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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, 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 November 4, 2004 there were outstanding 10,992,292 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
FORM 10-Q
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands except per share data)
(Unaudited)
September 30, December 31,
2004 2003
----------- -----------
Assets
Cash and due from banks $ 57,110 $ 50,564
Money market fund 5,311 6,290
----------- -----------
Cash and cash equivalents 62,421 56,854
Interest bearing time deposits 303 201
Investment securities
Available for sale 429,692 422,111
Held to maturity (fair value of $3,438 and $3,683) 3,230 3,431
----------- -----------
Total investment securities 432,922 425,542
Loans held for sale 2,135 1,965
Loans, net of allowance for loan losses of $11,899 and $11,509 933,620 843,962
Restricted stock, at cost 7,279 6,639
Premises and equipment, net 25,840 22,886
Goodwill 39,906 36,047
Intangible assets 6,726 5,347
Cash surrender value of life insurance 24,373 22,203
Other assets 21,180 21,083
----------- -----------
Total assets $ 1,556,705 $ 1,442,729
=========== ===========
Liabilities
Deposits
Noninterest bearing $ 139,082 $ 127,100
Interest bearing 1,095,218 1,064,210
----------- -----------
Total deposits 1,234,300 1,191,310
Short-term borrowings 41,627 27,508
Federal Home Loan Bank advances 103,547 62,751
Subordinated debentures 29,898 29,898
Notes payable 11,100 12,500
Other liabilities 14,154 13,338
----------- -----------
Total liabilities 1,434,626 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 - 10,992,292 and 6,729,256 5,600 3,413
Common stock to be distributed, 0 and 341,220 shares -- 170
Treasury stock - 204,065 and 95,149 shares, at cost (3,320) (2,190)
Additional paid-in capital 60,352 53,478
Retained earnings 57,935 49,338
Accumulated other comprehensive income 1,512 1,215
----------- -----------
Total shareholders' equity 122,079 105,424
----------- -----------
Total liabilities and shareholders' equity $ 1,556,705 $ 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 Nine months ended
September 30, September 30,
(Dollar amounts in thousands
except per share data) 2004 2003 2004 2003
-------- -------- -------- --------
Interest income:
Loans $ 15,022 $ 14,107 $ 41,953 $ 40,131
Investment securities 3,948 3,036 11,207 10,157
Other interest income 15 73 46 184
-------- -------- -------- --------
Total interest income 18,985 17,216 53,206 50,472
-------- -------- -------- --------
Interest expense:
Deposits 3,948 4,623 11,856 14,176
Other borrowings 1,095 890 2,847 2,323
Subordinated debentures 442 399 1,247 1,235
-------- -------- -------- --------
Total interest expense 5,485 5,912 15,950 17,734
-------- -------- -------- --------
Net interest income 13,500 11,304 37,256 32,738
Provision for loan losses 270 815 330 1,550
-------- -------- -------- --------
Net interest income after
provision for loan losses 13,230 10,489 36,926 31,188
Non-interest income:
Insurance commissions 706 668 2,095 1,862
Mortgage banking 701 1,811 2,419 4,820
Trust and investment product fees 228 166 670 494
Service charges on deposit accounts 1,931 1,446 5,189 3,480
Net realized gains on securities 44 466 817 1,301
Other income 1,294 967 3,860 2,812
-------- -------- -------- --------
Total non-interest income 4,904 5,524 15,050 14,769
-------- -------- -------- --------
Non-interest expense:
Salaries and employee benefits 6,388 6,046 19,468 17,052
Net occupancy expenses 824 715 2,344 2,034
Equipment expenses 1,047 945 2,911 2,597
Intangibles amortization 296 219 762 675
Telecommunications 409 332 1,173 946
Stationery printing and supplies 253 255 722 693
Other expenses 2,551 2,037 7,285 6,269
-------- -------- -------- --------
Total non-interest expense 11,768 10,549 34,665 30,266
-------- -------- -------- --------
Income before income tax 6,366 5,464 17,311 15,691
Income tax expense 1,760 1,615 4,751 4,603
-------- -------- -------- --------
Net income $ 4,606 $ 3,849 $ 12,560 $ 11,088
======== ======== ======== ========
Comprehensive income $ 9,382 $ 1,662 $ 12,857 $ 7,297
======== ======== ======== ========
Net income per share (basic and diluted) $ 0.42 $ 0.36 $ 1.17 $ 1.04
Cash dividends declared $ 0.125 $ 0.114 $ 0.370 $ 0.343
See notes to consolidated financial statements.
4
MAINSOURCE FINANCIAL GROUP
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW
(Unaudited)
(Dollars in thousands)
Nine months ended
September 30,
2004 2003
--------- ---------
Operating Activities
Net income $ 12,560 $ 11,088
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 330 1,550
Depreciation and amortization 2,210 1,945
Securities amortization, net 1,932 3,256
Amortization of intangibles 762 675
Increase in cash surrender value of life insurance policies (527) (318)
Investment securities gains (817) (1,301)
Change in loans held for sale (170) 11,788
Change in other assets and liabilities 1,711 1,277
--------- ---------
Net cash provided by operating activities 17,991 29,960
Investing Activities
Proceeds from maturities and payments
on securities held to maturity 237 1,288
Purchases of securities available for sale (132,136) (333,037)
Proceeds from maturities and payments
on securities available for sale 74,621 161,597
Proceeds from sales of securities available for sale 69,764 117,383
Purchases of restricted stock (640) (142)
Loan originations and payments, net (8,618) 21,755
Purchases of premises and equipment (1,790) (1,604)
Cash paid for life insurance policies -- (15,000)
Cash paid for bank acquisition, net (342) (12,795)
Cash received from acquisitions, net -- 12,203
--------- ---------
Net cash provided (used) by investing activities 1,096 (48,352)
Financing Activities
Net change in deposits (56,727) (29,279)
Net change in short-term borrowings 13,795 21,740
Proceeds from issuance of long-term debt -- 13,000
Repayment of long-term debt (2,100) (800)
Proceeds from issuance of trust preferred securities -- 21,000
Proceeds from FHLB advances 78,500 --
Repayment of FHLB advances (41,860) (166)
Redemption of trust preferred securities -- (22,425)
Purchase of treasury shares (1,153) (1,496)
Proceeds from exercise of stock options 28 --
Cash dividends and fractional stock dividends (4,003) (3,662)
--------- ---------
Net cash used by financing activities (13,520) (2,088)
--------- ---------
Net change in cash and cash equivalents 5,567 (20,480)
Cash and cash equivalents, beginning of period 56,854 77,917
--------- ---------
Cash and cash equivalents, end of period $ 62,421 $ 57,437
========= =========
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. The consolidated interim
financial statements have been prepared according to accounting principles
generally accepted in the United States of America and in accordance with the
instructions for Form 10-Q. The interim statements do not include all
information and footnotes normally included in the annual financial statements.
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. Some items in prior period
financial statements were reclassified to conform to current presentation.
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 nine months ended
-------------- -------------- -------------- --------------
Sept. 30, 2004 Sept. 30, 2003 Sept. 30, 2004 Sept. 30, 2003
-------------- -------------- -------------- --------------
Net income as reported $ 4,606 $ 3,849 $ 12,560 $ 11,088
Deduct: Stock-based compensation expense 20 6 71 23
--------- --------- ---------- ----------
determined under fair value based method $ 4,586 $ 3,843 $ 12,489 $ 11,065
Pro forma net income
Basic earnings per share as reported $ 0.42 $ 0.36 $ 1.17 $ 1.04
Pro forma basic earnings per share $ 0.42 $ 0.36 $ 1.16 $ 1.04
Diluted earnings per share as reported $ 0.42 $ 0.36 $ 1.17 $ 1.04
Pro forma diluted earnings per share $ 0.42 $ 0.36 $ 1.16 $ 1.04
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 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 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 June 2004, the Company consummated its acquisition of Peoples Financial Corp
("PFC"). At the date of acquisition, PFC had 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. The acquired company had $4,320 of
cash and cash equivalents, $81,130 of net loans, and $99,717 of deposits. A core
deposit intangible of $2,141 and goodwill of $3,853 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
September 30 as if the acquisition of PFC 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 nine months ended
------------------------------ ------------------------------
Sept. 30, 2004 Sept. 30, 2003 Sept. 30, 2004 Sept. 30, 2003
-------------- -------------- -------------- --------------
Net interest income 13,500 12,279 39,199 35,597
Net income 4,606 3,930 12,259 11,251
Basic earnings per share 0.42 0.36 1.11 1.01
Diluted earnings per share 0.42 0.36 1.11 1.01
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 September 30, 2004 Value Gains Losses
- --------------------------------------------------------------------------------------------
Available for Sale
Federal agencies $62,867 $362 ($143)
State and municipal 90,826 2,069 (330)
Mortgage-backed securities 259,695 1,414 (1,113)
Equity and other securities 16,304 293 (233)
- --------------------------------------------------------------------------------------------
Total available for sale $429,692 $4,138 ($1,819)
- --------------------------------------------------------------------------------------------
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 September 30, 2004 Amount Gains Losses Value
- -----------------------------------------------------------------------------------------------------
Held to Maturity
State and municipal $2,441 $95 -- $2,536
Other securities 789 113 -- 902
- -----------------------------------------------------------------------------------------------------
Total held to maturity $3,230 $208 -- $3,438
- -----------------------------------------------------------------------------------------------------
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
September 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------
Commercial and industrial loans $ 160,164 $ 158,271
Agricultural production financing 25,965 25,897
Farm real estate 38,840 37,107
Commercial real estate 136,217 101,022
Hotel 83,895 83,997
Residential real estate 353,024 315,848
Construction and development 37,605 33,605
Consumer 109,809 99,724
--------------------------------
Total loans 945,519 855,471
--------------------------------
Allowance for loan lossess (11,899) (11,509)
- -----------------------------------------------------------------------------------------
Net loans $ 933,620 $ 843,962
=========================================================================================
NOTE 6 - DEPOSITS
September 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------
Non-interest-bearing demand $ 139,082 $ 127,100
Interest-bearing demand 325,451 311,333
Savings 259,530 224,318
Certificates of deposit of $100 or more 134,102 141,327
Other certificates and time deposits 376,135 387,232
--------------------------------
Total deposits $1,234,300 $1,191,310
================================
NOTE 7 - EARNINGS PER SHARE
Earnings per share (EPS) were computed as follows:
For the three months ended September 30, 2004 September 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 $4,606 10,998,181 $0.42 $3,849 10,598,578 $0.36
------ ----- ------ -----
Effect of dilutive shares 11,301 5,064
------ -----
Diluted earnings per share $4,606 11,009,482 $0.42 $3,849 10,603,642 $0.36
====== ========== ===== ====== ========== =====
For the nine months ended September 30, 2004 September 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 $12,560 10,756,306 $1.17 $11,088 10,636,058 $1.04
------- ----- ------- -----
Effect of dilutive shares 14,579 1,353
------ -----
Diluted earnings per share $12,560 10,770,885 $1.17 $11,088 10,637,411 $1.04
======= ========== ===== ======= ========== =====
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 September 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.
In September 2004, the Company announced its plan to merge its Indiana banking
affiliates into MainSource Bank. In addition, the Company's Illinois affiliate,
Capstone, will change its name to MainSource Bank of Illinois before the end of
2004. The entire plan is projected to be completed by the end of the third
quarter of 2005.
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 2004 was $4,606 or 19.7% greater than the
third quarter of 2003. Earnings per share for the third quarter equaled $.42 in
2004, compared to $.36 in 2003, an increase of 16.7%. The Company's return on
average total assets for the third quarter was 1.18% in 2004 and 1.08% in 2003.
Return on average shareholders' equity for the third quarter was 15.54% in 2004
and 15.08% in 2003.
For the nine months ended September 30, 2004, net income was $12,560 compared to
$11,088 for the same period in 2003. Earnings per share for the nine months
ending September 30 were $1.17 in 2004 and $1.04 in 2003, which represents an
increase of 12.5%.
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 $13,500 in
2004 was an increase of 19.4% versus the third quarter of 2003. Net interest
income on a tax equivalent basis, reflected as a percentage of average earning
assets (net interest margin), was 3.97% for the third quarter of 2004 and 3.61%
for the same timeframe in 2003. For the nine months ended September 30, 2004,
the Company's net interest margin was 3.85% compared to 3.72% in 2003. The
increase in the Company's net interest margin was primarily attributable to the
decrease in premium amortization on mortgage-backed securities.
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 2004 was $4,904 compared to $5,524 for the
third quarter of 2003. This 11.2% decrease was primarily attributable to a
decrease in mortgage banking income. Mortgage banking income, which consists of
gains and losses on loan sales and service fee income, was $701 for the third
quarter of 2004 versus $1,811 for the third quarter of 2003. This decrease was
primarily due to the increase in mortgage rates versus prior year and the
corresponding decrease in refinancing activity. The impact of the acquisition of
Peoples and the implementation of a formalized overdraft program partially
offset the drop in mortgage banking activity.
For the nine months ended September 30, 2004, non-interest income was $15,050
compared to $14,769 for the same period a year ago. The 1.9% increase was
primarily due to acquisitions 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 $11,768 for the third quarter of 2004, which
represented an increase of $1,219, or 11.6%, from the third quarter of 2003. The
increase was primarily due to the acquisition of Peoples, which added $947 of
non-interest expense in 2004. Excluding this acquisition, non-interest expense
would have been $10,821, an increase of 2.6%, and would be primarily
attributable to normal staff salary increases.
For the nine months ended September 30, 2004, non-interest expense was $34,665
compared to $30,266 for the same period in 2003. The increase was due primarily
to acquisitions, which accounted for approximately $4,000 of non-interest
expense in 2004 that was not incurred 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 nine months was 27.4% for 2004 compared to
29.3% 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 September 30, 2004 were $1,556,705 compared to $1,442,729 as of
December 31, 2003. The acquisition of Peoples added approximately $120,000 in
assets. Average earning assets represented 90.2% of average total assets for the
first nine months of 2004 and 91.5% for the same period in 2003. Average loans
represented 75.2% of average deposits in the first nine months of 2004 and 71.9%
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 60.5% and 59.7% for the nine-month period ended September 30, 2004
and 2003 respectively.
The increase in deposits of $42,990 from December 31, 2003 to September 30, 2004
was due primarily to the acquisition of Peoples, which added $99,717 in
deposits. This increase was offset by the loss of public fund deposits which are
generally temporary and seasonal in nature and higher-priced consumer deposits
which matured and did not renew.
Shareholders' equity was $122,079 on September 30, 2004 compared to $105,424 on
December 31, 2003. Book value (shareholders' equity) per common share was $11.11
at September 30, 2004 versus $9.94 at year-end 2003. Accumulated other
comprehensive income increased book value per share by $.14 at September 30,
2004 and $.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 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 37.3% of total loans at September
30, 2004 and 36.9% at December 31, 2003.
On September 30, 2004, the Company had $2,135 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 has improved significantly during the last year.
Non-performing assets totaled $12.9 million, or 0.83% of total assets, as of
September 30, 2004, which included $0.7 million of non-performing assets
recently acquired in the Peoples acquisition, and is compared to $17.4 million,
or 1.24% of total assets, as of the same date a year ago, and $17.3 million,
or 1.20% of assets at year-end 2003. The allowance for loan losses was $11.9
million as of September 30, 2004 and represented 1.26% of total outstanding
loans.
The provision for loan losses was $270 in the third quarter of 2004 compared to
$815 for the same period in 2003. The decrease in the provision in 2004 was
primarily 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 September 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 September 30, 2004, $429,692 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 $2,319 was recorded to adjust the AFS
portfolio to current market value at September 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 89.2% and 90.7% of total average
earning assets for the periods ending September 30, 2004 and 2003. Total
interest-bearing deposits averaged 89.3% and 90.1% of average total deposits for
the periods ending September 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 $103,547 outstanding at September 30, 2004.
These advances have interest rates ranging from 1.92% to 6.72%. Approximately
$47,400 of these advances were obtained in the second and third quarters of 2004
for short-term liquidity needs and had original maturities of six months or
less. The remaining advances were originally 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 $122,079 at September 30, 2004, which was an
increase from $105,424 at December 31, 2003. The increase in equity was
primarily attributable to earnings for the nine-month period and the acquisition
of Peoples, which increased equity by $8,926. This increase was partially offset
by 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 September 30, 2004, Tier 1 capital to total average assets was 6.71%. 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 10.15%. Total capital to risk-adjusted
assets was 11.34%. 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 third
quarter of 2004 versus $.114 for the third quarter of 2003. For the nine months
ended September 30, 2004, the Company declared and paid common dividends of
$0.37 compared to $0.343 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 78.5% of total earning assets for the nine months ended
September 30, 2004 and 81.3% 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 September 30, 2004, the Company held approximately $408 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 September 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 third 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 Under the Plans or Programs (1) (2)
July 2004 -- -- -- 208,219
August 2004 7,000 $ 18.89 7,000 496,219
September 2004 2,000 $ 19.85 2,000 494,219
(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.
(2) In August 2004, the Company expanded its Stock Repurchase Plan and allowed
for an additional 295,000 shares of common stock to be repurchased. The
Plan expires January 31, 2005.
Item 4. Submission of Matters to a Vote of Security Holders
None
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 September 30, 2004 the Company filed the
following reports on Form 8-K.
The Form 8-K dated July 14, 2004, the Company announced
earnings and operating results for the second quarter ended
June 30, 2004.
The Form 8-K dated August 18, 2004, the Company announced
the expansion of its common stock repurchase plan.
The Form 8-K dated August 20, 2004, the Company announced
the declaration of their third quarter cash dividend.
The Form 8-K dated September 3, 2004, the Company announced
the details of a restructuring plan that will result in the
consolidation of its Indiana charters.
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 4, 2004
/s/ James L. Saner, Sr.
-------------------------------------------------
James L. Saner Sr.
President and Chief Executive Officer
November 4, 2004
/s/ Donald A. Benziger
-------------------------------------------------
Donald A. Benziger
Senior Vice President & Chief Financial Officer
November 4, 2004
/s/ James M. Anderson
-------------------------------------------------
James M. Anderson
Controller & Principal Accounting Officer
21