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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 JUNE 30, 2004
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 August 6, 2004 there were outstanding 11,001,292 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 Balance Sheets 3
Consolidated Statements of Income and Comprehensive Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated 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
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands except per share data)
(Unaudited)
June 30, December 31,
2004 2003
----------- -----------
Assets
Cash and due from banks $ 54,548 $ 50,564
Money market fund 2,943 6,290
----------- -----------
Cash and cash equivalents 57,491 56,854
Interest bearing time deposits 502 201
Investment securities
Available for sale 429,176 422,111
Held to maturity (fair value of $3,477 and $3,683) 3,318 3,431
----------- -----------
Total investment securities 432,494 425,542
Loans held for sale 2,175 1,965
Loans, net of allowance for loan losses of $12,254 and $11,509 933,950 843,962
Restricted stock, at cost 7,143 6,639
Premises and equipment, net 26,263 22,886
Goodwill 40,166 36,047
Intangible assets 7,027 5,347
Cash surrender value of life insurance 24,142 22,203
Other assets 21,141 21,083
----------- -----------
Total assets $ 1,552,494 $ 1,442,729
=========== ===========
Liabilities
Deposits
Noninterest bearing $ 138,509 $ 127,100
Interest bearing 1,079,488 1,064,210
----------- -----------
Total deposits 1,217,997 1,191,310
Short-term borrowings 67,653 27,508
Federal Home Loan Bank advances 100,862 62,751
Subordinated debentures 29,898 29,898
Notes payable 11,100 12,500
Other liabilities 10,742 13,338
----------- -----------
Total liabilities 1,438,252 1,337,305
----------- -----------
Shareholders' equity
Preferred stock, no par value
Authorized shares - 400,000
Issued and outstanding - none -- --
Common stock $.50 stated value:
Authorized shares - 25,000,000
Issued shares - 11,196,357 and 6,824,405
Outstanding shares - 11,001,292 and 6,729,256 5,600 3,413
Common stock to be distributed, 0 and 341,220 shares -- 170
Treasury stock - 195,065 and 95,149 shares, at cost (3,149) (2,190)
Additional paid-in capital 60,352 53,478
Retained earnings 54,703 49,338
Accumulated other comprehensive income (3,264) 1,215
----------- -----------
Total shareholders' equity 114,242 105,424
----------- -----------
Total liabilities and shareholders' equity $ 1,552,494 $ 1,442,729
=========== ===========
See notes to consolidated financial statements.
3
MAINSOURCE FINANCIAL GROUP
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
Three months ended Six months ended
June 30, June 30,
(Dollar amounts in thousands 2004 2003 2004 2003
except per share data) -------- -------- -------- --------
Interest income:
Loans $ 13,641 $ 12,980 $ 26,931 $ 26,024
Investment securities 3,805 3,489 7,259 7,121
Other interest income 28 55 48 111
-------- -------- -------- --------
Total interest income 17,474 16,524 34,238 33,256
-------- -------- -------- --------
Interest expense:
Deposits 3,902 4,720 7,908 9,553
Other borrowings 879 736 1,752 1,433
Subordinated debentures 409 348 822 836
-------- -------- -------- --------
Total interest expense 5,190 5,804 10,482 11,822
-------- -------- -------- --------
Net interest income 12,284 10,720 23,756 21,434
Provision for loan losses 60 345 60 735
-------- -------- -------- --------
Net interest income after
provision for loan losses 12,224 10,375 23,696 20,699
Non-interest income:
Insurance commissions 691 612 1,389 1,194
Mortgage banking 919 1,656 1,718 3,009
Trust and investment product fees 225 152 442 302
Service charges on deposit accounts 1,720 1,081 3,258 2,034
Net realized gains on securities 437 42 773 835
Other income 1,390 854 2,566 1,871
-------- -------- -------- --------
Total non-interest income 5,382 4,397 10,146 9,245
-------- -------- -------- --------
Non-interest expense:
Salaries and employee benefits 6,639 5,492 13,080 11,006
Net occupancy expenses 762 664 1,520 1,319
Equipment expenses 932 840 1,864 1,652
Intangibles amortization 232 235 466 456
Telecommunications 424 304 764 614
Stationery printing and supplies 250 209 469 438
Other expenses 2,577 1,661 4,734 4,232
-------- -------- -------- --------
Total non-interest expense 11,816 9,405 22,897 19,717
-------- -------- -------- --------
Income before income tax 5,790 5,367 10,945 10,227
Income tax expense 1,471 1,633 2,991 2,988
-------- -------- -------- --------
Net income $ 4,319 $ 3,734 $ 7,954 $ 7,239
======== ======== ======== ========
Comprehensive income (loss) $ (1,346) $ 3,775 $ 3,475 $ 5,635
======== ======== ======== ========
Net income per share (basic and diluted) $ 0.40 $ 0.35 $ 0.75 $ 0.68
Cash dividends declared $ 0.125 $ 0.114 $ 0.245 $ 0.229
See notes to consolidated financial statements.
4
MAINSOURCE FINANCIAL GROUP
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW
(Unaudited)
(Dollars in thousands)
Six months ended
June 30,
2004 2003
--------- ---------
Operating Activities
Net income $ 7,954 $ 7,239
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 60 735
Depreciation and amortization 1,263 1,306
Securities amortization, net 1,405 2,051
Amortization of intangibles 466 456
Increase in cash surrender value of life insurance policies (296) (75)
Investment securities gains/losses (773) (835)
Change in loans held for sale (210) (978)
Change in other assets and liabilities 845 (5,820)
--------- ---------
Net cash provided (used) by operating activities 10,714 4,079
Investing Activities
Proceeds from maturities and payments
on securities held to maturity 137 939
Purchases of securities available for sale (98,478) (210,142)
Proceeds from maturities and payments
on securities available for sale 53,363 115,776
Proceeds from sales of securities available for sale 49,955 27,257
Purchases of restricted stock (504) (88)
Loan originations and payments, net (8,678) 16,560
Purchases of premises and equipment (800) (1,111)
Cash paid for bank acquisition, net (135) (12,795)
Cash received from branch acquisitions, net -- 12,203
--------- ---------
Net cash provided (used) by investing activities (5,140) (51,401)
Financing Activities
Net change in deposits (73,030) 12,040
Net change in short-term borrowings 39,821 13,920
Proceeds from issuance of long-term debt -- 13,000
Repayment of long-term debt (2,100) --
Proceeds from issuance of trust preferred securities -- 21,000
Proceeds from FHLB advances 40,000 --
Repayment of FHLB advances (6,045) (70)
Redemption of trust preferred securities -- (22,425)
Purchase of treasury shares (982) (1,496)
Proceeds from exercise of stock options 28 --
Cash dividends and fractional stock dividends (2,629) (2,450)
--------- ---------
Net cash provided (used) by financing activities (4,937) 33,519
--------- ---------
Net change in cash and cash equivalents 637 (13,803)
Cash and cash equivalents, beginning of period 56,854 77,917
--------- ---------
Cash and cash equivalents, end of period $ 57,491 $ 64,114
========= =========
See Note 3 regarding non-cash transaction included in acquisition.
See notes to consolidated financial statements.
5
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.
6
NOTE 2 - STOCK COMPENSATION
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 six months ended
---------------------------- ----------------------------
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
------------- ------------- ------------- -------------
Net income as reported $ 4,319 $ 3,734 $ 7,954 $ 7,239
Deduct: Stock-based compensation expense
determined under fair value based method 20 17 51 17
--------- --------- --------- ---------
Pro forma net income $ 4,299 $ 3,717 $ 7,903 $ 7,222
Basic earnings per share as reported $ 0.40 $ 0.35 $ 0.75 $ 0.68
Pro forma basic earnings per share $ 0.40 $ 0.35 $ 0.74 $ 0.68
Diluted earnings per share as reported $ 0.40 $ 0.35 $ 0.75 $ 0.68
Pro forma diluted earnings per share $ 0.40 $ 0.35 $ 0.74 $ 0.68
The pro forma effects are computed using option pricing models, with the
following weighted-average assumptions for 2004 as of grant date: risk-free
interest rate 3.48%, expected option life 6.69 years, expected stock price
volatility 20.33% and dividend yield 2.75%.
NOTE 3 - ACQUISITIONS
In June 2003, the Company acquired First Community Bancshares, Inc. which had
ten branches located in the south central area of Indiana. 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.
In February 2003, the Company acquired one branch in Illinois. The results of
operations for this acquisition have been included since the transaction date.
In June 2004, the Company consummated its acquisition of Peoples Financial Corp
("PFC"). PFC has seven branches located in the southwestern part of Indiana. As
a result of this acquisition, the Company expects to expand its geographical
presence in the southwestern area of Indiana, increase its customer base to
enhance deposit fee income, provide an opportunity to market additional
products and services to new customers, and reduce operating costs through
economies of scale. As of the date of acquisition, the acquired company had
$4,320 of cash and cash equivalents, $81,130 of net loans, and $98,876 of
deposits. A core deposit intangible of $2,141 and goodwill of $4,119 were also
recorded. As of the date of this report, the Company was in the process of
obtaining third party valuations and completing fair value estimates for certain
assets acquired and liabilities assumed, and the allocation of the purchase
price is subject to refinement. The results of operations for this acquisition
have been included since the transaction date which was June 8, 2004. The
Company funded the purchase price of $13,380 by issuing 449,224 shares of its
common stock valued at $19.87 per the NASDAQ closing bid on June 7, 2004 and
using $4,454 of cash on hand.
The following table presents proforma information for the periods ended June 30
as if the acquisition had occurred at the beginning of 2004 and 2003. The pro
forma 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 six months ended
----------------------------- -----------------------------
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
------------- -------------- ------------- -------------
Net interest income 13,175 10,720 25,699 23,318
Net income 3,897 3,766 7,653 7,321
Basic earnings per share 0.36 0.35 0.72 0.69
Diluted earnings per share 0.36 0.35 0.72 0.69
7
NOTE 4 - 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 June 30, 2004 Value Gains Losses
- ----------------------------------------------------------------------
Available for Sale
Federal agencies $ 72,429 $ 241 ($ 1,217)
State and municipal 86,465 $ 1,071 (1,927)
Mortgage-backed securities 254,104 $ 753 (4,095)
Equity and other securities 16,178 $ 107 (257)
- ----------------------------------------------------------------------
Total available for sale $429,176 $ 2,172 ($ 7,496)
- ----------------------------------------------------------------------
As of December 31, 2003
- ----------------------------------------------------------------------
Available for Sale
Federal agencies $ 92,867 $ 1,409 ($ 36)
State and municipal 61,324 1,899 (152)
Mortgage-backed securities 255,541 1,297 (1,710)
Equity and other securities 12,379 103 (625)
- ----------------------------------------------------------------------
Total available for sale $422,111 $ 4,708 ($ 2,523)
- ----------------------------------------------------------------------
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 June 30, 2004 Amount Gains Losses Value
- ---------------------------------------------------------------------------
Held to Maturity
State and municipal $2,542 $ 62 $ -- $2,604
Other securities 776 97 -- 873
- ---------------------------------------------------------------------------
Total held to maturity $3,318 $ 159 $ -- $3,477
- ---------------------------------------------------------------------------
As of December 31, 2003
- ---------------------------------------------------------------------------
Held to Maturity
State and municipal $2,682 $ 122 $ -- $2,804
Other securities 749 130 -- 879
- ---------------------------------------------------------------------------
Total held to maturity $3,431 $ 252 $ -- $3,683
- ---------------------------------------------------------------------------
NOTE 5 - LOANS AND ALLOWANCE
June 30, December 31,
2004 2003
- ----------------------------------------------------------------
Commercial and industrial loans $ 152,471 $ 158,271
Agricultural production financing 25,260 25,897
Farm real estate 39,108 37,107
Commercial real estate 135,904 101,022
Hotel 84,356 83,997
Residential real estate 356,360 315,848
Construction and development 39,546 33,605
Consumer 113,199 99,724
--------- ---------
Total loans 946,204 855,471
--------- ---------
Allowance for loan lossess (12,254) (11,509)
- ---------------------------------------------------------------
Net loans $ 933,950 $ 843,962
===============================================================
NOTE 6 - DEPOSITS June 30, December 31,
2004 2003
---------- ----------
Non-interest-bearing demand $ 138,509 $ 127,100
Interest-bearing demand 295,969 311,333
Savings 243,785 224,318
Certificates of deposit of $100 or more 142,494 141,327
Other certificates and time deposits 397,239 387,232
---------- ----------
Total deposits $1,217,997 $1,191,310
========== ==========
NOTE 7 - EARNINGS PER SHARE
Earnings per share (EPS) were computed as follows:
For the three months ended June 30, 2004 June 30, 2003
---------------------------- ----------------------------
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 $ 4,319 10,681,081 $0.40 $ 3,734 10,632,787 $0.35
------- ----- ------- -----
Effect of dilutive shares 14,564 1,076
---------- ----------
Diluted earnings per share $ 4,319 10,695,645 $0.40 $ 3,734 10,633,863 $0.35
======= ========== ===== ======= ========== =====
For the six months ended June 30, 2004 June 30, 2003
---------------------------- ----------------------------
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 $ 7,954 10,634,159 $0.75 $ 7,239 10,655,110 $0.68
------- ----- ------- -----
Effect of dilutive shares 16,051 345
---------- ----------
Diluted earnings per share $ 7,954 10,650,210 $0.75 $ 7,239 10,655,455 $0.68
======= ========== ===== ======= ========== =====
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. ("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 June 30, 2004, the Company controlled five bank
subsidiaries, MainSource Bank, Regional Bank ("Regional"), First Community Bank
and Trust ("First Community"), Capstone Bank ("Capstone"), and Peoples Trust
Company ("Peoples"). 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., MSB Investments of Nevada,
Inc., and RB Investments, Inc.
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 second quarter of 2004 was $4,319 or 15.7% greater than the
second quarter of 2003. Earnings per share for the second quarter equaled $.40
in 2004, compared to $.35 in 2003, an increase of 14.3%. The Company's return on
average total assets for the second quarter was 1.19% in 2004 and 1.17% in 2003.
Return on average shareholders' equity for the second quarter was 15.83% in 2004
and 14.91% in 2003.
For the six months ended June 30, 2004, net income was $7,954 compared to $7,239
for the same period in 2003. Earnings per share for the six months ending June
30 were $0.75 in 2004 and $.68 in 2003, which represents an increase of 10.3%.
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. Second quarter net interest income of $12,284
in 2004 was an increase of 14.6% versus the second quarter of 2003. Net interest
income on a tax equivalent basis, reflected as a percentage of average earning
assets (net interest margin), was 3.85% for the second quarter of 2004 and 3.69%
for the same timeframe in 2003. For the six months ended June 30, 2004, the
Company's net interest margin was 3.72% compared to 3.79% in 2003.
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
Second quarter non-interest income for 2004 was $5,382 compared to $4,397 for
the second quarter of 2003. The impact of the acquisition of First Community and
the implementation of a formalized overdraft program were partially offset by a
decrease in mortgage banking activity. Mortgage banking income, which consists
of gains and losses on loan sales and service fee income, was $919 for the
second quarter of 2004 versus $1,656 for the second quarter of 2003.
For the six months ended June 30, 2004, non-interest income was $10,146 compared
to $9,245 for the same period a year ago. The 9.7% increase was primarily due to
the aforementioned acquisition of First Community and the formalized overdraft
program offsetting lower mortgage banking revenues.
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 $11,816 for the second quarter of 2004, which
represented an increase of $2,411, or 25.6%, from the second quarter of 2003.
The increase was primarily due to the acquisitions of First Community and
Peoples, which added approximately $1,600 of non-interest expense in 2004.
Excluding these acquisitions, non-interest expense would have been $10,216, an
increase of 8.6%, and would be primarily attributable to normal staff salary
increases.
For the six months ended June 30, 2004, non-interest expense was $22,897
compared to $19,717 for the same period in 2003. The increase was due primarily
to acquisitions, which accounted for approximately $3,000 of non-interest
expense in 2004 that was not in 2003. Offsetting this increase was a decrease in
the amortization of deferred debt acquisition costs. In the first quarter of
2003, the Company redeemed a portion of its subordinated debentures and
expensed approximately $850 in related costs.
Income Taxes
The effective tax rate for the first six months was 27.3% for 2004 compared to
29.2% for the same period a year ago. The decrease in the Company's effective
tax rate was primarily attributable to increased income from tax-free municipal
securities and the purchase of bank-owned life insurance. 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 June 30, 2004 were $1,552,494 compared to $1,442,729 as of
December 31, 2003. The acquisition of Peoples added approximately $120,000 in
assets. Average earning assets represented 90.3% of average total assets for the
first six months of 2004 and 91.3% for the same period in 2003. Average loans
represented 74.0% of average deposits in the first six months of 2004 and 71.5%
for the comparable period in 2003. Management continues to emphasize quality
loan growth to increase these averages. Average loans as a percent of average
assets were 60.1% and 59.4% for the six-month period ended June 30, 2004 and
2003 respectively.
The increase in deposits of $26,687 from December 31, 2003 to June 30, 2004 was
due primarily to the acquisition of Peoples, which added $98,876 in deposits.
This increase was offset by the loss of public fund deposits which are generally
temporary and seasonal in nature.
Shareholders' equity was $114,242 on June 30, 2004 compared to $105,424 on
December 31, 2003. Book value (shareholders' equity) per common share was $10.38
at June 30, 2004 versus $9.94 at year-end 2003. Accumulated other comprehensive
income decreased book value per share by $.30 at June 30, 2004 and increased
book value per share by $.12 at December 31, 2003. 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.
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 37.7% of total loans at June 30,
2004 and 36.9% at December 31, 2003.
On June 30, 2004, the Company had $2,175 of residential real estate loans held
for sale, which was relatively unchanged from the year-end balance of $1,965.
The Company generally retains the servicing rights on mortgages sold.
The Company's asset quality improved significantly during the second quarter of
2004. Non-performing assets totaled $13.0 million, or 0.84% of total assets, as
of June 30, 2004, which included $0.7 million of non-performing assets recently
acquired in the Peoples acquisition, and is compared to $16.9 million, or 1.18%
of total assets, as of the same period a year ago. Non-performing assets were
$16.1 million, or 1.13% of assets as of March 31, 2004, and $17.3 million, or
1.20% of assets at year-end 2003. The allowance for loan losses was $12.3
million as of June 30, 2004 and represented 1.30% of total outstanding loans.
The provision for loan losses was $60 in the second quarter of 2004 compared to
$345 for the same period in 2003. The decrease in the provision in 2004 was
attributable to the decrease in the balance of non-performing loans. 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 June 30, 2004 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
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 June 30, 2004, $429,176 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 loss of $5,324 was recorded to adjust the AFS
portfolio to current market value at June 30, 2004, compared to an unrealized
pre-tax gain of $2,185 at December 31, 2003. Unrealized losses on AFS securities
have not been recognized into income because management has the intent and
ability to hold these securities for the foreseeable future and the decline in
fair value is largely due to increases in market interest rates. The fair value
is expected to recover as the securities approach their maturity dates.
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 89.9% and 90.5% of total average
earning assets for the periods ending June 30, 2004 and 2003. Total
interest-bearing deposits averaged 89.6% and 90.3% of average total deposits for
the periods ending June 30, 2004 and 2003, 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 $100,862 outstanding at June 30, 2004. These
advances have interest rates ranging from 1.44% to 6.72%. Approximately $45,000
of these advances are short-term advances obtained in June of 2003 and mature in
2004. The Company also has long-term advances with $14,000 maturing in 2005,
$16,000 maturing in 2007, $6,000 maturing in 2010 and $20,000 maturing in 2012.
Capital Resources
Total shareholders' equity was $114,242 at June 30, 2004, which was an increase
from $105,424 at December 31, 2003. The increase in equity was primarily
attributable to earnings for the six-month period and the acquisition of
Peoples, which increased equity by $8,926. This increase was partially offset by
the change in the unrealized gain/loss on investment securities and cash
dividends paid on common stock.
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 loan losses.
At June 30, 2004, Tier 1 capital to total average assets was 6.68%.
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 10.01%. Total capital to risk-adjusted
assets was 11.25%. 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 $.125 per share in the second
quarter of 2004 versus $.114 for the second quarter of 2003. For the six months
ended June 30, 2004, the Company declared and paid common dividends of $0.245
compared to $0.229 for the same period a year ago.
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 79.0% of total earning assets for the six months ended June
30, 2004 and 81.4% for the same period in 2003.
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 June 30, 2004, the Company held approximately $600 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.
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 June 30, 2004 from the
analysis and disclosures provided in the Corporation's Form 10-K for the year
ended December 31, 2003.
18
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.
There was no change in the Company's internal control over financial reporting
that occurred during the Company's second fiscal quarter of 2004 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
19
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
Maximum Number
Total Number of Shares (or Approximate Dollar
Total Number Average Price (or Units) Purchased as Part Value) of Shares (or Units)
of Shares (or Paid Per Share of Publicly Announced Plans That May Yet Be Purchased
Period Units) Purchased (or Unit) or Programs (1) Under the Plans or Programs
April 2004 -- -- -- 234,219
May 2004 16,000 $ 20.21 16,000 218,219
June 2004 10,000 $ 19.52 10,000 208,219
(1) The Company has a Stock Repurchase Plan that allows for the repurchase of
up to 255,000 shares of common stock. The Plan expires January 31, 2005.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of shareholder of the Company was held on April 21,
2004.
(b) All director nominees were elected.
(c) Certain matters voted upon at the meeting and the votes cast with
respect to such matters are as follows:
Proposals and Vote Tabulations
Votes Cast
---------------------------
For Against
---------------------------
Management Proposals
NONE -- --
Election of Directors
---------------------------
Director For Withheld
- -------- ---------------------------
William G. Barron 5,588,581 288,203
Dale J. Deffner 5,617,453 259,331
Philip A. Frantz 5,400,334 476,450
Rick S. Hartman 5,585,420 291,364
Robert E. Hoptry 5,753,620 123,164
Douglas I. Kunkel 5,797,169 79,615
James L. Saner, Sr. 5,828,160 48,624
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) During the quarter ended June 30, 2004 the Company filed the
following reports on Form 8-K.
The Form 8-K dated April 14, 2004, the Company announced
earnings and operating results for the second quarter ended
June 30, 2004.
The Form 8-K dated May 21, 2004, the Company announced the
declaration of their second quarter cash dividend.
The Form 8-K dated June 8, 2004, the Company announced the
consummation of their acquisition of Peoples Financial Corp.
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.
August 6, 2004
/s/ James L. Saner, Sr.
-------------------------------------------------
James L. Saner Sr.
President and Chief Executive Officer
August 6, 2004
/s/ Donald A. Benziger
-------------------------------------------------
Donald A. Benziger
Senior Vice President & Chief Financial Officer
August 6, 2004
/s/ James M. Anderson
-------------------------------------------------
James M. Anderson
Controller & Principal Accounting Officer
21