EXHIBIT 13
CORPORATE PROFILE
MainSource financial Group (the "Company") is an Indiana-based, multi-bank
holding company that is focused on providing complete financial services. These
services go beyond just traditional bank products and include such services and
products as insurance, investment brokerage, mutual funds, wealth management and
financial planning.
At 2002 year-end, MainSource Financial Group owned three affiliate banks:
MainSource Bank with 35 branch offices in central Indiana; Regional Bank with
six branch offices in southern Indiana; and Capstone Bank with seven branch
offices in central Illinois and one in Indiana. MainSource also owned an
insurance agency and an investment and trust operation. MainSource Insurance
operated five insurance offices in Indiana and one in Kentucky; MainSource
Wealth Management operated three offices in Indiana and one in Illinois. Both
operations provide their services to all of the Company's banking offices.
During 2002, MainSource Financial acquired four branches in Illinois and one in
Indiana. At year end it also had a signed letter of intent to acquire a bank
with 10 branch offices in south central Indiana.
STOCK DATA
The common shares of the Company are listed on The Nasdaq Stock Market. The
trading symbol is MSFG. In newspaper listings, MainSource Financial shares are
frequently listed as MainSrce. For additional information, log on to our website
at www.mainsourcefinancial.com.
CONTENTS
Financial Highlights 1
Letter to Shareholders 2
Year in Review 4
Selected Financial Data 9
Management's Discussion and Analysis 10
Independent Auditor's Report 22
Consolidated Financial Statements 23
Notes to Consolidated Financial Statements 27
Directors and Officers 40
Shareholder Information 41
FINANCIAL HIGHLIGHTS
($--THOUSANDS EXCEPT PER SHARE DATA)
PERCENT
YEARS ENDED DECEMBER 31 2002 2001 CHANGE
- --------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Net interest income $ 45,050 $ 41,768 + 7.9
Provision for loan losses 2,995 2,136 + 40.2
Net income 14,011 11,177 + 25.4
- --------------------------------------------------------------------------------------------------
PER COMMON SHARE *
Earnings per share (basic) $ 2.06 $ 1.64 + 25.6
Earnings per share (diluted) 2.06 1.64 + 25.6
Dividends paid 0.657 0.603 + 9.0
Book value - end of period 14.69 12.88 + 14.1
Market price - end of period 24.01 16.71 + 43.7
- --------------------------------------------------------------------------------------------------
AT YEAR END
Total assets $1,251,760 $1,178,392 + 6.2
Loans, excluding held for sale 740,167 760,785 - 2.7
Allowance for loan losses 9,517 8,894 + 7.0
Total deposits 1,034,307 1,014,687 + 1.9
Shareholders' equity 99,771 87,872 + 13.5
- --------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Return on average assets 1.16% 0.93% + 24.7
Return on average common shareholders' equity 14.90 13.24 + 12.5
Tier one capital to average assets ** 7.56 7.37 + 2.6
Total capital to risk-adjusted assets ** 14.14 12.59 + 12.3
Shares outstanding at year end * 6,794,877 6,500,084 + 4.5
Number of common shareholders 2,984 2,819 + 5.9
Number of full-time equivalent employees 500 452 + 10.6
- --------------------------------------------------------------------------------------------------
* Adjusted for stock dividends
** As defined by regulatory agencies
1
TO OUR SHAREHOLDERS
THE YEAR 2002 WAS THE BEST EVER FOR BOTH SHAREHOLDERS AND THE COMPANY.
SHAREHOLDERS SAW A SIGNIFICANT INCREASE IN THE PRICE OF THEIR STOCK. THE COMPANY
ACHIEVED RECORD EARNINGS, ACQUIRED FIVE BRANCH OFFICES, AND CONCLUDED THE YEAR
WITH MORE CUSTOMERS, MORE LOCATIONS, MORE ASSETS AND MORE CAPITAL THAN AT ANY
OTHER TIME IN ITS HISTORY.
SHAREHOLDER GAINS
Our common stock had soared to $24.01* a share by December 31, 2002. This price
amounted to a 43.7 percent increase from its closing price of $16.71* a share
twelve months earlier. Cash dividend payments were nine percent higher at 65.7*
cents a share compared to 60.3* cents a share in 2001. In addition, the Company
declared its third consecutive year-end stock dividend.
Total shareholder return, which includes the advance in the price of our
stock as well as the cash dividend, amounted to 46.7 percent in 2002.
FINANCIAL RESULTS--IN BRIEF
Net income was a record $14.0 million in 2002, a 25 percent increase over
2001 net income of $11.2 million. On a per share basis, net income rose 25.6
percent to $2.06 in 2002 from $1.64 in 2001.
Last year's performance marked the fourth consecutive year of increased
earnings, which have grown at an annual compounded rate of 16.4 percent during
the years 1999-2002.
SHARE REPURCHASES AND
TRUST PREFERRED SECURITIES ISSUE
Last year our board of directors authorized the repurchase of up to 165,000
shares of our common stock. In January 2003, the board authorized a repurchase
of up to 170,000 shares.
Last December we issued $8 million of 30-year, variable rate Trust Preferred
Securities with a current rate of 4.66 percent. This issue can be called any
time after five years.
To offset this new issue, we redeemed $8.4 million, or 38 percent, of an
outstanding issue of Trust Preferred Securities, which carried a fixed rate of
8.75 percent. The net effect of these two transactions is expected to result in
an interest cost reduction of approximately $365,000 annually.
CORPORATE PURPOSE REVISITED
Our primary purpose is to reward shareholders while providing top quality
service to customers. We've chosen to concentrate in small towns because they
have sizable potential, and many customers have needs that are presently
underserved.
Many large, mega-city banks, for example, are focused on major cities and
their surrounding suburbs. Their lack of focus on smaller towns gives us a
decisive competitive advantage and the ability to implement our strategic plan
at an accelerated pace.
In addition, some smaller communities are experiencing sizable population
growth. Large amounts of wealth, once tied up in farmland, are gradually being
turned into cash as that land is sold for new housing developments and shopping
centers.
Consequently, we see a growing demand for more sophisticated financial
products which many smaller banks cannot meet because of staff limitations and
capital restraints.
While acquiring one or two small community branch offices may seem to be of
modest consequence, assembling 50 or more together with a common purpose and
operating platform becomes quite meaningful. Economies of scale come into play.
Our greater financial strength enables us to turn each traditional bank into a
financial services powerhouse by supplying each
*Adjusted for a five percent stock dividend declared in December, 2002.
2
with more products and wealth management services than any individual small
community bank could develop from its own resources.
Presently, we are doing mostly what many larger banks are doing--selling
more products, such as CDs, mutual funds, insurance and internet banking to
checking and savings account customers and reducing processing costs through
computer technology. That strategy has proved successful, but it's only the
first step. Much more can be achieved.
LONG-RANGE VISION
Only when customers and potential customers instinctively think of us as
their main source for financial products and their road map to wealth and
financial security will I be satisfied.
The climate for this change is now at hand. The faith of many investors in
other financial institutions, such as Wall Street brokerage firms and most
aggressive growth mutual funds, has been shattered. Not only have investors
suffered enormous losses in the stock market, they have also been sadly
disillusioned by Wall Street's tainted research reports, deficient investment
management strategies, as well as revelations of questionable accounting
practices by major auditing firms.
Consequently, the opportunity for our banks to greatly expand their overall
financial importance in the minds of customers is quite positive. We are not
there yet, but if such a scenario can be conceived, ways can and will be found
to achieve it. But it will take ingenuity, patience and persistence.
The promise of a friendly smile, that tired slogan of many banks, won't
achieve our objectives. What matters now is knowledge, the ability to
communicate it, and attractive pricing. That translates into more education,
improved oral and written communication skills, computer literacy, an in-depth
knowledge of the Internet, as well as further reductions in operating costs.
While our intranet currently provides efficient solutions for internal
communications, our website can serve a much wider audience. I believe it should
be greatly expanded into a powerful external information and communications
tool. I see it becoming a readily accessible source of definitive information
about our products, services and current interest rates for savers and borrowers
alike.
In the not too distant future, as access to broadband communication
increases, our website might include presentations by industry experts on a
variety of financial topics, from credit card use, borrowing versus leasing,
retirement planning, and strategies for investing in securities. Such a resource
would extend our services into markets that would otherwise be costly to enter.
Finally, although we remain committed to extending and modernizing our
branch office locations, we are also educating customers on the advantages of
using the Internet for their banking transactions. My goal is to have a high
percentage of our customers transact their business on-line within the next
three years. On-line access, which is available on a 24/7 basis, provides a
level of convenience unimaginable even five years ago. It gives customers direct
control over their accounts, as well as increased privacy. It will also reduce
our transaction costs substantially. The savings can go a long way toward
increasing our competitive position on product pricing.
CONCLUSION
The remainder of this report contains much information I believe you will
find useful. I am pleased to be able to report on our progress to date, but even
more important, I wanted each of you to gain an insider's perspective on the
opportunities that lie ahead for our Company.
As always, I am appreciative of the support you have shown us in the past,
and I look to your continued confidence for many years to come.
/s/ JAMES L. SANER SR.
March 7, 2003
3
YEAR IN REVIEW--FINANCIAL
IN TERMS OF FINANCIAL PERFORMANCE, WE COMPLETED OUR BEST YEAR TO DATE. VIRTUALLY
EVERY TRADITIONAL MEASURE OF BANKING PERFORMANCE SURPASSED THE BENCHMARKS OF THE
PREVIOUS YEAR, WHICH PREVIOUSLY HAD BEEN OUR BEST YEAR EVER. AS A RESULT,
SHAREHOLDERS EXPERIENCED A RECORD TOTAL RETURN OF 46.7 PERCENT ON THEIR
INVESTMENT IN 2002, AND A RETURN OF 88.9 PERCENT OVER THE PAST TWO YEARS.
IN 2002, net income advanced 25 percent to $14.0 million from $11.2 million in
2001. Earnings per share rose 25.6 percent to $2.06 from $1.64 the previous
year. Excluding the effect of securities and merchant card sales and accounting
changes, our operating earnings were $1.92 per share, 17.1 percent above the
comparable figure for 2001.
With interest rates being at a 40-year low last year, we generated $12.2
million less in interest income than we did in 2001. Fortunately, the same low
interest rates cut our interest expenses by $15.5 million. This $3.3 million
positive difference increased our net interest income by nearly eight
percent--to $45.1 million from $41.8 million in 2001.
In addition, noninterest income grew at an even faster rate--up 25.2 percent
to $14.4 million from $11.5 million, a net gain of $2.9 million. This gain was
partially offset by a $1.3 million rise in noninterest expense, attributable to
additional employee costs related to the acquisition of five banking offices in
2002 as well as other normal operating increases.
Thus, the $3.3 million gain in net interest income and the $1.6 million
positive difference between noninterest income over noninterest expenses were
the principal factors that enabled us to deliver record earnings in 2002.
OTHER OPERATING HIGHLIGHTS
With revenue increasing at a faster rate than expenses, our operating ratios
showed significant improvement. In the past year:
o Our net interest margin, on a fully-taxable equivalent basis, increased to
4.16 percent from 3.87 percent in 2001;
o Our return on average assets increased to 1.16 percent from 0.93 percent;
o Our return on average shareholders' equity rose to 14.90 percent from 13.24
percent, a 14.9 cent return on every dollar invested by
shareholders--considerably better than what the S&P 500 returned to its
shareholders last year.
BALANCE SHEET DATA
o Total assets increased modestly to $1.25 billion from $1.18 billion.
o Total deposits increased fractionally to $1.03 billion from $1.01 billion.
The increase was due primarily to the acquisition of five branch offices
during 2002.
o Total loans declined 2.7 percent or approximately $20 million in 2002. This
decline occurred because we refinanced a large number of customers'
variable-rate mortgages into fixed-rate mortgages and then sold them into
the secondary market, retaining the servicing rights. Consequently, total
loans decreased slightly, but the amount of loans we now service increased
by 34 percent, from $294 million to $395 million.
o The Company made considerable progress in addressing non-performing assets,
which amounted to $18.4 million at mid-year 2002. By 2002 year-end, these
non-performing assets had declined $7.5 million to $10.9 million, which
amounted to 0.87 percent of total assets versus 1.01 percent one year
earlier.
o Revenues within our Wealth Management Group increased 11 percent.
o The book value of each shareholder's investment increased to $14.69 per
share from $12.88, a 14 percent gain, and is a reflection of the Company's
overall improved performance.
[PHOTO CAPTIONS]
Wealth Management. MainSource Wealth Management continues to grow to meet the
increased needs of its customers.
Mortgages. (Opposite page) Mortgage banking at MainSource increased by more than
70% in 2002.
[CHART]
RETURN ON AVERAGE ASSETS
99 00 01 02
0.05% 0.76% 0.85% 0.93% 1.16%
4
[PHOTO]
[CHARTS]
NET INCOME * NET INTEREST INCOME *
$-MILLIONS $-MILLIONS
99 00 01 02 99 00 01 02
$5.0 $8.1 $9.9 $11.2 $14.0 $25.0 $35.8 $39.1 $41.8 $45.1
*Three-year compounded growth *Three-year compounded growth
rate: 20.0% rate: 8.0%
NON-INTEREST INCOME *
$-MILLIONS
99 00 01 02
$5.0 $7.6 $9.6 $11.5 $14.4
*Three-year compounded growth
rate: 23.7%
5
[PHOTO CAPTIONS]
New Signage. Last year, MainSource introduced a unifying signage and color
scheme (shown above at its branch office in Batesville, Indiana) for all
MainSource branch offices. This corporate identity was created last year when
the Company combined two of its affiliate banks, Union Bank and Trust Company of
Indiana and People's Trust Company, into a single entity with 35 branch
locations, and renamed it MainSource Bank. The new look also extends to the
signage of the holding company and its wealth management and insurance
divisions.
6
YEAR IN REVIEW---OPERATIONS
FROM AN OPERATIONAL PERSPECTIVE, 2002 WAS A BUSY AND PRODUCTIVE YEAR. WE
ACQUIRED FOUR BRANCH OFFICES IN ILLINOIS AND HAVE A FIFTH PENDING. WE PURCHASED
ONE BRANCH IN INDIANA AND SIGNED A LETTER OF INTENT TO ACQUIRE FIRST COMMUNITY
BANCSHARES, INC., A 10-BRANCH COMMUNITY BANK IN SOUTH CENTRAL INDIANA. IN
ADDITION, WE INSTALLED A USER-FRIENDLY LOAN AND DEPOSIT PLATFORM THAT
FACILITATES CROSS-SELLING TO CUSTOMERS. WE ALSO OPENED A MODERN OPERATIONS
CENTER, AS WELL AS A FULL-TIME TRAINING CENTER IN GREENSBURG, INDIANA.
WE introduced check and document imaging at MainSource Bank last year. This
feature will prove to be a decisive efficiency stroke as we move forward.
Ultimately it will eliminate one of the most costly aspects to banking--mailing
of checks and bank statements. Instead, customers will be able to access their
accounts via the internet and review and store their checks electronically.
Rather than customers having to endure the bank delays involved in sorting
checks, stuffing envelopes and mailing them, their check-writing and
check-clearing records, deposits and current balances will be instantly
available to all customers who have access to a computer, which is now becoming
nearly as commonplace as a television or telephone. Whenever they need to
produce a check to verify payment, for example, they can simply print it from
their home computer.
Check and document-imaging are the first steps to on-line banking. As
customers become comfortable operating in this environment, the ease and
convenience of on-line banking will become manifestly obvious, and we believe
few customers will ever go back to the old ways of banking. By the end of 2003,
we intend to offer complete on-line financial services throughout the MainSource
system.
From the Company's viewpoint, there are two principal benefits to on-line
banking: we remain competitive in the financial services field, and the time and
expense saved in back office operations can be used to improve personal customer
service, which is at the heart of our philosophy.
OTHER OPERATING ADVANCES
We also spent the greater part of 2002 installing and fine-tuning our
Marketing Customer Information File software. It analyzes pertinent customer
data, which is readily available from a mortgage or loan application. In turn,
this enables us to provide customers with information about financial services
products that meet their needs more precisely. For the most part, we can now
eliminate costly, broad-based mass advertising and substitute less costly
targeted mailings.
WE completed the new identity for our holding company as well as the signage and
branding program for the 35 banking offices in 15 Indiana counties that formerly
operated under the names Union Bank and Trust Company of Indiana and People's
Trust Company. These offices now bear the name MainSource Bank.
In addition, we also changed the names of our insurance and trust
operations. The Insurance Group, which comprises five offices in Indiana and one
in Kentucky, is now known as MainSource Insurance. The Trust and Investment
Group became MainSource Wealth Management.
Because of their strong local identity, we kept intact the names of our
other two banking affiliates--Capstone Bank in Illinois, and Regional Bank in
southern Indiana. We did, however, apply the MainSource Wealth Management title
to all their investment and trust operations.
Finally, we converted all of our insurance offices to a common operating
system. The continued improvements to our insurance operations led to a 8.2
percent increase in gross revenues over 2001.
[PHOTO CAPTION]
Internet Banking. The number of MainSource Financial Group's banking customers
transacting a portion of their business on-line has increased substantially
during the past two years. On-line access provides many banking conveniences to
customers and, at the same time, significantly reduces our processing costs.
7
MOVING INTO 2003
OUR COMPANY'S OPERATING PHILOSOPHY SEEKS TO PRESERVE THOSE ELEMENTS OF
TRADITIONAL COMMUNITY BANKING WHICH MANAGEMENT BELIEVES CREATES A COMPETITIVE
ADVANTAGE IN OUR PREDOMINANTLY RURAL MARKETS. ACCORDINGLY, OUR COMPANY EMPLOYS
PERSONAL SERVICE, PROMPT RESPONSE TO CUSTOMER NEEDS, CONVENIENCE, CONTINUITY OF
PERSONNEL AND MANAGEMENT, AND COMMITMENT TO AND PARTICIPATION IN THE
COMMUNITIES. WE DEPLOY TECHNOLOGY AS A MEANS TO INCREASE EFFICIENCIES, NOT
ELIMINATE CUSTOMER SERVICE.
Another advance in our community banking network will be the acquisition of
First Community Bancshares, Inc., which is expected to occur in the second
quarter of 2003. We will gain its 10 branch offices in four south-central
Indiana counties, thereby expanding our presence to 52 offices in 22 counties in
Indiana. Their locations will enable us to materially strengthen our market
thrust into rapidly-growing, smaller communities that lie to the south of
Indianapolis.
GOALS--2003
We have ambitious goals for the next 12 months. Whether we achieve them may
depend on many factors beyond our control. Among them are the health of the
overall economy, job opportunities in our communities, further changes in
interest rates, and the development of other social and political issues around
the world.
That said, our goals for 2003 are to:
o Materially increase customers' perception and awareness of MainSource as a
total financial services company rather than merely a bank;
o Increase core deposits;
o Increase loans;
o Increase the number of consumer accounts on Internet Banking;
o Drive the sale of insurance products through our branch banking offices;
o Establish brokerage services in all three affiliate banks;
o Continue to improve our efficiency ratio by further consolidation of
backroom functions; and finally
o Achieve a double digit percentage increase in operating earnings per share.
These goals are undeniably ambitious. Achieving them will require more
effective marketing and further development of our financial products that
better meet the needs of our customer base of 85,000 individuals and families.
[MAP CAPTION]
Our bank holding company operates primarily in smaller communities in 18
counties in Indiana and three in Illinois, which are shown at right. A
wholly-owned insurance subsidiary operates in Indiana, Illinois and Kentucky.
MainSource is expanding aggressively into smaller towns where mega banks do not
operate. Illinois is particularly attractive because there are five times as
many small banks in Illinois as there are in Indiana, thus giving us ample
opportunities to make sound and profitable acquisitions.
[PHOTO CAPTION]
Insurance Services. MainSource Insurance, our wholly-owned insurance agency,
with five offices in Indiana and one in Kentucky, recorded record premium
revenues last year. Automobile and homeowners insurance comprised the majority
of our insurance business in 2002
8
SELECTED FINANCIAL DATA
(Dollar amounts in thousands except per share data
DECEMBER 31 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Net interest income $ 45,050 $ 41,768 $ 39,089 $ 35,817 $ 30,067
Provision for loan losses 2,995 2,136 1,658 1,826 1,293
Noninterest income 14,379 11,486 9,591 7,605 6,589
Noninterest expense 35,610 34,311 33,168 29,903 23,777
Income before income tax 20,824 16,807 13,854 11,693 11,586
Income tax 6,813 5,630 4,000 3,605 3,955
Net income 14,011 11,177 9,854 8,088 7,631
Dividends paid on common stock 4,485 4,114 4,121 3,932 3,181
- -------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE*
Earnings per share (basic) $ 2.06 $ 1.64 $ 1.45 $ 1.20 $ 1.15
Earnings per share (diluted) 2.06 1.64 1.45 1.20 1.14
Dividends paid ** 0.657 0.603 0.566 0.553 0.505
Book value - end of period 14.69 12.88 11.48 10.05 10.22
Market price - end of period 24.01 16.71 13.38 16.20 19.11
- -------------------------------------------------------------------------------------------------------------------------------
AT YEAR END
Total assets $1,251,760 $1,178,392 $1,216,936 $1,110,252 $ 957,144
Investment securities 351,143 276,304 294,395 290,337 231,787
Loans, excluding held for sale 740,167 760,785 790,550 710,661 607,840
Allowance for loan losses 9,517 8,894 8,716 7,718 6,600
Total deposits 1,034,307 1,014,687 1,053,570 940,905 823,769
Notes payable 2,400 4,062 6,510 6,885 425
Federal Home Loan Bank advances 50,235 20,346 22,463 24,484 13,710
Trust preferred securities 30,425 22,425 22,425 22,425 22,425
Shareholders' equity 99,771 87,872 78,005 68,172 69,063
- -------------------------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Return on average assets 1.16% 0.93% 0.85% 0.76% 0.89%
Return on average common shareholders' equity 14.90 13.24 13.76 11.67 11.32
Allowance for loan losses to total loans
(year end, excluding held for sale) 1.29 1.17 1.10 1.09 1.09
Shareholders' equity to total assets (year end) 7.97 7.46 6.41 6.14 7.16
Average equity to average total assets 7.77 7.04 6.20 6.55 7.90
Dividend payout ratio 32.01 36.81 41.82 48.62 41.69
* Adjusted for stock split and dividends
** Dividends paid by MainSource Financial Group without restatement for
pooling of interests
9
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar Amounts in thousands except per share data)
FORWARD-LOOKING STATEMENTS
Except for historical information contained herein, the discussion in this
Annual 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 cost 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, and 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.
OVERVIEW
MainSource Financial Group, Inc. ("Company"), formerly Indiana United Bancorp,
is a bank holding company whose principal activity is the ownership and
management of its three wholly owned subsidiary banks ("Banks"). MainSource Bank
(formerly People's Trust Company and Union Bank and Trust Company of Indiana)
headquartered in Greensburg, Indiana, and Regional Bank ("Regional"),
headquartered in New Albany, Indiana, operate under state charters and are
subject to regulation by the Indiana Department of Financial Institutions and
the Federal Deposit Insurance Corporation. Capstone Bank, N.A. ("Capstone"),
headquartered in Watseka, Illinois, operates under a national charter and is
subject to regulation by the Office of the Comptroller of the Currency.
MainSource Insurance (formerly The Insurance Group, Inc.) is a wholly owned
subsidiary of MainSource Bank operating five offices in Indiana and one in
Kentucky and is subject to regulation by the Kentucky and Indiana Departments of
Insurance. IUB Capital Trust and MainSource Statutory Trust are business trusts
formed to issue the guaranteed preferred beneficial interests in the Company's
subordinated debentures ("Trust Preferred Securities"). The Company owns all of
the common stock of IUB Capital Trust and MainSource Statutory Trust. The
Company also has wholly owned subsidiaries to hold investment securities. These
investment subsidiaries are incorporated in Bermuda and Nevada. Additionally,
the Company formed IUB Reinsurance Company, Ltd., a credit life reinsurance
company, during 2000.
On May 1, 2002, the Company changed its name from Indiana United Bancorp to
MainSource Financial Group, Inc. This change was made to better reflect the
Company's expanding geographic territory as well as its current and future array
of products and services. With the name change, the ticker symbol of the
Company's common stock also changed from IUBC to MSFG. In addition, the Company
changed the name of its insurance subsidiary from The Insurance Group, Inc. to
MainSource Insurance, Inc.
In October 2002, the Company merged its two largest banking affiliates,
People's Trust Company and Union Bank and Trust Company of Indiana, with the
newly-created bank being called MainSource Bank.
BUSINESS STRATEGY
The Company operates under the broad tenets of a long-term strategic plan
("Plan") designed to improve the Company's financial performance, expand its
competitive position and enhance long-term shareholder value. The Plan is
premised on the belief of the Company's board of directors that it can best
promote long-term shareholder interests by pursuing strategies which will
continue to preserve its community-focused philosophy. The dynamics of the Plan
assure continually evolving goals, with the continued enhancement of shareholder
value being the constant, overriding objective. The extent of the Company's
success will depend upon how well it anticipates and responds to competitive
changes within its markets, the interest rate environment and other external
forces.
The Company continued its history of external growth through acquisitions.
In 2002, the Company purchased four branches in Illinois and one in Indiana,
which added approximately $64 million in deposits. Three branches were closed in
2002 and the Company is currently reviewing several smaller branches for their
viability. As of year end, the Company had entered into an agreement to purchase
one branch in Illinois that will add $20 million in deposits and $6 million in
loans. In addition, the Company has executed a letter of intent to purchase
First Community Bancshares, Inc. ("First Community"). First Community is
headquartered in Bargersville, Indiana and operates ten branches in four
counties in south central Indiana with total assets of approximately $150
million. This acquisition will be a cash transaction primarily funded by the
issuance of up to $10 million of Trust Preferred Securities and up to $10
million of long-term notes payable. The Company is continuously reviewing
acquisition targets including branches, whole banks, and other financial service
related entities focusing on the four-state Midwest region of Indiana, Illinois,
Kentucky, and Ohio.
In December 2002, the Company issued $8 million of variable rate Trust
Preferred Securities. The rate on these securities is tied to the 3-month LIBOR
rate and will adjust quarterly. The current rate is 4.66%. These securities
mature in 30 years and can be called at par anytime after five years. The
Company used these funds to redeem a portion of its current outstanding fixed
rate Trust Preferred Securities. These securities, which trade under the symbol
MSFGP, carry a fixed rate of 8.75%. The amount redeemed on February 11, 2003 was
$8.4 million. In addition, the Company entered into an agreement to issue
additional Trust Preferred Securities in order to refinance the remaining $14
million of its fixed rate Trust Preferred Securities. The refinancing is
expected to take place in April 2003. The interest rate on the new issuance will
be fixed for five years at a rate of 6.65% and then will float at 325 basis
points over the 3-month LIBOR. An interest rate swap will be utilized to obtain
the initial fixed rate on the issue.
During 2002, the Company maintained its focus on becoming a complete
financial services provider for its customers. The Company invested heavily in
the information technology and data processing areas in order to position
10
itself to support more products and services, to allow for future growth, and to
stay competitive in the current environment.
In 2003, the Company expects to utilize these technologies in conjunction
with its MCIF system to fuel internal growth through marketing to its existing
base of over 85,000 customers. The Company is emphasizing the cross-selling of
insurance and annuity products through its branch system. The insurance division
of the Company has grown steadily throughout the past several years and the
Company views this area as a potential source of increasing non-interest income.
In addition to the insurance division, the Company's wealth management division
has experienced steady growth. As of December 31, 2002, MainSource Wealth
Management, which operates as a division of MainSource Bank, had assets under
management of approximately $137 million.
A major objective of the Company's strategic plan is the implementation of
enterprise risk management. Enterprise risk management is defined as a system by
which an organization identifies, defines, evaluates, and monitors risk to
achieve its strategic goals and objectives. In order to accomplish this
objective, the Company has established a Risk Management Committee. A
comprehensive matrix is currently being used to identify and prioritize risk
throughout the organization to assure implementation of techniques to better
mitigate and control all types of risk including interest rate, credit,
liquidity, legal, compliance, reputational, operational, price and strategic
risks.
TABLE 2 - NON-INTEREST INCOME AND EXPENSE
- -------------------------------------------------------------------------------------------------------
PERCENT CHANGE
2002 2001 2000 02/01 01/00
- -------------------------------------------------------------------------------------------------------
Non-interest income
Insurance commissions $ 2,156 $ 1,993 $ 1,344 8.2% 48.3%
Fiduciary activities 561 506 474 10.9 6.8
Mortgage banking 4,757 2,767 859 71.9 222.1
Service charges on deposit accounts 4,011 3,835 3,652 4.6 5.0
Securities gains/(losses) 319 (111) (11) (387.4) 909.1
Other 2,575 2,496 3,273 3.2 (23.7)
- -------------------------------------------------------------------------------------------------------
Total non-interest income $ 14,379 $ 11,486 $ 9,591 25.2% 19.8%
- -------------------------------------------------------------------------------------------------------
Non-interest expense
Salaries and employee benefits $ 20,381 $ 19,061 $ 18,117 6.9% 5.2%
Net occupancy 2,414 2,247 1,995 7.4 12.6
Equipment 2,873 2,489 2,352 15.4 5.8
Telephone 1,038 855 791 21.4 8.1
Intangible amortization 828 1,966 1,922 (57.9) 2.3
Stationery, printing, and supplies 973 839 957 16.0 (12.3)
Other 7,103 6,854 7,034 3.6 (2.6)
- -------------------------------------------------------------------------------------------------------
Total non-interest expense $ 35,610 $ 34,311 $ 33,168 3.8% 3.4%
- -------------------------------------------------------------------------------------------------------
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar Amounts in thousands except per share data)
RESULTS OF OPERATIONS
Net income was $14,011 in 2002, $11,177 in 2001, and $9,854 in 2000. Earnings
per common share on a fully diluted basis were $2.06 in 2002 compared to $1.64
in 2001, which represents a 25.6% increase. As described in Note 7 to the
consolidated financial statements, in 2002 the Company adopted Statements of
Financial Accounting Standards (FAS) No. 142 and 147, which changed the method
of accounting for intangible assets. The adoption of these standards resulted in
a reduction of goodwill amortization in 2002, increasing net income $710, or
$0.10 per share. In addition, the Company realized gains related to the sales of
investment securities and the merchant credit card program of $.04, net of tax.
The change in goodwill and sales of securities and the merchant credit card
program contributed $0.14 per share in 2002, representing one-third of the
increase in earnings per share from 2001. The Company strives for annual
double-digit percentage increases in operating earnings per share. However, the
Company believes that another significant downturn in the economy could greatly
reduce the chance of achieving this goal.
Other key measures of the financial performance of the Company are return
on average shareholders' equity and return on average assets. Return on average
shareholders' equity was 14.90% in 2002, 13.24% in 2001, and 13.76% in 2000. The
Company's return on average assets was 1.16% in 2002, .93% in 2001, and .85% in
2000. The increase is representative of the Company's continuing effort to
improve profitability. The Company believes that its steady improvement in
performance validates its strategic course of action and will continue to
provide increased shareholder value.
NET INTEREST INCOME
Net interest income and net interest margin are influenced by the volume and
yield or cost of earning assets and interest-bearing liabilities. Tax equivalent
net interest income of $46,403 in 2002 increased 8.0% from $42,979 in 2001,
which was 7.9% above 2000 (See Table 3). With the overall interest rate
environment declining significantly in 2001 and 2002, the Company incurred a
decrease in the average yield on earning assets from 8.04% in 2000 to 7.72% in
2001 and 6.60% in 2002. Offsetting the decrease in yield, the Company
aggressively repriced its deposits and was able to significantly reduce its cost
of funds from 4.77% in 2000 to 4.22% in 2001 and 2.70% in 2002. The overall
effect was an increase in the Company's spread, which represents the difference
between the yield on earning assets versus the cost of funds. The Company's
spread in 2002 was 3.90%, 3.50% in 2001 and 3.27% in 2000.
PROVISION FOR LOAN LOSSES
The Company expensed $2,995 in provision for loan losses in 2002. This level of
provision allowed the Company to maintain an adequate allowance for loan losses.
This topic is discussed in detail under the heading "Loans, Credit Risk and the
Allowance and Provision for Loan Losses".
NON-INTEREST INCOME
Non-interest income increased in 2002 to $14,379 compared to $11,486 in 2001,
which represents a 25.2% increase. With the low interest rate environment in
2002, the Company realized a significant increase in its mortgage banking
activity. Mortgage banking income, which consists of gains and losses on loan
sales and service fee income, was $4,757 in 2002 compared to $2,767 in 2001, an
increase of $1,990, or 71.9%. As many customers refinanced their existing loans,
the Company elected to sell the majority of these loans while maintaining the
servicing rights. The Company also realized net gains on sales of investment
securities in 2002 of $319 compared to net losses in 2001 of $111.
Non-interest income increased in 2001 to $11,486 compared to $9,591 in
2000, which represents a 19.8% increase. Similar to 2002, the Company realized a
significant increase in its mortgage banking activity. Mortgage banking income
was $2,767 in 2001 compared to $859 in 2000, an increase of $1,908, or 222.1%.
Insurance commissions increased to $1,993 in 2001 versus $1,344 in 2000 due
primarily to the acquisition of the Vollmer insurance agencies in the second
quarter of 2001. Offsetting the increases in mortgage banking and insurance
commissions was a decrease in other non-interest income as the Company realized
income in 2000 from the death benefit related to a key man life insurance policy
and a refund of 1999 state income taxes.
NON-INTEREST EXPENSE
Total non-interest expense increased 3.8% in 2002 to $35,610 compared to $34,311
in 2001, or an increase of $1,299. The largest component of non-interest expense
is salaries and benefits. These expenses increased 6.9%, or $1,320, in 2002 due
to branch acquisitions, which increased the number of employees, an increase in
health care expense and normal merit increases (see Table 2 for detail of
non-interest expense). Due to the adoption of FAS 142 and 147, the Company's
intangible amortization decreased in 2002.
Total non-interest expense increased 3.4% in 2001 to $34,311 compared to
$33,168 in 2000, or an increase of $1,143. Employee-related expenses increased
5.2%, or $944, in 2001 due primarily to the acquisition of insurance agencies,
branch acquisitions and normal merit increases.
[CHARTS]
NET INCOME NET INTEREST INCOME
$-MILLIONS $-MILLIONS
00 01 02 00 01 02
$5.0 $9.9 $11.2 $14.0 $25.0 $39.1 $41.8 $45.1
NON-INTEREST INCOME
$-MILLIONS
99 00 01
$5.0 $9.6 $11.5 $14.5
12
INCOME TAXES
The effective tax rate was 32.7% in 2002, 33.5% in 2001, and 28.9% in 2000. The
increase in the Company's effective tax rate in 2001 was a direct result of
higher pre-tax income, which was generally taxable at the highest tax rate, and
the effect of establishing a deferred tax asset in conjunction with the
acquisition of First Affiliated in 2000, which reduced income tax expense in
that year. Disregarding the establishment of the deferred tax asset at First
Affiliated, the effective tax rate for 2000 would have been 31.8%.
BALANCE SHEET
At December 31, 2002, total assets were $1,251,760 compared to $1,178,392 at
December 31, 2001, an increase of $73,368. The increase was primarily
attributable to the branch acquisitions in 2002, which accounted for
approximately $64 million in deposits. Due to lower loan demand, these deposits
were typically invested in securities available for sale, which grew by $75
million year over year. In addition, the Company's cash and cash equivalents
increased by approximately $18 million as the year-end influx of public fund
deposits was invested in a short-term money market fund. The increases were
partially offset by a decrease in loans held for sale of $8 million and
portfolio loans of $20 million. Excluding branch acquisitions, the Company's
deposit base decreased by approximately $44 million. As loan demand diminished,
the Company allowed higher-rate deposits to mature and not renew. Instead, the
Company sought out wholesale borrowings through the Federal Home Loan Bank
("FHLB"). As a result, FHLB advances increased by $30 million year over year.
LOANS, CREDIT RISK AND THE ALLOWANCE AND PROVISION FOR LOAN LOSSES
Loans remain the Company's largest concentration of assets and continue to
represent the greatest potential 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 conservative loan underwriting standards have historically
resulted in higher loan quality and generally lower levels of net chargeoffs
than peer bank averages. The Company also 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 concentration policy. The Company believes it has no undue
concentrations of loans.
Total loans (excluding those held for sale) decreased $20 million from
year-end 2001. The Company experienced a $28 million decrease in its residential
real estate portfolio as customers took advantage of the decrease in mortgage
interest rates and refinanced their existing loans. The Company, in turn,
elected not to retain new fixed rate loans in its own portfolio and instead,
sold these in the secondary market while maintaining the servicing. Offsetting
this decrease in residential real estate loans was an increase in commercial and
agricultural loans. Despite the decrease mentioned above, residential real
estate loans continue to represent the largest portion of the total loan
portfolio. Such loans represented 40.7% and 43.3% of total loans at December 31,
2002 and 2001, respectively.
The Company regards its ability to identify and correct loan quality
problems as one of its greatest strengths. Loans are placed on "non-accrual"
status when, in management's judgment, the collateral value and/or the
borrower's financial condition does not justify accruing interest.
As a general rule, commercial and real estate loans are reclassified to
nonaccrual status at or before becoming 90 days past due. Interest previously
recorded but not deemed collectible is reversed and charged against current
income. Subsequent interest payments collected on nonaccrual loans may
thereafter be recognized as interest income or may be applied as a reduction of
the loan's principal balance, as circumstances warrant.
The provision for loan losses was $2,995 in 2002, $2,136 in 2001, and
$1,658 in 2000. The increase in the Company's provision is directly related to
the increase in net charge-offs in 2001 and 2002. During 2002, non-performing
loans reached a high of $17.8 million at the end of the second quarter and
finished the year at $7.9 million. During the fourth quarter of 2002, the
Company charged off $1.6 million in loans with approximately $0.9 million
relating to one large commercial credit. For the full year 2002, net charge-offs
were $2,372 compared to $1,958 in 2001, and $660 in 2000. As a percentage of
average loans, net chargeoffs equaled .31%, .25%, and .09% in 2002, 2001 and
2000, respectively.
Management maintains a list of loans warranting either the assignment of a
specific reserve amount or other special administrative attention. This watch
list, together with a listing of all classified loans, nonaccrual loans and
delinquent loans, is reviewed monthly by the board of directors of each
subsidiary. Additionally, the Company evaluates its consumer and residential
real estate loan pools for probable losses incurred based on historical trends,
adjusted by current delinquency and non-performing loan levels.
The ability to absorb loan losses promptly when problems are identified is
invaluable to a banking organization. Most often, losses incurred as a result of
prompt, aggressive collection actions are much lower than losses incurred after
prolonged legal proceedings. Accordingly, the Company observes the practice of
quickly initiating stringent collection efforts in the early stages of loan
delinquency.
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 upon management's continuing review and evaluation of loan loss
experience, changes in the composition of the loan portfolio, classified loans
including non-accrual and impaired loans, current economic conditions, the
amount of loans presently outstanding, and the amount and composition of loan
growth. The Company's allowance for loan losses was $9,517 at December 31, 2002
compared to $8,894 at the end of 2001. The increase in the allowance is
primarily attributable to increased charge-off trends and watch list loans,
which management attributes largely to the general state of the economy, and the
change in the Company's mix of loans with commercial loans representing a higher
percentage of total loans.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar Amounts in thousands except per share data)
TABLE 3 - AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
(Taxable Equivalent Basis)*
- -----------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
AVERAGE AVG. AVERAGE AVG. AVERAGE AVG.
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
ASSETS
Short-term investments $ 288 $ 5 1.74% $ 2,172 $ 80 3.68% $ 2,097 $ 74 3.53%
Federal funds sold and
money market accounts 38,002 727 1.91 50,534 2,139 4.23 17,217 1,085 6.30
Securities
Taxable 264,675 12,970 4.90 227,759 13,683 6.01 272,869 16,864 6.18
Non-taxable* 47,611 3,166 6.65 34,933 2,762 7.91 17,867 1,246 6.97
- -----------------------------------------------------------------------------------------------------------------------------------
Total securities 312,286 16,136 5.17 262,692 16,445 6.26 290,736 18,110 6.23
Loans **
Commercial 402,283 29,308 7.29 377,386 31,680 8.39 335,641 30,633 9.13
Residential real estate 237,709 17,627 7.42 296,709 24,194 8.15 313,058 24,951 7.97
Consumer 124,626 9,853 7.91 121,866 11,218 9.21 118,209 11,772 9.96
Total loans 764,618 56,788 7.43 795,961 67,092 8.43 766,908 67,356 8.78
Total earning assets 1,115,194 73,656 6.60 1,111,359 85,756 7.72 1,076,958 86,625 8.04
Cash and due from banks 36,912 29,981 30,609
Unrealized gains (losses)
on securities 4,801 2,102 (7,467)
Allowance for loan losses (9,404) (9,143) (8,351)
Premises and equipment, net 18,521 16,883 17,199
Intangible assets 23,363 23,482 24,050
Accrued interest receivable
and other assets 21,358 25,246 21,692
Total assets $1,210,745 $1,199,910 $1,154,690
- -----------------------------------------------------------------------------------------------------------------------------------
LIABILITIES
Interest-bearing deposits
DDA, savings and money
market accounts $ 443,684 $ 5,064 1.14 $ 401,349 $ 8,728 2.17 $ 362,405 $11,456 3.16
Certificates of deposit 478,643 17,546 3.67 545,458 29,716 5.45 540,353 30,037 5.56
Total interest-
bearing deposits 922,327 22,610 2.45 946,807 38,444 4.06 902,758 41,493 4.60
Short-term borrowings 17,769 372 2.09 19,149 611 3.19 28,611 1,210 4.23
Trust preferred securities 22,758 2,035 8.94 22,425 2,023 9.02 22,425 2,023 9.02
Notes payable and FHLB borrowings 45,497 2,236 4.91 26,362 1,699 6.44 27,292 2,083 7.63
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-
bearing liabilities 1,008,351 27,253 2.70 1,014,743 42,777 4.22 981,086 46,809 4.77
Demand deposits 94,054 85,317 93,987
Other liabilities 14,283 15,452 8,003
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,116,688 1,115,512 1,083,076
Shareholders' equity 94,057 84,398 71,614
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $1,210,745 27,253 2.44*** $1,199,910 42,777 3.85*** $1,154,690 46,809 4.35***
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income $46,403 4.16**** $42,979 3.87**** $39,816 3.70****
- -----------------------------------------------------------------------------------------------------------------------------------
Conversion of tax exempt income
to a fully taxable equivalent basis
using a marginal rate of 35% $ 1,353 $ 1,211 $ 727
* Adjusted to reflect income related to securities and loans exempt from
Federal income taxes.
** Nonaccruing loans have been included in the average balances.
*** Total interest expense divided by total earning assets. **** Net interest
income divided by total earning assets.
14
TABLE 4 - LOAN PORTFOLIO
- ---------------------------------------------------------------------------------------------------------
DECEMBER 31 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------
Types of loans
Commercial $ 98,526 $ 83,143 $ 77,648 $ 65,426 $ 51,741
Agricultural production financing and other
loans to farmers 25,105 20,726 20,744 22,107 23,653
Commercial real estate mortgage 156,277 149,099 138,132 104,150 101,568
Residential real estate mortgage 301,232 329,660 389,622 326,720 267,404
Farm real estate 43,762 46,549 49,284 44,367 39,078
Construction and development 34,987 53,753 40,813 50,721 30,881
Consumer 72,702 69,957 64,548 87,270 80,053
State and political 7,576 7,898 9,759 9,900 13,462
Total loans $740,167 $760,785 $790,550 $710,661 $607,840
- ---------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
Investment securities offer flexibility in the Company's management of interest
rate risk, and are the primary means by which the Company provides liquidity and
responds to changing maturity characteristics of assets and liabilities. The
Company's investment policy prohibits trading activities and does not allow
investment in high-risk derivative products or junk bonds.
As of December 31, 2002, 98.7% of the investment securities are classified
as "available for sale" ("AFS") and are carried at fair value with unrealized
gains and losses, net of taxes, excluded from earnings and reported as a
separate component of shareholders' equity. A net unrealized gain of $7,065 was
recorded to adjust the AFS portfolio to current market value at December 31,
2002 compared to a net unrealized gain of $2,228 at December 31, 2001. The
remaining 1.3% of the investment portfolio is classified as "held to maturity"
("HTM") and is carried at book value. The majority of the Company's HTM
portfolio consists of tax-exempt municipal bonds.
For 2002 the tax equivalent yield of the investment securities portfolio
was 5.17%, compared to 6.26% and 6.23% for 2001 and 2000, respectively. The
average life of the Company's investment security portfolio was 2.6 years at
December 31, 2002. During 2002, the Company made a concerted effort to shorten
the life of its portfolio in order to position itself for an economic recovery
and thus reinvest the cash flows generated from the portfolio at higher interest
rates. As a result of this strategy, the current yield on the portfolio was
sacrificed for longer-term profitability.
Variable rate securities comprised 3.6% of the total portfolio on December
31, 2002 with the remaining 96.4% invested in fixed rate investments.
SOURCES OF FUNDS
The Company relies primarily on customer deposits and securities sold under
agreement to repurchase ("repurchase agreements"), along with shareholders'
equity to fund earning assets. Federal Home Loan Bank ("FHLB") advances are used
to provide additional funding. The Company also attempts to purchase local
deposits through branch acquisitions.
Deposits generated within local markets provide the major source of funding
for earning assets. Average total deposits were 91.1% and 92.9% of total average
earning assets in 2002 and 2001. Total interest-bearing deposits averaged 90.7%
and 91.7% of average total deposits during 2002 and 2001. Management is
continuing efforts to increase the percentage of transaction-related deposits to
total deposits due to the positive effect on earnings.
Repurchase agreements are high denomination investments utilized by public
entities and commercial customers as an element of their cash management
responsibilities. During 2002, short-term borrowings averaged $17,769 with
repurchase agreements representing $17,372 of the total.
Another source of funding is the Federal Home Loan Bank (FHLB). The Company
had FHLB advances of $50,235 outstanding at December 31, 2002. These advances
have interest rates ranging from 3.33% to 6.70%. The Company has $10,000 of
advances maturing in 2004, 2005 and 2007 while $20,000 matures in 2012. The
Company averaged $41,890 in FHLB advances during 2002 compared to $21,078 during
2001.
[CHARTS]
LOAN LOSS RESERVE TOTAL ASSETS
$-MILLIONS $-MILLIONS
00 01 02 00 01 02
$5.0 $8.7 $8.9 $9.5 $800 $1,217 $1,178 $1,252
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar Amounts in thousands except per share data)
In February 1999 the Company borrowed $8,000 at a floating rate based upon
LIBOR. These funds were used to fund branch acquisitions. At year-end 2002, the
balance on this note was $2,400 with an effective interest rate of 3.87%.
CAPITAL RESOURCES
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 ("Tier 1") consists of common shareholders'
equity adjusted for unrealized gains or losses on available for sale (AFS)
securities plus limited amounts of Trust Preferred Securities less goodwill and
intangible assets. Total capital consists of core capital, certain debt
instruments and a portion of the allowance for loan losses. At December 31,
2002, Tier 1 capital to average assets was 7.6%. Total capital to risk-weighted
assets was 14.1%. Both ratios substantially exceed all required ratios
established for bank holding companies. Risk-adjusted capital levels of each of
the Company's subsidiary banks exceed regulatory definitions of well-capitalized
institutions.
The 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 these securities cannot constitute more than 25% of the
total Tier 1 capital of the Company. Consequently, the amount of Preferred
Securities in excess of the 25% limitation constitutes Tier 2 capital, or
supplementary capital, of the Company.
Common shareholders' equity is impacted by the Company's decision to
categorize a portion of its securities portfolio as available for sale (AFS).
Securities in this category are carried at fair value, and common shareholders'
equity is adjusted to reflect unrealized gains and losses, net of taxes.
The Company declared and paid common dividends of $.657 per share in 2002,
$.603 in 2001 and $.566 in 2000. Book value per common share increased to $14.69
at December 31, 2002 compared to $12.88 at the end of 2001. The net adjustment
for AFS securities increased book value by $.67 at December 31, 2002 and by $.22
at December 31, 2001. Depending on market conditions, the adjustment for AFS
securities can cause significant fluctuations in equity.
The Company declared separate five percent stock dividends for shareholders
of record as of December 29, 2000, December 31, 2001, and December 31, 2002. All
financial information used throughout this report has been adjusted to reflect
these transactions.
In January 2002, the Company announced the commencement of a twelve-month
common stock repurchase plan that authorized the repurchase of approximately
2.5% of its outstanding common shares. The Company renewed this plan in January
2003. The purchase of stock will generally occur in the open market but may
involve unsolicited negotiated transactions.
TABLE 5 - NONPERFORMING LOANS
- --------------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------
Nonaccruing loans $ 7,695 $10,406 $ 3,454 $ 4,187 $ 4,095
Accruing loans contractually past due 90 days or more 245 766 532 978 500
- --------------------------------------------------------------------------------------------------------------------
Total $ 7,940 $11,172 $ 3,986 $ 5,165 $ 4,595
- --------------------------------------------------------------------------------------------------------------------
% of total loans 1.07% 1.47% 0.50% 0.73% 0.76%
[CHARTS]
BOOK VALUE PER SHARE
00 01 02
$8.00 $11.48 $12.88 $14.69
16
TABLE 6 - SUMMARY OF THE ALLOWANCE OR LOAN LOSSES
- -------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------
Balance at January 1 $8,894 $8,716 $7,718 $6,600 $5,972
Chargeoffs
Commercial 1,715 1,392 403 321 274
Commercial real estate mortgage -- 100 107 458 --
Residential real estate mortgage 473 266 164 77 99
Consumer 583 621 443 589 732
- -------------------------------------------------------------------------------------------------
Total Chargeoffs 2,771 2,379 1,117 1,445 1,105
- -------------------------------------------------------------------------------------------------
Recoveries
Commercial 116 127 201 278 116
Commercial real estate mortgage 5 24 7 -- --
Residential real estate mortgage 127 40 35 63 25
Consumer 151 230 214 396 299
- -------------------------------------------------------------------------------------------------
Total Recoveries 399 421 457 737 440
- -------------------------------------------------------------------------------------------------
Net Chargeoffs 2,372 1,958 660 708 665
Provision for loan losses 2,995 2,136 1,658 1,826 1,293
- -------------------------------------------------------------------------------------------------
Balance at December 31 $9,517 $8,894 $8,716 $7,718 $6,600
- -------------------------------------------------------------------------------------------------
Net Chargeoffs to average loans 0.31% 0.25% 0.09% 0.11% 0.12%
Provision for loan losses to average loans 0.39 0.27 0.22 0.28 0.23
Allowance to total loans at year end 1.29 1.17 1.10 1.09 1.09
- -------------------------------------------------------------------------------------------------
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 approximately $240 million of
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, supports liquidity, extends the contractual
maturity of liabilities, and limits reliance on volatile short-term purchased
funds. Short-term funding needs may 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, which provide a sizable source of relatively stable low-cost funds.
The Company defines core deposits as all deposits except certificates of
deposits greater than $100. Average core deposits funded approximately 81.8% of
total earning assets during 2002 and approximately 82.7% in 2001.
Management believes the Company has sufficient liquidity to meet all
reasonable borrower, depositor and creditor needs in the present economic
environment. The Company has not received any directives from regulatory
authorities that would materially affect liquidity, capital resources or
operations.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar Amounts in thousands except per share data)
TABLE 7 - RATE SENSITIVITY ANALYSIS AT DECEMBER 31, 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Over 5
Years or
3 Months 1 Year 2 Years 5 Years Insensitive Total
- -----------------------------------------------------------------------------------------------------------------------------------
INTEREST-EARNING ASSETS
Loans $ 223,086 $ 183,571 $ 123,866 $ 127,799 $ 97,560 $ 755,882
Securities 48,647 79,936 94,497 81,845 46,218 351,143
Federal funds sold and money market fund 23,369 -- -- -- -- 23,369
Restricted Stock 5,690 -- -- -- -- 5,690
- -----------------------------------------------------------------------------------------------------------------------------------
Total Interest-earning assets 300,792 263,507 218,363 209,644 143,778 1,136,084
- -----------------------------------------------------------------------------------------------------------------------------------
Other assets -- -- -- -- 125,193 125,193
Allowance for loan losses -- -- -- -- (9,517) (9,517)
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 300,792 $ 263,507 $ 218,363 $ 209,644 $ 259,454 $ 1,251,760
- -----------------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES
Interest-bearing demand $ 260,120 $ -- $ -- $ -- $ -- $ 260,120
Savings 196,056 -- -- -- -- 196,056
Certificates of deposit 93,823 169,402 138,921 58,595 13,108 473,849
Short term borrowings 19,529 -- -- -- -- 19,529
Notes payable -- 2,400 -- -- -- 2,400
Federal Home Loan Bank advances 20,038 -- 10,034 163 20,000 50,235
Trust preferred securities 8,000 -- -- -- 22,425 30,425
- -----------------------------------------------------------------------------------------------------------------------------------
Total Interest-bearing liabilities 597,566 171,802 148,955 58,758 55,533 1,032,614
- -----------------------------------------------------------------------------------------------------------------------------------
Demand deposits -- -- -- -- 104,282 104,282
Other liabilities -- -- -- -- 15,093 15,093
Stockholders' equity -- -- -- -- 99,771 99,771
- -----------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and stockholders' equity $ 597,566 $ 171,802 $ 148,955 $ 58,758 $ 274,679 $ 1,251,760
- -----------------------------------------------------------------------------------------------------------------------------------
Rate sensitivity gap (assets less liabilities) $ (296,774) $ 91,705 $ 69,408 $ 150,886
- -----------------------------------------------------------------------------------------------------------------------------------
Rate sensitivity gap (cumulative) (296,774) (205,069) (135,661) 15,225
- -----------------------------------------------------------------------------------------------------------------------------------
Percent of total assets (cumulative) (23.71)% (16.38)% (10.84)% 1.22%
Rate sensitive assets/liabilities (cumulative) 50.34% 73.35% 85.23% 101.56%
- -----------------------------------------------------------------------------------------------------------------------------------
18
INTEREST RATE SENSITIVITY
At year-end 2002, the Company held approximately $564,000 in assets comprised of
securities, loans, short-term investments, and federal funds sold, which were
interest sensitive in one year or less time horizons. The Company's interest
rate sensitivity analysis for the year ended December 31, 2002 appears in Table
7. A significant assumption that creates the large negative gap in the 0 to 3
month category is that all interest-bearing demand and savings accounts are
subject to immediate repricing. While it is true that, contractually, those
accounts are subject to immediate repricing, the rates paid on those accounts
are generally not tied to specific indices and are influenced by market
conditions and other factors. Accordingly, a general movement in interest rates,
either up or down, may not have any immediate effect on the rates paid on these
deposit accounts. The foregoing table illustrates only one source of information
about sensitivity to interest rate movements, Our asset and liability management
process also uses simulations that take into account the time that various
assets and liabilities may reprice and the degree to which various categories of
such assets and liabilities will respond to general interest rate movements.
Interest rate risk can only be represented by a measurement of the effects of
changing interest rates given the capacity for and magnitude of change on
specific assets and liabilities.
Management believes that the Company has taken steps to position itself to
react to changes occurring in the current rate environment. Short-term interest
rates are at historically low levels and the Company expects them to remain
relatively stable with a possible slight upward bias toward the second half of
2003. The Company has attempted to identify the correlation between the
repricing of assets and liabilities so as to maintain an acceptable net interest
margin during interest rate fluctuations. Economic forecasts anticipate
improving conditions throughout 2003. This would generally indicate higher loan
growth rates than levels achieved during the economic downturn experienced in
2001 and 2002. Assuming a stable or rising interest rate environment, the
Company does not foresee its earnings materially impacted in 2003. However, if
interest rates decline further, the Company believes that its earnings may be
adversely impacted primarily due to its limited ability to further reprice its
core deposits.
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.
Table 8 provides information about the Company's significant financial
instruments at December 31, 2002 that are sensitive to changes in interest
rates. The table presents principal cash flows and related weighted average
interest rates by maturity dates.
The table presents only a static measurement of asset and liability volumes
based on maturity, cash flow estimates and interest rates. It does not reflect
the differences in the timing and degree of repricing of assets and liabilities
due to interest rate changes.
In analyzing interest rate sensitivity, management considers these
differences and incorporates other assumptions and factors, such as balance
sheet growth and prepayments, to better measure interest rate risk. The Company
cannot make any assurances as to the outcome of these assumptions, nor can it
assess the impact of customer product preference changes and competitive factors
as well as other internal and external variables. In addition, this analysis
cannot reflect actions taken by the asset/liability management committees;
therefore, this analysis should not be relied upon as indicative of expected
operating results.
EFFECTS OF CHANGING PRICES
The Company's asset and liability structure is substantially different from that
of an industrial company in that most of its assets and liabilities are monetary
in nature. Management believes the impact of inflation on financial results
depends upon the Company's ability to react to changes in interest rates and, by
such reaction, reduce the inflationary impact on performance. Interest rates do
not necessarily move in the same direction at the same time, or at the same
magnitude, as the prices of other goods and services. As discussed previously,
management relies on its ability to manage the relationship between
interest-sensitive assets and liabilities to protect against wide interest rate
fluctuations, including those resulting from inflation.
NEW ACCOUNTING MATTERS
New accounting standards on asset retirement obligations, restructuring
activities and exit costs, operating leases, and early extinguishment of debt
were issued in 2002. Management determined that when the new accounting
standards are adopted in 2003 they will not have a material impact on the
Company's financial condition or results of operations.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar Amounts in thousands except per share data)
TABLE 8 - PRINCIPAL CASH FLOWS
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------------------------
THERE FAIR
DECEMBER 31 2003 2004 2005 2006 2007 AFTER TOTAL VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investment securities
Fixed rate $ 88,935 $ 84,542 $ 57,425 $ 31,842 $ 14,954 $ 51,440 $329,138 $336,436
Average interest rate 4.23% 4.14% 4.05% 5.34% 5.10% 5.58% 4.53%
Variable rate - - - - 866 14,074 14,940 14,971
Average interest rate - - - - 3.67% 4.89% 4.81%
Loans
Fixed rate $ 31,680 $ 19,273 $ 24,135 $ 24,220 $ 27,492 $113,240 $240,040 $243,300
Average interest rate 7.31% 8.37% 8.61% 7.95% 7.14% 7.52% 7.67%
Variable rate 75,506 2,584 $ 6,536 $ 13,438 7,602 410,176 515,842 528,826
Average interest rate 4.97% 5.67% 5.33% 4.97% 5.81% 6.85% 6.48%
LIABILITIES
Deposits
NOW, money market and
savings deposits
Variable rate $456,176 - - - - - $456,176 $455,938
Average interest rate 1.16% - - - - - 1.16%
Certificates of deposit
Fixed rate $243,881 $134,645 $ 47,437 $ 5,369 $ 15,392 $ 764 $447,488 $448,902
Average interest rate 3.08% 3.98% 4.11% 4.40% 4.63% 6.32%
Variable rate 19,345 4,277 2,035 482 222 - 26,361 26,361
Average interest rate 2.47% 3.07% 4.12% 4.77% 4.50% -
Borrowings
Variable rate $ 19,529 - - - - - $ 19,529 $ 19,529
Average interest rate 1.15% - - - - - 1.15%
FHLB advances
Variable rate - - $ 10,000 - $ 10,000 - $ 20,000 $ 23,133
Average interest rate - - 6.58% - 6.27% - 6.43%
Fixed rate $ 38 $ 10,034 31 132 - $ 20,000 30,235 29,253
Average interest rate 6.20% 3.34% 6.20% 6.20% - 4.26% 3.97%
Long-term debt
Variable rate $ 1,600 $ 800 - - - - $ 2,400 $ 2,400
Average interest rate 3.87% 3.87% - - - - 3.87%
Trust Preferred Securities
Fixed rate - - - - - $ 22,425 $ 22,425 $ 22,582
Average interest rate - - - - - 8.75% 8.75%
Variable rate - - - - - 8,000 8,000 8,000
Average interest rate - - - - - 4.66% 4.66%
20
REPORT OF MANAGEMENT ON RESPONSIBILITY
FOR FINANCIAL INFORMATION
The consolidated financial statements and related financial information
presented in this annual report have been prepared by the management of
MainSource Financial Group, Inc. in accordance with generally accepted
accounting principles, and include amounts based on management's best estimates
and judgments at the time of preparation. In presenting this financial
information, management is responsible for its integrity, content and
consistency of preparation.
To meet this responsibility, management maintains a system of internal control,
policies and administrative procedures designed to provide reasonable assurance
that transactions are recorded accurately. As an integral part of internal
control, the Company maintains a professional staff of internal auditors who
monitor compliance with regulations, policies and procedures, and assess the
effectiveness of internal control. In addition, the Company's audit committee,
which is comprised entirely of outside directors, meets periodically with
management, internal auditors and/or independent auditors and banking regulators
have unrestricted access to the audit committee. Management believes the
Company's system provides a basis for the preparation of reliable financial
statements.
The Company's consolidated financial statements have been audited by Crowe,
Chizek and Company LLP. Their responsibility is to express an opinion as to the
integrity of the company's consolidated financial statements and, in performing
their audit, to evaluate the Company's internal control to the extent they deem
necessary in order to issue such an opinion. As described further in their
report that follows, their opinion is based on their audit, which was conducted
in accordance with auditing standards generally accepted in the United States of
America and is believed by them to provide a reasonable basis for their opinion.
The selection of Crowe, Chizek and Company LLP was approved by the Board of
Directors and ratified by shareholders.
/s/ James L. Saner, Sr.
James L. Saner, Sr.
President and Chief Executive Officer
/s/ Donald A. Benziger
Donald A. Benziger
Senior Vice President and Chief Financial Officer
21
Report of Independent Auditors
Shareholders and Board of Directors
MainSource Financial Group
Greensburg, Indiana
We have audited the accompanying consolidated balance sheets of MainSource
Financial Group as of December 31, 2002 and 2001 and the related consolidated
statements of income, changes in shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of MainSource Financial
Group as of December 31, 2002 and 2001, and the results of its operations and
its cash flows for each of the three years in the period ended December 31, 2002
in conformity with accounting principles generally accepted in the United States
of America.
As disclosed in Note 7, during 2002 the Company adopted new accounting guidance
for goodwill and intangible assets.
/s/ Crowe, Chizek and Company LLP
Crowe, Chizek and Company LLP
Indianapolis, Indiana
January 31, 2003
22
CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
DECEMBER 31 2002 2001
- ----------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 54,548 $ 54,068
Money market fund 22,869 5,351
Federal funds sold 500 --
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 77,917 59,419
Interest bearing time deposits -- 599
Investment securities
Available for sale 346,468 268,136
Held to maturity (fair value of $4,939 and $8,292) 4,675 8,168
- ----------------------------------------------------------------------------------------------------------------
Total investment securities 351,143 276,304
Loans held for sale 15,715 23,256
Loans, net of allowance for loan losses of $9,517 and $8,894 730,650 751,891
Restricted stock, at cost 5,690 5,109
Premises and equipment, net 19,258 16,840
Goodwill 20,708 2,673
Intangible assets 5,005 20,142
Other assets 25,674 22,159
- ----------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,251,760 $ 1,178,392
- ----------------------------------------------------------------------------------------------------------------
LIABILITIES
Deposits
Noninterest bearing $ 104,282 $ 103,391
Interest bearing 930,025 911,296
- ----------------------------------------------------------------------------------------------------------------
Total deposits 1,034,307 1,014,687
Securities sold under agreement to repurchase 19,529 15,478
Federal Home Loan Bank advances 50,235 20,346
Guaranteed preferred beneficial interests in company's subordinated debentures 30,425 22,425
Notes payable 2,400 4,062
Other liabilities 15,093 13,522
- ----------------------------------------------------------------------------------------------------------------
Total Liabilities 1,151,989 1,090,520
- ----------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred stock, no par value
Authorized - 400,000
Issued and outstanding - none - - Common stock, $.50 stated value:
Authorized shares--10,000,000 shares
Issued shares--6,500,084 and 6,191,232
Outstanding shares--6,469,873 and 6,191,232 3,251 3,096
Common stock to be distributed, 325,004 and 308,852 shares 163 155
Treasury stock--30,211 and 0 shares, at cost (694) --
Additional paid-in capital 43,025 35,385
Retained earnings 49,529 47,806
Accumulated other comprehensive income 4,497 1,430
- ----------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 99,771 87,872
- ----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,251,760 $ 1,178,392
- ----------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements.
23
CONSOLIDATED STATEMENTS OF INCOME
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31 2002 2001 2000
- ----------------------------------------------------------------------------------------
INTEREST INCOME:
Loans
Taxable $ 56,088 $ 66,394 $ 66,524
Tax exempt 455 454 541
Investment securities
Taxable 12,970 13,683 16,864
Tax exempt 2,058 1,795 810
Federal funds sold and money market funds 727 2,139 1,085
Deposits with financial institutions 5 80 74
- ----------------------------------------------------------------------------------------
Total interest income 72,303 84,545 85,898
- ----------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits 22,610 38,444 41,493
Short-term borrowings 372 611 1,210
Trust preferred securities 2,035 2,023 2,023
Other borrowings 2,236 1,699 2,083
- ----------------------------------------------------------------------------------------
Total interest expense 27,253 42,777 46,809
- ----------------------------------------------------------------------------------------
Net interest income 45,050 41,768 39,089
Provision for loan losses 2,995 2,136 1,658
- ----------------------------------------------------------------------------------------
Net interest income after provision for loan losses 42,055 39,632 37,431
NON-INTEREST INCOME:
Insurance commissions 2,156 1,993 1,344
Mortgage banking 4,757 2,767 859
Fiduciary activities 561 506 474
Service charges on deposit accounts 4,011 3,835 3,652
Net realized gains/(losses) on securities 319 (111) (11)
Other income 2,575 2,496 3,273
- ----------------------------------------------------------------------------------------
Total non-interest income 14,379 11,486 9,591
- ----------------------------------------------------------------------------------------
NON-INTEREST EXPENSE:
Salaries and employee benefits 20,381 19,061 18,117
Net occupancy expenses 2,414 2,247 1,995
Equipment expenses 2,873 2,489 2,352
Merger expenses -- -- 440
Intangibles amortization 828 1,966 1,922
Telephone 1,038 855 791
Stationery printing and supplies 973 839 957
Other expenses 7,103 6,854 6,594
- ----------------------------------------------------------------------------------------
Total non-interest expense 35,610 34,311 33,168
- ----------------------------------------------------------------------------------------
Income before income tax 20,824 16,807 13,854
Income tax expense 6,813 5,630 4,000
- ----------------------------------------------------------------------------------------
NET INCOME $ 14,011 $ 11,177 $ 9,854
- ----------------------------------------------------------------------------------------
Net income per share (basic and diluted) $ 2.06 $ 1.64 $ 1.45
See notes to consolidated financial statements.
24
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
ACCUMULATED
OTHER
ADDITIONAL COMPRE-
COMMON STOCK PAID-IN RETAINED HENSIVE
SHARES AMOUNT CAPITAL EARNINGS INCOME TOTAL INCOME
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, JANUARY 1, 2000 5,856,639 $ 2,928 $ 25,563 $ 44,775 $(5,094) $ 68,172
Net income 9,854 9,854 $ 9,854
Unrealized gains on securities net
of reclassification adjustment 4,100 4,100 4,100
--------
Total comprehensive income $ 13,954
--------
Cash dividends - $.566 per share (1) (4,121) (4,121)
Stock dividend 293,148 147 4,185 (4,332) --
Issuance of common stock to redeem
stock options 17,261 9 (9) --
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000 6,167,048 3,084 29,739 46,176 (994) 78,005
Net income 11,177 11,177 $ 11,177
Unrealized gains on securities net
of reclassification adjustment 2,424 2,424 2,424
--------
Total comprehensive income $ 13,601
--------
Cash dividends - $.603 per share (4,114) (4,114)
Stock dividend and fractional shares 308,852 155 5,271 (5,433) (7)
Issuance of common stock in acquisition 24,184 12 375 387
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 6,500,084 3,251 35,385 47,806 1,430 87,872
Net income 14,011 14,011 $ 14,011
Unrealized gains on securities net
of reclassification adjustment 3,067 3,067 3,067
--------
Total comprehensive income $ 17,078
--------
Cash dividends - $.657 per share (4,485) (4,485)
Stock dividend and fractional shares 325,004 163 7,640 (7,803) --
Purchase of treasury stock (30,211) (694) (694)
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 6,794,877 $ 2,720 $ 43,025 $ 49,529 $ 4,497 $ 99,771
- -----------------------------------------------------------------------------------------------------------------------------------
(1) Dividends per share represent dividends paid by MSFG without restatement
for pooling of interests.
See notes to consolidated financial statements.
25
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
YEARS ENDED DECEMBER 31 2002 2001 2000
- -----------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 14,011 $ 11,177 $ 9,854
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 2,995 2,136 1,658
Depreciation and amortization 2,246 1,971 1,823
Amortization of mortgage servicing rights 649 1,117 392
Securities amortization, net 1,623 546 241
Amortization of intangibles 828 1,966 1,922
Investment securities gains/losses (319) 111 11
Change in loans held for sale 7,541 (21,373) 6,032
Change in other assets and liabilities (704) 1,175 (1,367)
- -----------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities 28,870 (1,174) 20,566
INVESTING ACTIVITIES
Net change in short term investments 599 (5) 1,525
Proceeds from maturities and payments
on securities held to maturity 3,532 4,556 5,127
Purchases of securities available for sale (227,229) (199,629) (41,681)
Proceeds from maturities and payments
on securities available for sale 121,805 205,928 38,030
Proceeds from sales of securities available for sale 30,586 10,507 622
Purchases of restricted stock (581) (1,842) (856)
Loan originations and payments, net 36,646 27,807 (83,018)
Purchases of premises and equipment (3,408) (1,888) (1,786)
Proceeds from sale of other real estate -- -- 2,265
Cash (paid) received from acquisitions, net 37,054 (655) 42,037
Proceeds from sale of premises and equipment -- 635 --
- -----------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities (996) 45,414 (37,735)
FINANCING ACTIVITIES
Net change in deposits (44,475) (38,883) 69,141
Net change in short-term borrowings 4,051 (5,167) (19,419)
Repayment of notes payable (1,662) (2,448) (375)
Proceeds from FHLB advances 40,000 -- 22,000
Repayment of FHLB advances (10,111) (2,117) (24,021)
Proceeds from issuance of trust preferred securities 8,000 -- --
Purchase of treasury shares (694) -- --
Cash dividends and fractional stock dividends (4,485) (4,121) (4,121)
- -----------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities (9,376) (52,736) 43,205
- -----------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents 18,498 (8,496) 26,036
Cash and cash equivalents, beginning of period 59,419 67,915 41,879
- -----------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 77,917 $ 59,419 $ 67,915
- -----------------------------------------------------------------------------------------------------
Additional Cash Flows Information
Interest paid $ 27,835 $ 44,435 $ 45,380
Income tax paid 6,793 6,076 5,622
Loan balances transferred to foreclosed real estate 3,658 -- 2,491
See note 2 regarding noncash transactions included in acquisitions.
See notes to consolidated financial statements.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation: The consolidated financial
statements include MainSource Financial Group, formerly known as Indiana United
Bancorp, ("Company") and its wholly owned subsidiaries. Intercompany
transactions and balances are eliminated in consolidation.
The Company's wholly owned subsidiaries include MainSource Bank (formed in
2002 by the merger of two subsidiaries, People's Trust Company and Union Bank
and Trust Company of Indiana), Regional Bank ("Regional"), Capstone Bank, N.A.
("Capstone"), IUB Reinsurance Company, Ltd., IUB Capital Trust and MainSource
Statutory Trust. IUB Capital Trust and MainSource Statutory Trust are business
trusts formed to issue the guaranteed preferred beneficial interests in the
Company's subordinated debentures ("Trust Preferred Securities"). MainSource
Insurance, Inc. is a wholly owned subsidiary of MainSource Bank.
The Company provides financial services through its offices in Indiana,
Illinois, and Kentucky. Its primary deposit products are checking, savings, and
term certificate accounts, and its primary lending products are residential
mortgage, commercial, and installment loans. Substantially all loans are secured
by specific items of collateral including business assets, consumer assets and
real estate. Commercial loans are expected to be repaid from cash flow from
operations of businesses. Real estate loans are secured by both residential and
commercial real estate. Other financial instruments which potentially represent
concentrations of credit risk include deposit accounts in other financial
institutions and federal funds sold.
Use of Estimates: To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided, and future results could differ. The allowance for loan
losses and fair values of financial instruments are particularly subject to
change.
Cash Flows: Cash and cash equivalents include cash, deposits with other
financial institutions under 90 days, and federal funds sold. Net cash flows are
reported for loan and deposit transactions.
Securities: Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available for sale when they might be
sold before maturity. Securities available for sale are carried at fair value,
with unrealized holding gains and losses reported in other comprehensive income.
Restricted stock, such as Federal Home Loan Bank stock, is carried at cost.
Interest income includes amortization of purchase premium or discount.
Gains and losses on sales are based on the amortized cost of the security sold.
Securities are written down to fair value when a decline in fair value is not
temporary.
Loans: Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at the principal
balance outstanding, net of unearned interest, deferred loan fees and costs, and
an allowance for loan losses. Loans held for sale are reported at the lower of
cost or market, on an aggregate basis.
Interest income is reported on the interest method and includes
amortization of net deferred loan fees and costs over the loan term. Interest
income is not reported when full loan repayment is in doubt, typically when the
loan is impaired or payments are past due over 90 days. Loans are placed on
non-accrual or charged-off at an earlier date if collection of principal or
interest is considered doubtful.
All interest accrued but not received for loans placed on nonaccrual is
reversed against interest income. Interest received on such loans is accounted
for on the cash-basis until qualifying for return to accrual. Loans are returned
to accrual status when all the principal and interest amounts contractually due
are brought current and future payments are reasonably assured.
Allowance for Loan Losses: The allowance for loan losses is a valuation
allowance for probable incurred credit losses, increased by the provision for
loan losses and decreased by chargeoffs less recoveries. Management estimates
the allowance balance required using past loan loss experience, the nature and
volume of the portfolio, information about specific borrower situations and
estimated collateral values, economic conditions, and other factors. Allocations
of the allowance may be made for specific loans, but the entire allowance is
available for any loan that, in management's judgment, should be chargedoff.
Loan losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed.
A loan is impaired when full payment under the loan terms is not expected.
Impairment is evaluated in total for smaller-balance loans of similar nature
such as residential real estate, consumer, and credit card loans, and are not
separately identified for impairment disclosure. Other loans are evaluated
individually for impairment. If a loan is impaired, a portion of the allowance
is allocated so that the loan is reported, net, at the present value of
estimated future cash flows using the loan's existing rate or at the fair value
of collateral if repayment is expected solely from the collateral.
Foreclosed Assets: Assets acquired through or instead of loan foreclosure are
initially recorded at fair value when acquired, establishing a new cost basis.
If fair value declines, a valuation allowance is recorded through expense. Costs
after acquisition are expensed.
Premises and Equipment: Land is carried at cost. Premises and equipment are
stated at cost less accumulated depreciation. Buildings and related components
are depreciated using the straightline method with useful lives ranging from 5
to 39 years. Furniture, fixtures and equipment are depreciated using the
straightline method with useful lives ranging from 3 to 10 years.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
Servicing Assets: Servicing assets represent the allocated value of retained
servicing rights on loans sold. Servicing assets are expensed in proportion to,
and over the period of, estimated net servicing revenues. Impairment is
evaluated based on the fair value of the assets, using groupings of the
underlying loans as to product type and interest rates. Fair value is determined
using prices for similar assets with similar characteristics, when available, or
based upon discounted cash flows using market-based assumptions. Any impairment
of a grouping is reported as a valuation allowance.
Goodwill and Other Intangible Assets: Goodwill results from prior business
acquisitions and represents the excess of the purchase price over the fair value
of acquired tangible assets and liabilities and identifiable intangible assets.
Upon adopting new accounting guidance on January 1, 2002, the Company ceased
amortizing goodwill. Goodwill is assessed at least annually for impairment and
any such impairment will be recognized in the period identified.
Other intangible assets consist of core deposit intangibles arising from
whole bank and branch acquisitions. They are initially measured at fair value
and then are amortized on an accelerated method over their estimated useful
lives, which range from 8-12 years.
Long-term Assets: Premises and equipment and other long-term assets are reviewed
for impairment when events indicate their carrying amount may not be recoverable
from future undiscounted cash flows. If impaired, the assets are recorded at
fair values.
Repurchase Agreements: Substantially all repurchase agreement liabilities
represent amounts advanced by various customers. Securities are pledged to cover
these liabilities, which are not covered by federal deposit insurance.
Income Taxes: Income tax expense is the total of the current year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are the expected future tax amounts for the temporary
differences between carrying amounts and tax bases of assets and liabilities,
computed using enacted tax rates. A valuation allowance, if needed, reduces
deferred tax assets to the amount expected to be realized.
Off Balance Sheet Financial Instruments: Financial instruments include
offbalance sheet credit instruments, such as commitments to make loans and
standby letters of credit, issued to meet customer financing needs. The face
amount for these items represents the exposure to loss, before considering
customer collateral or ability to repay. Such financial instruments are recorded
when they are funded.
Derivatives: All derivative instruments are recorded at their fair values. If
derivative instruments are designated as hedges of fair values, both the change
in the fair value of the hedge and the hedged item are included in current
earnings. Fair value adjustments related to cash flow hedges are recorded in
other comprehensive income and reclassified to earnings when the hedged
transaction is reflected in earnings. Ineffective portions of hedges are
reflected in earnings as they occur.
Earnings Per Common Share: Basic earnings per common share is net income divided
by the weighted average number of common shares outstanding during the period.
Diluted earnings per common share includes the dilutive effect of additional
potential common shares issuable under stock options. Earnings and dividends per
share are restated for all stock splits and dividends through the date of issue
of the financial statements.
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale, which are also recognized as a separate
component of equity.
Loss Contingencies: Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably
estimated.
Dividend Restriction: Banking regulations require maintaining certain capital
levels and may limit the dividends paid by the banks to the holding company or
by the holding company to shareholders.
Fair Value of Financial Instruments: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed in a separate note. Fair value estimates involve uncertainties and
matters of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could
significantly affect the estimates.
Operating Segments: While the Company's chief decision-makers monitor the
revenue streams of the various Company products and services, the identifiable
segments are not material and operations are managed and financial performance
is evaluated on a Company-wide basis. Accordingly, all of the Company's
financial service operations are considered by management to be aggregated in
one reportable operating segment.
Reclassifications: Some items in the prior year financial statements were
reclassified to conform to the current presentation.
Newly Issued But Not Yet Effective Accounting Standards: New accounting
standards on asset retirement obligations, restructuring activities and exit
costs, operating leases, and early extinguishment of debt were issued in 2002.
Management determined that when the new accounting standards are adopted in 2003
they will not have a material impact on the Company's financial condition or
results of operations.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
2. ACQUISITIONS
During 2002, three branch acquisitions were closed, for a total cash price of
$3,132. The results of operations for each acquisition have been included since
the transaction date. Below is a summary of the acquisitions:
o In August 2002, one branch located in Lynn, Indiana was acquired and
merged into MainSource Bank.
o In July 2002, three branches in Vermillion County, Illinois were
acquired and merged into Capstone.
o In February 2002, one branch located in Grant Park, Illinois was
acquired and merged into Capstone.
The branch acquisitions were made to further solidify the Company's market
share in existing markets and to expand its customer base into new markets,
thereby enhancing deposit fee income and providing an opportunity to market
additional products and services to new customers. The acquisition also helped
to prevent another financial institution from entering these markets, and it
allowed the Company to establish additional branch locations to improve customer
convenience.
The following is a summary of assets acquired and liabilities assumed (in
millions). Intangible assets include core deposit intangibles which are being
amortized over 10 years. Goodwill is fully deductible for tax purposes.
- ------------------------------------------------------------------------------
GRANT VERMILLION
PARK COUNTY LYNN TOTAL
- ------------------------------------------------------------------------------
Cash and cash equivalents $15.6 $20.3 $1.1 $37.0
Loans 3.2 9.1 9.7 22.0
Fixed and other assets 0.9 0.3 0.4 1.6
Goodwill 0.6 1.3 0.8 2.7
Intangible assets 0.2 0.6 0.2 1.0
Deposits (20.4) (31.5) (12.2) (64.1)
Other liabilities (0.1) (0.1) - (0.2)
The following table presents pro forma information for the periods ended
December 31 as if the acquisition of the branches had occurred at the beginning
of 2002 and 2001. The pro forma information includes adjustments for the
amortization of intangibles arising from the transaction, depreciation expense
on property acquired, interest income and expense on loans acquired and deposits
assumed, and the related income tax effects. The pro forma financial information
presented below does not reflect earnings on cash acquired, fees that could be
earned on deposits, or operating expenses related to the new branch. The pro
forma financial information is not necessarily indicative of the results of
operations as they would have been had the transactions been effected on the
assumed dates.
- -------------------------------------------------------------------------------
2002 2001
- -------------------------------------------------------------------------------
Net interest income $ 45,405 $ 41,044
Net income 14,033 10,328
- -------------------------------------------------------------------------------
Earnings per share $ 2.06 $ 1.51
- -------------------------------------------------------------------------------
During 2001, the Company consummated its acquisition of the insurance
agencies of Vollmer & Associates, Inc. ("Vollmer"). The transaction was
accounted for using the purchase method of accounting. The purchase price
consisted of cash and shares of Company stock. The acquisition resulted in
goodwill of approximately $1,000. The results of operations have been included
since the acquisition date. The Vollmer agencies were subsequently merged into
MainSource Insurance, Inc.
On May 1, 2000 the Company consummated its acquisition of First Affiliated
Bancorp of Watseka, Illinois and its wholly owned banking subsidiary, Capstone
Bank, N.A. The transaction was accounted for using the pooling-of-interests
method of accounting. The Company issued 1,178,878 shares of its common stock to
the shareholders of First Affiliated Bancorp (adjusted for stock dividend). The
conversion rate was 4.4167 shares of Company stock for each outstanding share of
First Affiliated. Merger and related costs were charged against net income
during 2000. The financial information contained herein includes Capstone for
all periods presented.
During 2000, the Company purchased two branches within target market areas.
These branch acquisitions were accounted for using the purchase method of
accounting. Total fair value of assets acquired and liabilities assumed was
$43,794 including cash of $42,037 and deposits of $43,524. The results of
operations of the branches have been included since their acquisition dates.
Goodwill of $1,458 was recorded.
In October 2002, the Company executed a letter of intent to acquire one
branch located in Illinois. The transaction will be accounted for using the
purchase method of accounting and is expected to close in the first quarter of
2003. This branch will be merged into Capstone. Approximately $6 million of
loans, $0.3 million of fixed assets, and $12 million of cash will be acquired
along with approximately $20 million of deposits assumed.
In November 2002, the Company executed a letter of intent to acquire First
Community Bancshares, Inc ("First Community"). First Community has ten branches
throughout the south central area of Indiana with total consolidated assets of
approximately $150 million. The agreement provides that the shareholders of
First Community will receive $21.00 in cash for each share of common stock of
First Community. The transaction is subject to execution of a definitive
agreement, regulatory approval, and approval of First Community shareholders.
The transaction is expected to close in the second quarter of 2003.
3. RESTRICTION ON CASH AND DUE FROM BANKS
The Banks are required to maintain reserve funds in cash or on deposit with the
Federal Reserve Bank. The reserve required at December 31, 2002 and 2001 was
$13,089 and $10,138, respectively.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
4. INVESTMENT 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
VALUE GAINS LOSSES
- -------------------------------------------------------------------------------
2002
- -------------------------------------------------------------------------------
Available for Sale
Federal agencies $ 80,483 $ 2,928 $ -
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)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
GROSS GROSS
FAIR UNREALIZED UNREALIZED
VALUE GAINS LOSSES
- -------------------------------------------------------------------------------
2001
- -------------------------------------------------------------------------------
Available for Sale
Federal agencies $ 97,654 $ 2,205 $ (113)
State and municipal 41,920 558 (600)
Mortgage-backed securities 102,086 970 (505)
Equity and other securities 26,476 565 (852)
- -------------------------------------------------------------------------------
Total available for sale $ 268,136 $ 4,298 $ (2,070)
- -------------------------------------------------------------------------------
The carrying amount, unrecognized gains and losses, and fair value of securities
held to maturity were as follows:
- ---------------------------------------------------------------------------------------------
GROSS GROSS
CARRYING UNRECOGNIZED UNRECOGNIZED FAIR
AMOUNT GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------
2002
- ---------------------------------------------------------------------------------------------
Held to Maturity
State and municipal $ 3,977 $ 119 $ - $ 4,096
Other securities 698 145 - 843
- ---------------------------------------------------------------------------------------------
Total held to maturity $ 4,675 $ 264 $ - $ 4,939
- ---------------------------------------------------------------------------------------------
2001
- ---------------------------------------------------------------------------------------------
Held to Maturity
State and municipal $ 7,018 $ 68 $ (38) $ 7,048
Other securities 1,150 94 - 1,244
- ---------------------------------------------------------------------------------------------
Total held to maturity $ 8,168 $ 162 $ (38) $ 8,292
- ---------------------------------------------------------------------------------------------
Contractual maturities of securities as of December 31, 2002 were as follows.
Securities not due at a single maturity date are shown separately.
- -------------------------------------------------------------------------------
AVAILABLE
HELD TO MATURITY FOR SALE
- -------------------------------------------------------------------------------
CARRYING FAIR FAIR
AMOUNT VALUE VALUE
- -------------------------------------------------------------------------------
Within one year $ 1,084 $ 1,088 $ 7,627
Two through five years 1,307 1,362 91,300
Six through ten years 1,909 2,108 16,734
After ten years 375 381 13,849
Mortgage-backed securities - - 194,490
Equity and other securities - - 22,468
- -------------------------------------------------------------------------------
Total investment securities $ 4,675 $ 4,939 $ 346,468
- -------------------------------------------------------------------------------
Gross proceeds from sales of securities available for sale during 2002, 2001 and
2000 were $30,586, $10,507, and $622. Gross gains of $373, $72, and $24 and
gross losses of $65, $232, and $35 were realized on those sales in 2002, 2001
and 2000, respectively. In addition, the Company also realized $11 and $49 of
gains on called securities in 2002 and 2001, respectively.
Securities with a carrying value of $59,337 and $49,085 were pledged at
December 31, 2002 and 2001 to secure certain deposits and for other purposes as
permitted or required by law.
30
5. LOANS AND ALLOWANCE
- -------------------------------------------------------------------------------
December 31 2002 2001
- -------------------------------------------------------------------------------
Commercial and industrial loans $ 97,517 $ 81,808
Agricultural production financing 25,105 20,726
Farm real estate 43,762 46,524
Commercial real estate 84,024 96,747
Hotel 73,262 74,888
Residential real estate 301,232 328,107
Construction and development 34,987 34,130
Consumer 72,702 69,957
State and political 7,576 7,898
- -------------------------------------------------------------------------------
Total loans 740,167 760,785
Allowance for loan losses (9,517) (8,894)
- -------------------------------------------------------------------------------
Net loans $ 730,650 $ 751,891
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
DECEMBER 31 2002 2001 2000
- -------------------------------------------------------------------------------
Allowance for loan losses
Balances, January 1 $ 8,894 $ 8,716 $ 7,718
Provision for losses 2,995 2,136 1,658
Recoveries on loans 399 421 457
Loans charged off (2,771) (2,379) (1,117)
- -------------------------------------------------------------------------------
Balances, December 31 $ 9,517 $ 8,894 $ 8,716
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
DECEMBER 31 2002 2001 2000
- -------------------------------------------------------------------------------
Impaired loans with an allowance $ 2,267 $ 5,989 $ 1,220
Impaired loans with no
allocated allowances - - 198
- -------------------------------------------------------------------------------
Total impaired loans $ 2,267 $ 5,989 $ 1,418
- -------------------------------------------------------------------------------
Allowance allocated for impaired loans $ 269 $ 898 $ 47
Average balance of impaired loans $ 2,866 $ 4,174 $ 1,779
Interest income recognized on
impaired loans - - -
Cash basis interest included above - - -
Nonperforming loans were as follows:
- -------------------------------------------------------------------------
2002 2001
- -------------------------------------------------------------------------
Loans past due over 90 days still
on accrual $ 245 $ 766
Nonaccrual loans 7,695 10,406
- -------------------------------------------------------------------------
Total nonperforming loans $ 7,940 $ 11,172
- -------------------------------------------------------------------------
Nonperforming loans and impaired loans are defined differently. Some loans may
be included in both categories, whereas other loans may only be included in one
category.
6. PREMISES & Equipment
- ------------------------------------------------------------------------------
DECEMBER 31 2002 2001
- ------------------------------------------------------------------------------
Land $ 3,037 $ 2,726
Buildings 18,312 17,139
Equipment 18,507 15,874
- ------------------------------------------------------------------------------
Total cost 39,856 35,739
Accumulated depreciation (20,598) (18,899)
- ------------------------------------------------------------------------------
Net $ 19,258 $ 16,840
- ------------------------------------------------------------------------------
Depreciation expense was $2,246, $1,971 and $1,823 for 2002, 2001 and 2000.
7. GOODWILL AND INTANGIBLE ASSETS
Goodwill
Upon adopting new accounting guidance in 2002, unidentifiable intangibles from
bank branch acquisitions were reclassified to goodwill. The change in the
carrying amount of goodwill for the year is as follows:
- -------------------------------------------------------------------------------
2002
- -------------------------------------------------------------------------------
Beginning of year $ 2,673
Reclassified from unidentifiable intangible asset 15,295
Goodwill from acquisitions during year 2,740
- -------------------------------------------------------------------------------
End of year $ 20,708
- -------------------------------------------------------------------------------
Upon adopting new accounting guidance, goodwill is no longer amortized starting
in 2002. The effect of not amortizing goodwill is summarized as follows:
- -------------------------------------------------------------------------------
2002 2001 2000
- -------------------------------------------------------------------------------
Reported net income $ 14,011 $ 11,177 $ 9,854
Add back: goodwill amortization, net of tax - 710 636
- -------------------------------------------------------------------------------
Adjusted net income $ 14,011 $ 11,887 $ 10,490
- -------------------------------------------------------------------------------
Basic and diluted earnings per share:
Reported net income $ 2.06 $ 1.64 $ 1.45
Goodwill amortization, net of tax - .10 .09
- -------------------------------------------------------------------------------
Adjusted net income $ 2.06 $ 1.74 $ 1.54
- -------------------------------------------------------------------------------
The effect of ceasing goodwill amortization on 2002 net income was $710.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
7. GOODWILL AND INTANGIBLE ASSETS, CONTINUED
Acquired Intangible Assets
Acquired intangible assets were as follows as of year end:
- -------------------------------------------------------------------------------
2002 2001
-----------------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
- -------------------------------------------------------------------------------
Amortized intangible assets:
Core deposit intangibles $ 8,553 $ 3,548 $ 9,059 $ 2,879
Unidentified branch
acquisition intangibles - - 16,358 2,396
- -------------------------------------------------------------------------------
Total $ 8,553 $ 3,548 $ 25,417 $ 5,275
- -------------------------------------------------------------------------------
Aggregate amortization expense was $828, $1,700, and $1,708 for 2002, 2001 and
2000.
Estimated amortization expense for each of the next five years:
2003 $ 880
2004 876
2005 873
2006 869
2007 862
8. DEPOSITS
- -------------------------------------------------------------------------------
December 31 2002 2001
- -------------------------------------------------------------------------------
Non-interest bearing $ 104,282 $ 103,391
Interest bearing demand 260,120 212,812
Savings deposits 196,056 223,640
Certificates and other time deposits
_of $100 or more 93,192 87,480
Other certificates and time deposits 380,657 387,364
- -------------------------------------------------------------------------------
Total deposits $ 1,034,307 $ 1,014,687
- -------------------------------------------------------------------------------
Certificates and other time deposits maturing in years ending after December 31,
2002:
2003 $ 263,225
2004 138,921
2005 49,472
2006 5,852
2007 3,271
Thereafter 13,108
- -------------------------------------------------------------------------------
Total $ 473,849
- -------------------------------------------------------------------------------
9. SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE
Securities sold under repurchase agreements ("agreements") consist of
obligations secured by U.S. Treasury and Federal agency securities, and a
safekeeping agent holds such collateral. As of December 31, 2002 and 2001, the
amount of outstanding agreements was $19,529 and $15,478 respectively. The
maximum amount of outstanding agreements at any month-end during 2002 and 2001
totaled $19,529 and $19,175. The daily average of such agreements during 2002
and 2001 totaled $17,372 and $15,798. The weighted average rate was 1.15% and
1.64% at December 31, 2002 and 2001, while the weighted average rate during 2002
and 2001 was approximately 1.64% and 3.27%, respectively. The majority of the
agreements at December 31, 2002 mature within 30 days.
10. FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank ("FHLB") advances at year end were:
- -------------------------------------------------------------------------------
2002 2001
- -------------------------------------------------------------------------------
Maturities February 2002 through September 2007,
with rates from 6.2% to 6.7%, averaging 6.4% $ - $ 20,346
Maturities March 2003 through August 2012,
with rates from 3.3% to 6.7%, averaging 5.0% 50,235 -
- -------------------------------------------------------------------------------
$ 50,235 $ 20,346
- -------------------------------------------------------------------------------
The FHLB advances are secured by first mortgage loans totaling approximately
145% of the advance under a blanket security agreement. The advances are subject
to restrictions or penalties in the event of prepayment.
Maturities over the next five years are:
2003 $ 38
2004 10,034
2005 10,031
2006 132
2007 10,000
Thereafter 20,000
11. NOTES PAYABLE
Notes payable include a term note secured by 100% of the common stock of
MainSource Bank and Regional with a balance of $2,400 and $4,000 at December 31,
2002 and 2001. The note requires semi-annual principal payments of $800 plus
quarterly interest payments. Interest accrues at LIBOR+1.2%, which resulted in a
rate of 3.87% at December 31, 2002. The loan matures July 1, 2004. The scheduled
annual principal reductions will be $1,600 in 2003 with a final payment of $800
in 2004.
32
12. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN
COMPANY'S SUBORDINATED DEBENTURES
On December 12, 1997, trust preferred securities totaling $22,425 were issued.
On such date, IUB Capital Trust completed the public offering of 2,242,500
shares of trust preferred securities with a liquidation preference of $10 per
security. Distributions on the securities are payable quarterly in arrears at
the annual rate of 8.75% of the liquidation preference. The trust preferred
securities mature December 31, 2027 and are redeemable prior to the maturity
date at the option of the Company on or after December 31, 2002. The Company has
the option to defer distributions on the subordinated debentures from time to
time for a period not to exceed 20 consecutive quarters. Issuance costs of
$1,227 paid from the proceeds are being amortized over the estimated life of the
securities.
On December 19, 2002, the Company announced the intent to redeem a portion
of its fixed rate trust preferred securities, and issued $8,000 of floating rate
obligated mandatory redeemable securities through MainSource Statutory Trust as
part of a pooled offering. The redemption of $8.4 million of fixed rate
securities occurred February 11, 2003. The floating rate securities bear an
interest rate of 325 basis points over the 3-month LIBOR rate, resulting in a
rate of 4.66% at year end. After five years, the securities may be redeemed at
par value. The securities mature in February 2033. Distributions are payable
quarterly in arrears. The Company has the option to defer distributions from
time to time for a period not to exceed 20 consecutive quarters. Debt issue
costs of $160 have been capitalized and are being amortized over the term of the
securities.
Trust preferred securities count as Tier 1 capital for regulatory capital
purposes, within defined limits.
13. LOAN SERVICING
Loans serviced for others are not included in the accompanying consolidated
balance sheet. The unpaid principal balances of loans serviced for others
totaled $395,359 and $293,640 at December 31, 2002 and 2001. The fair value of
capitalized mortgage servicing assets is based on comparable market values and
expected cash flows, with impairment assessed based on portfolio characteristics
including product type and interest rates. No valuation allowance was necessary
during 2002 or 2001.
- -------------------------------------------------------------------------------
2002 2001
- -------------------------------------------------------------------------------
Mortgage servicing assets
Balances, January 1 $ 1,105 $ 881
Servicing assets capitalized 1,678 1,341
Amortization of servicing assets (649) (1,117)
- -------------------------------------------------------------------------------
Balance, December 31 $ 2,134 $ 1,105
- -------------------------------------------------------------------------------
14. INCOME TAX
Retained earnings of Regional Bank include approximately $2,162 for which no
deferred income tax liability has been recognized. This amount represents an
allocation of income to bad debt deductions as of December 31, 1987 for tax
purposes only. Reduction of amounts so allocated for purposes other than tax bad
debt losses including redemption of Regional Bank stock or excess dividends, or
loss of "bank" status for Regional Bank would create income for tax purposes
only, which would be subject to the then-current corporate income tax rate. The
unrecorded deferred income tax liability on the above amount for Regional at
December 31, 2002 was approximately $735.
Income tax expense (benefit) was as follows:
- -------------------------------------------------------------------------------
Year Ended December 31 2002 2001 2000
- -------------------------------------------------------------------------------
Income tax expense
Currently payable $ 5,899 $ 5,378 $ 5,941
Deferred 914 252 (1,541)
Capstone change in tax status - - (400)
- -------------------------------------------------------------------------------
Total income tax expense $ 6,813 $ 5,630 $ 4,000
- -------------------------------------------------------------------------------
Reconciliation of federal statutory to actual tax expense
Federal statutory income tax rate 35% 35% 35%
Federal statutory income tax $ 7,288 $ 5,883 $ 4,849
Tax exempt interest (838) (672) (766)
Effect of state income taxes 483 351 490
Non-deductible expenses 42 109 186
Tax exempt income on life insurance (73) (66) (178)
Capstone deferred tax asset - - (400)
Other (89) 25 (181)
- -------------------------------------------------------------------------------
Actual tax expense $ 6,813 $ 5,630 $ 4,000
- -------------------------------------------------------------------------------
The components of the net deferred tax asset (liability) are as follows:
- -------------------------------------------------------------------------------
DECEMBER 31 2002 2001
- -------------------------------------------------------------------------------
ASSETS
Allowance for loan losses $ 3,781 $ 3,507
Intangibles - 116
Deferred compensation 486 533
Accrued expenses 350 406
Other 170 60
- -------------------------------------------------------------------------------
Total assets $ 4,787 $ 4,622
- -------------------------------------------------------------------------------
LIABILITIES
Accretion on securities (23) (42)
Depreciation (798) (503)
Fair value adjustments in accounting
_for assets acquired (354) (381)
Intangibles (466) -
Mortgage servicing rights (844) (433)
Deferred loan fees/costs (327) (342)
Unrealized gain on securities AFS (2,593) (798)
Other (328) (360)
- -------------------------------------------------------------------------------
Total liabilities $ (5,733) $ (2,859)
$ (946) $ 1,763
- -------------------------------------------------------------------------------
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
15. OTHER COMPREHENSIVE INCOME
- ---------------------------------------------------------------------------------------------------------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
YEAR ENDED DECEMBER 31, 2002 AMOUNT /BENEFIT AMOUNT
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized losses on securities
Unrealized holding losses arising during the year $ 5,156 $ (1,882) $ 3,274
Less: reclassification adjustment for gains realized in net income 319 (112) 207
- ---------------------------------------------------------------------------------------------------------------------------
Other comprehensive income $ 4,837 $ (1,770) $ 3,067
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
YEAR ENDED DECEMBER 31, 2001 AMOUNT /BENEFIT AMOUNT
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized gains on securities
Unrealized holding gains arising during the year $ 3,707 $ (1,355) $ 2,352
Less: reclassification adjustment for losses realized in net income (111) 39 (72)
- ---------------------------------------------------------------------------------------------------------------------------
Other comprehensive income $ 3,818 $ (1,394) $ 2,424
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
YEAR ENDED DECEMBER 31, 2000 AMOUNT /BENEFIT AMOUNT
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized gains on securities
Unrealized holding gains arising during the year $ 6,419 $ (2,326) $ 4,093
Less: reclassification adjustment for losses realized in net income (11) 4 (7)
- ---------------------------------------------------------------------------------------------------------------------------
Other comprehensive income $ 6,430 $ (2,330) $ 4,100
- ---------------------------------------------------------------------------------------------------------------------------
16. COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business there are outstanding commitments and
contingent liabilities, such as commitments to extend credit and standby letters
of credit, which are not included in the accompanying financial statements. The
Banks' exposure to credit loss in the event of nonperformance by the other party
to the financial instruments for commitments to extend credit and standby
letters of credit is represented by the contractual or notional amount of those
instruments. The Banks use the same credit policies in making such commitments
as they do for instruments that are included in the consolidated balance sheet.
Financial instruments whose contract amount represents credit risk as of
December 31 were as follows:
- -------------------------------------------------------------------------------
2002 2001
- -------------------------------------------------------------------------------
Commitments to extend credit $ 139,685 $ 123,639
Standby letters of credit 1,766 584
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Commitments are predominantly short-term or variable
in rate. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. Collateral held varies, but may include accounts receivable,
inventory, property and equipment and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Banks to
guarantee the performance of a customer to a third party.
The Company and Banks may, from time to time, be subject to claims and
lawsuits that arise primarily in the ordinary course of business. Management
does not believe there are now such matters that will have a material impact on
the financial statements.
17. STOCK DIVIDENDS
On December 12, 2000, the Company announced a 5% stock dividend to be paid on
January 19, 2001 to shareholders of record as of December 29, 2000. The stock
dividend was recorded in 2000, and all share and per share amounts have been
retroactively adjusted for all prior years to reflect this stock dividend.
On December 19, 2001, the Company announced a 5% stock dividend to be paid
on January 25, 2002 to shareholders of record as of December 31, 2001. The stock
dividend was recorded in 2001, and all share and per share amounts have been
retroactively adjusted for all prior years to reflect this stock dividend.
On December 17, 2002, the Company announced a 5% stock dividend to be paid
on January 17, 2003 to shareholders of record as of December 31, 2002. The stock
dividend was recorded in 2002, and all share and per share amounts have been
retroactively adjusted for all prior years to reflect this stock dividend.
34
18. DIVIDENDS AND CAPITAL RESTRICTIONS
Without prior approval, the Banks are restricted by Indiana law and regulatory
agencies as to the maximum amount of dividends the Banks can pay to the parent
in any calendar year to their retained net profits (as defined) for that year
and the two preceding years.
At December 31, 2002, total shareholders' equity of the Banks was $111,436
of which $100,395 was restricted or limited from dividend distribution to the
Company. As a practical matter, the Banks may restrict dividends to a lesser
amount because of the need to maintain an adequate capital structure.
19. DIVIDEND REINVESTMENT PLAN
The Company maintains an Automatic Dividend Reinvestment Plan. The plan enables
shareholders to elect to have their cash dividends on all or a portion of shares
held automatically reinvested in additional shares of the Company's common
stock. The stock is purchased by the Company's transfer agent on the open market
and credited to participant accounts at fair market value. Dividends are
reinvested on a quarterly basis.
20. REGULATORY CAPITAL
The Company and Banks are subject to various regulatory capital requirements
administered by the federal banking agencies and are assigned to a capital
category. The assigned capital category is largely determined by three ratios
that are calculated according to the regulations. The ratios are intended to
measure capital relative to assets and credit risk associated with those assets
and off-balance sheet exposures. The capital category assigned to an entity can
also be affected by qualitative judgments made by regulatory agencies about the
risk inherent in the entity's activities that are not part of the calculated
ratios.
There are five capital categories defined in the regulations, ranging from
well capitalized to critically undercapitalized. Classification in any of the
undercapitalized categories can result in actions by regulators that could have
a material effect on operations. At December 31, 2002 and 2001, the Banks were
categorized as well capitalized and met all subject capital adequacy
requirements.
- ----------------------------------------------------------------------------------------------------------------------------------
REQUIRED FOR TO BE WELL
ACTUAL ADEQUATE CAPITAL CAPITALIZED
DECEMBER 31, 2002 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ----------------------------------------------------------------------------------------------------------------------------------
MAINSOURCE FINANCIAL GROUP
Total capital (to risk-weighted assets) $ 109,503 14.1% $ 62,243 8.0% N/A N/A
Tier 1 capital (to risk-weighted assets) 92,516 11.9 31,121 4.0 N/A N/A
Tier 1 capital (to average assets) 92,516 7.6 49,061 4.0 N/A N/A
MAINSOURCE
Total capital (to risk-weighted assets) $ 60,536 11.3% $ 43,048 8.0% $ 53,810 10.0%
Tier 1 capital (to risk-weighted assets) 53,887 10.1 21,524 4.0 32,286 6.0
Tier 1 capital (to average assets) 53,887 6.8 31,608 4.0 39,510 5.0
REGIONAL
Total capital (to risk-weighted assets) $ 17,341 11.6% $ 11,930 8.0% $ 14,912 10.0%
Tier 1 capital (to risk-weighted assets) 15,543 10.4 5,965 4.0 8,947 6.0
Tier 1 capital (to average assets) 15,543 6.4 9,748 4.0 12,186 5.0
CAPSTONE
Total risk-based capital (to risk-weighted assets) $ 12,866 15.4% $ 6,704 8.0% $ 8,381 10.0%
Tier 1 capital (to risk-weighted assets) 11,818 14.1 3,352 4.0 5,028 6.0
Tier 1 capital (to average assets) 11,818 6.4 7,425 4.0 9,281 5.0
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
20. REGULATORY CAPITAL, CONTINUED
- ----------------------------------------------------------------------------------------------------------------------------------
REQUIRED FOR TO BE WELL
ACTUAL ADEQUATE CAPITAL CAPITALIZED
DECEMBER 31, 2001 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ----------------------------------------------------------------------------------------------------------------------------------
MAINSOURCE FINANCIAL GROUP
Total capital (to risk-weighted assets) $ 94,946 12.6% $60,323 8.0% N/A N/A
Tier 1 capital (to risk-weighted assets) 86,052 11.4 30,161 4.0 N/A N/A
Tier 1 capital (to average assets) 86,052 7.4 46,698 4.0 N/A N/A
MAINSOURCE
Total capital (to risk-weighted assets) $ 62,338 11.8% $ 42,149 8.0% $ 52,688 10.0%
Tier 1 capital (to risk-weighted assets) 56,040 10.6 21,075 4.0 31,612 6.0
Tier 1 capital (to average assets) 56,040 7.0 32,128 4.0 40,160 5.0
REGIONAL
Total risk-based capital (to risk-weighted assets) $ 16,970 11.5% $11,820 8.0% $ 14,776 10.0%
Tier 1 capital (to risk-weighted assets) 15,133 10.2 5,910 4.0 8,865 6.0
Tier 1 capital (to average assets) 15,133 7.0 8,652 4.0 10,815 5.0
CAPSTONE
Total risk-based capital (to risk-weighted assets) $ 10,972 14.9% $ 5,873 8.0% $ 7,341 10.0%
Tier 1 capital (to risk-weighted assets) 10,301 14.0 2,936 4.0 4,405 6.0
Tier 1 capital (to average assets) 10,301 7.4 5,559 4.0 6,949 5.0
21. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution retirement plan in which substantially
all employees may participate. The Company matches a portion of employees'
contributions and makes additional Company contributions based on employee
compensation. Expense was $1,138 in 2002, $1,337 in 2001, and $1,133 in 2000.
22. RELATED PARTY TRANSACTIONS
The Company has entered into transactions with certain directors, executive
officers, significant stockholders and their affiliates or associates (related
parties). Such transactions were made in the ordinary course of business on
substantially the same terms and conditions, including interest rates and
collateral, as those prevailing at the same time for comparable transactions
with other customers, and did not, in the opinion of management, involve more
than normal credit risk or present other unfavorable features.
The aggregate amount of loans, as defined, to such related parties were as
follows:
Balances, January 1, 2002 $ 9,199
Changes in composition of related parties 980
New loans, including renewals and advances 9,159
Payments, etc. including renewals (10,290)
- -------------------------------------------------------------------------------
Balances, December 31, 2002 $ 9,048
- -------------------------------------------------------------------------------
Deposits from related parties held by the company at December 31, 2002 and 2001
totaled $4,360 and $4,495.
36
23. STOCK OPTION PLANS
Under stock option plans effective through May 1, 2000, options were issued to
shareholders of the Company in exchange for shares held in retirement accounts
(to facilitate Capstone's 1998 conversion to an S-Corporation), and the pro
forma disclosures of SFAS No. 123 regarding stock-based compensation are not
applicable. These options were redeemed in the acquisition of First Affiliated
Bancorp in 2000, and a stock option plan is no longer maintained.
- ----------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS (RESTATED FOR STOCK DIVIDEND) SHARES PRICE SHARES PRICE SHARES PRICE
- ----------------------------------------------------------------------------------------------------------------------
Outstanding, beginning of year - - - - 55,434 $ 9.19
Granted - - - - - -
Exercised or redeemed - - - - (55,434) 9.19
Outstanding, end of year - - - - - -
Options exercisable at year end - - - - - -
24. EARNINGS PER SHARE
Earnings per share were computed as follows:
- ---------------------------------------------------------------------------------------------------------
WEIGHTED
AVERAGE PER-SHARE
YEAR ENDED DECEMBER 31, 2002 INCOME SHARES AMOUNT
- ---------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net income available to common shareholders $ 14,011 6,806,087 $ 2.06
Effect of dilutive stock options -
- ---------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE
Net income available to common shareholders and assumed conversions $ 14,011 6,806,087 $ 2.06
- ---------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2001
- ---------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net income available to common shareholders $ 11,177 6,819,259 $ 1.64
Effect of dilutive stock options -
- ---------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE
Net income available to common shareholders and assumed conversions $ 11,177 6,819,259 $ 1.64
- ---------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2000
- ---------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net income available to common shareholders $ 9,854 6,792,564 $ 1.45
Effect of dilutive stock options 6,606
- ---------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE
Net income available to common shareholders and assumed conversions $ 9,854 6,799,170 $ 1.45
- ---------------------------------------------------------------------------------------------------------
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
25. FAIR VALUES OF FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002 DECEMBER 31, 2001
- --------------------------------------------------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
- --------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 80,736 $ 80,736 $ 59,149 $ 59,149
Interest-bearing time deposits - - 599 599
Securities available for sale 346,468 346,468 268,136 268,136
Securities held to maturity 4,675 4,939 8,168 8,292
Loans including loans held for sale, net 746,365 772,126 775,147 783,841
Restricted stock 5,690 5,690 5,109 5,109
Income receivable 5,171 5,171 7,970 7,970
LIABILITIES
Deposits (1,034,307) (1,035,483) (1,014,687) (1,020,233)
Borrowings
Short-term (19,529) (19,529) (15,478) (15,478)
FHLB advances (50,235) (52,386) (20,346) (21,338)
Notes payable (2,400) (2,400) (4,062) (4,062)
Interest payable (3,502) (3,502) (4,084) (4,084)
Trust preferred securities (30,425) (30,582) (22,425) (22,425)
The methods and assumptions used to estimate fair value are described as
follows.
Carrying amount is the estimated fair value of cash and cash equivalents,
interest-bearing time deposits, restricted stock, accrued interest receivable
and payable, demand deposits, short-term borrowings, variable rate notes
payable, and variable rate loans or deposits that reprice frequently and fully.
Security fair values are based on market prices or dealer quotes, and if no such
information is available, on the rate and term of the security and information
about the issuer. For fixed rate loans or deposits and for variable rate loans
or deposits with infrequent repricing or repricing limits, fair value is based
on discounted cash flows using current market rates applied to the estimated
life and credit risk. Fair values for impaired loans are estimated using
discounted cash flow analysis or underlying collateral values. Fair value of
loans held for sale is based on market quotes. Fair value of debt is based on
current rates for similar financing. Fair value of trust preferred securities is
based on market price. The fair value of off-balance-sheet items is based on the
current fees or cost that would be charged to enter into or terminate such
arrangements, and are not considered significant.
26. QUARTERLY FINANCIAL DATA (UNAUDITED)
- ---------------------------------------------------------------------------------------------
INTEREST NET INTEREST NET EARNINGS PER SHARE
INCOME INCOME INCOME BASIC DILUTED
- ---------------------------------------------------------------------------------------------
2002
First quarter $ 18,365 $ 11,063 $ 3,336 $ 0.49 $ 0.49
Second quarter 18,127 11,169 3,318 0.49 0.49
Third quarter 18,292 11,693 3,419 0.50 0.50
Fourth quarter 17,519 11,125 3,938 0.58 0.58
2001
First quarter $ 22,312 $ 9,854 $ 2,574 $ 0.38 $ 0.38
Second quarter 21,407 9,903 2,786 0.40 0.40
Third quarter 20,775 10,476 2,843 0.42 0.42
Fourth quarter 20,051 11,535 2,974 0.44 0.44
38
27. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
Parent Only Condensed Balance Sheets
- -------------------------------------------------------------------------------------------------------------------
DECEMBER 31 2002 2001
- -------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 15,131 $ 4,914
Investment securities - AFS 1,057 850
Investment in subsidiaries 112,717 106,606
Other assets 6,182 4,051
- -------------------------------------------------------------------------------------------------------------------
Total assets $ 135,087 $ 116,421
- -------------------------------------------------------------------------------------------------------------------
LIABILITIES
Subordinated debentures $ 31,367 $ 23,119
Notes payable 2,400 4,000
Other liabilities 1,523 1,430
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 35,290 28,549
Shareholders' equity 99,797 87,872
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 135,087 $ 116,421
- -------------------------------------------------------------------------------------------------------------------
Parent Only Condensed Statement of Income
- -------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
Income
Dividends from subsidiaries $ 18,261 $ 11,020 $ 9,883
Fees from subsidiaries 6,370 4,016 1,598
Other income 196 207 313
- -------------------------------------------------------------------------------------------------------------------
Total income 24,827 15,243 11,794
Expenses
Interest expense 2,172 2,395 2,569
Salaries and benefits 4,854 3,890 2,456
Professional fees 573 503 403
Other expenses 3,882 1,967 1,517
- -------------------------------------------------------------------------------------------------------------------
Total expenses 11,481 8,755 6,945
Income (loss) before income tax and equity in undistributed income
of subsidiaries 13,346 6,488 4,849
Income tax expense (benefit) (1,995) (1,844) (2,016)
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before equity in undistributed income of subsidiaries 15,341 8,332 6,865
Equity in undistributed income of subsidiaries (1,304) 2,845 2,989
- -------------------------------------------------------------------------------------------------------------------
Net income $ 14,037 $ 11,177 $ 9,854
- -------------------------------------------------------------------------------------------------------------------
Parent Only Condensed Statement of Cash Flows
- -------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 14,037 $ 11,177 $ 9,854
Undistributed income of subsidiaries 1,304 (2,845) (2,989)
Changes in other assets and liabilities (317) 989 2,453
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 15,024 9,321 9,318
INVESTING ACTIVITIES
Capital contributed to subsidiary (4,348) - (2,300)
Purchases of equipment (1,720) (1,764) (456)
Purchase of security AFS (208) - (100)
- -------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (6,276) (1,764) (2,856)
FINANCING ACTIVITIES
Payments on notes payable (1,600) (2,400) (300)
Proceeds from issuance of trust preferred securities 8,248 - -
Purchase of treasury shares (694) - -
Cash dividends and fractional stock dividends (4,485) (4,121) (4,121)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 1,469 (6,521) (4,421)
Net change in cash and cash equivalents 10,217 1,036 2,041
Cash and cash equivalents, beginning of period 4,914 3,878 1,837
- -------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 15,131 $ 4,914 $ 3,878
- -------------------------------------------------------------------------------------------------------------------
39
DIRECTORS AND OFFICERS
MAINSOURCE FINANCIAL GROUP
Robert E. Hoptry
Chairman, Retired President and CEO
MainSource Financial Group
Eric E. Anderson
President and CEO
Anderson Insurance and Financial Services
William G. Barron, CCIM
Chairman and President
Wm. G. Barron Enterprises, Inc.
Dale J. Deffner
Retired Partner, Deffner and Tebbe
Don Dunevant, M.D.
Family Physician, Portage Medical Group
Philip A. Frantz
Attorney at Law; Partner, Coldren and Frantz
Rick S. Hartman, CPA
President, The HRH Group, Ltd.
James L. Saner, Sr.
President and CEO
MainSource Financial Group
Edward J. Zoeller
President, E.M. Cummings Veneer, Inc.
MAINSOURCE FINANCIAL GROUP
SENIOR MANAGEMENT
James L. Saner, Sr.
President and CEO
Donald A. Benziger
Senior Vice President and CFO
John C. Parker
Senior Vice President of Operations
MAINSOURCE BANK
Daryl R. Tressler
Chairman, President and CEO
MainSource Bank
Dale J. Deffner, Secretary
Retired Partner, Deffner and Tebbe
Dieter K. H. Johnsen
Owner, K. H. Johnsen, Inc.
Larry A. Johnson
Retired Small Business Owner
John G. Seale, CPA
Partner, Rettig, Blankman, Mack and Seale PC CPA Accounting Firm
Norman L. Winkler
Farmer
Philip A. Frantz
Attorney at Law; Partner, Coldren and Frantz
Robert E. Hoptry
Retired President and CEO
MainSource Financial Group
David L. Miers
President, Miers Farm Corporation
Lawrence R. Rueff, D.V.M.
President, Swine Veterinary Services
John G. Young
Retired Chairman, Jay Garment Corporation
MAINSOURCE BANK SENIOR MANAGEMENT
Daryl R. Tressler
Chairman, President and CEO
Dawn M. Schwering
Senior Vice President - Retail Services
Mark W. Dunevant
Senior Vice President - Mortgage Lending
Daniel F. Anderson
Senior Vice President - Wealth Management
REGIONAL BANK
Michael K. Bauer
Chairman, President and CEO, Regional Bank
William G. Barron, CCIM
Chairman and President
Wm. G. Barron Enterprises, Inc.
D.J. Hines
President, Schuler Bauer Realty
Michael J. Kapfhammer
President, Buckhead Mountain Grill
Edward J. Zoeller
President, E.M. Cummings Veneer, Inc.
REGIONAL BANK SENIOR MANAGEMENT
Michael K. Bauer
Chairman, President and CEO
Larry W. Brumley
Senior Vice President - Head of Lending
John Baumann
Vice President - Retail Services
CAPSTONE BANK
W. Brent Hoptry
Chairman, President and CEO, Capstone Bank
Rick S. Hartman, CPA
President, The HRH Group, Ltd.
Roy A. Koester
Farmer
George D. Williams
Retired Sales Representative
Telescope Casual Furniture Company
Dennis F. Nardoni
Owner and CEO
Chicago Steel Tape Co., Inc. and Affiliates
Donald A. Benziger
Senior Vice President and CFO
MainSource Financial Group
CAPSTONE BANK SENIOR MANAGEMENT
W. Brent Hoptry
Chairman, President and CEO
William J. Krones
Senior Vice President - Head of Lending
Georgann J. Buttefield
Vice President - Retail Services
MAINSOURCE INSURANCE
James L. Saner, Sr.
Chairman, President and CEO
MainSource Financial Group
C. Todd Anderson
President, MainSource Insurance
William G. Barron, CCIM
Chairman and President
Wm. G. Barron Enterprises, Inc.
Daryl R. Tressler
Chairman, President and CEO
MainSource Bank
Jerry Vollmer
Insurance Sales Manager - Indiana
MainSource Insurance
MAINSOURCE INSURANCE
SENIOR MANAGEMENT
C. Todd Anderson
President, Sales Manager - Kentucky
Jerry Vollmer
Vice President, Sales Manager - Indiana
40
SHAREHOLDER INFORMATION
ANNUAL MEETING
Wednesday, April 23, 2003, 10:00 AM
MainSource Financial Group Operations Center
1927 Greensburg Crossing
Greensburg, IN 47240
CORPORATE ADDRESS
MainSource Financial Group
201 North Broadway
P. O. Box 87
Greensburg, Indiana 47240
Tel: 812-663-0157
Fax : 812-663-4812
www.mainsourcefinancial.com
FORM 10-K
Copies of the Company's 2002 Form 10-K filed with the Securities and Exchange
Commission are available without charge to all shareholders upon request. Please
direct requests to the attention of the Chief Financial Officer.
The Form 10-K and other SEC filings can also be accessed from the Company's
website.
TRANSFER AGENT
Investor Relations Department
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016-9982
Tel: (800) 368-5948
COMMON SHARES
The Common shares of the Company are listed on The Nasdaq Stock Market(R). The
trading symbol is MSFG. In newspaper listings, Company shares are frequently
listed as MainSrce.
MARKET MAKERS
Market Makers in the Company's common stock include:
Stifel, Nicolaus & Company, Inc.
J.J.B. Hilliard/W.L. Lyons, Inc.
NatCity Investments, Inc.
Howe Barnes Investments, Inc.
FTN Financial Securities
The range of known per share prices by calendar quarter, based on actual
transactions, excluding commissions, is shown below.
2002 Q4 Q3 Q2 Q1
- ----------------------------------------------------
High $ 24.95 $ 23.91 $ 24.00 $19.18
Low $ 21.88 $ 21.24 $ 19.06 $16.29
Last Sale $ 24.01 $ 22.66 $ 23.04 $18.95
2001 Q4 Q3 Q2 Q1
- ----------------------------------------------------
High $ 17.62 $ 17.01 $ 15.10 $15.19
Low $ 14.40 $ 14.65 $ 14.47 $13.38
Last Sale $ 16.71 $ 14.79 $ 14.96 $15.15
The following dividends per share were paid by MainSource Financial Group:
2002 Q4 Q3 Q2 Q1
- ----------------------------------------------------
$ .171 $ .162 $ .162 $ .162
2001 Q4 Q3 Q2 Q1
- ----------------------------------------------------
$ .153 $ .150 $ .150 $ .150
Amounts have been adjusted to reflect the 5% stock dividends declared in 2001
and 2002.
41