SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 2004
Commission file number 0-12422
MAINSOURCE FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Indiana 35-1562245
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
201 North Broadway
Greensburg, Indiana 47240
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (812) 663-0157
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act
Common shares, no-par value
(Title of Class)
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]
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 [ ]
The aggregate market value (not necessarily a reliable indication of the price
at which more than a limited number of shares would trade) of the voting stock
held by non-affiliates of the registrant was $223,287,723 as of June 30, 2004.
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 March 15, 2005, there were outstanding 11,534,056 common shares, without
par value, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K
Documents Into Which Incorporated
--------- -----------------------
Definitive Proxy Statement for Annual Part III (Items 10 through 14)
Meeting of Shareholders to be held
May 25, 2005
EXHIBIT INDEX: Page 10-11
FORM 10-K TABLE OF CONTENTS
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Part I Page
Item 1 Business 3
Item 2 Properties 8
Item 3 Legal Proceedings 8
Item 4 Submission of Matters to a Vote of Security Holders 8
Part II
Item 5 Market For the Registrant's Common Equity and Related 8
Stockholder Matters
Item 6 Selected Financial Data 9
Item 7 Management's Discussion and Analysis of Financial 9
Condition and Results of Operations
Item 7A Quantitative and Qualitative Disclosures About Market Risk 9
Item 8 Financial Statements and Supplementary Data 9
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 10
Item 9A Controls and Procedures 10
Item 9B Other Information 10
Part III
Item 10 Directors and Executive Officers of the Registrant See below
Item 11 Executive Compensation See below
Item 12 Security Ownership of Certain Beneficial Owners and See below
Management
Item 13 Certain Relationships and Related Transactions See below
Item 14 Principal Accountant Fees and Services See below
Part IV
Item 15 Exhibits, Financial Statement Schedules, and Reports 10
on Form 8-K
Pursuant to General Instruction G, the information called for by Items 10-14 is
omitted by MainSource Financial Group, Inc. since MainSource Financial Group,
Inc. will file with the Commission a definitive proxy statement to shareholders
pursuant to regulation 14A not later than 120 days after the close of the fiscal
year containing the information required by Items 10-14.
2
PART I
ITEM 1. BUSINESS
- -------------------
(Dollars in thousands except per share data)
GENERAL
MainSource Financial Group, Inc. ("the Company") is a financial holding company
based in Greensburg, Indiana. As of December 31, 2004, the Company owned four
banking subsidiaries: MainSource Bank, Regional Bank, MainSource Bank of
Illinois (formerly known as Capstone Bank), and Peoples Trust Company (together
"the Banks"). Through its non-bank affiliates, the Company provides services
incidental to the business of banking. Since its formation in 1982, the Company
has acquired and established various institutions and financial services
companies and may acquire additional financial institutions and financial
services companies in the future. For further discussion of the business of the
Company see Management's Discussion and Analysis in Part II, Item 7.
As of December 31, 2004, the Company operated 62 branch banking offices in
Indiana and Illinois as well as nine insurance offices in Indiana and one in
Kentucky. As of December 31, 2004, the Company had consolidated assets of
$1,549,379, consolidated deposits of $1,226,367 and shareholders' equity of
$123,320.
Through its Banks, the Company offers a broad range of financial services,
including: accepting time and transaction deposits; making consumer, commercial,
agribusiness and real estate mortgage loans; renting safe deposit facilities;
providing general agency personal and business insurance services; providing
personal and corporate trust services; and providing other corporate services
such as letters of credit and repurchase agreements.
The lending activities of the Banks are separated into primarily the categories
of commercial/agricultural, real estate and consumer. Loans are originated by
the lending officers of the Banks subject to limitations set forth in lending
policies. The Board of Directors of the Banks reviews and approves loans up to
the Banks' legal lending limits, monitors concentrations of credit, problem and
past due loans and charge-offs of uncollectible loans and formulates loan
policy. The Banks maintain conservative loan policies and underwriting practices
in order to address and manage loan risks. These policies and practices include
granting loans on a sound and collectible basis, serving the legitimate needs of
the community and the general market area while obtaining a balance between
maximum yield and minimum risk, ensuring that primary and secondary sources of
repayment are adequate in relation to the amount of the loan, developing and
maintaining adequate diversification of the loan portfolio as a whole and of the
loans within each category and developing and applying adequate collection
policies.
Commercial loans include secured and unsecured loans, including real estate
loans, to individuals and companies and to governmental units within the market
area of the Banks for a myriad of business purposes.
Agricultural loans are generated in the Banks' markets. Most of the loans are
real estate loans on farm properties. Loans are also made for agricultural
production and such loans are generally reviewed annually.
3
Residential real estate lending has been the largest component of the loan
portfolio for many years. All affiliate banks generate residential mortgages for
their own portfolios. However, the Company elects to sell the majority of its
fixed rate mortgages into the secondary market while maintaining the servicing.
At December 31, 2004, the Company was servicing a $501 million loan portfolio.
By originating loans for sale in the secondary market, the Company can more
fully satisfy customer demand for fixed rate residential mortgages and increase
fee income.
The principal source of revenues for the Company is interest and fees on loans,
which accounted for 61.9% of total revenues in 2004, 61.8% in 2003 and 65.2% in
2002.
The Company's investment securities portfolio is primarily comprised of U. S.
Treasuries, federal agencies, state and municipal bonds, mortgage-backed
securities and corporate securities. The Company has classified 99.2% of its
investment portfolio as available for sale, with market value changes reported
separately in shareholders' equity. Funds invested in the investment portfolio
generally represent funds not immediately required to meet loan demand. Income
related to the Company's investment portfolio accounted for 16.6% of total
revenues in 2004, 15.7% in 2003 and 17.3% in 2002. As of December 31, 2004, the
Company had not identified any securities as being "high risk" as defined by the
FFIEC Supervisory Policy Statement on Securities Activities.
The primary sources of funds for the Banks are deposits generated in local
market areas. To attract and retain stable depositors, the Banks market various
programs for demand, savings and
4
time deposit accounts. These programs include interest and non-interest
bearing demand and individual retirement accounts.
Currently, national retailing and manufacturing subsidiaries, brokerage and
insurance firms and credit unions are fierce competitors within the financial
services industry. Mergers between financial institutions within Indiana and
neighboring states, which became permissible under the Interstate Banking and
Branching Efficiency Act of 1994, have also added competitive pressure.
The Company's Banks are located in predominantly non-metropolitan areas and
their business is centered in loans and deposits generated within markets
considered largely rural in nature. In addition to competing vigorously with
other banks, thrift institutions, credit unions and finance companies located
within their service areas, they also compete, directly and indirectly, with all
providers of financial services.
EMPLOYEES
As of December 31, 2004, the Company and its subsidiaries had approximately 645
full-time equivalent employees to whom it provides a variety of benefits and
with whom it enjoys excellent relations.
REGULATION AND SUPERVISION OF THE COMPANY
The Company is a financial holding company ("FHC") within the meaning of the
Bank Holding Company Act of 1956, as amended ("Act"). This Act subjects FHC's to
regulations of the Federal Reserve Board ("FRB") and restricts the business of
FHC's to financial and related activities.
The Gramm-Leach-Bliley Financial Modernization Act of 1999 was enacted on
November 12, 1999. The Modernization Act, which amended the Bank Holding Company
Act, provides the following:
o it allows bank holding companies that qualify as "financial holding
companies" to engage in a broad range of financial and related
activities;
o it allows insurers and other financial services companies to acquire
banks;
o it removes various restrictions that applied to bank holding company
ownership of securities firms and mutual fund advisory companies; and
o it establishes the overall regulatory structure applicable to bank
holding companies that also engage in insurance and securities
operations.
The Company qualified as a financial holding company in December, 2004. Thus the
Company is authorized to operate as a financial holding company and therefore is
eligible to engage in, or acquire companies engaged in, the broader range of
activities that are permitted by the Modernization Act. These activities include
those that are determined to be "financial in nature," including insurance
underwriting, securities underwriting and dealing, and making merchant banking
investments in commercial and financial companies. If any of our banking
subsidiaries ceases to be "well capitalized" or "well managed" under applicable
regulatory standards, the Federal Reserve Board may, among other things, place
limitations on our ability to conduct these broader financial activities or, if
the deficiencies persist, require us to divest the banking subsidiary. In
addition, if any of our banking subsidiaries receives a rating of less than
satisfactory under the Community Reinvestment Act of 1977 ("CRA"), we would be
prohibited from engaging in any additional activities other than those
permissible for bank holding companies that are not financial holding companies.
Our banking subsidiaries currently meet these capital, management and CRA
requirements.
5
Acquisitions by the Company of banks and savings associations are subject to
federal and state regulation. Any acquisition by the Company of more than five
percent of the voting stock of any bank requires prior approval of the FRB.
Acquisition of savings associations is also subject to the approval of the OTS.
Indiana law permits FHCs to acquire bank holding companies and banks out of
state on a reciprocal basis, subject to certain limitations. Under current law,
the Company may acquire banks, and may be acquired by bank holding companies,
located in any state in the United States that permits reciprocal entry by
Indiana FHCs. Under the Act, FHCs may acquire savings associations without
geographic restrictions.
A FHC and its subsidiaries are prohibited from engaging in certain tying
arrangements in connection with the extension of credit, lease or sale of
property, or the provision of any property or service.
The Company is under the jurisdiction of the Securities and Exchange
Commission("SEC") and state securities commission for matters relating to the
offering and sale of its securities. The Company is subject to the SEC's rules
and regulations relating to periodic reporting, reporting to shareholders, proxy
solicitation and insider trading.
The Company's liquidity is principally derived from dividends paid on the common
stock of its subsidiaries. The payment of these dividends is subject to certain
regulatory restrictions.
Under bank holding company policy, the Company is expected to act as a source of
financial strength to, and commit resources to support, its affiliates. As a
result of such policy, the Company may be required to commit resources to its
affiliate banks in circumstances where it might not otherwise do so.
Certain regulations define relevant capital measures for five capital
categories. A "well capitalized" institution is one that has a total risk-based
capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 8%,
a leverage ratio of at least 5% and is not subject to regulatory direction to
maintain a specific level for any capital measure. An "adequately capitalized"
institution is one that has ratios greater than 8%, 4% and 4%. An institution is
"undercapitalized" if its respective ratios are less than 8%, 4% and 4%.
"Significantly undercapitalized" institutions have ratios of less than 6%, 3%
and 3%. An institution is deemed to be "critically undercapitalized" if it has a
ratio of tangible equity to total assets that is 2% or less. Institutions with
capital ratios at levels of "undercapitalized" or lower are subject to various
limitations that, in most situations, will reduce the competitiveness of the
institution.
REGULATION AND SUPERVISION OF THE SUBSIDIARY BANKS
The Company's affiliate banks are supervised, regulated and examined by their
respective state regulatory banking agencies and the Federal Deposit Insurance
Corporation ("FDIC"). A cease-and-desist order may be issued against the banks,
if the respective agency finds that the activities of the bank represent an
unsafe and unsound banking practice or violation of law. The deposits of all
three banking subsidiaries are insured to the maximum extent permitted by law by
the Bank Insurance Fund ("BIF") of the FDIC.
Branching by banks in Indiana is subject to the jurisdiction, and requires the
prior approval, of the bank's primary federal regulatory authority and, if the
branching bank is a state bank, of the Indiana Department of Financial
Institutions ("DFI"). Under Indiana law, banks may branch anywhere in the state.
The Company is a legal entity separate and distinct from its subsidiary Banks.
There are various legal limitations on the extent to which the Banks can supply
funds to the Company. The principal source of the Company's funds consists of
dividends from its subsidiary Banks. State and Federal law restricts the amount
of dividends that may be paid by banks. In addition, the Banks are subject to
certain restrictions on extensions of credit to the Company, on investments in
the stock or other securities of the Company and in taking such stock or
securities as collateral for loans.
6
CAPITAL REQUIREMENTS
The Company and its subsidiary Banks must meet certain minimum capital
requirements mandated by the FRB, FDIC and DFI. These regulatory agencies
require BHCs and banks to maintain certain minimum ratios of primary capital to
total assets and total capital to total assets. The FRB requires BHCs to
maintain a minimum Tier 1 leverage ratio of 3 percent capital to total assets;
however, for all but the most highly rated institutions which do not anticipate
significant growth, the minimum Tier 1 leverage ratio is 3 percent plus an
additional cushion of 100 to 200 basis points. As of December 31, 2004, the
Company's leverage ratio of capital to total assets was 7.0%. The FRB and FDIC
each have approved the imposition of "risk-adjusted" capital ratios on BHCs and
financial institutions. The Company's Tier 1 Capital to Risk-Weighted Assets
Ratio was 10.6% and its Total Capital to Risk-Weighted Assets Ratio was 11.8% at
December 31, 2004. The Company's Banks had capital to asset ratios and risk-
adjusted capital ratios at December 31, 2004, in excess of the applicable
regulatory minimum requirements.
7
ITEM 2. PROPERTIES
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MainSource Financial Group owns no physical properties. Its subsidiaries own, or
lease, all of the facilities from which they conduct business. All leases are
comparable to other leases in the respective market areas and do not contain
provisions detrimental to the Company or its subsidiaries. As of December 31,
2004 the Company had 62 banking locations of which MainSource Bank had 42,
Regional had 6, Capstone had 7, and Peoples had 7. In addition, the Company
operates nine insurance offices in Indiana and one in Kentucky. At December 31,
2004, the Company had approximately $26 million invested in premises and
equipment.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
The subsidiaries may be parties (both plaintiff and defendant) to ordinary
litigation incidental to the conduct of business. Management is presently not
aware of any material claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted during the fourth quarter of 2004 to a vote of
security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
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The Company's Common Stock is traded on NASDAQ's National Market System under
the symbol MSFG. The Common Stock was held by approximately 3,110 shareholders
at March 11, 2004. The quarterly high and low closing prices for the Company's
common stock as reported by NASDAQ and quarterly cash dividends declared and
paid are set forth in the tables below. All per share data is retroactively
restated for all stock dividends and splits.
Market Prices
- ---------------------------------------------------------------
2004 Q4 Q3 Q2 Q1
- ----------- ------------ ------------ ------------ ------------
High $25.21 $20.50 $22.92 $23.08
Low $18.35 $16.48 $17.81 $20.12
2003 Q4 Q3 Q2 Q1
- ----------- ------------ ------------ ------------ ------------
High $20.17 $16.32 $15.61 $15.46
Low $16.17 $14.67 $13.90 $13.61
Cash Dividends
- ---------------------------------------------------------------
2004 Q4 Q3 Q2 Q1
- ----------- ------------ ------------ ------------ ------------
$0.124 $0.119 $0.119 $0.114
2003 Q4 Q3 Q2 Q1
- ----------- ------------ ------------ ------------ ------------
$0.109 $0.109 $0.109 $0.109
The activity in the Company's Stock Repurchase Program for the fourth quarter of
2004 was as follows:
Maximum Number
Total Number of Shares (or Approximate Dollar
Total Number Average Price (or Units) Purchased as Part Value) of Shares (or Units)
of Shares (or Paid Per Share of Publicly Announced Plans That May Yet Be Purchased
Period Units) Purchased (or Unit) or Programs Under the Plans or Programs (1)
- ---------------------------------------------------------------------------------------------------------------------
October 2004 -- -- -- 494,219
November 2004 7,171 $ 22.19 7,171 487,048
December 2004 -- -- -- 487,048
(1) On January 27, 2004, the Company announced that its Board of Directors had
approved a stock repurchase program for up to 255,000 of its outstanding common
shares. This plan was expanded by the Board of Directors on August 17, 2004 to
include an additional 295,000 shares. The plan expired January 31, 2005.
8
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
Selected Financial Data
(Dollar amounts in thousands except per share data)
- -------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Results of Operations
Net interest income $ 50,002 $ 44,232 $ 45,050 $ 41,768 $ 39,089
Provision for loan losses 600 1,325 2,995 2,136 1,658
Noninterest income 19,544 19,443 14,379 11,486 9,591
Noninterest expense 45,880 40,448 35,610 34,311 33,168
Income before income tax 23,066 21,902 20,824 16,807 13,854
Income tax 6,273 6,597 6,813 5,630 4,000
Net income 16,793 15,305 14,011 11,177 9,854
Dividends paid on common stock 5,421 4,873 4,485 4,121 4,121
- -------------------------------------------------------------------------------------------------------------------------------
Per Common Share *
Earnings per share (basic) $ 1.48 $ 1.37 $ 1.24 $ 0.99 $ 0.88
Earnings per share (diluted) 1.48 1.37 1.24 0.99 0.88
Dividends paid ** 0.476 0.435 0.397 0.365 0.342
Book value - end of period 10.68 9.47 8.88 7.78 6.94
Market price - end of period 23.88 19.47 14.52 10.10 8.09
- -------------------------------------------------------------------------------------------------------------------------------
At Year End
Total assets $ 1,549,379 $ 1,442,729 $ 1,251,760 $ 1,178,392 $ 1,216,936
Investment securities 428,686 425,542 351,143 276,304 294,395
Loans, excluding held for sale 929,005 855,471 740,167 760,785 790,550
Allowance for loan losses 11,698 11,509 9,517 8,894 8,716
Total deposits 1,226,367 1,191,310 1,034,307 1,014,687 1,053,570
Notes payable 9,100 12,500 2,400 4,062 6,510
Federal Home Loan Bank advances 90,981 62,751 50,235 20,346 22,463
Subordinated debentures 29,898 29,898 30,425 22,425 22,425
Shareholders' equity 123,320 105,424 99,771 87,872 78,005
- -------------------------------------------------------------------------------------------------------------------------------
Financial Ratios
Return on average assets 1.13% 1.14% 1.16% 0.93% 0.85%
Return on average common
shareholders' equity 14.70 15.07 14.90 13.24 13.76
Allowance for loan losses to total
loans (year end,excluding held for sale) 1.26 1.35 1.29 1.17 1.10
Shareholders' equity to total assets
(year end) 7.96 7.31 7.97 7.46 6.41
Average equity to average total assets 7.67 7.57 7.77 7.04 6.20
Dividend payout ratio 32.28 31.84 32.01 36.87 41.82
* Adjusted for stock splits and dividends
** Dividends paid by MainSource Financial Group without restatement for
pooling of interests
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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MainSource Financial Group
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") is a financial holding
company whose principal activity is the ownership and management of its four
wholly owned subsidiary banks ("Banks"): MainSource Bank headquartered in
Greensburg, Indiana, Regional Bank ("Regional"), headquartered in New Albany,
Indiana, MainSource Bank of Illinois (formerly known as Capstone Bank),
headquartered in Kankakee, Illinois, and Peoples Trust Company ("Peoples
Trust"), headquartered in Linton, Indiana. In February 2005, the Company merged
Regional Bank into MainSource Bank. The banks operate under state charters and
are subject to regulation by their respective state regulatory agencies and the
Federal Deposit Insurance Corporation. MainSource Insurance (formerly The
Insurance Group, Inc.) is a wholly owned subsidiary of MainSource Bank operating
nine offices in Indiana and one in Kentucky and is subject to regulation by the
Kentucky and Indiana Departments of Insurance. The Company also has wholly owned
subsidiaries to hold investment securities. These investment subsidiaries are
incorporated in Nevada. Additionally, the Company owns IUB Reinsurance Company,
Ltd., a credit life reinsurance company. In November 2003, the Company formed
MSB Realty, Inc., which holds real estate backed assets of 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 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
during the current year. In June 2004, the Company acquired Peoples Financial
Corp. and its wholly-owned subsidiary, Peoples Trust Company, in a combination
cash and stock transaction. Peoples Trust Company is headquartered in Linton,
Indiana with total assets of approximately $119 million. 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.
During 2004, the Company announced a restructuring plan that will
eventually lead to the consolidation of its Indiana banking charters into the
holding company's lead bank, MainSource Bank. This consolidation is projected to
be complete by the end of the third quarter of 2005 and will involve a complete
management restructuring. The management structure will include geographical
segmentation of the offices and will provide each defined area with a senior
management team led by a regional president. This team will provide local
decisions and personalized service to the customers and employees of each
office.
In 2005, the Company will continue to emphasize its wide array of both
traditional and non-traditional financial products and services. As the economy
rebounds, the Company believes that 2005 will see increased activity in its
lending areas and an increase in the yield on its investment portfolio.
Management expects that these items will be partially offset by a stagnant
mortgage banking market.
Results of Operations
Net income was $16,793 in 2004, $15,305 in 2003, and $14,011 in 2002. Earnings
per common share on a fully diluted basis were $1.48 in 2004, $1.37 in 2003, and
$1.24 in 2002. In the fourth quarter of 2004, the Company incurred $650 of
restructuring costs, or $.03 per share net of tax, related to the consolidation
of its Indiana charters and the name change of its Illinois affiliate. Excluding
these costs, earnings per share would have been $1.51 for 2004, which represents
an increase of 10.2%. The increase was primarily attributable to an increase in
the Company's net interest margin, the effect of the Peoples Trust acquisition,
and a decrease in the Company's effective tax rate.
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 14.70% in 2004, 15.07% in 2003, and 14.90% in 2002. The
Company's return on average assets was 1.13% in 2004, 1.14% in 2003, and 1.16%
in 2002. The current levels of return on shareholders' equity and return on
assets are representative of the Company's continuing effort to improve
profitability. The Company believes that its consistent 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 $52,042 in 2004 increased significantly from $45,655 in
2003 (See Table 3). As rates stayed relatively low throughout 2004, the
Company's yield on earning assets decreased to 5.50% in 2004 from 5.64% in 2003.
Offsetting the decrease in yield, the Company aggressively repriced its deposits
and borrowings and was able to significantly reduce its cost of funds to 1.77%
in 2004 from 2.09% in 2003. The overall effect was an increase in the Company's
net interest margin in 2004 of 14 basis points going from 3.73% in 2003 to 3.87%
in 2004.
The following table summarizes net interest income (on a tax-equivalent basis)
for each of the past three years.
Average Balance Sheet and Net Interest Analysis (Taxable Equivalent Basis)*
2004 2003
------------------------------------- -------------------------------------
Average Average Average Average
Assets Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------
Short-term investments $ 6,139 $ 42 0.68% $ 1,224 $ 7 0.57%
Federal funds sold and money market accounts 4,377 76 1.74 15,679 192 1.22
Securities
Taxable 353,457 12,094 3.42 352,813 11,480 3.25
Non-taxable* 79,882 4,691 5.87 52,820 3,341 6.33
- --------------------------------------------- ------------------------------------- -------------------------------------
Total securities 433,339 16,785 3.87 405,633 14,821 3.65
Loans **
Commercial 490,595 31,455 6.41 430,992 29,456 6.83
Residential real estate 223,100 13,913 6.24 218,461 14,543 6.66
Consumer 185,783 11,610 6.25 151,127 10,005 6.62
- --------------------------------------------- ------------------------------------- -------------------------------------
Total loans 899,478 56,978 6.33 800,580 54,004 6.75
- --------------------------------------------- ------------------------------------- -------------------------------------
Total earning assets 1,343,333 73,881 5.50 1,223,116 69,024 5.64
- --------------------------------------------- ------------------------------------- -------------------------------------
Cash and due from banks 46,920 38,413
Unrealized gains (losses) on securities 693 3,750
Allowance for loan losses (11,798) (11,065)
Premises and equipment,net 24,769 21,500
Intangible assets 44,332 34,206
Accrued interest receivable
and other assets 40,617 32,199
- --------------------------------------------- ------------- -------------
Total assets $ 1,488,866 $ 1,342,119
============================================= ===================================== =====================================
Liabilities
Interest-bearing deposits
DDA, savings, and money market accounts $ 551,885 $ 3,438 0.62 $ 476,627 $ 3,050 0.64
Certificates of deposit 521,112 12,928 2.48 526,304 15,494 2.94
- --------------------------------------------- ------------------------------------- -------------------------------------
Total interest-bearing deposits 1,072,997 16,366 1.53 1,002,931 18,544 1.85
Short-term borrowings 44,806 580 1.29 18,565 172 0.93
Subordinated debentures 29,898 1,677 5.61 26,845 1,626 6.06
Notes payable and FHLB borrrowings 82,836 3,216 3.88 67,706 3,027 4.47
- --------------------------------------------- ------------------------------------- -------------------------------------
Total interest-bearing liabilities 1,230,537 21,839 1.77 1,116,047 23,369 2.09
Demand deposits 131,110 111,480
Other liabilities 13,004 13,013
- --------------------------------------------- ------------- -------------
Total liabilities 1,374,651 1,240,540
Shareholders' equity 114,215 101,579
------------- -------------
Total liabilities and shareholders' equity $ 1,488,866 21,839 1.63 *** $ 1,342,119 23,369 1.91 ***
=============------------------------ =============------------------------
Net interest income $ 52,042 3.87 **** $ 45,655 3.73 ****
============================================= ===================================== =====================================
Conversion of tax exempt income to a fully
taxable equivalent basis using a marginal
rate of 35% $ 2,040 $ 1,423
- --------------------------------------------- ------------------------------------- -------------------------------------
2002
---------------------------------------
Average Average
Assets Balance Interest Rate
Short-term investments $ 288 $ 5 1.74%
Federal funds sold and money market accounts 38,002 727 1.91
Securities
Taxable 264,675 12,970 4.90
Non-taxable* 47,611 3,166 6.65
- --------------------------------------------- -------------------------------------
Total securities 312,286 16,136 5.17
Loans **
Commercial 402,283 29,308 7.29
Residential real estate 237,709 17,627 7.42
Consumer 124,626 9,853 7.91
- --------------------------------------------- -------------------------------------
Total loans 764,618 56,788 7.43
- --------------------------------------------- -------------------------------------
Total earning assets 1,115,194 73,656 6.60
- --------------------------------------------- -------------------------------------
Cash and due from banks 36,912
Unrealized gains (losses) on securities 4,801
Allowance for loan losses (9,404)
Premises and equipment,net 18,521
Intangible assets 23,363
Accrued interest receivable
and other assets 21,358
- --------------------------------------------- -------------
Total assets $ 1,210,745
============================================= =====================================
Liabilities
Interest-bearing deposits
DDA, savings, and money market accounts $ 443,684 $ 5,064 1.14
Certificates of deposit 478,643 17,546 3.67
- --------------------------------------------- -------------------------------------
Total interest-bearing deposits 922,327 22,610 2.45
Short-term borrowings 17,769 372 2.09
Subordinated debentures 22,758 2,035 8.94
Notes payable and FHLB borrrowings 45,497 2,236 4.91
- --------------------------------------------- -------------------------------------
Total interest-bearing liabilities 1,008,351 27,253 2.70
Demand deposits 94,054
Other liabilities 14,283
- --------------------------------------------- -------------
Total liabilities 1,116,688
Shareholders' equity 94,057
-------------
Total liabilities and shareholders' equity $ 1,210,745 27,253 2.44 ***
=============------------------------
Net interest income $ 46,403 4.16 ****
============================================= =====================================
Conversion of tax exempt income to a fully
taxable equivalent basis using a marginal
rate of 35% $ 1,353
- --------------------------------------------- -------------------------------------
* 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.
The following table sets forth for the periods indicated a summary of the
changes in interest income and interest expense resulting from changes in volume
and changes in rates.
Volume/Rate Analysis of Changes in Net Interest Income
(Tax Equivalent Basis)
- ---------------------------------------------- ------------------------------------ ------------------------------------
2004 OVER 2003 2003 OVER 2002
- ---------------------------------------------- ------------------------------------ ------------------------------------
Volume Rate Total Volume Rate Total
- ---------------------------------------------- ------------------------------------ ------------------------------------
Interest income
Loans $ 6,336 $ (3,362) $ 2,974 $ 2,672 $ (5,450) $ (2,778)
Securities 1,072 892 1,964 4,826 (6,141) (1,315)
Federal funds sold and money market funds (198) 82 (116) (426) (109) (535)
Short-term investments 34 1 35 16 (14) 2
- ---------------------------------------------- ------------------------------------ ------------------------------------
Total interest income 7,244 (2,387) 4,857 7,088 (11,714) (4,626)
- ---------------------------------------------- ------------------------------------ ------------------------------------
Interest expense
Interest-bearing DDA, savings,
and money market accounts $ 483 $ (95) $ 388 $ 376 $ (2,390) $ (2,014)
Certificates of deposit (145) (2,421) (2,566) 1,749 (3,717) (1,968)
Borrowings 930 (333) 597 1,091 (592) 499
Subordinated debentures 172 (121) 51 365 (762) (397)
- ---------------------------------------------- ------------------------------------ ------------------------------------
Total interest expense 3,581 (2,970) (1,530) 3,581 (7,461) (3,880)
- ---------------------------------------------- ------------------------------------ ------------------------------------
Change in net interest income $ 3,663 $ 583 6,387 $ 3,507 $ (4,253) (746)
===================== =====================
Change in tax equivalent adjustment 617 72
- ---------------------------------------------- ------------------------------------ ------------------------------------
Change in net interest income before
tax equivalent adjustment $ 5,770 $ (818)
============================================== ==================================== ====================================
Provision for Loan Losses
The Company expensed $600 in provision for loan losses in 2004. 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 remained relatively flat in 2004 compared to 2003. The
acquisition of Peoples Trust and increased service charge income related to the
Company's overdraft program were offset by decreases in mortgage banking
activity and lower gains on sales of investment securities. Mortgage banking
income was $3.2 million in 2004 versus $5.7 million in 2003, a decrease of
43.9%. As the level of refinancings declined throughout the year, the Company
anticipated this decrease in income.
MainSource Financial Group
Management's Discussion and Analysis
(Dollar amounts in thousands except per share data)
Non-interest income increased in 2003 to $19,443 compared to $14,379 in
2002, which represents an increase of $5,064 or 35.2%. The acquisition of First
Community in 2003 added a total of $926, contributing approximately 18% of the
increase in 2003. In addition to the acquisition of First Community, the Company
realized increases in several areas. As interest rates remained at historically
low levels throughout much of 2003, 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, net of mortgage servicing
right amortization, was $5,671 in 2003 compared to $4,757 in 2002, an increase
of 19.2%. As many customers refinanced their existing loans, the Company elected
to sell the majority of these loans into the secondary market while maintaining
the servicing rights. The Company also realized net gains on sales of investment
securities in 2003 of $1,300 compared to gains of $319 in 2002. Other
non-interest income increased in 2003 versus 2002 as the Company realized
increases in the following areas: annuity fees ($360), cash surrender value of
company-owned life insurance policies ($418), gains on the sales of various OREO
properties ($245), and contingency fees from insurance companies ($165).
Non-interest Income and Expense
Percent Change
---------------
2004 2003 2002 04/03 03/02
- --------------------------------------------------------------------------------------------------------
Non-interest income
Insurance commissions $ 2,643 $ 2,400 $ 2,156 10.1% 11.3%
Trust and investment product fees 911 678 605 34.4% 12.1%
Mortgage banking 3,198 5,671 4,757 -43.6% 19.2%
Service charges on deposit accounts 6,912 5,092 4,011 35.7% 27.0%
Securities gains/(losses) 991 1,300 319 -23.8% 307.5%
Gain on cash surrender value of life insurance 1,016 626 208 62.3% 201.0%
Interchange income 1,996 1,796 1,160 11.1% 54.8%
Other 1,877 1,880 1,163 -0.2% 61.7%
--------------------------------
Total non-interest income $19,544 $19,443 $14,379 0.5% 35.2%
================================
- -------------------------------------------------------------------------------------
Non-interest expense
Salaries and employee benefits $25,411 $22,421 $20,381 13.3% 10.0%
Net occupancy 3,165 2,753 2,414 15.0% 14.0%
Equipment 3,949 3,488 2,873 13.2% 21.4%
Telephone 1,581 1,287 1,038 22.8% 24.0%
Intangible amortization 1,059 909 828 16.5% 9.8%
Stationary, printing, and supplies 988 916 973 7.9% -5.9%
Other 9,727 8,674 7,103 12.1% 22.1%
--------------------------------
Total non-interest expense $45,880 $40,448 $35,610 13.4% 13.6%
=====================================================================================
Non-interest Expense
Total non-interest expense increased 13.4% in 2004 to $45,880 compared to
$40,448 in 2003, or an increase of $5,432. The largest component of non-interest
expense in both years was salaries and benefits. These expenses were $25,411 in
2004 compared to $22,421 in 2003. The increase of approximately $3 million was
primarily related to the full-year effect of the acquisition of First Community
in 2004, the acquisition of Peoples Trust in June 2004, and normal staff salary
increases of roughly 4%. The Company also incurred certain costs in 2004 related
to the restructuring of its banking affiliates that were not incurred in 2003.
These costs included system conversion costs, costs associated with the name
change of the Company's Illinois affiliate, and contract termination penalties.
The total restructuring costs incurred in 2004 were $650.
Total non-interest expense increased 13.6% in 2003 to $40,448 compared to
$35,610 in 2002, or an increase of $4,838. The largest component of non-interest
expense in both years was salaries and benefits. These expenses increased 10.0%,
or $2,040, in 2003 due primarily to the acquisition of First Community, which
added $1,435 of employee costs. The remaining increase is attributable to normal
merit increases. Other non-interest expense increased in 2003 compared to 2002
as the Company incurred approximately $850 of costs related to the redemption of
trust preferred securities in the first quarter of 2003. These costs related to
the Company's investment in trusts formed to issue trust preferred securities
and are a result of accelerated amortization of debt issuance costs by the
trusts.
Income Taxes
The effective tax rate was 27.2% in 2004, 30.1% in 2003, and 32.7% in 2002. The
decrease in the Company's effective tax rate in 2004 was primarily related to
various tax strategies implemented by the Company including the formation of MSB
Realty, Inc., a real-estate investment trust.
Balance Sheet
At December 31, 2004, total assets were $1,549,379 compared to $1,442,729 at
December 31, 2003, an increase of $106,650. The increase was primarily
attributable to the acquisition of Peoples Trust, which accounted for
approximately $119 million in assets.
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 charge-offs
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) increased by approximately $73
million from year-end 2003. The increase was primarily related to the
acquisition of Peoples Trust. Excluding the acquisition of Peoples Trust, the
Company's total loan portfolio remained relatively flat. Residential real estate
loans continue to represent the largest portion of the total loan portfolio.
Such loans represented 38.1% and 36.9% of total loans at December 31, 2004 and
2003, respectively.
The following table details the Company's loan portfolio by type of loan.
Loan Portfolio
December 31
2004 2003 2002 2001 2000
- ---------------------------------------------------------------------------------------------
Types of loans
Commercial $143,511 $141,571 $ 98,526 $ 83,143 $ 77,648
Agricultural production
financing and other
loans to farmers 22,647 25,897 25,105 20,726 20,744
Commercial real estate
mortgage 213,359 183,938 156,277 150,677 138,132
Residential real estate
mortgage 353,515 315,848 301,232 328,107 389,622
Farm real estate 38,281 37,107 43,762 46,524 49,284
Construction and development 38,056 34,686 34,987 53,753 40,813
Consumer 108,430 99,724 72,702 69,957 64,548
State and political 11,206 16,700 7,576 7,898 9,759
- ---------------------------------------------------------------------------------------------
Total loans $929,005 $855,471 $740,167 $760,785 $790,550
- ---------------------------------------------------------------------------------------------
The following table indicates the amounts of loans (excluding residential and
commercial mortgages and consumer loans) outstanding as of December 31, 2004
which, based on remaining scheduled repayments of principal, are due in the
periods indicated.
Maturities and Sensitivity to Changes in Interest Rates of Commercial and Construction Loans
- ----------------------------------------------------------------------------------------------------------
Due: Within 1 Year 1 - 5 Years Over 5 years Total
- ----------------------------------------------------------------------------------------------------------
Loan Type
Commercial and industrial $47,870 $34,137 $61,504 143,511
Agricultural production financing 16,276 4,371 2,000 22,647
Construction and development 29,533 3,730 4,793 38,056
- ----------------------------------------------------------------------------------------------------------
Totals $93,679 $42,238 $68,297 $204,214
- ----------------------------------------------------------------------------------------------------------
Percent 46% 21% 33% 100%
- ----------------------------------------------------------------------------------------------------------
Rate Sensitivity
Fixed Rate $20,666 $22,276 $8,653 $51,595
Variable Rate 108,982 42,636 1,001 152,619
- ----------------------------------------------------------------------------------------------------------
Totals $129,648 $64,912 $9,654 $204,214
- ----------------------------------------------------------------------------------------------------------
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 is reversed and charged against current income. Subsequent interest
payments collected on nonaccrual loans are thereafter applied as a reduction of
the loan's principal balance.
Non-performing loans were $14.0 million as of December 31, 2004 compared to
$14.8 million as of December 31, 2003 and represented 1.51% of total loans at
December 31, 2004 versus 1.73% one year ago.
The following table details the Company's non-performing loans as of December 31
for the years indicated.
Non-performing Loans
2004 2003 2002 2001 2000
-----------------------------------------------
Nonaccruing loans $13,611 $14,626 $ 7,695 $10,406 $ 3,454
Accruing loans contractually
past due 90 days or more 431 196 245 766 532
-----------------------------------------------
Total $14,042 $14,822 $ 7,940 $11,172 $ 3,986
-----------------------------------------------
% of total loans 1.51% 1.73% 1.07% 1.47% 0.50%
The provision for loan losses was $600 in 2004, $1,325 in 2003, and $2,995
in 2002. The decrease in the Company's provision in 2004 was primarily due to
the decrease in non-performing loans in 2004 and the decrease in net charge-offs
on non-acquired loans. Net charge-offs were $2,186 in 2004 compared to $1,411 in
2003 and $2,372 in 2002. As a percentage of average loans, net charge-offs
equaled .24%, .18%, and .31% in 2004, 2003 and 2002, respectively. Although net
charge-offs were up in 2004, approximately half of these charge-offs related to
loans that were acquired in the First Community and Peoples Trust acquisitions
and were adequately provided for as of the date of acquisition.
Summary of the Allowance for Loan Losses
2004 2003 2002 2001 2000
---------------------------------------------------------------------
Balance at January 1 $ 11,509 $ 9,517 $ 8,894 $ 8,716 $ 7,718
Chargeoffs
Commercial 1,069 588 1,715 1,392 403
Commercial real estate mortgage 43 - - 100 107
Residential real estate mortgage 534 555 473 266 164
Consumer 886 777 583 621 443
---------------------------------------------------------------------
Total Chargeoffs 2,532 1,920 2,771 2,379 1,117
---------------------------------------------------------------------
Recoveries
Commercial 123 160 116 127 201
Commercial real estate mortgage 2 43 5 24 7
Residential real estate mortgage 43 54 127 40 35
Consumer 178 252 151 230 214
---------------------------------------------------------------------
Total Recoveries 346 509 399 421 457
---------------------------------------------------------------------
Net Chargeoffs 2,186 1,411 2,372 1,958 660
Addition resulting from acquisition 1,775 2,078 - - -
Provision for loan losses 600 1,325 2,995 2,136 1,658
---------------------------------------------------------------------
Balance at December 31 $ 11,698 $ 11,509 $ 9,517 $ 8,894 $ 8,716
=====================================================================
Net Chargeoffs to average loans 0.24% 0.18% 0.31% 0.25% 0.09%
Provision for loan losses to average loans 0.07% 0.17% 0.39% 0.27% 0.22%
Allowance to total loans at year end 1.26% 1.35% 1.29% 1.17% 1.10%
=====================================================================
Allocation of the Allowance for Loan Losses
2004 2003 2002 2001 2000
------------------- ------------------- ------------------- ------------------- -------------------
Percent Percent Percent Percent Percent
of loans of loans of loans of loans of loans
to total to total to total to total to total
December 31 Amount loans Amount loans Amount loans Amount loans Amount loans
- ----------------------- ------------------- ------------------- ------------------- ------------------- -------------------
Real estate
Residential $ 1,123 38% $ 1,230 37% $ 2,097 41% $ 2,159 43% $ 1,076 47%
Farm real estate 681 4 704 4 776 6 301 6 442 6
Commercial 3,997 23 3,907 21 2,715 21 2,453 20 1,004 16
Construction and
development 648 4 658 4 647 5 858 7 909 6
- ----------------------- ------------------- ------------------- ------------------- ------------------- -------------------
Total real estate 6,449 69 6,499 66 6,235 73 5,771 75 3,431 75
- ----------------------- ------------------- ------------------- ------------------- ------------------- -------------------
Commercial
Agribusiness 464 3 491 3 388 3 368 3 965 3
Other commercial 2,831 17 3,003 19 1,810 14 1,349 11 1,204 12
- ----------------------- ------------------- ------------------- ------------------- ------------------- -------------------
Total Commercial 3,295 20 3,494 22 2,198 17 1,717 14 2,169 15
- ----------------------- ------------------- ------------------- ------------------- ------------------- -------------------
Consumer 1,581 11 1,053 12 951 10 952 11 1,349 10
Unallocated 373 463 133 554 1,767
- ----------------------- ------------------- ------------------- ------------------- ------------------- -------------------
Total $11,698 100% $11,509 100% $ 9,517 100% $ 8,994 100% $ 8,716 100%
- ----------------------- ------------------- ------------------- ------------------- ------------------- -------------------
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 $11,698, or 1.26% of total
loans, at December 31, 2004 compared to $11,509, or 1.35% of total loans, at the
end of 2003.
Securities
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, 2004, 99.2% of the 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 $175 was recorded to
adjust the AFS portfolio to current market value at December 31, 2004 compared
to a net unrealized gain of $2,185 at December 31, 2003. The remaining 0.8% 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 2004 the tax equivalent yield of the investment securities portfolio was
3.87%, compared to 3.65% and 5.17% for 2003 and 2002, respectively. The average
life of the Company's investment security portfolio was 3.59 years at December
31, 2004. During 2004 portfolio return increased as rising interest rates due to
Federal Reserve tightening improved reinvestment yields and the selective
selling of securities provided net gains. Management began the process of moving
the portfolio from its defensive position to a more balanced position as higher
rates allowed for reinvestment in longer maturity investments. At the beginning
of 2005 the portfolio still retains protection against extension risk and will
provide significant cash flow for reinvestment. Management anticipates a
continued improvement in its investment portfolio return due primarily to rising
interest rates and selectively purchasing longer maturity investments when the
opportunities arise.
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 89.6% and 91.1% of total average
earning assets in 2004 and 2003, respectively. Total interest-bearing deposits
averaged 89.1% and 90.0% of average total deposits during 2004 and 2003.
Management is continuing efforts to increase the
MainSource Financial Group
Management's Discussion and Analysis
(Dollar amounts in thousands except per share data)
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 2004, repurchase agreements averaged $22,166.
Another source of funding is the Federal Home Loan Bank (FHLB). The Company
had FHLB advances of $90,981 outstanding at December 31, 2004. These advances
have interest rates ranging from 2.36% to 6.58% (see note 10 to the consolidated
financial statements for the maturity schedule of these advances). The Company
averaged $69,861 in FHLB advances during 2004 compared to $56,721 during 2003.
In June 2003 the Company borrowed $13,000 at a floating rate based on
LIBOR. These funds were used in the cash acquisition of First Community. At
year-end 2004, the balance on this note was $9,100 with an effective interest
rate of 3.16%.
Average Deposits
- ------------------------------------------------------ -------------------------- --------------------------
2004 2003 2002
- ------------------------------------------------------ -------------------------- --------------------------
Amount Rate Amount Rate Amount Rate
- ------------------------------------------------------ -------------------------- --------------------------
Demand $ 131,110 $ 111,480 $ 94,054
Interest Bearing Demand 301,611 0.54% 258,213 0.60% 236,802 1.06%
Savings 250,274 0.73 218,414 0.69 206,882 1.18
Certificates of Deposit 521,112 2.48 526,304 2.94 478,643 3.67
- --------------------------------------- ----------- -----------
Totals $1,204,107 1.36% $1,114,411 1.67% $1,016,381 2.22%
========== ========== ==========
As of December 31, 2004, certificates of deposit and other time deposits of $100
or more mature as follows:
3 months or less 4-6 months 6-12 months over 12 months Total
---------------- ---------- ----------- -------------- -----
Amount $46,687 $14,365 $17,827 $38,482 $117,361
Percent 40% 12% 15% 33%
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,
2004, Tier 1 capital to average assets was 7.0%. Total capital to risk-weighted
assets was 11.8%. Both ratios 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 (which are classified as subordinated
debentures) 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 Trust 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 $.476 per share in 2004,
$.435 in 2003 and $.397 in 2002. Book value per common share increased to $10.68
at December 31, 2004 compared to $9.47 at the end of 2003. The net adjustment
for AFS securities increased book value per share by $.01 at December 31, 2004
and by $.11 at December 31, 2003. Depending on market conditions, the adjustment
for AFS securities can cause significant fluctuations in equity.
During 2004, the Company declared a three-for-two stock split and a five
percent stock dividend for the fifth consecutive year. All financial information
used throughout this report has been adjusted to reflect these transactions.
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 $355 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 79.3% of
total earning assets during 2004 and approximately 81.2% in 2003.
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.
Contractual Obligations as of December 31, 2004
Less than 1 - 3 3 - 5 More than
Total 1 Year Years Years 5 Years
-------- -------- -------- -------- --------
Notes Payable $ 9,100 $ 2,600 $ 5,200 $ 1,300 $ --
FHLB Advances 90,981 49,115 15,630 -- 26,236
Subordinated Debentures 29,898 -- -- -- 29,898
Time Deposits 465,832 286,671 130,977 45,681 2,503
-------- -------- -------- -------- --------
Total $595,811 $338,386 $151,807 $ 46,981 $ 58,637
======== ======== ======== ======== ========
MainSource Financial Group
Management's Discussion and Analysis
(Dollar amounts in thousands except per share data)
Interest Rate Sensitivity
At year-end 2004, the Company held approximately $623,000 in assets comprised of
securities, loans, short-term investments, and federal funds sold, which were
interest rate sensitive in one year or less time horizons. The Company's
interest rate sensitivity analysis for the year ended December 31, 2004 appears
in the table below. 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.
Rate Sensitivity Analysis at December 31, 2004
- -----------------------------------------------------------------------------------------------------------------------------------
Over 5
Years or
3 Months 1 Year 2 Years 5 Years Insensitive Total
- -----------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets
Loans $ 278,070 $ 207,071 $ 151,592 $ 198,734 $ 94,362 $ 929,829
Securities 30,605 93,888 74,658 127,199 102,336 428,686
Federal funds sold and money market fund 4,662 -- -- -- -- 4,662
Interest-bearing deposits in banks 304 -- -- -- -- 304
Restricted stock 7,902 -- -- -- -- 7,902
- -----------------------------------------------------------------------------------------------------------------------------------
Total Interest-earning assets 321,543 300,959 226,250 325,933 196,698 1,371,383
- -----------------------------------------------------------------------------------------------------------------------------------
Other assets -- -- -- -- 189,694 189,694
Allowance for loan losses -- -- -- -- (11,698) (11,698)
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 321,543 $ 300,959 $ 226,250 $ 325,933 $ 374,694 $ 1,549,379
===================================================================================================================================
Interest-bearing liabilities
Interest-bearing demand $ 310,306 -- -- -- -- $ 310,306
Savings 304,230 -- -- -- -- 304,230
Certificates of deposit 126,459 159,768 83,578 85,823 10,204 465,832
Short term borrowings 57,175 -- -- -- -- 57,175
Notes payable 9,100 -- -- -- -- 9,100
Federal Home Loan Bank advances 35,032 14,215 -- 15,498 26,236 90,981
Subordinated debentures 29,898 -- -- -- -- 29,898
- -----------------------------------------------------------------------------------------------------------------------------------
Total Interest-bearing liabilities 872,200 173,983 83,578 101,321 36,440 1,267,522
- -----------------------------------------------------------------------------------------------------------------------------------
Demand deposits -- -- -- -- 145,999 145,999
Other liabilities -- -- -- -- 12,538 12,538
Stockholders equity -- -- -- -- 123,320 123,320
- -----------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and stockholders' equity $ 872,200 $ 173,983 $ 83,578 $ 101,321 $ 318,297 $ 1,549,379
- -----------------------------------------------------------------------------------------------------------------------------------
Rate sensitivity gap
(assets less liabilities) ($550,657) $ 126,976 $ 142,672 $ 224,612
- -----------------------------------------------------------------------------------------------------------------------------------
Rate sensitivity gap(cumulative) (550,657) (423,681) (281,009) (56,397)
- -----------------------------------------------------------------------------------------------------------------------------------
Percent of total assets (cumulative) -35.54% -27.35% -18.14% -3.64%
Rate sensitive assets/liabilities
(cumulative) 36.87% 59.50% 75.13% 95.42%
- -----------------------------------------------------------------------------------------------------------------------------------
Management believes that the Company has taken steps to position itself to
react to changes occurring in the current interest rate environment. With an
economic expansion underway, short term rates began rising in the middle of 2004
and both trends are expected to continue in 2005. Management believes this would
result in a higher level of loan growth than the Company realized in 2003 and
2004. The Company continues to monitor the repricing characteristics of its
balance sheet so as to maintain an acceptable net interest margin during
interest rate fluctuations. Assuming a stable to moderately higher interest rate
environment, the Company does not foresee its earnings materially impacted for
2005.
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.
The following table provides information about the Company's significant
financial instruments at December 31, 2004 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.
Principal Cash Flows
There Fair
December 31 2005 2006 2007 2008 2009 after Total Value
--------------------------------------------------------------------------------
(Dollars in Thousands)
Assets
Investment securities
Fixed rate $70,061 $52,865 $102,258 $60,363 $62,154 $73,624 $421,325 $421,477
Average interest rate 3.20% 3.23% 3.77% 3.90% 4.50% 5.98% 4.12%
Variable rate $423 $161 $1,110 $1,956 - $3,711 $7,361 $7,380
Average interest rate 3.60% 2.76% 4.23% 4.27% - 3.33% 3.72%
Loans
Fixed rate $37,269 $19,570 $29,992 $39,957 $39,262 $87,036 $253,086 $248,962
Average interest rate 5.87% 7.66% 6.81% 6.01% 5.96% 6.58% 6.40%
Variable rate $91,836 $10,602 $8,654 $6,519 $15,676 $543,456 $676,743 $664,904
Average interest rate 5.88% 4.99% 5.47% 5.83% 7.00% 6.03% 6.01%
Liabilities
Deposits
NOW, money market and
savings deposits
Variable rate $614,536 - - - - - $614,536 $611,061
Average interest rate 1.03% - - - - - 1.03%
Certificates of deposit
Fixed rate $264,917 $79,032 $46,116 $33,387 $12,659 $2,290 $438,401 $437,562
Average interest rate 2.31% 2.71% 3.53% 3.73% 3.87% 4.54% 2.67%
Variable rate $21,209 $5,228 $593 $196 $202 $3 $27,431 $27,431
Average interest rate 2.36% 2.38% 2.87% 3.57% 3.47% 3.64% 2.39%
Borrowings
Variable rate $57,175 - - - - - $57,175 $57,175
Average interest rate 1.77% - - - - - 1.77%
FHLB advances
Variable rate $35,000 - - - - - $35,000 $35,000
Average interest rate 1.95% - - - - - 1.95%
Fixed rate $14,115 $132 $15,498 - - $26,236 $55,981 $57,837
Average interest rate 5.39% 6.20% 4.88% - - 4.06% 4.63%
Long-term debt
Variable rate $2,600 $2,600 $2,600 $1,300 - - $9,100 $9,100
Average interest rate 3.16% 3.16% 3.16% 3.16% - - 3.16%
Subordinated debentures
Variable rate - - - - - $29,898 $29,898 $29,898
Average interest rate - - - - - 5.61% 5.61%
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.
Critical Accounting Policies
The accounting and reporting policies of the Company comply with accounting
principles generally accepted in the United States and conform to general
practices within the banking industry. These policies require estimates and
assumptions. Changes in underlying factors, assumptions, or estimates in any of
these areas could have a material impact on the Company's future financial
condition and results of operations. In management's opinion, some of these
areas have a more significant impact than others on the Company's financial
reporting. These areas currently include accounting for the allowance for loan
losses and goodwill.
Allowance for Loan Losses -- The level of the allowance for loan losses is
based upon management's evaluation of the loan and lease portfolios, past loan
loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay (including the timing of future
payments), the estimated value of any underlying collateral, composition of the
loan portfolio, economic conditions, and other pertinent factors. This
evaluation is inherently subjective as it requires material estimates including
the amounts and timing of future cash flows expected to be received on impaired
loans that may be susceptible to significant change. The level of allowance
maintained is believed by management to be adequate to cover losses inherent in
the portfolio. The allowance is increased by provisions charged to expense and
decreased by charge-offs, net of recoveries of amounts previously charged-off.
Goodwill -- Statement of Financial Accounting Standards No. 141 "Business
Combinations" and No. 142 "Goodwill and Other Intangible Assets" were issued in
June of 2001 and were effective for fiscal years beginning after December 15,
2001. Under these rules, goodwill and intangible assets deemed to have
indefinite lives, if any, will no longer be amortized, but will be subject to
annual impairment tests in accordance with the Statements. The Company has
selected June 30 as its date for annual impairment testing.
New Accounting Matters
See Note 1 to the Consolidated Financial Statements regarding the adoption of
new accounting standards in 2004.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
The information required in this section is incorporated herein by reference to
the information provided in the "Interest Rate Sensitivity" section of Item 7.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------
[LOGO OF CROWE CHIZEK AND COMPANY]
Crowe Chizek and Company LLC
Member Horwath International
Report of Independent Registered Public Accounting Firm on Financial Statements
Shareholders and Board of Directors
MainSource Financial Group
Greensburg, Indiana
We have audited the accompanying consolidated balance sheets of MainSource
Financial Group (the Company) as of December 31, 2004 and 2003, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 2004. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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 the Company as of
December 31, 2004 and 2003, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2004, in conformity
with U.S. generally accepted accounting principles.
/s/ Crowe Chizek and Company LLC
Indianapolis, Indiana
February 11, 2005, except for Note 2
with respect to the pending acquisition,
as to which the date is March 8, 2005
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands except per share data)
December 31, December 31,
2004 2003
----------- -----------
Assets
Cash and due from banks $ 71,607 $ 50,564
Money market and federal funds sold 4,662 6,290
----------- -----------
Cash and cash equivalents 76,269 56,854
Interest bearing time deposits 304 201
Investment securities
Available for sale 425,443 422,111
Held to maturity (fair value of $3,414 and $3,683) 3,243 3,431
----------- -----------
Total investment securities 428,686 425,542
Loans held for sale 824 1,965
Loans, net of allowance for loan losses of $11,698 and $11,509 917,307 843,962
Restricted stock, at cost 7,902 6,639
Premises and equipment, net 25,766 22,886
Goodwill 40,642 36,047
Purchased intangible assets 6,429 5,347
Cash surrender value of life insurance 24,776 22,203
Interest receivable and other assets 20,474 21,083
----------- -----------
Total assets $ 1,549,379 $ 1,442,729
=========== ===========
Liabilities
Deposits
Noninterest bearing $ 145,999 $ 127,100
Interest bearing 1,080,368 1,064,210
----------- -----------
Total deposits 1,226,367 1,191,310
Short-term borrowings 57,175 27,508
Federal Home Loan Bank (FHLB) advances 90,981 62,751
Subordinated debentures 29,898 29,898
Notes payable 9,100 12,500
Other liabilities 12,538 13,338
----------- -----------
Total liabilities 1,426,059 1,337,305
----------- -----------
Commitments and contingencies (Note 16)
Shareholders' equity
Preferred stock, no par value
Authorized shares - 400,000
Issued and outstanding shares - none -- --
Common stock $.50 stated value:
Authorized shares - 25,000,000
Issued shares - 11,196,357 and 6,824,405
Outstanding shares - 10,985,121 and 6,729,256 5,600 3,413
Common stock to be distributed, 559,818 and 341,220 shares 280 170
Treasury stock - 211,236 and 95,149 shares, at cost (3,479) (2,190)
Additional paid-in capital 73,451 53,478
Retained earnings 47,371 49,338
Accumulated other comprehensive income 97 1,215
----------- -----------
Total shareholders' equity 123,320 105,424
----------- -----------
Total liabilities and shareholders' equity $ 1,549,379 $ 1,442,729
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED STATEMENTS OF INCOME
(Dollar amounts in thousands except per share data) 2004 2003 2002
------- ------- -------
Interest income
Loans, including fees $56,580 $53,754 $56,543
Investment securities
Taxable 12,094 11,480 12,970
Tax exempt 3,049 2,172 2,058
Federal funds sold and money market funds 76 192 727
Deposits with financial institutions 42 7 5
------- ------- -------
Total interest income 71,841 67,605 72,303
------- ------- -------
Interest expense
Deposits 16,366 18,628 22,610
Short-term borrowings 580 172 372
Subordinated debentures 1,677 1,638 2,035
Other borrowings 3,216 2,935 2,236
------- ------- -------
Total interest expense 21,839 23,373 27,253
------- ------- -------
Net interest income 50,002 44,232 45,050
Provision for loan losses 600 1,325 2,995
------- ------- -------
Net interest income after
provision for loan losses 49,402 42,907 42,055
Non-interest income
Insurance commissions 2,643 2,400 2,156
Mortgage banking 3,198 5,671 4,757
Trust and investment product fees 911 678 605
Service charges on deposit accounts 6,912 5,092 4,011
Net realized gains on securities 991 1,300 319
Gain on cash surrender value of life insurance 1,016 626 208
Interchange income 1,996 1,796 1,160
Other income 1,877 1,880 1,163
------- ------- -------
Total non-interest income 19,544 19,443 14,379
------- ------- -------
Non-interest expense
Salaries and employee benefits 25,411 22,421 20,381
Net occupancy expenses 3,165 2,753 2,414
Equipment expenses 3,949 3,488 2,873
Intangibles amortization 1,059 909 828
Telecommunications 1,581 1,287 1,038
Stationery printing and supplies 988 916 973
Other expenses 9,727 8,674 7,103
------- ------- -------
Total non-interest expense 45,880 40,448 35,610
------- ------- -------
Income before income tax 23,066 21,902 20,824
Income tax expense 6,273 6,597 6,813
------- ------- -------
Net income $16,793 $15,305 $14,011
======= ======= =======
Net income per share (basic and diluted) $ 1.48 $ 1.37 $ 1.24
The accompanying notes are an integral part of these consolidated financial
statements.
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollar Amounts in Thousands Except Per Share Data)
Accumulated
Additional Other
Common Stock Paid-in Retained Comprehensive Comprehensive
Shares Outstanding Amount Capital Earnings Income Total Income
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 2002 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 $17,078
=======
Cash dividends ($ .397 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
=====================================================================================================================
Net income 15,305 15,305 $15,305
Unrealized loss on cash flow hedge, net (117) (117) (117)
Unrealized loss on securities net of
reclassification adjustment (3,165) (3,165) (3,165)
-------
Total comprehensive income $12,023
=======
Cash dividends ($ .435 per share) (4,857) (4,857)
Stock dividend and fractional shares 340,537 170 10,453 (10,639) (16)
Purchase of treasury stock (64,938) (1,497) (1,497)
- ---------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 7,070,476 1,393 $ 53,478 $ 49,338 $ 1,215 $ 105,424
=====================================================================================================================
Net income 16,793 16,793 $16,793
Unrealized gain on cash flow hedge, net 148 148 148
Unrealized loss on securities net of
reclassification adjustment (1,266) (1,266) (1,266)
-------
Total comprehensive income $15,675
=======
Cash dividends ($ .476 per share) (5,391) (5,391)
Stock split/dividend and fractional shares 4,141,326 2,071 11,268 (13,369) (30)
Issuance of common stock in acquisition 449,224 225 8,701 8,926
Exercise of stock options 1,575 24 4 28
Purchase of treasury stock (117,662) (1,312) (1,312)
- ---------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2004 11,544,939 $ 2,401 $ 73,451 $ 47,371 $ 97 $ 123,320
=====================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOW
(Dollars in thousands)
2004 2003 2002
--------- --------- ---------
Operating Activities
Net income $ 16,793 $ 15,305 $ 14,011
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 600 1,325 2,995
Depreciation and amortization 2,962 2,629 2,246
Amortization of mortgage servicing rights 956 1,863 649
Securities amortization, net 2,469 4,093 1,623
Amortization of core deposit intangibles 1,059 909 828
Increase in cash surrender value of life insurance policies (930) (571) (208)
Investment securities gains (991) (1,300) (319)
Change in loans held for sale 1,141 12,062 7,541
Change in other assets and liabilities 2,904 3,526 (496)
--------- --------- ---------
Net cash provided by operating activities 26,963 39,841 28,870
Investing Activities
Net change in short-term investments 197 (201) 599
Proceeds from maturities and payments
on securities held to maturity -- 1,288 3,532
Purchases of securities available for sale (166,864) (379,327) (227,229)
Proceeds from maturities and payments
on securities available for sale 110,650 182,311 121,805
Proceeds from sales of securities available for sale 69,347 117,382 30,586
Purchases of restricted stock (455) -- (581)
Loan originations and payments, net 4,435 4,197 36,646
Purchases of premises and equipment (2,468) (1,960) (3,408)
Cash received from branch acquisitions, net -- 12,203 37,054
Cash paid for bank acquisition, net (342) (12,836) --
Purchase of life insurance policies -- (15,000) --
--------- --------- ---------
Net cash provided (used) by investing activities 14,500 (91,943) (996)
Financing Activities
Net change in deposits (64,660) 21,869 (44,475)
Net change in short-term borrowings 29,343 7,229 4,051
Repayment of notes payable (4,100) (2,900) (1,662)
Proceeds from issuance of notes payable -- 13,000 --
Proceeds from FHLB advances 123,500 -- 40,000
Repayment of FHLB advances (99,426) (1,262) (10,111)
Redemption of trust preferred securities -- (22,425) --
Proceeds from issuance of trust preferred securities -- 21,898 8,000
Purchase of treasury shares (1,312) (1,497) (694)
Cash dividends and fractional stock dividends (5,421) (4,873) (4,485)
Proceeds from exercise of stock options 28 -- --
--------- --------- ---------
Net cash provided (used) by financing activities (22,048) 31,039 (9,376)
--------- --------- ---------
Net change in cash and cash equivalents 19,415 (21,063) 18,498
Cash and cash equivalents, beginning of year 56,854 77,917 59,419
--------- --------- ---------
Cash and cash equivalents, end of year $ 76,269 $ 56,854 $ 77,917
========= ========= =========
Supplemental Information
Interest paid $ 22,640 $ 23,683 $ 27,835
Income taxes paid 3,487 4,150 6,793
Loan balances transferred to foreclosed real estate 2,741 1,896 3,658
See Note 2 regarding non-cash transaction included in acquisitions. The
accompanying notes are an integral part of these consolidated financial
statements.
Note 1 - Summary of Significant Accounting Policies
Nature of Operations and Principles of Consolidation: The consolidated financial
statements include MainSource Financial Group, Inc. and its wholly owned
subsidiaries, together referred to as "the Company". Intercompany transactions
and balances are eliminated in consolidation.
The Company's wholly owned subsidiaries include MainSource Bank, Regional Bank
("Regional"), MainSource Bank of Illinois (formerly known as Capstone Bank),
Peoples Trust Company ("Peoples"), and IUB Reinsurance Company, Ltd. MainSource
Insurance, Inc. is a wholly owned subsidiary of MainSource Bank. In October
2004, the Company merged its wholly-owned subsidiary of First Community Bank and
Trust into 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 actual results could differ. The allowance for loan
losses, loan servicing rights, and fair values of financial instruments are
particularly subject to change.
Cash Flows: Cash and cash equivalents include cash and due from banks, interest
bearing deposits with other financial institutions with maturities under 90
days, money market funds and federal funds sold. Net cash flows are reported for
loan and deposit transactions, federal funds purchased and repurchase
agreements.
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. Premiums
and discounts on securities are amortized on the level-yield method, which
considers prepayments on mortgage-backed securities. Gains and losses on sales
are based on the amortized cost of the security sold. Declines in the fair value
of securities below their cost that are other than temporary are reflected as
realized losses. In estimating other-than-temporary losses, management considers
(1) the length of time and extent that fair value has been less than cost, (2)
the financial condition and near term prospects of the issuer, and (3) the
Company's ability and intent to hold the security for a period sufficient to
allow for any anticipated recovery in fair value.
Loans Held for Sale: Loans originated and intended for sale in the secondary
market are carried at the lower of cost or market in the aggregate. Net
unrealized losses, if any, are recorded as a valuation allowance and charged to
earnings.
Mortgage loans held for sale are generally sold with servicing rights retained.
The carrying value of mortgage loans sold is reduced by the cost allocated to
the servicing right. Gains and losses on sales of mortgage loans are based on
the difference between the selling price and the carrying value of the related
loan sold.
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. Interest income is accrued on the unpaid principal
balance. Loan originations fees, net of certain direct origination costs, are
deferred and recognized in interest income using the level-yield method without
anticipating prepayments.
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. Payments received on such loans subsequent to being
placed on non-accrual are applied to the principal balance of the loans. 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. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
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 charged-off.
The allowance consists of specific and general components. The specific
component relates to loans that are individually classified as impaired or loans
otherwise classified as substandard or doubtful. The general component covers
pools of other loans and is based on historical loss experience adjusted for
current factors.
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 net of estimated selling costs,
establishing a new cost basis. If fair value declines after acquisition, 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 straight-line method with useful lives ranging from 5
to 39 years. Furniture, fixtures and equipment are depreciated using the
straight-line method with useful lives ranging from 3 to 10 years.
Company Owned Life Insurance: The Company has purchased life insurance policies
on certain key executives. Company owned life insurance is recorded at its cash
surrender value, or the amount that can be realized.
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, to the extent that fair
value is less than the capitalized amount for a grouping.
Transfers of Financial Assets: Transfers of financial assets are accounted for
as sales when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been
isolated from the Company, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Company does not maintain effective
control over the transferred assets through an agreement or option to repurchase
them before their maturity.
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.
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,
generally ten 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 value.
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.
Repurchase agreements are included in short-term borrowings on the consolidated
balance sheets.
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.
Loan Commitments and Related Financial Instruments: Financial instruments
include off-balance sheet credit instruments, such as commitments to make loans
and commercial 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.
Mortgage Banking Income: Mortgage banking income consists of gains on loan
sales, mortgage servicing rights, and loan servicing fee income, net of
amortization of mortgage servicing rights.
Stock Compensation: Compensation expense for 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".
2004 2003 2002
---------- ---------- ----------
Net income as reported $ 16,793 $ 15,305 $ 14,011
Deduct: Stock-based compensation expense, net,
determined under fair value based method 92 29 --
---------- ---------- ----------
Pro forma net income $ 16,701 $ 15,276 $ 14,011
========== ========== ==========
Basic earnings per share as reported $ 1.48 $ 1.37 $ 1.24
Pro forma basic earnings per share $ 1.47 $ 1.37 $ 1.24
Diluted earnings per share as reported $ 1.48 $ 1.37 $ 1.24
Pro forma diluted earnings per share $ 1.47 $ 1.37 $ 1.24
The pro forma effects are computed using option pricing models, with the
following weighted-average assumptions for 2004 as of grant date: risk-free
interest rate 3.48%, expected option life 6.69 years, expected stock price
volatility 20.34% and dividend yield 2.75%. For 2003, the following
weighted-average assumptions were used as of the 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%. No stock options were granted in 2002.
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 and unrealized gains and losses on cash
flow hedges, 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. Management does not believe there are now any such matters that will
have a material effect on the financial statements.
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. These restrictions pose no practical
limit on the ability of the banks or holding company to pay dividends at
historical levels.
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.
Effect of Recently Issued Accounting Standards Not Yet Adopted: At December 31,
2004, recently issued but not yet adopted accounting standards were Financial
Accounting Standard (FAS) 123 Revised and Statement of Position (SOP) 03-3.
FAS 123, Revised, requires all public companies to record compensation cost for
stock options provided to employees in return for employee service. The cost is
measured at the fair value of the options when granted, and this cost is
expensed over the employee service period, which is normally the vesting period
of the options. This will apply to awards granted or modified after the first
quarter or year beginning after June 15, 2005. Compensation cost will also be
recorded for prior option grants that vest after the date of adoption. The
effect on results of operations will depend on the level of future option grants
and the calculation of the fair value of the options granted at such future
date, as well as the vesting periods provided, and so cannot currently be
predicted. Existing options that will vest after adoption date are expected to
result in additional compensation expense of approximately $81 during 2005, $81
in 2006, $66 in 2007, and $9 in 2008. There will be no significant effect on
financial position as total equity will not change.
SOP 03-3 requires that a valuation allowance for loans acquired in a transfer,
including in a business combination, reflect only losses incurred after
acquisition and should not be recorded at acquisition. It applies to any loan
acquired in a transfer that showed evidence of credit quality deterioration
since it was made. This SOP is effective for fiscal years beginning after
December 31, 2004.
The effect of these other new standards on the Company's financial position and
results of operations is not expected to be material upon and after adoption.
Note 2 - Business Combinations
In June 2004, the Company acquired 100% of the outstanding shares of Peoples
Financial Corp., parent of Peoples Trust Company. Operating results of this
acquisition are included in the consolidated financial statements since the date
of the acquisition. As a result of this acquisition, the Company expects to
further solidify its market share in the southwest Indiana market, expand its
customer base to enhance deposit fee income, provide an opportunity to market
additional products and services to new customers, and reduce operating costs
through economies of scale.
The aggregate purchase price was $13.6 million in stock and cash. The purchase
price resulted in approximately $4.6 million in goodwill, and $2.1 million in
core deposit intangible. The core deposit intangible asset is being amortized
over 10 years, using an accelerated method. Goodwill will not be amortized but
will instead be evaluated periodically for impairment.
The following table summarizes the estimated fair value of assets acquired and
liabilities assumed at the date of acquisition.
Cash $ 4,320
Securities available for sale 19,497
Loans, net 81,371
Goodwill 4,595
Core deposit intangible 2,141
Other assets 7,290
---------
Total assets acquired 119,214
Deposits (99,717)
Borrowings (5,180)
Other liabilities (729)
---------
Total liabilities assumed (105,626)
---------
Net assets acquired $ 13,588
The following table presents pro forma information as if the acquisition had
occurred at the beginning of 2004 and 2003. The pro forma information includes
adjustments for interest income on loans and securities acquired, amortization
of intangibles arising from the transaction, depreciation expense on property
acquired, interest expense on deposits and borrowings acquired, and the related
income tax effects. 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.
2004 2003
------ ------
Net interest income $52,219 $48,810
Net income 16,580 15,674
Earnings per share (basic and diluted) 1.43 1.35
Pending Acquisition: In March 2005, the Company executed a definitive agreement
to acquire The Madison Bank & Trust Company ("Madison"). Madison, which has
approximately $180 million in assets, operates a total of five offices with four
in Jefferson County, Indiana and one in Ohio County, Indiana. The transaction,
which is subject to regulatory approval, is expected to close in the third
quarter of 2005.
Note 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 which do not earn interest. The reserves required at
December 31, 2004 and 2003 were $18,614 and $14,588, respectively. The Company
also had compensating balances of $6,229 and $2,995 at December 31, 2004 and
2003 respectively.
NOTE 4 - Investment Securities
The fair value of securities available for sale and related unrealized gross
gains/losses recognized in accumulated other comprehensive income (loss) at year
end were as follows:
- ---------------------------------------------------------------------------
Gross Gross
Fair Unrealized Unrealized
2004 Value Gains Losses
- ---------------------------------------------------------------------------
Available for Sale
Federal agencies $56,557 $152 ($388)
State and municipal 88,338 1,546 (583)
Mortgage-backed 262,690 1,005 (1,924)
Equity and other 17,858 427 (60)
- ---------------------------------------------------------------------------
Total available for sale $425,443 $3,130 ($2,955)
- ---------------------------------------------------------------------------
2003
- ---------------------------------------------------------------------------
Available for Sale
Federal agencies $92,867 $1,409 ($36)
State and municipal 61,324 1,899 (152)
Mortgage-backed 255,541 1,297 (1,710)
Equity and other 12,379 103 (625)
- ---------------------------------------------------------------------------
Total available for sale $422,111 $4,708 ($2,523)
- ---------------------------------------------------------------------------
The carrying amount, unrecognized gains and losses, and fair value of securities
held to maturity at year end were as follows:
Gross Gross
Carrying Unrecognized Unrecognized Fair
2004 Amount Gains Losses Value
- -------------------------------------------------------------------------------
Held to Maturity
State and municipal $2,439 $74 $ -- $2,513
Other 804 97 -- 901
- -------------------------------------------------------------------------------
Total held to maturity $3,243 $171 $ -- $3,414
- -------------------------------------------------------------------------------
2003
- -------------------------------------------------------------------------------
Held to Maturity
State and municipal $2,682 $122 $ -- $2,804
Other 749 130 -- 879
- -------------------------------------------------------------------------------
Total held to maturity $3,431 $252 $ -- $3,683
- -------------------------------------------------------------------------------
Contractual maturities of securities at December 31, 2004 were as follows.
Securities not due at a single maturity at year end are shown separately.
Available
Held to Maturity for Sale
-------------------------------------
Carrying Fair Fair
Amount Value Value
-------------------------------------
Within one year $ 137 $ 138 $ 12,870
Two through five years 1,788 1,919 72,435
Six through ten years 1,318 1,357 27,835
After ten years -- - 31,755
Mortgage-backed -- - 262,690
Equity and other -- - 17,858
------ ------ --------
Total investment securities $3,243 $3,414 $425,443
Gross proceeds from sales of securities available for sale during 2004, 2003 and
2002 were $69,347, $117,382, and $30,586. Gross gains of $1,020, $1,443, and
$384 and gross losses of $29, $143, and $65 were realized on those sales in
2004, 2003 and 2002, respectively.
Securities with a carrying value of $110,175 and $50,560 were pledged at
December 31, 2004 and 2003 to secure certain deposits, repurchase agreements and
for other purposes as permitted or required by law.
Note 4 - Investment Securities (continued)
Below is a summary of securities with unrealized losses as of year-end 2004 and
2003 presented by length of time the securities have been in a continuous
unrealized loss position.
2004 Less than 12 months 12 months or longer Total
---------------------------- -------------------------- ---------------------------
Unrealized Unrealized Unrealized
Description of securities Fair Value Losses Fair Value Losses Fair Value Losses
- ----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Federal agencies $ 33,536 ($388) $ -- $ -- $ 33,536 ($388)
State and municipal 32,139 (509) 2,713 (74) 34,852 (583)
Mortgage-backed securities 138,958 (879) 56,602 (1,045) 195,560 (1,924)
Equity and other securities -- - 3,000 (60) 3,000 (60)
--------- ------- -------- -------- --------- -------
Total temporarily impaired $ 204,633 ($1,776) $ 62,315 $ (1,179) $ 266,948 ($2,955)
2003 Less than 12 months 12 months or longer Total
---------------------------- -------------------------- ---------------------------
Unrealized Unrealized Unrealized
Description of securities Fair Value Losses Fair Value Losses Fair Value Losses
- ----------------------------- ---------- ---------- ---------- ---------- ---------- ----------
Federal agencies $ 32,512 ($36) $ -- $ -- $ 32,512 ($36)
State and municipal 8,061 (152) - -- 8,061 (152)
Mortgage-backed securities 144,882 (1,710) - -- 144,882 (1,710)
Equity and other securities -- - 5,594 (625) 5,594 (625)
--------- ------- -------- -------- --------- -------
Total temporarily impaired $ 185,455 ($1,898) $ 5,594 $ (625) $ 191,049 ($2,523)
Unrealized losses on state and municipal bonds have not been recognized into
income because management has the intent and ability to hold for a period of
time sufficient to allow for any anticipated recovery in fair value. The fair
value of debt securities is expected to recover as the bonds approach their
maturity date.
Unrealized losses on mortgage-backed securities have not been recognized into
income as the decline in fair value is largely due to increases in market
interest rates. The fair value is expected to recover as the bonds approach
their maturity date and/or market rates change.
Unrealized losses on equity and other securities have not been recognized into
income because the issuers bonds are of high credit quality (rated AA or
higher), management has the intent and ability to hold for the foreseeable
future, and the decline in fair value is largely due to changes in interest
rates. The fair value is expected to recover as the bonds approach their
maturity date or as interest rates change.
Note 5 - Loans and Allowance
Loans at year end were as follows:
- ------------------------------------------------------------------------------
December 31 2004 2003
- ------------------------------------------------------------------------------
Commercial and industrial loans $ 154,717 $ 158,271
Agricultural production financing 22,647 25,897
Farm real estate 38,281 37,107
Commercial real estate 133,360 101,022
Hotel 80,234 83,997
Residential real estate 353,515 315,848
Construction and development 37,821 33,605
Consumer 108,430 99,724
---------------------------
Total loans 929,005 855,471
---------------------------
Allowance for loan lossess (11,698) (11,509)
- ------------------------------------------------------------------------------
Net loans $ 917,307 $ 843,962
==============================================================================
Activity in the allowance for loan losses was as follows:
- -------------------------------------------------------------------------------
December 31 2004 2003 2002
- -------------------------------------------------------------------------------
Allowance for loan losses
Balances, January 1 $ 11,509 $ 9,517 $ 8,894
Addition resulting from acquisition 1,775 2,078 --
Provision for losses 600 1,325 2,995
Recoveries on loans 346 509 399
Loans charged off (2,532) (1,920) (2,771)
- -------------------------------------------------------------------------------
Balances, December 31 $ 11,698 $ 11,509 $ 9,517
===============================================================================
Impaired loans were as follows:
- --------------------------------------------------------------------------------
December 31 2004 2003 2002
- --------------------------------------------------------------------------------
Impaired loans with an allowance allocated $ 8,908 $ 6,954 $ 2,267
Impaired loans with no allocated allowances -- -- --
- --------------------------------------------------------------------------------
Total impaired loans $ 8,908 $ 6,954 $ 2,267
================================================================================
Allowance allocated for impaired loans $ 1,578 $ 1,086 $ 269
=============================
Average balance of impaired loans during the year $ 6,758 $ 4,997 $ 2,866
Interest income recognized on impaired loans -- -- --
Cash basis interest included above -- -- --
Nonperforming loans were as follows:
- -----------------------------------------------------------------------------
December 31 2004 2003
- -----------------------------------------------------------------------------
Loans past due 90 days or more still on accrual $ 431 $ 196
Nonaccrual loans 13,611 14,626
---------------------------
Total nonperforming loans $ 14,042 $ 14,822
---------------------------
Nonperforming loans include both smaller balance homogeneous loans that are
collectively evaluated for impairment and individually classified impaired
loans.
Note 6 - Premises and Equipment
- -----------------------------------------------------------------
December 31 2004 2003
- -----------------------------------------------------------------
Land $ 4,604 $ 3,731
Buildings 24,086 21,556
Furniture and equipment 23,860 21,451
- -----------------------------------------------------------------
Total cost 52,550 46,738
Accumulated depreciation (26,784) (23,852)
- -----------------------------------------------------------------
Net $ 25,766 $ 22,886
=================================================================
Depreciation expense was $2,962, $2,629, and $2,246 in 2004, 2003 and 2002.
Note 7 - Goodwill and Intangible Assets
Goodwill
The change in carrying amount of goodwill is as follows:
- --------------------------------------------------------------------------
2004 2003
- --------------------------------------------------------------------------
Beginning of year $36,047 $20,708
Goodwill from acquisition during the year 4,595 15,339
- --------------------------------------------------------------------------
End of year $40,642 $36,047
==========================================================================
Acquired Intangible Assets
---------------------------
2004 2003
---------------------------
Core deposit intangibles $11,945 $9,804
Accumulated amortization (5,516) (4,457)
---------------------------
Core deposit intangibles, net $ 6,429 $5,347
---------------------------
Aggregate amortization expense was $1,059, $909, and $828 for 2004, 2003, and
2002.
Estimated amortization expense for each of the next five years follows:
2005 $ 1,161
2006 1,144
2007 1,125
2008 1,007
2009 498
Note 8 - Deposits
Deposits at year end were as follows:
- ------------------------------------------------------------------------------
December 31 2004 2003
- ------------------------------------------------------------------------------
Non-interest bearing $ 145,999 $ 127,100
Interest bearing demand 310,306 311,333
Savings deposits 304,230 224,318
Certificates and other time deposits of $100 or more 117,361 141,327
Other certificates and time deposits 348,471 387,232
- ------------------------------------------------------------------------------
Total deposits $1,226,367 $1,191,310
==============================================================================
Certificates and other time deposits mature as follows:
2005 $ 286,671
2006 84,267
2007 46,710
2008 33,581
2009 12,100
Thereafter 2,503
=================================================================
Total $ 465,832
=================================================================
Note 9 - Short Term Borrowings
- -----------------------------------------------------------------------------
December 31 2004 2003
- -----------------------------------------------------------------------------
Short term borrowings consisted of the following
at year-end:
Federal funds purchased $ 26,900 $ 7,460
Line of credit 3,000 --
Securities sold under repurchase agreements 27,275 20,048
----------------------
Total short-term borrowings $ 57,175 $ 27,508
----------------------
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. The maximum amount of outstanding
repurchase agreements at any month-end during 2004 and 2003 totaled $28,782 and
$20,048. The daily average of such agreements during 2004 and 2003 totaled
$22,166 and $16,680. The weighted average rate was 1.34% and 0.71% at December
31, 2004 and 2003, while the weighted average rate during 2004 and 2003 was
approximately 0.96% and 0.88%, respectively. The majority of the agreements at
December 31, 2004 mature within 30 days.
The Company has a revolving credit facility for $3,000 as a standby for funding
needs which matures June 5, 2005. The interest rate is 120 basis points above
the 3-month LIBOR rate which resulted in a rate of 3.69% at year-end. The
outstanding balance at December 31, 2004 was $3,000. There was no outstanding
balance as of December 31, 2003. The line is unsecured.
Note 10 - Federal Home Loan Bank Advances
Federal Home Loan Bank ("FHLB") advances at year end were:
2004 2003
------- -------
Maturities June 2005 through August 2012,
primarily fixed rates from 2.4% to 6.6%, averaging 3.8% $90,981 $ --
Maturities January 2004 through August 2012,
primarily fixed rates from 1.3% to 6.6%, averaging 4.5% -- 62,751
------- -------
Total FHLB advances $90,981 $62,751
======= =======
The majority of the FHLB advances are secured by first mortgage loans totaling
approximately 145% of the advance under a blanket security agreement.
Approximately $163 of advances are secured by cash. The advances are subject to
restrictions or penalties in the event of prepayment.
Maturities over the next five years are:
2005 $ 49,115
2006 132
2007 15,498
2008 --
2009 --
Thereafter 26,236
Note 11 - Notes Payable
Notes payable include a term note secured by the common stock of MainSource Bank
with a balance of $9,100 and $11,700 at December 31, 2004 and 2003. The note
requires semi-annual principal payments of $1,300 plus quarterly interest
payments. Interest accrues at LIBOR plus 140 basis points, which resulted in a
rate of 3.16% at December 31, 2004. The loan matures June 30, 2008.
Notes payable at December 31, 2003 also included a term note with a balance of
$800 secured by the common stock of MainSource Bank and Regional Bank. The note
required semi-annual principal payments of $800 plus quarterly interest
payments. Interest accrued at LIBOR plus 120 basis points, which resulted in a
rate of 2.41% at December 31, 2003. The loan matured July 1, 2004.
The Company has certain debt covenants related to these notes payable. As of
December 31, 2004, the Company was in compliance with all of these covenants.
Note 12 - Subordinated Debentures and Trust Preferred Securities
The Company formed three separate trusts in 2002 and 2003 that issued floating
rate trust preferred securities as part of pooled offerings. The Company issued
subordinated debentures to the trusts in exchange for the proceeds of the
offerings, which debentures represent the sole asset of the trusts. Other than
the items detailed below, the terms of the subordinated debentures are generally
the same. Interest payments are payable quarterly in arrears and the Company has
the option to defer distributions from time to time for a period not to exceed
20 consecutive quarters. The subordinated debentures mature in 30 years from
issuance and can be called anytime after five years at par. The following table
summarizes the other terms of each issuance.
Variable Rate as of
Issuance Amount Rate 12/31/04 Maturity
-------------------------------------------------------
Trust 1 2002 $ 8,248 LIBOR +3.25% 5.80% 2032
Trust 2 2003 14,433 LIBOR +3.25% 5.81% 2033
Trust 3 2003 7,217 LIBOR +3.15% 5.64% 2033
During 2003, the Company entered into an interest rate swap and cap. Both the
interest rate swap and the cap have a 60 month term and a notional principal
amount of $14,000. The interest rate swap and cap were designated as hedges
against a portion of the subordinated debentures. Under the interest rate swap
agreement, the Company made fixed rate payments at 6.65%, and received variable
payments based on LIBOR. Net settlement expense or benefit is included in
interest expense. The interest rate cap requires the counter-party to pay the
Company the excess of 3 month LIBOR over 12%. No payments are currently required
under the agreement. The fair values for the interest rate swap and cap were $55
and $(3) at December 31, 2004 and were included in other assets. The fair values
were $(146) and $(49) at December 31, 2003 and were included in other
liabilities. Both the interest rate swap and cap expire in April 2008.
Note 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 $500,797 and $498,385 at December 31, 2004 and 2003. Mortgage servicing
rights are included in other assets on the consolidated balance sheets. 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 2004 or 2003. The fair market value of
capitalized mortgage servicing rights was $4,789 and $3,395 at year end 2004 and
2003.
- -------------------------------------------------------------------
2004 2003
- -------------------------------------------------------------------
Mortgage servicing assets
Balances, January 1 $ 2,618 $ 2,134
Additions resulting from acquisition - 143
Servicing assets capitalized 1,226 2,204
Amortization of servicing assets (956) (1,863)
- -------------------------------------------------------------------
Balance, December 31 $ 2,888 $ 2,618
- -------------------------------------------------------------------
Note 14 - Income Tax
Income tax expense (benefit) was as follows:
- -------------------------------------------------------------------------------
Year Ended December 31 2004 2003 2002
- -------------------------------------------------------------------------------
Income tax expense
Currently payable $ 4,154 $ 4,749 $ 5,899
Deferred 2,119 1,848 914
--------------------------------
Total income tax expense $ 6,273 $ 6,597 $ 6,813
================================
Effective tax rates differ from the federal statutory rate of 35% applied to
income before income taxes due to the following:
Federal statutory income tax rate 35% 35% 35%
Federal statutory income tax $ 8,073 $ 7,666 $ 7,288
Tax exempt interest (1,231) (893) (838)
Effect of state income taxes 63 397 483
Non-deductible expenses 50 52 42
Tax exempt income on life insurance (356) (219) (73)
Low income housing credits (132) (175) --
Other (194) (231) (89)
--------------------------------
Income tax expense $ 6,273 $ 6,597 $ 6,813
================================
The components of the net deferred tax asset (liability) are as follows:
- -------------------------------------------------------------------------------
December 31 2004 2003
- -------------------------------------------------------------------------------
Assets
Allowance for loan losses $ 4,585 $ 4,556
Deferred compensation 439 452
Fair value adjustments on assets acquired 707 472
Accrued expenses 226 323
Alternative minimum tax credits - 106
Net operating loss carryforward 242 189
Net unrealized depreciation on interest rate swap - 78
Other 325 338
- -------------------------------------------------------------------------------
Total assets $ 6,524 $ 6,514
- -------------------------------------------------------------------------------
Liabilities
Accretion on securities (28) (17)
Depreciation (1,530) (1,282)
Intangibles (2,900) (1,538)
Mortgage servicing rights (1,151) (1,037)
Deferred loan fees/costs (195) (237)
FHLB stock dividends (303) (160)
Unrealized gain on securities AFS (35) (853)
Net unrealized appreciation on interest rate swap (21) -
Other (710) (780)
- -------------------------------------------------------------------------------
Total liabilities $ (6,873) $ (5,904)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Less: Valuation allowance $ (242) $ --
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Net deferred tax asset/(liability) $ (591) $ 610
===============================================================================
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, 2004 was approximately $757.
Note 15 - Other Comprehensive Income
Before-Tax Tax (Expense)/ Net-of-Tax
Year Ended December 31, 2004 Amount Benefit Amount
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized holding losses on available for sale securities $ (1,019) $ 380 $ (639)
Unrealized holding gains on interest rate swap and cap 247 (99) 148
Less: reclassification adjustment for gains realized in net income 991 (364) 627
- ---------------------------------------------------------------------------------------------------------------------------
Other comprehensive loss $ (1,763) $ 645 $ (1,118)
===========================================================================================================================
Before-Tax Tax (Expense)/ Net-of-Tax
Year Ended December 31, 2003 Amount Benefit Amount
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized holding losses on available for sale securities $ (3,580) $ 1,260 $ (2,320)
Unrealized holding losses on interest rate swap and cap (195) 78 (117)
Less: reclassification adjustment for gains realized in net income 1,300 (455) 845
- ---------------------------------------------------------------------------------------------------------------------------
Other comprehensive loss $ (5,075) $ 1,793 $ (3,282)
===========================================================================================================================
Before-Tax Tax (Expense)/ Net-of-Tax
Year Ended December 31, 2002 Amount Benefit Amount
- ---------------------------------------------------------------------------------------------------------------------------
Unrealized holding gains on available for sale securities $ 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
===========================================================================================================================
Note 16 - Commitments
Some financial instruments, such as loan commitments, credit lines, letters of
credit, and overdraft protection, are issued to meet customer financing needs.
These are agreements to provide credit or to support the credit of others, as
long as conditions established in the contract are met, and usually have
expiration dates. Commitments may expire without being used. Off-balance-sheet
risk to credit loss exists up to the face amount of these instruments, although
material losses are not anticipated. The same credit policies are used to make
such commitments as are used for loans, including obtaining collateral at
exercise of the commitment.
Financial instruments whose contract amount represents credit risk as of
December 31 were as follows:
2004 2003
--------- ---------
Commitments to extend credit $ 155,280 $ 152,494
Commercial letters of credit 17,925 2,936
Commitments are predominantly short-term or variable in rate.
Note 17 - Stock Dividends and Splits
On November 29, 2004, the Company announced a 5% stock dividend to be paid on
January 15, 2005 to shareholders of record as of December 31, 2004. The stock
dividend was recorded in 2004, and all share and per share amounts have been
retroactively adjusted for all prior years to reflect this stock dividend.
On March 16, 2004, the Company announced a 3-for-2 stock split to be distributed
on April 16, 2004 to shareholders of record as of March 31, 2004. The stock
split was recorded in 2004, and all share and per share amounts have been
retroactively adjusted for all prior years to reflect this stock split.
On November 26, 2003, the Company announced a 5% stock dividend to be paid on
January 9, 2004 to shareholders of record as of December 22, 2003. The stock
dividend was recorded in 2003, 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.
Note 18 - Dividends and Capital Restrictions
Without prior approval, the Banks are restricted by state and federal
regulations as to the maximum amount of dividends they can pay to the holding
company in any calendar year. The Banks may dividend their retained net profits
(as defined) for that year and the two preceding years.
At December 31, 2004, total shareholders' equity of the Banks was $155,893 of
which $147,269 was restricted or limited from dividend distribution to the
holding company. As a practical matter, the Banks may restrict dividends to a
lesser amount because of the need to maintain an adequate capital structure.
Note 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.
Note 20 - Regulatory Capital
Banks and bank holding companies 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, 2004 and 2003, the most recent
regulatory notifications categorized the banks as well capitalized under the
regulatory framework for prompt corrective actions. There are no conditions or
events since that notification that management believes have changed the
institutions' category.
Actual and required capital amounts and ratios are presented below.
Required for To Be Well
Actual Adequate Capital Capitalized
- ------------------------------------------------------------------------------------------------------------------
December 31, 2004 Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------
MainSource Financial Group
Total capital (to risk-weighted assets) $ 116,851 11.8% $ 79,061 8.0% N/A N/A
Tier 1 capital (to risk-weighted assets) 105,153 10.6 39,530 4.0 N/A N/A
Tier 1 capital (to average assets) 105,153 7.0 60,271 4.0 N/A N/A
MainSource Bank
Total capital (to risk-weighted assets) 76,178 11.8% 51,572 8.0% 64,465 10.0%
Tier 1 capital (to risk-weighted assets) 68,331 10.6 25,786 4.0 38,679 6.0
Tier 1 capital (to average assets) 68,331 7.3 37,410 4.0 46,762 5.0
Regional
Total capital (to risk-weighted assets) 19,699 11.6% 13,538 8.0% 16,922 10.0%
Tier 1 capital (to risk-weighted assets) 18,129 10.7 6,769 4.0 10,153 6.0
Tier 1 capital (to average assets) 18,129 7.1 10,253 4.0 12,816 5.0
MainSource Bank of Illinois
Total capital (to risk-weighted assets) 14,290 15.2% 7,531 8.0% 9,414 10.0%
Tier 1 capital (to risk-weighted assets) 13,463 14.3 3,765 4.0 5,648 6.0
Tier 1 capital (to average assets) 13,463 7.0 7,713 4.0 9,642 5.0
Peoples Trust Company
Total capital (to risk-weighted assets) 9,808 13.0% 6,020 8.0% 7,525 10.0%
Tier 1 capital (to risk-weighted assets) 8,867 11.8 3,010 4.0 4,515 6.0
Tier 1 capital (to average assets) 8,867 7.9 4,495 4.0 5,619 5.0
Required for To Be Well
Actual Adequate Capital Capitalized
- ------------------------------------------------------------------------------------------------------------------
December 31, 2003 Amount Ratio Amount Ratio Amount Ratio
- ------------------------------------------------------------------------------------------------------------------
MainSource Financial Group
Total capital (to risk-weighted assets) $ 103,223 11.3% $ 73,011 8.0% N/A N/A
Tier 1 capital (to risk-weighted assets) 83,753 9.2 36,505 4.0 N/A N/A
Tier 1 capital (to average assets) 83,753 6.0 55,914 4.0 N/A N/A
MainSource Bank (includes First Community)
Total capital (to risk-weighted assets) 76,979 11.7% 52,605 8.0% 65,756 10.0%
Tier 1 capital (to risk-weighted assets) 68,760 10.5 26,302 4.0 39,454 6.0
Tier 1 capital (to average assets) 68,760 7.3 37,873 4.0 47,341 5.0
Regional
Total capital (to risk-weighted assets) 17,991 11.2% 12,853 8.0% 16,066 10.0%
Tier 1 capital (to risk-weighted assets) 16,330 10.2 6,426 4.0 9,640 6.0
Tier 1 capital (to average assets) 16,330 6.7 9,710 4.0 12,137 5.0
MainSource Bank of Illinois
Total capital (to risk-weighted assets) 14,352 15.9% 7,233 8.0% 9,042 10.0%
Tier 1 capital (to risk-weighted assets) 13,418 14.8 3,617 4.0 5,425 6.0
Tier 1 capital (to average assets) 13,418 6.7 8,011 4.0 10,014 5.0
Note 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 contributions based on employee compensation.
Expense was $1,621 in 2004, $1,284 in 2003, and $1,138 in 2002.
Note 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 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, 2004 $ 9,592
Changes in composition of related parties 1,038
New loans, including renewals and advances 4,081
Payments, including renewals (4,864)
---------
Balances, December 31, 2004 $ 9,847
=========
Deposits from related parties held by the company at December 31, 2004 and 2003
totaled $4,462 and $5,980.
Note 23 - Stock Option Plans
Options to buy stock were granted to directors and officers of the Company under
the Company's Stock Option Plan, which was adopted in 2003 and provides for the
issue of up to 578,813 options. Exercise price is the market price at date of
grant, so there is no compensation expense recognized in the consolidated
statements of income. The maximum option term is ten years, and options vest
immediately for the directors' grant and over four years for the officers'
grant. The weighted average remaining contractual life is 8.8 years at December
31, 2004. A summary of the activity in the plan is as follows:
Year Ended December 31 2004 2003
------------------------ ------------------------
Weighted Weighted
Average Average
Options (restated for stock dividends and splits) Shares Exercise Price Shares Exercise Price
------ -------------- ------ --------------
Outstanding, beginning of year 57,054 $ 14.03 -- --
Granted 61,425 22.26 57,054 $ 14.03
Exercised or redeemed (1,654) 14.03 -- --
------- ------- ------ -------
Outstanding, end of year 116,825 $ 18.36 57,054 $ 14.03
Options exercisable at year end 39,371 $ 17.09 17,612 $ 14.03
Weighted average fair value of options
granted during the year $ 4.21 $ 2.15
Options outstanding at year-end 2004 were as follows.
Outstanding Exercisable
------------------------- -----------
Remaining
Exercise Contractual
Prices Number Life (years) Number
- ------ ------ ------------ ------
$14.03 55,400 8.3 24,723
$22.26 61,425 9.2 14,648
Total at year-end 116,825 39,371
Note 24 - Earnings Per Share
Earnings per share were computed as follows:
- --------------------------------------------------------------------------------------
Weighted
Net Average Per-Share
Year Ended December 31, 2004 Income Shares Amount
- --------------------------------------------------------------------------------------
Basic Earnings Per Share
Net income available to common shareholders $ 16,793 11,355,665 $ 1.48
Effect of dilutive stock options 16,329
--------------
Diluted Earnings Per Share
Net income available to common shareholders
and assumed conversions $ 16,793 11,371,994 $ 1.48
--------------------------------------
======================================================================================
Year Ended December 31, 2003
- --------------------------------------------------------------------------------------
Basic Earnings Per Share
Net income available to common shareholders $ 15,305 11,157,943 $ 1.37
Effect of dilutive stock options 3,290
--------------
Diluted Earnings Per Share
Net income available to common shareholders
and assumed conversions $ 15,305 11,161,233 $ 1.37
--------------------------------------
======================================================================================
Year Ended December 31, 2002
- --------------------------------------------------------------------------------------
Basic Earnings Per Share
Net income available to common shareholders $ 14,011 11,255,566 $ 1.24
Effect of dilutive stock options -
--------------
Diluted Earnings Per Share
Net income available to common shareholders
and assumed conversions $ 14,011 11,255,566 $ 1.24
--------------------------------------
- --------------------------------------------------------------------------------------
Stock options for 61,425 shares of common stock were not considered in computing
diluted earnings per common share for 2004 because they were antidilutive. All
stock options were dilutive in 2003 and there were no stock options granted in
2002.
Note 25 - Fair Values of Financial Instruments
December 31 2004 2003
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
Assets
Cash and cash equivalents $ 76,269 $ 76,269 $ 56,854 $ 56,854
Interest-bearing time deposits 304 304 201 201
Securities available for sale 425,443 425,443 422,111 422,111
Securities held to maturity 3,243 3,414 3,431 3,683
Loans including loans held for sale, net 918,131 913,866 845,927 865,266
Restricted stock 7,902 7,902 6,639 6,639
Interest receivable 7,123 7,123 6,938 6,938
Interest rate swap and cap 52 52 -- --
Liabilities
Deposits (1,226,367) (1,222,053) (1,191,310) (1,201,574)
Borrowings
Short-term (57,175) (57,175) (27,508) (27,508)
FHLB advances (90,981) (92,837) (62,751) (63,519)
Notes payable (9,100) (9,100) (12,500) (12,500)
Interest payable (2,391) (2,391) (3,192) (3,192)
Subordinated debentures (29,898) (29,898) (29,898) (29,898)
Interest rate swap and cap - - (195) (195)
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 subordinated debentures, 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 FHLB advances is based on current rates for similar financing. 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.
Note 26 - Quarterly Financial Data (Unaudited)
Earnings per Share
Interest Net Interest Net ----------------------
Income Income Income Basic Fully Diluted
------ ------ ------ ----- -------------
2004
First quarter $ 16,764 $ 11,472 $ 3,635 $ 0.33 $ 0.33
Second quarter 17,474 12,284 4,319 0.38 0.38
Third quarter 18,985 13,500 4,606 0.40 0.40
Fourth quarter 18,618 12,746 4,233 0.37 0.37
2003
First quarter $ 16,732 $ 10,714 $ 3,505 $ 0.32 $ 0.32
Second quarter 16,524 10,720 3,734 0.33 0.33
Third quarter 17,216 11,304 3,849 0.34 0.34
Fourth quarter 17,133 11,494 4,217 0.38 0.38
Note 27 - Parent Only Condensed Financial Statements
Parent Only Condensed Balance Sheets
December 31 2004 2003
----------------------
Assets
Cash and cash equivalents $ 1,787 $ 1,744
Investment securities available for sale 3,099 1,057
Investment in subsidiaries 157,320 142,945
Other assets 4,687 3,290
----------------------
Total assets $166,893 $149,036
======================
Liabilities
Subordinated debentures $ 29,898 $ 29,898
Notes payable 9,100 12,500
Short-term borrowings 3,000 --
Other liabilities 1,575 1,186
----------------------
Total liabilities 43,573 43,584
Shareholders' equity 123,320 105,452
----------------------
Total liabilities and shareholders' equity $166,893 $149,036
======================
Note 27 - Parent Only Condensed Financial Statements (continued)
Parent Only Condensed Statements of Income
Year Ended December 31 2004 2003 2002
------------------------------------
Income
Dividends from subsidiaries $ 17,850 $ 14,250 $ 18,261
Fees from subsidiaries 9,197 7,813 6,370
Other Income 95 207 170
------------------------------------
Total income 27,142 22,270 24,801
Expenses
Interest expense 1,993 1,898 2,172
Salaries and benefits 5,280 4,869 4,854
Professional fees 689 582 573
Other expenses 4,962 5,085 3,882
------------------------------------
Total expenses 12,924 12,434 11,481
------------------------------------
Income (loss) before income taxes and equity in undistributed
income of subsidiaries 14,218 9,836 13,320
Income tax expense (benefit) (1,588) (1,877) (1,995)
------------------------------------
Income (loss) before equity in undistributed income of subsidiaries 15,806 11,713 15,315
Equity in undistributed income of subsidiaries 987 3,592 (1,304)
------------------------------------
Net income $ 16,793 $ 15,305 $ 14,011
====================================
Note 27 - Parent Only Condensed Financial Statements (continued)
Condensed Statements of Cash Flows Parent Only
Year Ended December 31 2004 2003 2002
- ----------------------------------------------------------------------------------------------
Operating Activities
Net income $ 16,793 $ 15,305 $ 14,011
Undistributed income of subidiaries (987) (3,592) 1,304
Changes in other assets and liabilities 183 3,228 (291)
------------------------------------
Net cash provided by operating activities 15,989 14,941 15,024
Investing Activities
Capital contributed to subsidiary (1,300) (5,600) (4,348)
Cash paid for acquisition (4,662) (24,283) --
Purchases of equipment (948) (705) (1,720)
Proceeds from sales of securities available for sale 165 -- --
Purchase of securities available for sale (2,096) -- (208)
------------------------------------
Net cash used by investing activities (8,841) (30,588) (6,276)
Financing Activities
Payments on long-term debt (3,400) (2,900) (1,600)
Payments on subordinated debentures -- (23,119) --
Proceeds from issuance of subordinated debentures -- 21,650 8,248
Proceeds from issuance of long-term debt -- 13,000 --
Net change in short-term borrowings 3,000 -- --
Purchase of treasury shares (1,312) (1,497) (694)
Proceeds from exercise of stock options 28 -- --
Cash dividends and fractional shares (5,421) (4,874) (4,485)
------------------------------------
Net cash provided (used) by financing activities (7,105) 2,260 1,469
------------------------------------
Net change in cash and cash equivalents 43 (13,387) 10,217
Cash and cash equivalents, beginning of year 1,744 15,131 4,914
------------------------------------
Cash and cash equivalents, end of year $ 1,787 $ 1,744 $ 15,131
====================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- ------------------------------------------------------------------------
In connection with its audits for the three most recent fiscal years ended
December 31, 2004, there have been no disagreements with the Company's
independent certified public accountants on any matter of accounting principles
or practices, financial statement disclosure or auditing scope or procedure.
ITEM 9A. CONTROLS & PROCEDURES
- -------------------------------
Disclosure Controls and Procedures
As of the end of the 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-15(e) and 15d-15(e) 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 are, 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.
Internal Control Over Financial Reporting
1. Management's Annual Report on Internal Control Over Financial Reporting
The Company's management is responsible for establishing and maintaining
adequate internal control over financial reporting. The Company's internal
control over financial reporting is a process designed under the supervision of
the Company's Chief Executive Officer and Chief Financial Officer to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of the Company's financial statements for external purposes in
accordance with generally accepted accounting principles.
We are in the process of completing our evaluation and testing of internal
control over financial reporting as required by Section 404 of the
Sarbanes-Oxley Act of 2002 and Item 308(a) of Regulation S-K. In this Annual
Report on Form 10-K, we have not published our annual report on internal control
over financial reporting (Internal Control Report). We expect to complete our
evaluation for the year ended December 31, 2004, and publish our Internal
Control Report, prior to April 30, 2005. Based on testing completed to date,
utilizing criteria established in "Internal Control -- Integrated Framework"
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria), we and our registered public accounting firm, Crowe Chizek
(our "independent auditors"), have not identified any material weaknesses in the
Company's internal control over financial reporting.
2. Changes in Internal Control Over Financial Reporting
Our management has evaluated our internal control over financial reporting and
there were no changes in our internal control over financial reporting that
occurred during the most recent fiscal quarter that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.
ITEM 9B. OTHER INFORMATION
- ---------------------------
None
PART IV
ITEM 15--EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements.
Financial Statements filed as part of this Form 10-K are included under
Part II, Item 8, above.
(a) 2. Financial statement schedules
All schedules are omitted because they are not applicable or not
required, or because the required information is included in the consolidated
financial statements or related notes in Part II, Item 8 above.
(a) 3. Exhibits:
3.1 Restated Articles of Incorporation (incorporated by reference to
Exhibit 3.1 to the Annual Report on Form 10-K of the registrant for the fiscal
year ended December 31, 2003 filed March 12, 2004 with the Commission
(Commission File No. 0-12422)).
3.2 Amended and Restated Bylaws dated April 28, 1998 (incorporated by
reference to Exhibit 3.2 to the Annual Report on Form 10-K of the registrant for
the fiscal year ended December 31,1998 filed March 29, 1999 with the Commission
(Commission File No. 0-12422)).
4.1 Indenture dated as of December 19, 2002 between the Registrant, as
issuer, and State Street Bank and Trust Company of Connecticut, N.A., as
trustee, re: floating rate junior subordinated deferrable interest debentures
due 2032 (incorporated by reference to Exhibit 4.6 to the Annual Report on Form
10-K of the registrant for the fiscal year ended December 31, 2002 filed March
28, 2003 with the Commission (Commission File No. 0-12422)).
4.2 Amended and Restated Declaration of Trust dated as of December 19, 2002
among State Street Bank and Trust Company of Connecticut, N.A., as institutional
trustee, the Registrant, as sponsor, and James L. Saner Sr., Donald A. Benziger
and James M. Anderson, as administrators (incorporated by reference to Exhibit
4.7 to the Annual Report on Form 10-K of the registrant for the fiscal year
ended December 31, 2002 filed March 28, 2003 with the Commission (Commission
File No. 0-12422)).
4.3 Guarantee Agreement dated as of December 19, 2002 between the
Registrant, and State Street Bank and Trust Company of Connecticut, N.A
(incorporated by reference to Exhibit 4.8 to the Annual Report on Form 10-K of
the registrant for the fiscal year ended December 31, 2002 filed March 28, 2003
with the Commission (Commission File No. 0-12422)).
4.4 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 (incorporated by reference to Exhibit
4.1 to the Quarterly Report on Form 10-Q of the registrant for the quarter ended
June 30, 2003 filed August 14, 2003 with the Commission (Commission File No.
0-12422)).
4.5 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 (incorporated by reference to Exhibit 4.2 to
the Quarterly Report on Form 10-Q of the registrant for the quarter ended
June 30, 2003 filed August 14, 2003 with the Commission (Commission File
No. 0-12422)).
4.6 Guarantee Agreement dated as of April 1, 2003 between the Registrant,
and U.S. Bank, N.A (incorporated by reference to Exhibit 4.3 to the Quarterly
Report on Form 10-Q of the registrant for the quarter ended June 30, 2003 filed
August 14, 2003 with the Commission (Commission File No. 0-12422)).
4.7 Indenture dated as of June 12, 2003 between the Registrant, as issuer,
and The Bank of New York, as trustee, re: rate junior subordinated deferrable
interest debentures due (incorporated by reference to Exhibit 4.4 to the
Quarterly Report on Form 10-Q of the registrant for the quarter ended June 30,
2003 filed August 14, 2003 with the Commission (Commission File No. 0-12422)).
4.8 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 (incorporated by reference to Exhibit 4.5 to the Quarterly Report
on Form 10-Q of the registrant for the quarter ended June 30, 2003 filed August
14, 2003 with the Commission (Commission File No. 0-12422)).
4.9 Guarantee Agreement dated as of June 12, 2003 between the Registrant,
and The Bank of New York (incorporated by reference to Exhibit 4.6 to the
Quarterly Report on Form 10-Q of the registrant for the quarter ended June 30,
2003 filed August 14, 2003 with the Commission (Commission File No. 0-12422)).
10.1 Registrant's 2003 Stock Option Plan (incorporated by reference to
Exhibit 10.1 to the Annual Report on Form 10-K of the registrant for the fiscal
year ended December 31, 2003 filed March 12, 2004 with the Commission
(Commission File No. 0-12422)).*
10.2 Form of Stock Option Agreement Under 2003 Stock Option Plan for
Directors of Registrant dated May 19, 2003 (incorporated by reference to Exhibit
10.2 to the Annual Report on Form 10-K of the registrant for the fiscal year
ended December 31, 2003 filed March 12, 2004 with the Commission (Commission
File No. 0-12422)).*
10.3 Form of Stock Option Agreement Under 2003 Stock Option Plan for
Officers of Registrant (incorporated by reference to Exhibit 10.1 to the Report
on Form 8-K of the registrant filed February 24, 2005 with the Commission
(Commission File No. 0-12422)).*
10.4 Form of Executive Severance Agreement dated January 16, 2001
between the Registrant and James L. Saner, Sr. (incorporated by reference
to Exhibit 10.2 to the Annual Report on Form 10-K of the registrant for
the fiscal year ended December 31, 2000 filed March 30, 2001 with the
Commission (Commission File No. 0-12422)).*
10.5 Form of Executive Severance Agreement dated January 16, 2001 between
the Registrant and Donald A. Benziger (incorporated by reference to Exhibit 10.2
to the Annual Report on Form 10-K of the registrant for the fiscal year ended
December 31, 2000 filed March 30, 2001 with the Commission (Commission File No.
0-12422)).*
10.6 Form of Executive Severance Agreement dated January 16, 2001 between
the Registrant and John C. Parker (incorporated by reference to Exhibit 10.4 to
the Annual Report on Form 10-K of the registrant for the fiscal year ended
December 31, 2002 filed March 28, 2003 with the Commission (Commission File No.
0-12422)).*
10.7 Form of Indemnification Agreement for Directors and Certain Officers
of Registrant (incorporated by reference to Exhibit 10.1 to the Report on Form
8-K of the registrant filed February 24, 2005 with the Commission (Commission
File No. 0-12422)).
14 Code of Ethical Conduct (incorporated by reference to Exhibit 14 to the
Annual Report on Form 10-K of the registrant for the fiscal year ended December
31, 2003 filed March 12, 2004 with the Commission (Commission File No.
0-12422)).
21 List of subsidiaries of the Registrant.
23.1 Consent of Crowe Chizek and Company LLC
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
The following exhibits accompany this periodic report pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (the "2002 Act"). These exhibits shall be
deemed only to accompany this periodic report and 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 for any purpose other than compliance with the 2002 Act.
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
* A management contract or compensatory plan or agreement.
(b) Exhibits
Reference is made to Item 15(a)(3) above. There are no exhibits included in Item
15(a)(3) above that are filed concurrently with this report.
(c) Schedules
None required
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned; thereunto duly authorized, on the 16th day of March,
2005.
MAINSOURCE FINANCIAL GROUP, INC.
/s/ James L. Saner, Sr.
------------------------------
James L. Saner, Sr., President
And Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
on Form 10-K has been signed by the following persons on behalf of the
registrant and in the capacities with the Company and on the dates indicated.
Signature Capacity Date
--------- -------- ----
/s/ William G. Barron
- --------------------------------
William G. Barron Director March 16, 2005
/s/ Dale J. Deffner
- --------------------------------
Dale J. Deffner Director March 16, 2005
/s/ Douglas I. Kunkel
- --------------------------------
Douglas I. Kunkel Director March 16, 2005
/s/ Philip A. Frantz
- --------------------------------
Philip A. Frantz Director March 16, 2005
/s/ Rick S. Hartman
- --------------------------------
Rick S. Hartman Director March 16, 2005
/s/ Robert E. Hoptry
- --------------------------------
Robert E. Hoptry Director March 16, 2005
Chairman of the
Board
/s/ James M. Anderson
- --------------------------------
James M. Anderson Controller & March 16, 2005
Principal
Accounting Officer
/s/ Donald A. Benziger
- --------------------------------
Donald A. Benziger Senior Vice March 16, 2005
President &
Chief Financial
Officer
/s/ James L. Saner, Sr.
- --------------------------------
James L. Saner, Sr. Director March 16, 2005
President & Chief
Executive Officer