $ 141,404 $ 105,093
Agricultural real estate and production 67,353 68,867
Commercial real estate 93,417 84,024
Hotel 83,770 73,262
Residential real estate 320,701 301,232
Construction and development 33,559 34,987
Consumer 100,036 72,702
--------- ---------
Total loans 840,240 740,167
Allowance for loan lossess (12,165) (9,517)
--------- ---------
Net loans $ 828,075 $ 730,650
========= =========
NOTE 5 - DEPOSITS September 30 December 31,
2003 2002
---- ----
Non-interest-bearing demand $ 122,391 $ 104,282
Interest-bearing demand 253,453 260,120
Savings 229,234 196,056
Certificates of deposit of $100 or more 128,477 93,192
Other certificates and time deposits 406,607 380,657
----------- -----------
Total deposits $ 1,140,162 $ 1,034,307
=========== ===========
NOTE 6 - SHORT-TERM BORROWINGS
September 30 December 31,
2003 2002
---- ----
Short-term borrowings:
Federal funds purchased $ 26,350 $ --
Securities sold under agreement to repurchase 15,669 19,529
-------- -------
Total short-term borrowings $ 42,019 $19,529
======== =======
7
NOTE 7 - NOTES PAYABLE and TRUST PREFERRED SECURITIES
The Company obtained a note payable from a financial institution during the
second quarter of 2003. The note payable for $13,000 requires semi-annual
principal payments of $1,300 plus accrued interest quarterly and matures June
2008. The loan is secured by the common stock of certain subsidiary banks of the
Company and accrues interest at a rate that is tied to LIBOR.
The Company also issued $21,000 in trust preferred securities. The securities
distributions are payable quarterly at rates ranging from 4.54% to 6.65% and
mature in 2033. The securities may be redeemed by the Company prior to maturity
in 2008 and anytime thereafter. Distributions may be deferred from time to time
not to exceed 20 consecutive quarters. Trust preferred securities count as Tier
1 Capital for regulatory purposes, within defined limits.
Proceeds from these advances were used to redeem $14,000 of 8.75% fixed rate
trust preferred securities and finance the First Community acquisition. The
Company has various financial covenants related to the notes payable and the
trust preferred securities. As of September 30, 2003, the Company was in
compliance with all of these covenants.
NOTE 8 - EARNINGS PER SHARE
Earnings per share (EPS) were computed as follows:
For the three months ended September 30, 2003 September 30, 2002
----------------------------------- -----------------------------------
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 $3,849 6,729,256 $0.57 $3,419 6,795,398 $0.50
------ ----- ------ -----
Effect of dilutive shares 3,215 --
--------- ---------
Diluted earnings per share $3,849 6,732,471 $0.57 $3,419 6,795,398 $0.50
====== ========= ===== ====== ========= =====
For the nine months ended September 30, 2003 September 30, 2002
----------------------------------- -----------------------------------
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 $11,088 6,753,053 $1.64 $10,073 6,810,375 $1.48
------- ----- ------- -----
Effect of dilutive shares 859 --
--------- ---------
Diluted earnings per share $11,088 6,753,912 $1.64 $10,073 6,810,375 $1.48
======= ========= ===== ======= ========= =====
8
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. ("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, 2003, the Company controlled four bank
subsidiaries, MainSource Bank, Regional Bank ("Regional"), Capstone Bank
("Capstone"), and First Community Bank and Trust ("First Community"). First
Community was acquired on June 12, 2003 and results have been included since the
date of acquisition.
In addition to the banking subsidiaries, the Company owned, either directly or
indirectly, the following subsidiaries: MainSource Insurance, Inc., MainSource
Statutory Trust I, MainSource Statutory Trust II, MainSource Statutory Trust
III, IUB Reinsurance Company, Ltd., People's Investment Company, Ltd., PTC
Investments, Inc., RB Investments, Inc. and Union Investment Company, Ltd.
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 2003 was $3,849 or 12.6% greater than the
third quarter of 2002 due primarily to an increase in the Company's non-interest
income. Earnings per share for the third quarter equaled $.57 in 2003, compared
to $.50 in 2002, an increase of 14.0%. The Company's return on average total
assets for the third quarter was 1.08% in 2003 and 1.13% for the same period in
2002. Return on average shareholders' equity for the third quarter was 15.08% in
2003 and 14.30% in 2002.
For the nine months ended September 30, 2003, net income was $11,088 compared to
$10,073 for the same period in 2002. Earnings per share for the nine months
ending September 30 were $1.64 in 2003 and $1.48 in 2002, which represents an
increase of 10.8%.
9
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 $11,304 in
2003 was a decrease of 3.3% versus the third quarter of 2002. Net interest
income on a tax equivalent basis, reflected as a percentage of average earning
assets (net interest margin), was 3.61% for the third quarter of 2003 and 4.12%
for the same period in 2002. As a result of the current interest rate
environment, the Company's yield on earning assets decreased from 6.72% for the
third quarter of 2002 to 5.70% in the third quarter of 2003. The Company's cost
of funds also decreased, but to a lesser extent.
For the nine months ended September 30, 2003, the Company's net interest margin
was 3.72% compared to 4.19% for the same period in 2002.
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 2003 was $5,524 compared to $3,482 for the
same period a year ago, representing an increase of 58.7%. The increase was
primarily due to three factors: the acquisition of First Community, an increase
in mortgage banking activity, and gains on the sales of investment securities.
Mortgage banking income, which consists of gains and losses on loan sales and
service fee income, was $1,811 for the third quarter of 2003 versus $1,073 for
the third quarter of 2002.
For the nine months ended September 30, 2003, non-interest income was $14,769
compared to $10,290 for the same period a year ago. The 43.5% increase was
primarily due to the aforementioned increase in mortgage banking activity as
well as gains on the sales of investment securities.
As the Company continues to actively manage its investment portfolio, gains
and/or losses on the sales of investment securities will be periodically
realized in order to take advantage of current market conditions or to
reposition the portfolio for future profitability.
Non-interest Income
Three months ended Nine months ended
September 30, September 30,
------------------- --------------------
2003 2002 2003 2002
------- ------- ------- -------
Insurance commissions $ 668 $ 522 $ 1,862 $ 1,642
Fiduciary activities 150 148 452 513
Mortgage banking income 1,811 1,073 4,820 2,876
Service charges on deposit accounts 1,446 1,073 3,480 2,948
Gain (loss) on sales of securities 466 26 1,301 340
Other income * 983 640 2,854 1,971
------- ------- ------- -------
Total $ 5,524 $ 3,482 $14,769 $10,290
======= ======= ======= =======
* 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.
10
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 $10,549 for the third quarter of 2003, which
represented an increase of 12.7% over the third quarter of 2002. The largest
component of non-interest expense is personnel expense. Personnel expenses were
$6,046 for the third quarter of 2003 versus $5,322 for the same period a year
ago, which represents a 13.6% increase. Normal staff salary increases and the
acquisition of First Community were the primary contributors to the increase.
For the nine months ended September 30, 2003, non-interest expense was $30,266
versus $27,256 for the same period a year ago, which represents an increase of
11.0%. In addition to the aforementioned increase in personnel costs, the
Company incurred $840 of costs in the first quarter of 2003 associated with the
write-off of deferred debt acquisition costs due to the redemption of its fixed
rate trust preferred securities issued in 1997.
Because of the adoption of new accounting guidance in the fourth quarter of
2002, unidentified intangibles from bank branch acquisitions are now classified
as goodwill and are not amortized. As a result, intangible amortization
decreased in 2003 versus 2002.
Non-interest Expense
Three months ended Nine months ended
September 30, September 30,
------------------- -------------------
2003 2002 2003 2002
------- ------- ------- -------
Salaries and employee benefits $ 6,046 $ 5,322 $17,052 $15,483
Net occupancy 715 632 2,034 1,800
Equipment 945 688 2,597 2,017
Intangible amortization 219 479 675 1,348
Stationary, printing, and supplies 255 262 693 747
Telephone 332 264 946 827
Amortization of deferred debt issuance costs 4 27 861 81
Other * 2,033 1,689 5,408 4,953
------- ------- ------- -------
Total non-interest expense $10,549 $ 9,363 $30,266 $27,256
======= ======= ======= =======
* 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 29.3% for 2003 and 33.0%
for 2002. The decrease in the effective tax rate was primarily due to tax
credits related to the Company's investment in low-income housing projects and
an increase in invested balances at its investment subsidiaries domiciled in a
state without income tax. In addition, the Company modified its retirement plan
to allow for the deductibility of dividends paid on its common stock held in the
plan. The Company and its subsidiaries file consolidated income tax returns.
11
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, 2003 were $1,404,064 compared to $1,251,760 as of
December 31, 2002. The acquisition of First Community added $156,215 of assets.
Average earning assets represented 91.5% of average total assets for the first
nine months of 2003 and 92.7% for the same period in 2002. Average loans
represented 71.9% of average deposits in the first nine months of 2003 and 76.0%
for the comparable period in 2002. Management continues to emphasize quality
loan growth to increase these averages. Average loans as a percent of average
assets were 59.7% and 64.0% for the nine-month period ended September 30, 2003
and 2002, respectively.
The increase in deposits of $105,855 from December 31, 2002 to September 30,
2003 was due primarily to the acquisition of First Community, which added
$115,480 of deposits.
Shareholders' equity was $101,910 on September 30, 2003 compared to $99,771 on
December 31, 2002. Book value (shareholders' equity) per common share was $15.14
at September 30, 2003 versus $14.69 at year-end 2002. The unrealized gain on
securities available for sale, net of taxes, increased book value per share by
$.10 at September 30, 2003 and by $.66 at December 31, 2002. Depending on market
conditions, the unrealized gain or loss on securities available for sale can
cause fluctuations in shareholders equity.
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.
12
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 38.2% of total loans at September
30, 2003 and 40.7% at December 31, 2002.
On September 30, 2003, the Company had $4,443 of residential real estate loans
held for sale, which was a decrease from the year-end balance of $15,715. The
Company generally retains the servicing rights on mortgages sold.
Non-performing loans totaled $13.9 million as of September 30, 2003, which was
an increase from year-end when non-performing loans were $7.9 million. The
primary contributor to this increase was the acquisition of First Community. As
of the date of acquisition, First Community had $4.0 million of non-performing
loans and an allowance for loan losses of $2.1 million. As of September 30,
2003, the Company's non-performing loans represented 1.65% of total loans
compared to 1.69% a year ago.
The provision for loan losses was $815 in the third quarter of 2003 compared to
$810 for the same period in 2002. For the nine months ended September 30, 2003,
the Company recorded $1,550 in provision expense compared to $1,925 for the same
period a year ago. The Company had net charge-offs of $980 for the first nine
months of 2003 compared to net charge-offs of $769 for the comparable period in
2002. As a percent of average loans, net charge-offs represented 0.16% for 2003
compared to 0.13% for 2002. The provision for 2003 was lower than 2002 as the
Company's specific allocations for two large commercial credits were reduced due
to their improving financial performance. Also, the Company incurred additional
loan loss provision expense in the third quarter of 2002 for an unrelated
commercial credit.
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, 2003 was
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
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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, 2003, $396,774 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 $1,582 was recorded to adjust the AFS
portfolio to current market value at September 30, 2003, compared to an
unrealized pre-tax gain of $7,065 at December 31, 2002.
Effective January 1, 2002 the Company formed two 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. Average total deposits funded 90.7% of total average earning
assets for the nine-month periods ending September 30, 2003 and 2002. Total
interest-bearing deposits averaged 90.1% and 90.8% of average total deposits for
the periods ending September 30, 2003 and 2002, respectively. Management
constantly strives to increase the percentage of transaction-related deposits to
total deposits due to the positive effect on earnings.
The Company had FHLB advances of $63,849 outstanding at September 30, 2003.
These advances have interest rates ranging from 3.3% to 6.7% with $10,000
maturing in the first quarter of 2004. Approximately $50,500 of these advances
mature in 2005 or later.
Capital Resources
Total shareholders' equity was $101,910 at September 30, 2003, which was a
slight increase from $99,771 at December 31, 2002. The Company's earnings were
largely offset by the decrease in the unrealized gain on investment securities,
cash dividends paid on common stock, and treasury stock purchases.
During 2003, the Company redeemed $8,425 of its 8.75% fixed rate trust preferred
securities and refinanced the remaining $14,000 of the 1997 issuance. As part of
the refinancing that took place on April 1, 2003, the Company issued $14,000 of
trust preferred securities in a pooled offering. The rate on these securities is
fixed for the first five years at 6.65% and then becomes variable at a rate tied
to the 3-month LIBOR rate and adjusts quarterly. These securities mature in 30
years and can be called anytime after 5 years. An interest rate swap was
utilized to obtain the initial fixed rate on the issue. The Company also issued
$7,000 of variable rate trust preferred securities on June 12, 2003. The rate is
tied to the 3-month LIBOR rate and adjusts quarterly. These securities mature in
30 years and can be called anytime after 5 years.
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, 2003, Tier 1 capital to total average assets was 5.71%.
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MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Tier 1 capital to risk-adjusted assets was 8.87%. Total capital to risk-adjusted
assets was 11.17%. 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 $.18 per share in the first,
second, and third quarters of 2003 versus $.162 for the first, second, and third
quarters of 2002.
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 81.3% of total earning assets for the nine months ended
September 30, 2003 and 82.1% for the same period in 2002.
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.
15
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
At September 30, 2003, the Company held approximately $500 million 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.
16
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, 2003 from the
analysis and disclosures provided in the Corporation's Form 10-K for the year
ended December 31, 2002.
17
Item 4. Controls and Procedures
As of the end of the quarterly period covered by 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) 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 were, 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 as of such date.
18
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
Sections 302 and 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.
31.1 Certification pursuant to Section 302 of Sarbanes-Oxley
Act of 2002 by Chief Executive Officer
31.2 Certification pursuant to Section 302 of Sarbanes-Oxley
Act of 2002 by Chief Financial Officer
32.1 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, by Chief Executive Officer
32.2 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, by Chief Financial Officer
b) Reports on Form 8-K
None
No other information is required to be filed under Part II of this form.
19
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 14, 2003
/s/ James L. Saner, Sr.
-------------------------------------------------
James L. Saner Sr.
President and Chief Executive Officer
November 14, 2003
/s/ Donald A. Benziger
-------------------------------------------------
Donald A. Benziger
Senior Vice President & Chief Financial Officer
November 14, 2003
/s/ James M. Anderson
-------------------------------------------------
James M. Anderson
Controller & Principal Accounting Officer
20