FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED JUNE 30, 2003
COMMISSION FILE NUMBER 0-12422
MAINSOURCE FINANCIAL GROUP, INC.
--------------------------------
(Exact name of registrant as specified in its charter)
INDIANA 35-1562245
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
201 NORTH BROADWAY GREENSBURG, INDIANA 47240
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(Address of principal executive offices) (Zip Code)
(812) 663-0157
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if
changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes X No
--- ---
As of August 9, 2003 there were outstanding 6,729,256 shares, without par
value of the registrant.
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
INDEX
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PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Condensed Balance Sheets 3
Consolidated Condensed Statements of Income and Comprehensive Income 4
Consolidated Condensed Statements of Cash Flows 5
Notes to Consolidated Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial 10
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
2
MAINSOURCE FINANCIAL GROUP
FORM 10-Q
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in thousands except per share data)
(Unaudited)
June 30, December 31,
2003 2002
----------- -----------
Assets
Cash and due from banks $ 43,831 $ 54,548
Money market fund 20,283 22,869
Federal funds sold -- 500
----------- -----------
Cash and cash equivalents 64,114 77,917
Investment securities
Available for sale 414,222 346,468
Held to maturity (fair value of $4,102 and $4,939) 3,757 4,675
Loans held for sale 17,209 15,715
Loans, net of allowance for loan losses of $11,856 and $9,517 834,085 730,650
Restricted stock, at cost 6,817 5,690
Premises and equipment, net 23,324 19,258
Goodwill 36,476 20,708
Intangible assets 5,801 5,005
Other assets 33,254 25,674
----------- -----------
Total assets $ 1,439,059 $ 1,251,760
=========== ===========
Liabilities
Deposits
Noninterest bearing $ 134,048 $ 104,282
Interest bearing 1,047,433 930,025
----------- -----------
Total deposits 1,181,481 1,034,307
Short-term borrowings 34,199 19,529
Federal Home Loan Bank advances 63,943 50,235
Trust preferred securities 29,000 30,425
Notes payable 15,400 2,400
Other liabilities 13,576 15,093
----------- -----------
Total liabilities 1,337,599 1,151,989
Shareholders' equity
Preferred stock - no par value
Authorized - 400,000
Issued and outstanding - none -- --
Common stock $.50 stated value:
Authorized - 10,000,000 shares
Issued shares - 6,824,405 and 6,500,084
Outstanding shares - 6,729,256 and 6,469,873 3,414 3,251
Common stock to be distributed, 0 and 325,004 shares -- 163
Treasury stock, 95,149 and 30,211 shares (2,190) (694)
Additional paid-in capital 43,009 43,025
Retained earnings 54,334 49,529
Accumulated other comprehensive income 2,893 4,497
----------- -----------
Total shareholders' equity 101,460 99,771
----------- -----------
Total liabilities and shareholders' equity $ 1,439,059 $ 1,251,760
=========== ===========
See notes to consolidated condensed financial statements.
3
MAINSOURCE FINANCIAL GROUP
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands except per share data)
Three months ended Six months ended
June 30, June 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
Interest income:
Loans, including fees $12,980 $13,843 $26,024 $28,453
Investment securities 3,489 4,021 7,121 7,621
Other 55 263 111 418
------- ------- ------- -------
Total interest income 16,524 18,127 33,256 36,492
------- ------- ------- -------
Interest expense:
Deposits 4,720 5,819 9,553 12,114
Trust preferred securities 348 505 836 1,011
Other borrowings 736 634 1,433 1,135
------- ------- ------- -------
Total interest expense 5,804 6,958 11,822 14,260
------- ------- ------- -------
Net interest income 10,720 11,169 21,434 22,232
Provision for loan losses 345 565 735 1,115
------- ------- ------- -------
Net interest income after
provision for loan losses 10,375 10,604 20,699 21,117
Non-interest income:
Securities gains 42 186 835 314
Other income 4,355 3,123 8,410 6,494
------- ------- ------- -------
Total non-interest income 4,397 3,309 9,245 6,808
Non-interest expense 9,405 9,011 19,717 17,893
------- ------- ------- -------
Income before income tax 5,367 4,902 10,227 10,032
Income tax expense 1,633 1,584 2,988 3,378
------- ------- ------- -------
Net income $ 3,734 $ 3,318 $ 7,239 $ 6,654
======= ======= ======= =======
Comprehensive income $ 3,775 $ 6,836 $ 5,635 $ 9,136
======= ======= ======= =======
Net income per share (basic and diluted) $ 0.55 $ 0.49 $ 1.07 $ 0.98
Cash dividends declared 0.180 0.162 0.360 0.324
See notes to consolidated condensed financial statements.
4
MAINSOURCE FINANCIAL GROUP
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW
(Unaudited)
(Dollars in thousands)
Six months ended
June 30,
--------
2003 2002
--------- ---------
Operating Activities
Net income $ 7,239 $ 6,654
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 735 1,115
Depreciation and amortization 1,306 1,032
Securities amortization, net 2,051 386
Amortization of intangibles 456 870
Investment securities gains (835) (314)
Change in loans held for sale (978) 17,860
Change in other assets and liabilities (5,895) (2,783)
--------- ---------
Net cash provided by operating activities 4,079 24,820
Investing Activities
Net change in short term investments -- 599
Proceeds from maturities and payments
on securities held to maturity 939 1,512
Purchases of securities available for sale (210,142) (104,573)
Proceeds from maturities and payments
on securities available for sale 115,776 47,808
Proceeds from sales of securities available for sale 27,257 25,323
Loan originations and payments, net 16,560 15,232
Purchases of restricted stock (88) (840)
Cash received from branch acquisitions 12,203 15,654
Cash paid for bank acquisition (12,795) --
Purchases of premises and equipment (1,111) (1,690)
--------- ---------
Net cash provided (used) by investing activities (51,401) (975)
Financing Activities
Net change in deposits 12,040 14,282
Short-term borrowings 13,920 12,059
Proceeds from issuance of long-term debt 13,000 --
Repayment of notes payable -- (862)
Repayment of FHLB advances (70) (76)
Proceeds from FHLB borrowings -- 20,000
Proceeds from issuance of trust preferred securities 21,000 --
Redemption of trust preferred securities (22,425) --
Purchase of shares for treasury (1,496) (598)
Cash dividends and fractional shares (2,450) (2,220)
--------- ---------
Net cash provided (used) by financing activities 33,519 42,585
--------- ---------
Net change in cash and cash equivalents (13,803) 66,430
Cash and cash equivalents, beginning of period 77,917 59,419
--------- ---------
Cash and cash equivalents, end of period $ 64,114 $ 125,849
(See Note 2 regarding non-cash transactions ========= =========
included in acquisitions)
See notes to consolidated condensed financial statements.
5
NOTES to CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)
NOTE 1 SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by MainSource Financial Group,
Inc., ("Company") for interim financial reporting are consistent with the
accounting policies followed for annual financial reporting. All adjustments
which are, in the opinion of management, necessary for a fair presentation of
the results for the periods reported have been included in the accompanying
unaudited consolidated financial statements and all such adjustments are of a
normal recurring nature.
STOCK OPTION PLAN
Options to buy stock are granted to directors, officers and employees under the
MainSource Financial Group, Inc. 2003 Stock Option Plan approved on April 23,
2003, which provides for issue of up to 350,000 options. Exercise price is the
market price at date of grant, so there is no compensation expense recognized in
the income statement. The maximum option term is ten years, and options vest
over four years for incentive stock options and immediately for non-qualified
options. A total of 34,500 options, 8,000 non-qualified and 26,500 incentive
stock options, were granted on May 19, 2003, 2003 at an exercise price of $23.20
all with a ten-year life.
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in net
income, as all options granted had an exercise price equal to or greater than
the market price of the underlying common stock at date of grant. The following
table illustrates the effect on net income and earnings per share if expense was
measured using the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation.
For the three months ended For the six months ended
---------------------------- ----------------------------
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
Net income as reported $ 3,734 $ 3,318 $ 7,239 $ 6,654
Deduct: Stock-based compensation expense
determined under fair value based method 17 -- 17 --
------------- ------------- ------------- -------------
Pro forma net income $ 3,717 $ 3,318 $ 7,222 $ 6,654
Basic earnings per share as reported $ 0.55 $ 0.49 $ 1.07 $ 0.98
Pro forma basic earnings per share $ 0.55 $ 0.49 $ 1.06 $ 0.98
Diluted earnings per share as reported $ 0.55 $ 0.49 $ 1.07 $ 0.98
Pro forma diluted earnings per share $ 0.55 $ 0.49 $ 1.06 $ 0.98
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions for 2003 as of grant date: risk-free
interest rate 2.80%, expected option life 6.54 years, expected stock price
volatility 18.60% and dividend yield 2.90%.
NOTE 2 ACQUISITIONS
In June 2003, the Company consummated its acquisition of First Community
Bancshares, Inc. which has 10 branches located in the south central area of
Indiana. As of the date of acquisition, the acquired company had $11,448 of
cash, $114,303 of net loans, and $115,481 of deposits. A core deposit intangible
of $1,080 and goodwill of $14,950 were also recorded. As of the date of this
report, the Company was in the process of obtaining third party valuations for
certain assets acquired and the allocation of the purchase price is subject to
refinement. The results of operations for this acquisition have been included
since the transaction date which was June 12, 2003. The Company funded the cash
purchase price of $24,243 by issuing $7,000 of floating rate trust preferred
securities and securing a long-term note of $13,000. The additional amount was
obtained from internal sources.
The following table presents proforma information for the periods ended June 30
as if the acquisition had occurred at the beginning of 2003 and 2002. The pro
forma information includes adjustments for the amortization of intangibles
arising from the transaction. The pro forma financial information is not
necessarily indicative of the results of operations as they would have been had
the transaction been effected on the assumed dates.
For the three months ended For the six months ended
---------------------------- ----------------------------
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
Net interest income $11,804 $12,613 $23,916 $25,092
Net income 2,541 3,083 6,190 6,649
Earnings per share 0.38 0.46 0.91 0.98
In February 2003, the Company acquired one branch in Illinois. The acquired
branch consisted of $12,203 of cash, $6,427 of loans, and $19,653 of deposits. A
core deposit intangible of $166 and goodwill of $818 were also recorded. The
results of operations for this acquisition have been included since the
transaction date. The branch acquisition was 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.
These acquisitions were made to further solidify the Company's market share in
existing markets and to expand its customer base into new markets, thereby
enhancing deposit fee income and providing an opportunity to market additional
products and services to new customers. The acquistions also helped to prevent
another financial institution from entering these markets.
6
NOTE 3 - SECURITIES
The fair value of securities available for sale and related gains/losses
recognized in accumulated other comprehensive income (loss) were as follows:
Gross Gross
Fair Unrealized Unrealized
As of June 30, 2003 Value Gains Losses
- -----------------------------------------------------------------------------
Available for Sale
Federal agencies $ 68,942 $ 1,937 $ --
State and municipal 56,963 2,702 (121)
Mortgage-backed securities 259,795 1,594 (737)
Equity and other securities 28,522 449 (597)
- -----------------------------------------------------------------------------
Total available for sale $414,222 $ 6,682 $(1,455)
- -----------------------------------------------------------------------------
As of December 31, 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)
- -----------------------------------------------------------------------------
The carrying amount, unrecognized gains and losses, and fair value of securities
held to maturity were as follows:
Gross Gross
Carrying Unrecognized Unrecognized Fair
As of June 30, 2003 Amount Gains Losses Value
- -------------------------------------------------------------------------------
Held to Maturity
State and municipal $3,034 $ 173 $ -- $3,207
Other securities 723 172 -- 895
- -------------------------------------------------------------------------------
Total held to maturity $3,757 $ 345 $ -- $4,102
- -------------------------------------------------------------------------------
As of December 31, 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
- -------------------------------------------------------------------------------
7
NOTE 4 - LOANS
June 30, December 31,
2003 2002
- --------------------------------------------------------------------------
Commercial and industrial loans $ 142,794 $ 105,093
Agricultural real estate and production 69,195 68,867
Commercial real estate 92,743 84,024
Hotel 80,216 73,262
Residential real estate 326,631 301,232
Construction and development 32,229 34,987
Consumer 102,133 72,702
----------------------------
Total loans 845,941 740,167
Allowance for loan lossess (11,856) (9,517)
- --------------------------------------------------------------------------
Net loans $ 834,085 $ 730,650
==========================================================================
NOTE 5 - DEPOSITS June 30, December 31,
2003 2002
---- ----
Non-interest-bearing demand $ 134,048 $ 104,282
Interest-bearing demand 263,256 260,120
Savings 234,987 196,056
Certificates of deposit of $100 or more 133,801 93,192
Other certificates and time deposits 415,389 380,657
---------- ----------
Total deposits $1,181,481 $1,034,307
========== ==========
NOTE 6 - SHORT-TERM BORROWINGS
June 30, December 31,
2003 2002
---- ----
Short-term borrowings:
Federal funds purchased $18,400 $ --
Securities sold under agreement to repurchase 15,799 19,529
------- -------
Total short-term borrowings $34,199 $19,529
======= =======
NOTE 7 - NOTES PAYABLE and TRUST PREFERRED SECURITIES
The Company obtained a note payable from a financial institution during the
second quarter. The note payable for $13,000 requires semi-annual principal
payments of $1,300 plus accrued interest quarterly and matures June 2008. The
loan is secured by the common stock of certain subsidiary banks of the Company
and accrues interest at a rate that is tied to LIBOR.
The Company also issued $21,000 in trust preferred securities. The securities
distributions are payable quarterly at rates ranging from 4.54% to 6.65% and
mature in 2033. The securities may be redeemed by the Company prior to maturity
in 2008 and anytime thereafter. Distributions may be deferred from time to time
not to exceed 20 consecutive quarters. Trust preferred securities count as Tier
1 Capital for regulatory purposes, within defined limits.
Proceeds from these advances were used to redeem $14,000 of 8.75% fixed rate
trust preferred securities and finance the First Community acquisition. The
Company has various financial covenants related to the notes payable and the
trust preferred securities. As of June 30, 2003, the Company was in compliance
with all of these covenants.
8
NOTE 8 - EARNINGS PER SHARE
Earnings per share (EPS) were computed as follows:
For the three months ended June 30, 2003 June 30, 2002
---------------------------------- -------------------------------------
Weighted Per Weighted Per
Net Average Share Net Average Share
Income Shares Amount Income Shares Amount
------ -------- ------ ------ -------- ------
Basic earnings per share:
Income available to
common shareholders $ 3,734 6,750,976 $ 0.55 $ 3,318 6,814,136 $ 0.49
Effect of dilutive shares 683
Diluted earnings per share $ 3,734 6,751,659 $ 0.55 $ 3,336 6,814,136 $ 0.49
========= ========= ======== ========= ========= ========
For the six months ended June 30, 2003 June 30, 2002
---------------------------------- -------------------------------------
Weighted Per Weighted Per
Net Average Share Net Average Share
Income Shares Amount Income Shares Amount
------ -------- ------ ------ -------- ------
Basic earnings per share:
Income available to
common shareholders $ 7,239 6,765,149 $ 1.07 $ 6,654 6,817,986 $ 0.98
Effect of dilutive shares 219
Diluted earnings per share $ 7,239 6,765,368 $ 1.07 $ 6,654 6,817,986 $ 0.98
========= ========= ======== ========= ========= ========
9
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Overview
MainSource Financial Group, Inc. until May 1, 2002 known as Indiana United
Bancorp, ("Company") is a multi-bank, bank holding company that provides an
array of financial services and is headquartered in Greensburg, Indiana. The
Company's shares trade on the NASDAQ national market under the symbol MSFG. On
June 30, 2003, the Company controlled four bank subsidiaries, MainSource Bank,
Regional Bank ("Regional"), Capstone Bank ("Capstone"), and First Community Bank
and Trust ("First Community"). First Community was acquired on June 12, 2003 and
results have been included since the date of acquisition.
In addition to the banking subsidiaries, the Company owned, either directly or
indirectly, the following subsidiaries: MainSource Insurance, Inc., MainSource
Statutory Trust I, MainSource Statutory Trust II, MainSource Statutory Trust
III, IUB Reinsurance Company, Ltd., People's Investment Company, Ltd., PTC
Investments, Inc., RB Investments, Inc. and Union Investment Company, Ltd.
The Company continues to explore various acquisition targets including branches,
whole banks, and other financial service providers. In order to fund these
acquisitions, the Company may assume additional debt or issue additional shares.
Forward-Looking Statements
Except for historical information contained herein, the discussion in this Form
10-Q quarterly report includes certain forward-looking statements based upon
management expectations. Factors which could cause future results to differ from
these expectations include the following: general economic conditions;
legislative and regulatory initiatives; monetary and fiscal policies of the
federal government; deposit flows; the costs of funds; general market rates of
interest; interest rates on competing investments; demand for loan products;
demand for financial services; changes in accounting policies or guidelines; and
changes in the quality or composition of the Company's loan and investment
portfolios.
The forward-looking statements included in the Management's Discussion and
Analysis ("MD&A") relating to certain matters involve risks and uncertainties,
including anticipated financial performance, business prospects, and other
similar matters, which reflect management's best judgment based on factors
currently known. Actual results and experience could differ materially from the
anticipated results or other expectations expressed in the Company's forward-
looking statements as a result of a number of factors, including but not limited
to those discussed in the MD&A.
Results of Operations
Net income for the second quarter of 2003 was $3,734 or 12.5% greater than the
second quarter of 2002 due primarily to an increase in the Company's
non-interest income. Earnings per share for the second quarter equaled $.55 in
2003, compared to $.49 in 2002, an increase of 12.2%. The Company's return on
average total assets for the second quarter was 1.17% in 2003 and 1.12% for the
same period in 2002. Return on average shareholders' equity for the second
quarter was 14.91% in 2003 and 14.65% in 2002.
For the six months ended June 30, 2003, net income was $7,239 compared to $6,654
for the same period in 2002. Earnings per share for the six months ending June
30 were $1.07 in 2003 and $.98 in 2002, which represents an increase of 9.2%.
10
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Net Interest Income
The volume and yield of earning assets and interest-bearing liabilities
influence net interest income. Net interest income reflects the mix of interest-
bearing and non-interest-bearing liabilities that fund earning assets, as well
as interest spreads between the rates earned on these assets and the rates paid
on interest-bearing liabilities. Second quarter net interest income of $10,720
in 2003 was a decrease of 4.0% versus the second quarter of 2002. Net interest
income on a tax equivalent basis, reflected as a percentage of average earning
assets (net interest margin), was 3.69% for the second quarter of 2003 and 4.11%
for the same period in 2002. As a result of the current interest rate
environment, the Company's yield on earning assets decreased from 6.61% for the
second quarter of 2002 to 5.63% in the second quarter of 2003. The Company's
cost of funds also decreased, but to a lesser extent.
For the six months ended June 30, 2003, the Company's net interest margin was
3.79% compared to 4.17% for the same period in 2002.
Provision for Loan Losses
This topic is discussed under the heading "Loans, Credit Risk and the Allowance
and Provision for Probable Loan Losses".
Non-interest Income
Second quarter non-interest income for 2003 was $4,397 compared to $3,309 for
the same period a year ago, representing an increase of 32.9%. The increase was
primarily due to an increase in mortgage banking activity. Mortgage banking
income, which consists of gains and losses on loan sales and service fee income,
was $1,656 for the second quarter of 2003 versus $738 for the second quarter of
2002. As mortgage rates continue to stay near record lows, this area of the
Company's business remains strong.
For the six months ended June 30, 2003, non-interest income was $9,245 compared
to $6,808 for the same period a year ago. The 35.8% increase was primarily due
to the aforementioned increase in mortgage banking activity as well as gains on
the sales of investment securities. As the Company continues to actively manage
its investment portfolio, gains and/or losses on the sales of investment
securities will be periodically realized in order to take advantage of current
market conditions or to reposition the portfolio for future profitability.
Non-interest Income
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
------ ------ ------ ------
Insurance commissions $ 612 $ 561 $1,194 $1,120
Fiduciary activities 152 168 302 365
Mortgage banking income 1,656 738 3,009 1,803
Service charges on deposit accounts 1,081 970 2,034 1,875
Gain (loss) on sales of securities 42 186 835 314
Other income * 854 686 1,871 1,331
------ ------ ------ ------
Total $4,397 $3,309 $9,245 $6,808
====== ====== ====== ======
* Other Income consists of interchange fees related to debit and credit card
activity, customer service fees, rental fees on safe deposit boxes, gains on
sales of assets other than securities, and other miscellaneous fees.
11
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Non-interest expense
Total non-interest expense was $9,405 for the second quarter of 2003, which
represented an increase of 4.4% over the second quarter of 2002. The largest
component of non-interest expense is personnel expense. Personnel expenses were
$5,492 for the second quarter of 2003 versus $5,159 for the same period a year
ago, which represents a 6.5% increase. Normal staff salary increases and
increased benefit costs were incurred in 2003. Included in the 6.5% increase are
the personnel costs related to the addition of five branches since the end of
the second quarter of 2002 and the effect of the acquisition of First Community.
For the six months ended June 30, 2003, non-interest expense was $19,717 versus
$17,893 for the same period a year ago, which represents an increase of 10.2%.
In addition to the aforementioned increase in personnel costs, the Company
incurred $840 of costs in the first quarter of 2003 associated with the
write-off of deferred debt acquisition costs due to the redemption of its fixed
rate trust preferred securities issued in 1997.
Because of the adoption of new accounting guidance in the fourth quarter of
2002, unidentified intangibles from bank branch acquisitions are now classified
as goodwill and are not amortized. As a result, intangible amortization
decreased in 2003 versus 2002.
Non-interest Expense
Three months ended Six months ended
June 30, June 30,
------------------ -------------------
2003 2002 2003 2002
------- ------- ------- -------
Salaries and employee benefits $ 5,492 $ 5,159 $11,006 $10,161
Net occupancy 664 589 1,319 1,168
Equipment 840 730 1,652 1,329
Intangible amortization 235 436 456 869
Stationary, printing, and supplies 209 231 438 485
Telephone 304 271 614 520
Amortization of deferred debt issuance costs 3 27 857 54
Other * 1,658 1,568 3,375 3,307
------- ------- ------- -------
Total non-interest expense $ 9,405 $ 9,011 $19,717 $17,893
======= ======= ======= =======
* Other Expenses consists of professional fees, directors' fees, marketing,
postage, travel, communications, regulatory fees, and other miscellaneous items.
Income Taxes
The effective tax rate for the first six months was 29.2% for 2003 and 33.6% for
2002. The decrease in the effective tax rate was primarily due to tax credits
related to the Company's investment in low-income housing projects and an
increase in invested balances at its investment subsidiaries domiciled in a
state without income tax. The Company and its subsidiaries file consolidated
income tax returns.
12
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Financial Condition
Total assets at June 30, 2003 were $1,439,059 compared to $1,251,760 as of
December 31, 2002. The acquisition of First Community added $156,215 of assets.
Average earning assets represented 91.9% of average total assets for the first
six months of 2003 and 92.5% for the same period in 2002. Average loans
represented 71.5% of average deposits in the first six months of 2003 and 75.7%
for the comparable period in 2002. Management continues to emphasize quality
loan growth to increase these averages. Average loans as a percent of average
assets were 59.4% and 64.0% for the six-month period ended June 30, 2003 and
2002 respectively.
The increase in deposits of $147,174 from December 31, 2002 to June 30, 2003
was due primarily to the acquisition of First Community, which added
approximately $115,480 of deposits.
Shareholders' equity was $101,460 on June 30, 2003 compared to $99,771 on
December 31, 2002. Book value (shareholders' equity) per common share was $15.08
at June 30, 2003 versus $14.69 at year-end 2002. The unrealized gain on
securities available for sale, net of taxes, increased book value per share by
$.49 at June 30, 2003 and by $.66 at December 31, 2002. Depending on market
conditions, the unrealized gain or loss on securities available for sale can
cause fluctuations in shareholders equity.
Loans, Credit Risk and the Allowance and Provision for Probable Loan Losses
Loans remain the Company's largest concentration of assets and, by their nature,
carry a higher degree of risk. The loan underwriting standards observed by the
Company's subsidiaries are viewed by management as a means of controlling
problem loans and the resulting charge-offs.
The Company's loan underwriting standards have historically resulted in lower
levels of net charge-offs than peer bank averages. The Company believes credit
risks may be elevated if undue concentrations of loans in specific industry
segments and to out-of-area borrowers are incurred. Accordingly, the Company's
Board of Directors regularly monitors such concentrations to determine
compliance with its loan allocation policy. The Company believes it has no undue
concentrations of loans.
13
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Residential real estate loans continue to represent a significant portion of the
total loan portfolio. Such loans represented 38.6% of total loans at June 30,
2003 and 40.7% at December 31, 2002.
On June 30, 2003, the Company had $17,209 of residential real estate loans held
for sale, which was an increase from the year-end balance of $15,715. The
Company generally retains the servicing rights on mortgages sold.
Asset quality improved from a year ago with non-performing assets totaling
$16,942, or 1.18% of total assets, as of June 30, 2003, compared to $18,360, or
1.47% of total assets, as of the same period a year ago. However, this was a
deterioration from year-end when non-performing assets totaled $10,857 and
represented 0.87% of total assets. The primary contributor to this increase was
the acquisition of First Community, which added $4,227 of non-performing assets.
During the first six months of 2003, the Company experienced an increase of
$6,954 in loans related to the hotel industry. As of June 30, 2003, these loans
represented 9.5% of the Company's total loan portfolio. Given the current
economic conditions and the recent downturn in the travel/lodging industry,
allocations were made to watch list loans in this industry to reflect the higher
risk level.
The provision for loan losses was $345 in the second quarter of 2003 compared to
$565 for the same period in 2002. For the six months ended June 30, 2003, the
Company recorded $735 in provision expense compared to $1,115 for the same
period a year ago. The Company had net charge-offs of $474 for the first six
months of 2003 compared to net charge-offs of $465 for the comparable period in
2002. The provision for 2003 was lower than 2002 as the effect of declining
non-performing loan balances more than offset the increased allocations on hotel
loans.
The adequacy of the allowance for loan losses in each subsidiary is reviewed at
least quarterly. The determination of the provision amount in any period is
based on management's continuing review and evaluation of loan loss experience,
changes in the composition of the loan portfolio, current economic conditions,
the amount of loans presently outstanding, and information about specific
borrower situations. The allowance for loan losses as of June 30, 2003 was
considered adequate by management.
Investment Securities
Investment securities offer flexibility in the Company's management of interest
rate risk, and are an important source of liquidity as a response to changing
characteristics of assets and
14
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
liabilities. The Company's investment policy prohibits trading activities and
does not allow investment in high-risk derivative products, junk bonds or
foreign investments.
As of June 30, 2003, $414,222 of investment securities are classified as
"available for sale" ("AFS") and are carried at fair value with unrealized gains
and losses, net of taxes, reported as a separate component of shareholders'
equity. An unrealized pre-tax gain of $5,227 was recorded to adjust the AFS
portfolio to current market value at June 30, 2003, compared to an unrealized
pre-tax gain of $7,065 at December 31, 2002.
Effective January 1, 2002 the Company formed two investment subsidiaries, PTC
Investments, Inc. and RB Investments, Inc., which are incorporated in Nevada.
These subsidiaries, which are 100% owned by and fully consolidated in the
Company's financial statements, hold a large portion of the Company's investment
portfolios and were formed with the intent to enhance the management and
profitablity of the investment portfolios.
Sources of Funds
The Company relies primarily on customer deposits, securities sold under
agreement to repurchase ("agreements") and shareholders' equity to fund earning
assets. FHLB advances are also used to provide additional funding.
Deposits generated within local markets provide the major source of funding for
earning assets. Average total deposits funded 90.5% and 91.4% of total average
earning assets for the six-month periods ending June 30, 2003 and 2002. Total
interest-bearing deposits averaged 90.3% and 91.0% of average total deposits for
the periods ending June 30, 2003 and 2002, respectively. Management constantly
strives to increase the percentage of transaction-related deposits to total
deposits due to the positive effect on earnings.
The Company had FHLB advances of $63,943 outstanding at June 30, 2003. These
advances have interest rates ranging from 3.3% to 6.7% with $10,000 maturing in
the first quarter of 2004. Approximately $50,500 of these advances mature in
2005 or later.
Capital Resources
Total shareholders' equity was $101,460 at June 30, 2003, which was a slight
increase from $99,771 at December 31, 2002. The Company's earnings were largely
offset by the decrease in the unrealized gain on investment securities, cash
dividends paid on common stock, and treasury stock purchases.
During the first six months of 2003, the Company redeemed $8,425 of its 8.75%
fixed rate trust preferred securities and refinanced the remaining $14,000 of
the 1997 issuance. As part of the refinancing that took place on April 1, 2003,
the Company issued $14,000 of trust preferred securities in a pooled offering.
The rate on these securities is fixed for the first five years at 6.65% and then
becomes variable at a rate tied to the 3-month LIBOR rate and adjusts quarterly.
These securities mature in 30 years and can be called anytime after 5 years. An
interest rate swap was utilized to obtain the initial fixed rate on the issue.
The Company also issued $7,000 of variable rate trust preferred securities on
June 12, 2003. The rate is tied to the 3-month LIBOR rate and adjusts quarterly.
These securities mature in 30 years and can be called anytime after 5 years.
The Federal Reserve Board and other regulatory agencies have adopted risk-based
capital guidelines that assign risk weightings to assets and off-balance sheet
items. The Company's core capital consists of shareholders' equity, excluding
accumulated other comprehensive income, while Tier 1 consists of core capital
less goodwill and intangibles. Trust preferred securities qualify as Tier 1
capital or core capital with respect to the Company under the risk-based capital
guidelines established by the Federal Reserve. Under such guidelines, capital
received from the proceeds of the sale of trust preferred securities cannot
constitute more than 25% of the total core capital of the Company. Consequently,
the amount of trust preferred securities in excess of the 25% limitation
constitutes Tier 2 capital of the Company. Total regulatory capital consists of
Tier 1, certain debt instruments and a portion of the allowance for credit
losses. At June 30, 2003, Tier 1 capital to total average assets was 6.30%.
Tier 1
15
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
capital to risk-adjusted assets was 8.79%. Total capital to risk-adjusted assets
was 11.20%. All three ratios exceed all required ratios established for bank
holding companies. Risk-adjusted capital levels of the Company's subsidiary
banks exceed regulatory definitions of well-capitalized institutions.
The Company declared and paid common dividends of $.18 per share in the first
and second quarters of 2003 versus $.162 for the first and second quarters of
2002.
Liquidity
Liquidity management involves maintaining sufficient cash levels to fund
operations and to meet the requirements of borrowers, depositors, and creditors.
Higher levels of liquidity bear higher corresponding costs, measured in terms of
lower yields on short-term, more liquid earning assets, and higher interest
expense involved in extending liability maturities. Liquid assets include cash
and cash equivalents, loans and securities maturing within one year, and money
market instruments. In addition, the Company holds AFS securities maturing after
one year, which can be sold to meet liquidity needs.
Maintaining a relatively stable funding base, which is achieved by diversifying
funding sources and extending the contractual maturity of liabilities, supports
liquidity and limits reliance on volatile short-term purchased funds. Short-term
funding needs arise from declines in deposits or other funding sources, funding
of loan commitments and requests for new loans. The Company's strategy is to
fund assets to the maximum extent possible with core deposits that provide a
sizable source of relatively stable and low-cost funds. Average core deposits
funded approximately 81.4% of total earning assets for the six months ended June
30, 2003 and 82.6% for the same period in 2002.
Management believes the Company has sufficient liquidity to meet all reasonable
borrower, depositor, and creditor needs in the present economic environment. In
addition, the affiliates have access to the Federal Home Loan Bank for borrowing
purposes. The Company has not received any recommendations from regulatory
authorities that would materially affect liquidity, capital resources or
operations.
Interest Rate Risk
Asset/liability management strategies are developed by the Company to manage
market risk. Market risk is the risk of loss in financial instruments including
investments, loans, deposits and borrowings arising from adverse changes in
prices/rates. Interest rate risk is the Company's primary market risk exposure,
and represents the sensitivity of earnings to changes in market interest rates.
Strategies are developed that impact asset/liability committee activities based
on interest rate risk sensitivity, board policy limits, desired sensitivity gaps
and interest rate trends.
Effective asset/liability management requires the maintenance of a proper ratio
between maturing or repriceable interest-earning assets and interest-bearing
liabilities. It is the policy of the Company that the cumulative GAP divided by
total assets shall be plus or minus 20% at the 3-month, 6-month, and 1-year time
horizons.
16
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
At June 30, 2003, the Company held approximately $541,704 in assets comprised of
securities, loans, short-term investments, and federal funds sold, which were
interest sensitive in one year or less time horizons.
Other
The Securities and Exchange Commission ("Commission") maintains a Web site that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission, including
the Company. That address is http://www.sec.gov.
17
MAINSOURCE FINANCIAL GROUP, INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
(Dollar amounts in thousands except per share data)
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk of the Corporation encompasses exposure to both liquidity and
interest rate risk and is reviewed monthly by the Asset/Liability Committee and
the Board of Directors. There have been no material changes in the quantitative
and qualitative disclosures about market risks as of June 30, 2003 from the
analysis and disclosures provided in the Corporation's Form 10-K for the year
ended December 31, 2002.
18
Item 4. Controls and Procedures
As of the end of the quarterly period covered by this report, an evaluation was
carried out under the supervision and with the participation of the Company's
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of our disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14(c) under the Securities Exchange Act of 1934). Based
on their evaluation, our Chief Executive Officer and Chief Financial Officer
have concluded that the Company's disclosure controls and procedures were, to
the best of their knowledge, effective to ensure that information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms as of such date.
19
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of shareholder of the Company was held on
April 23, 2003.
(b) All director nominees were elected.
(c) Certain matters voted upon at the meeting and the votes cats with
respect to such matters are as follows:
Proposals and Vote Tabulations
Votes Cast
---------------------------
For Against
---------------------------
Management Proposals
Approval of the appointment of independent
auditors for 2003 5,943,594 59,663
Approval of the 2003 Stock Option Plan 4,738,247 467,365
Approval of proposed restated articles of
incorporation 5,724,548 261,833
Election of Directors
---------------------------
Director For Withheld
- -------- ---------------------------
William G. Barron 5,978,115 37,724
Dale J. Deffner 5,984,151 31,689
Don S. Dunevant 5,984,371 31,469
Philip A. Frantz 5,946,214 69,626
Rick S. Hartman 5,881,123 134,717
Robert E. Hoptry 5,927,052 88,788
James L. Saner, Sr. 5,933,426 82,414
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are furnished in accordance with the
provisions of Item 601 of Regulation S-K.
4.1 Indenture dated as of April 1, 2003 between the
Registrant, as issuer, and U.S. Bank, N.A., as trustee, re: floating
rate junior subordinated deferrable interest debentures due 2033.
4.2 Amended and Restated Declaration of Trust dated as of
April 1, 2003 among U.S. Bank, N.A., as institutional trustee, the
Registrant, as sponsor, and James L. Saner Sr., Donald A. Benziger and
James M. Anderson, as administrators.
4.3 Guarantee Agreement dated as of April 1, 2003 between the
Registrant, and U.S. Bank, N.A.
4.4 Indenture dated as of June 12, 2003 between the
Registrant, as issuer, and The Bank of New York, as trustee, re:
floating rate junior subordinated deferrable interest debentures due
2033.
4.5 Amended and Restated Declaration of Trust dated as of June
12, 2003 among The Bank of New York, as institutional trustee, the
Registrant, as sponsor, and James L. Saner Sr., Donald A. Benziger and
James M. Anderson, as administrators.
4.6 Guarantee Agreement dated as of June 12, 2003 between the
Registrant, and The Bank of New York.
The following exhibits accompany this periodic report pursuant
Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 (the "2002
Act"). These exhibits shall be deemed only to accompany this periodic
report are not part of this periodic report, shall not be deemed filed
for purposes of the Securities Exchange Act of 1934, and may not be
used for any purpose other than compliance with the 2002 Act.
31.1 Certification pursuant to Section 302 of Sarbanes-Oxley
Act of 2002 by Chief Executive Officer
31.2 Certification pursuant to Section 302 of Sarbanes-Oxley
Act of 2002 by Chief Financial Officer
32.1 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, by Chief Executive Officer
32.2 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, by Chief Financial Officer
b) Reports on Form 8-K
During the quarter ended June 30, 2003 the Company filed the
following reports on Form 8-K.
The Form 8-K dated April 1, 2003 reported under Item 5, "Other
Events" the Company's announcement of the refinancing of $14
million of trust preferred securities.
The Form 8-K dated June 13, 2003 reported under Item 5, "Other
Events" the Company's announcement of the consummation of its
acquisition of First Community Bancshares, Inc.
No other information is required to be filed under Part II of this form.
20
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MAINSOURCE FINANCIAL GROUP, INC.
August 14, 2003
/s/ James L. Saner, Sr.
-------------------------------------------------
James L. Saner Sr
President and Chief Executive Officer
August 14, 2003
/s/ Donald A. Benziger
-------------------------------------------------
Donald A. Benziger
Senior Vice President & Chief Financial Officer
August 14, 2003
/s/ James M. Anderson
-------------------------------------------------
James M. Anderson
Controller & Principal Accounting Officer
21