FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED JUNE 30, 2005
COMMISSION FILE NUMBER 0-12422
MAINSOURCE FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
INDIANA 35-1562245
------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
201 NORTH BROADWAY GREENSBURG, INDIANA 47240
------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(812) 663-0157
--------------
(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year, if
changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Act) Yes X No
--- ---
As of August 5, 2005 there were outstanding 13,471,128 shares of common
stock, without par value of the registrant.
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
INDEX
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PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and Comprehensive Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial 10
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits 20
Signatures 23
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands except per share data)
(Unaudited)
June 30, December 31,
2005 2004
----------- -----------
Assets
Cash and due from banks $ 59,254 $ 71,607
Money market and federal funds sold 4,932 4,662
----------- -----------
Cash and cash equivalents 64,186 76,269
Interest bearing time deposits -- 304
Investment securities
Available for sale 443,408 425,443
Held to maturity (fair value of $3,117 and $3,414) 2,992 3,243
----------- -----------
Total investment securities 446,400 428,686
Loans held for sale 2,066 824
Loans, net of allowance for loan losses of $11,275 and $11,698 902,051 917,307
Restricted stock, at cost 8,080 7,902
Premises and equipment, net 25,369 25,766
Goodwill 39,311 40,642
Purchased intangible assets 5,839 6,429
Cash surrender value of life insurance 24,922 24,776
Interest receivable and other assets 22,088 20,474
----------- -----------
Total assets $ 1,540,312 $ 1,549,379
=========== ===========
Liabilities
Deposits
Noninterest bearing $ 146,398 $ 145,999
Interest bearing 1,104,036 1,080,368
----------- -----------
Total deposits 1,250,434 1,226,367
Short-term borrowings 17,692 57,175
Federal Home Loan Bank (FHLB) advances 75,718 90,981
Subordinated debentures 29,898 29,898
Notes payable -- 9,100
Other liabilities 11,597 12,538
----------- -----------
Total liabilities 1,385,339 1,426,059
----------- -----------
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 - 13,494,549 and 11,196,357
Outstanding shares - 13,210,268 and 10,985,121 6,750 5,600
Common stock to be distributed, 0 and 559,818 shares -- 280
Treasury stock - 284,281 and 211,236, at cost (4,860) (3,479)
Additional paid-in capital 101,055 73,451
Retained earnings 52,496 47,371
Accumulated other comprehensive income (468) 97
----------- -----------
Total shareholders' equity 154,973 123,320
----------- -----------
Total liabilities and shareholders' equity $ 1,540,312 $ 1,549,379
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
3
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(UNAUDITED)
Three months ended Six months ended
June 30, June 30,
(Dollar amounts in thousands except per share data) 2005 2004 2005 2004
-------------------- --------------------
Interest income
Loans, including fees $ 15,208 $ 13,641 $ 29,799 $ 26,931
Investment securities 4,307 3,805 8,333 7,259
Other interest income 18 28 94 48
-------------------- --------------------
Total interest income 19,533 17,474 38,226 34,238
-------------------- --------------------
Interest expense
Deposits 4,554 3,902 8,863 7,908
Subordinated debentures 472 409 930 822
Other borrowings 1,322 879 2,543 1,752
-------------------- --------------------
Total interest expense 6,348 5,190 12,336 10,482
-------------------- --------------------
Net interest income 13,185 12,284 25,890 23,756
Provision for loan losses 340 60 460 60
-------------------- --------------------
Net interest income after
provision for loan losses 12,845 12,224 25,430 23,696
Non-interest income
Insurance commissions 523 691 1,110 1,389
Mortgage banking 679 919 1,225 1,718
Trust and investment product fees 284 225 564 442
Service charges on deposit accounts 1,805 1,720 3,471 3,258
Net realized gains on securities 213 437 224 773
Gain on cash surrender of life insurance 291 264 441 512
Interchange income 473 460 963 868
Other income 571 546 1,420 949
-------------------- --------------------
Total non-interest income 4,839 5,262 9,418 9,909
-------------------- --------------------
Non-interest expense
Salaries and employee benefits 6,886 6,639 13,762 13,080
Net occupancy expenses 824 762 1,723 1,520
Equipment expenses 985 932 2,015 1,864
Intangibles amortization 295 232 590 466
Telecommunications 409 424 799 764
Stationery printing and supplies 236 250 414 469
Other expenses 2,228 2,457 4,654 4,497
-------------------- --------------------
Total non-interest expense 11,863 11,696 23,957 22,660
-------------------- --------------------
Income before income tax 5,821 5,790 10,891 10,945
Income tax expense 1,495 1,471 2,775 2,991
-------------------- --------------------
Net income $ 4,326 $ 4,319 $ 8,116 $ 7,954
==================== ====================
Comprehensive income (loss) $ 6,742 $ (1,346) $ 7,625 $ 3,475
==================== ====================
Cash dividends declared per share $ 0.13 $ 0.12 $ 0.26 $ 0.23
Net income per share - basic $ 0.37 $ 0.39 $ 0.70 $ 0.71
Net income per share - diluted $ 0.37 $ 0.38 $ 0.70 $ 0.71
The accompanying notes are an integral part of these consolidated financial
statements.
4
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOW
(Dollars in thousands)
(UNAUDITED)
Six months ended
June 30,
2005 2004
--------- ---------
Operating Activities
Net income $ 8,116 $ 7,954
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 460 60
Depreciation and amortization 1,561 1,263
Securities amortization, net 806 1,405
Amortization of core deposit intangibles 590 466
Increase in cash surrender value of life insurance policies (441) (296)
Gain on life insurance benefit (85) --
Investment securities gains (224) (773)
Change in loans held for sale (1,242) (210)
Change in other assets and liabilities (2,255) 845
--------- ---------
Net cash provided by operating activities 7,286 10,714
Investing Activities
Net change in short-term investments 304 --
Proceeds from maturities and payments
on securities held to maturity 277 137
Purchases of securities available for sale (104,924) (98,478)
Proceeds from maturities and payments
on securities available for sale 60,310 53,363
Proceeds from sales of securities available for sale 24,929 49,955
Purchases of restricted stock -- (504)
Proceeds from life insurance benefit 400
Loan originations and payments, net 14,796 (8,678)
Purchases of premises and equipment (1,164) (800)
Cash paid for bank acquisitions, net -- (135)
--------- ---------
Net cash provided (used) by investing activities (5,072) (5,140)
Financing Activities
Net change in deposits 24,067 (73,030)
Net change in short-term borrowings (39,483) 39,821
Repayment of long-term debt (9,100) (2,100)
Proceeds from FHLB advances 68,000 40,000
Repayment of FHLB advances (83,263) (6,045)
Proceeds from stock issue 28,490 --
Purchase of treasury shares (27) (982)
Cash dividends and fractional stock dividends (3,009) (2,629)
Proceeds from exercise of stock options 28 28
--------- ---------
Net cash provided (used) by financing activities (14,297) (4,937)
--------- ---------
Net change in cash and cash equivalents (12,083) 637
Cash and cash equivalents, beginning of year 76,269 56,854
--------- ---------
Cash and cash equivalents, end of year $ 64,186 $ 57,491
========= =========
See Note 3 regarding non-cash transaction included in acquisitions. The
accompanying notes are an integral part of these consolidated financial
statements.
5
NOTE 1 - BASIS OF PRESENTATION
The significant accounting policies followed by MainSource Financial Group, Inc.
("Company") for interim financial reporting are consistent with the accounting
policies followed for annual financial reporting. The consolidated interim
financial statements have been prepared according to accounting principles
generally accepted in the United States of America and in accordance with the
instructions for Form 10-Q. The interim statements do not include all
information and footnotes normally included in the annual financial statements.
All adjustments which are, in the opinion of management, necessary for a fair
presentation of the results for the periods reported have been included in the
accompanying unaudited consolidated financial statements and all such
adjustments are of a normal recurring nature. Some items in prior period
financial statements were reclassified to conform to current presentation.
6
NOTE 2 - STOCK COMPENSATION
Employee compensation expense 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.
For the three months ended For the six months ended
------------------------------- --------------------------------
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
------------- ------------- ------------- -------------
Net income as reported $4,326 $4,319 $8,116 $7,954
Deduct: Stock-based compensation expense
determined under fair value based method 39 20 80 51
------ ------ ------ ------
Pro forma net income $4,287 $4,299 $8,036 $7,903
Basic earnings per share as reported $0.37 $0.39 $0.70 $0.71
Pro forma basic earnings per share $0.37 $0.38 $0.69 $0.71
Diluted earnings per share as reported $0.37 $0.38 $0.70 $0.71
Pro forma diluted earnings per share $0.36 $0.38 $0.69 $0.71
The pro forma effects are computed using option pricing models, with the
following weighted-average assumptions for 2005 as of grant date: risk-free
interest rate 4.07%, expected option life 6.82 years, expected stock price
volatility 21.66% and dividend yield 2.50%. For 2004, the following weighted-
average assumptions were used as of grant date: risk-free interest rate 3.48%,
expected option life 6.69 years, expected stock price volatility 20.33% and
dividend yield 2.75%.
NOTE 3 - ACQUISITIONS
In June 2004, the Company consummated its acquisition of Peoples Financial Corp
("PFC"). At the date of acquisition, PFC had seven branches located in the
southwestern part of Indiana. The acquired company had $4,320 of cash and cash
equivalents, $81,371 of net loans, and $99,717 of deposits. A core deposit
intangible of $2,141 and goodwill of $4,595 were also recorded. The results of
operations for this acquisition have been included since the transaction date
which was June 8, 2004. The Company funded the purchase price of $13,588 by
issuing 471,685 shares of its common stock valued at $18.92 per share per the
NASDAQ closing bid on June 7, 2004 and using $4,454 of cash on hand.
In March 2005, the Company executed a definitive agreement to acquire The
Madison Bank & Trust Company ("Madison"). Madison, which has approximately
$180,000 in assets, operates a total of five offices with four in Jefferson
County, Indiana and one in Ohio County, Indiana. The transaction is expected to
close in the third quarter of 2005.
In March 2005, the Company disposed of the Kentucky division of MainSource
Insurance to its previous owners. The consideration received by the Company
totaled shares of the Company's common stock with an approximate value of
$1,380.
7
NOTE 4 - SECURITIES
The fair value of securities available for sale and related unrealized
gains/losses recognized in accumulated other comprehensive income (loss) were as
follows:
Gross Gross
Fair Unrealized Unrealized
As of June 30, 2005 Value Gains Losses
- --------------------------------------------------------------------------------------------
Available for Sale
Federal agencies $ 66,185 $ 74 $ (706)
State and municipal 105,669 $1,540 (548)
Mortgage-backed securities 256,726 $599 (2,371)
Equity and other securities 14,828 $477 (2)
- --------------------------------------------------------------------------------------------
Total available for sale $443,408 $2,690 ($3,627)
- --------------------------------------------------------------------------------------------
As of December 31, 2004
- --------------------------------------------------------------------------------------------
Available for Sale
Federal agencies $ 56,557 $ 152 ($388)
State and municipal 88,338 1,546 (583)
Mortgage-backed securities 262,690 1,005 (1,924)
Equity and other securities 17,858 427 (60)
- --------------------------------------------------------------------------------------------
Total available for sale $425,443 $3,130 ($2,955)
- --------------------------------------------------------------------------------------------
The carrying amount, unrecognized gains and losses, and fair value of securities
held to maturity were as follows:
Gross Gross
Carrying Unrecognized Unrecognized Fair
As of June 30, 2005 Amount Gains Losses Value
- -----------------------------------------------------------------------------------------------------------
Held to Maturity
State and municipal $2,160 $ 52 $- $2,212
Other securities 832 73 - 905
- -----------------------------------------------------------------------------------------------------------
Total held to maturity $2,992 $125 $- $3,117
- -----------------------------------------------------------------------------------------------------------
As of December 31, 2004
- -----------------------------------------------------------------------------------------------------------
Held to Maturity
State and municipal $2,439 $ 74 $- $2,513
Other securities 804 97 - 901
- -----------------------------------------------------------------------------------------------------------
Total held to maturity $3,243 $171 $- $3,414
- -----------------------------------------------------------------------------------------------------------
NOTE 5 - LOANS AND ALLOWANCE
June 30, December 31,
2005 2004
- -----------------------------------------------------------------------------------------------
Commercial and industrial loans $ 159,777 $ 154,717
Agricultural production financing 28,449 22,647
Farm real estate 37,358 38,281
Commercial real estate 133,475 133,360
Hotel 57,796 80,234
Residential real estate 344,083 353,515
Construction and development 38,214 37,821
Consumer 114,174 108,430
----------------------------------
Total loans 913,326 929,005
----------------------------------
Allowance for loan losses (11,275) (11,698)
- -----------------------------------------------------------------------------------------------
Net loans $ 902,051 $ 917,307
- -----------------------------------------------------------------------------------------------
Activity in the allowance for loan losses was as follows:
- -----------------------------------------------------------------
2005 2004
- -----------------------------------------------------------------
Allowance for loan losses
- -----------------------------------------------------------------
Balances, January 1 $ 11,698 $ 11,509
Addition resulting from acquisition - 1,775
Provision for losses 460 60
Recoveries on loans 117 201
Loans charged off (1,000) (1,291)
- -----------------------------------------------------------------
Balances, June 30 $ 11,275 $ 12,254
- -----------------------------------------------------------------
8
NOTE 6 - DEPOSITS June 30, December 31,
2005 2004
------------- -------------
Non-interest-bearing demand $ 146,398 $ 145,999
Interest-bearing demand 357,692 310,306
Savings 303,703 304,230
Certificates of deposit of $100 or more 116,021 117,361
Other certificates and time deposits 326,620 348,471
------------- -------------
Total deposits $ 1,250,434 $ 1,226,367
============= =============
NOTE 7 - EARNINGS PER SHARE
Earnings per share (EPS) were computed as follows:
For the three months ended June 30, 2005 June 30, 2004
---------------------------------------- ----------------------------------------
Weighted Per Weighted Per
Net Average Share Net Average Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic earnings per share:
Income available to
common shareholders $ 4,326 11,738,688 $ 0.37 $ 4,319 11,215,135 $ 0.39
---------- -------- ---------- --------
Effect of dilutive shares 13,143 15,292
---------- ----------
Diluted earnings per share $ 4,326 11,751,831 $ 0.37 $ 4,319 11,230,427 $ 0.38
========== ========== ======== ========== ========== ========
For the six months ended June 30, 2005 June 30, 2004
---------------------------------------- ----------------------------------------
Weighted Per Weighted Per
Net Average Share Net Average Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic earnings per share:
Income available to
common shareholders $ 8,116 11,633,685 $ 0.70 $ 7,954 11,165,867 $ 0.71
---------- -------- ---------- --------
Effect of dilutive shares 15,853 16,854
---------- ----------
Diluted earnings per share $ 8,116 11,649,538 $ 0.70 $ 7,954 11,182,721 $ 0.71
========== ========== ======== ========== ========== ========
Stock options for 128,425 shares of common stock were not considered in
computing diluted earnings per common share for the three months and six months
ending June 30, 2005 because they were antidilutive.
NOTE 8 - SUBSEQUENT EVENT.
On July 8, 2005, the Company sold an additional 260,860 shares of its common
stock to the public pursuant to the overallotment option in its public offering
that closed during the second quarter. Including this additional sale, the net
proceeds of the offering were approximately $32,900, before expenses. The
majority of the proceeds will be used in connection with the Company's purchase
of The Madison Bank and Trust Company, which is anticipated to be completed in
the third quarter of 2005.
9
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Overview
MainSource Financial Group, Inc. ("Company") is a multi-bank, financial holding
company that provides an array of financial services and is headquartered in
Greensburg, Indiana. The Company's shares trade on the NASDAQ national market
under the symbol MSFG. On June 30, 2005, the Company controlled three bank
subsidiaries, MainSource Bank, MainSource Bank of Illinois, and Peoples Trust
Company ("Peoples"). In addition to the banking subsidiaries, the Company owned
the following subsidiaries: MainSource Insurance, LLC, MainSource Statutory
Trust I, MainSource Statutory Trust II, MainSource Statutory Trust III, IUB
Reinsurance Company, Ltd., MSB Investments of Nevada, Inc., MainSource Title,
LLC, and MainSource Mortgage, LLC. As required by current accounting guidance,
the trusts are no longer consolidated with the Company. Accordingly, the Company
does not report the securities issued by the trusts as liabilities, and instead
reports as liabilities the subordinated debentures issued by the Company. During
the first quarter of 2005, the Company sold the Kentucky division of MainSource
Insurance at its approximate book value.
In June 2005, the Company completed a public offering of approximately 1.7
million shares of its common stock at a price to the public of $17.50 per share,
resulting in net proceeds of approximately $28,609 before expenses. On July 8,
2005, the Company sold 260,860 additional shares pursuant to the overallotment
option on the public offering, resulting in additional net proceeds of
approximately $4,291.
The Company continues to actively pursue various acquisition opportunities, and
we expect to continue to review such opportunities in the future, including
branches, whole banks, and other financial service providers.
Forward-Looking Statements
Except for historical information contained herein, the discussion in this Form
10-Q quarterly report includes certain forward-looking statements based upon
management expectations. Factors which could cause future results to differ from
these expectations include the following: an inability to find suitable
acquisition candidates, or unexpected losses or expenses from acquisitions; loss
of key management personnel; general economic conditions;legislative and
regulatory initiatives; monetary and fiscal policies of the federal government;
deposit flows; the costs of funds; general market rates of interest; interest
rates on competing investments; demand for loan products; demand for financial
services; changes in accounting policies or guidelines; and changes in the
quality or composition of the Company's loan and investment portfolios.
The forward-looking statements included in the Management's Discussion and
Analysis ("MD&A") relating to certain matters involve risks and uncertainties,
including anticipated financial performance, business prospects, and other
similar matters, which reflect management's best judgment based on factors
currently known. Actual results and experience could differ materially from the
anticipated results or other expectations expressed in the Company's forward-
looking statements as a result of a number of factors, including but not limited
to those discussed in the MD&A and in the Company's other public filings.
Results of Operations
Net income for the second quarter of 2005 was $4,326 compared to $4,319 for the
second quarter of 2004. Diluted earnings per share for the second quarter
totaled $0.37 in 2005, which was a 2.6% decrease compared to the $0.38 per share
reported in the second quarter of 2004. In June 2005, the Company completed a
public offering of approximately 1.7 million shares of common stock. As
previously announced, the majority of the proceeds from this offering and the
subsequent sale in July 2005 of shares pursuant to the overallotment option,
will be used in the acquisition of The Madison Bank and Trust Company, which is
expected to close in the third quarter of 2005. Excluding the effect of the
additional shares issued in the offering, the Company's earnings per share would
have been $0.38. For the six months ended June 30, 2005, the Company reported
earnings per share of $0.70, which represents a 1.4% decrease compared to the
$0.71 reported for the same period a year ago.
10
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Net Interest Income
The volume and yield of earning assets and interest-bearing liabilities
influence net interest income. Net interest income reflects the mix of interest-
bearing and non-interest-bearing liabilities that fund earning assets, as well
as interest spreads between the rates earned on these assets and the rates paid
on interest-bearing liabilities. Second quarter net interest income of $13,185
in 2005 was an increase of 7.3% versus the second quarter of 2004. Average
earning assets increased 4.6% while net interest margin, on a fully-taxable
equivalent basis, was 4.04% for the second quarter of 2005 compared to 3.85% for
the same period a year ago. For the six months ended June 30, 2005, the
Company's net interest margin was 3.95% versus 3.72% a year ago. The increase in
the Company's net interest margin was primarily attributable to an increase in
the Company's yield on earning assets. The Company's cost of funds also
increased, but to a lesser extent.
Provision for Loan Losses
See "Loans, Credit Risk and the Allowance and Provision for Probable Loan
Losses" below.
Non-interest Income
Second quarter non-interest income for 2005 was $4,839 compared to $5,262 for
the second quarter of 2004. This decrease was primarily attributable to a
decrease in mortgage banking income, lower insurance commissions and a lower
level of securities gains. Mortgage banking income, which consists of gains and
losses on loan sales and service fee income, was $679 for the second quarter of
2005 versus $919 for the second quarter of 2004. This decrease was primarily due
to lower refinancing activity versus the prior year. Insurance commissions
decreased due to the aforementioned sale of the Kentucky division of MainSource
Insurance during the quarter. Partially offsetting these decreases was an
increase in service charges on deposit accounts and increases resulting from the
acquisition of Peoples Trust Company in June 2004.
For the six months ended June 30, 2005, non-interest income was $9,418 compared
to $9,909 for the same period a year ago. The 5.0% decrease was primarily
attributable to the decrease in mortgage banking income and lower gains on sales
of investment securities.
11
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Non-interest expense
Total non-interest expense was $11,863 for the second quarter of 2005, which
represented an increase of 1.4% from the second quarter of 2004. Normal
increases in staffing costs and staff increases associated with the acquisition
of Peoples Trust Company in June 2004 were partially offset by the cost savings
related to the consolidation of the Indiana bank charters and the disposal of
the Kentucky division of the Company's insurance subsidiary.
Income Taxes
The effective tax rate for the first six months was 25.5% for 2005 compared to
27.3% for the same period a year ago. The decrease in the Company's effective
tax rate was primarily attributable to increased income from tax-free municipal
securities. The Company and its subsidiaries file consolidated income tax
returns.
12
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Financial Condition
Total assets at June 30, 2005 were $1,540,386 compared to $1,549,379 as of
December 31, 2004. Average earning assets represented 90.2% of average total
assets for the first six months of 2005 and 90.3% for the same period in 2004.
Average loans represented 76.2% of average deposits in the first six months of
2005 and 74.0% for the comparable period in 2004. Management continues to
emphasize quality loan growth to increase these averages. Average loans as a
percent of average assets were 60.4% and 60.1% for the six-month period ended
June 30, 2005 and 2004 respectively.
The increase in deposits of $24,067 from December 31, 2004 to June 30, 2005 was
due primarily to the seasonal fluctuation of public fund deposits.
Shareholders' equity was $154,973 on June 30, 2005 compared to $123,320 on
December 31, 2004. Book value (shareholders' equity) per common share was $11.74
at June 30, 2005 versus $10.68 at year-end 2004. Accumulated other comprehensive
income decreased book value per share by $0.04 at June 30, 2005 and increased
book value per share $0.01 at December 31, 2004. Depending on market conditions,
the unrealized gain or loss on securities available for sale can cause
fluctuations in shareholders' equity.
Loans, Credit Risk and the Allowance and Provision for Probable Loan Losses
Loans remain the Company's largest concentration of assets and, by their nature,
carry a higher degree of risk. The loan underwriting standards observed by the
Company's subsidiaries are viewed by management as a means of controlling
problem loans and the resulting charge-offs.
The Company believes credit risks may be elevated if undue concentrations of
loans in specific industry segments and to out-of-area borrowers are incurred.
Accordingly, the Company's Board of Directors regularly monitors such
concentrations to determine compliance with its loan allocation policy. The
Company believes it has no undue concentrations of loans.
13
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Residential real estate loans continue to represent a significant portion of the
total loan portfolio. Such loans represented 37.7% of total loans at June 30,
2005 and 38.1% at December 31, 2004.
On June 30, 2005, the Company had $2,066 of residential real estate loans held
for sale, which was an increase from the year-end balance of $824. The Company
generally retains the servicing rights on mortgages sold.
Non-performing assets totaled $14,326, or 0.93% of total assets, as of June 30,
2005, compared to $17,548, or 1.18% of total assets, as of March 31, 2005, and
$15,732, or 1.02% of assets at year-end 2004. The allowance for loan losses was
$11,275 as of June 30, 2005 and represented 1.23% of total outstanding loans
compared to $11,698 as of December 31, 2004 or 1.26% of total outstanding loans.
This decrease in the allowance as a percent of total outstanding loans was
primarily attributable to the decrease in identified problem credits.
The provision for loan losses was $340 in the second quarter of 2005 compared to
$60 for the same period in 2004. The increase in the provision in 2005 was
primarily attributable to the increase in the balance of non-performing loans
versus the prior year and the corresponding increase in specific allowance
allocations for these loans. The adequacy of the allowance for loan losses in
each subsidiary is reviewed at least quarterly. The determination of the
provision amount in any period is based on management's continuing review and
evaluation of loan loss experience, changes in the composition of the loan
portfolio, current economic conditions, the amount of loans presently
outstanding, and information about specific borrower situations. The allowance
for loan losses as of June 30, 2005 was considered adequate by management.
Investment Securities
Investment securities offer flexibility in the Company's management of interest
rate risk, and are an important source of liquidity as a response to changing
characteristics of assets and
14
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
liabilities. The Company's investment policy prohibits trading activities and
does not allow investment in high-risk derivative products, junk bonds or
foreign investments.
As of June 30, 2005, $443,408 of investment securities were classified as
"available for sale" ("AFS") and were carried at fair value with unrealized
gains and losses, net of taxes, reported as a separate component of
shareholders' equity. An unrealized pre-tax loss of $937 was recorded to adjust
the AFS portfolio to current market value at June 30, 2005, compared to an
unrealized pre-tax gain of $175 at December 31, 2004. Unrealized losses on AFS
securities have not been recognized into income because management has the
intent and ability to hold these securities for the foreseeable future and the
decline in fair value is largely due to increases in market interest rates. The
fair value is expected to recover as the securities approach their maturity
dates.
Sources of Funds
The Company relies primarily on customer deposits, securities sold under
agreement to repurchase and shareholders' equity to fund earning assets. FHLB
advances are also used to provide additional funding.
Deposits generated within local markets provide the major source of funding for
earning assets. Average total deposits funded 88.0% and 89.9% of total average
earning assets for the periods ending June 30, 2005 and 2004. Total interest-
bearing deposits averaged 88.5% and 89.6% of average total deposits for the
periods ending June 30, 2005 and 2004, respectively. Management constantly
strives to increase the percentage of transaction-related deposits to total
deposits due to the positive effect on earnings.
The Company had FHLB advances of $75,718 outstanding at June 30, 2005. These
advances have interest rates ranging from 2.36% to 6.58%. Approximately $30,000
of these advances were obtained for short-term liquidity needs and had original
maturities of six months or less. The remaining advances were originally
long-term advances with approximately $5,000 maturing in 2005, $15,000 maturing
in 2007, $5,000 maturing in 2010 and $20,000 maturing in 2012.
Capital Resources
Total shareholders' equity was $154,973 at June 30, 2005, which was an increase
of $31,653 compared to the $123,320 of shareholders' equity at December 31,
2004. In June 2005, the Company completed a public offering of approximately 1.7
million shares of common stock. The net proceeds from the offering were $28,490,
net of the underwriting discount and expenses. Subsequent to the end of the
quarter, the Company sold additional shares of common stock pursuant to the
overallotment option granted in the offering, raising additional net proceeds of
approximately $4,291.
The Federal Reserve Board and other regulatory agencies have adopted risk-based
capital guidelines that assign risk weightings to assets and off-balance sheet
items. The Company's core capital consists of shareholders' equity, excluding
accumulated other comprehensive income, while Tier 1 capital consists of core
capital less goodwill and intangibles. Trust preferred securities qualify as
Tier 1 capital or core capital with respect to the Company under the risk-based
capital guidelines established by the Federal Reserve. Under such guidelines,
capital received from the proceeds of the sale of trust preferred securities
cannot constitute more than 25% of the total core capital of the Company.
Consequently, the amount of trust preferred securities in excess of the 25%
limitation constitutes Tier 2 capital of the Company. Total regulatory capital
consists of Tier 1, certain debt instruments and a portion of the allowance for
loan losses. At June 30, 2005, Tier 1 capital to total average assets was 9.30%.
Tier 1
15
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
capital to risk-adjusted assets was 14.06%. Total capital to risk-adjusted
assets was 15.20%. All three ratios exceed all required ratios established for
bank holding companies. Risk-adjusted capital levels of the Company's subsidiary
banks exceed regulatory definitions of well-capitalized institutions.
The Company declared and paid common dividends of $0.13 per share in the second
quarter of 2005 versus $0.12 for the second quarter of 2004. For the six months
ended June 30, 2005, the Company declared and paid common dividends of $0.26
per share compared to $0.23 for the same period a year ago.
Liquidity
Liquidity management involves maintaining sufficient cash levels to fund
operations and to meet the requirements of borrowers, depositors, and creditors.
Higher levels of liquidity bear higher corresponding costs, measured in terms of
lower yields on short-term, more liquid earning assets, and higher interest
expense involved in extending liability maturities. Liquid assets include cash
and cash equivalents, loans and securities maturing within one year, and money
market instruments. In addition, the Company holds AFS securities maturing after
one year, which can be sold to meet liquidity needs.
Maintaining a relatively stable funding base, which is achieved by diversifying
funding sources and extending the contractual maturity of liabilities, supports
liquidity and limits reliance on volatile short-term purchased funds. Short-term
funding needs arise from declines in deposits or other funding sources, funding
of loan commitments and requests for new loans. The Company's strategy is to
fund assets to the maximum extent possible with core deposits that provide a
sizable source of relatively stable and low-cost funds. Average core deposits
funded approximately 78.7% of total earning assets for the six months ended June
30, 2005 and 79.0% for the same period in 2004.
Management believes the Company has sufficient liquidity to meet all reasonable
borrower, depositor, and creditor needs in the present economic environment. In
addition, the Company's affiliates have access to the Federal Home Loan Bank for
borrowing purposes. The Company has not received any recommendations from
regulatory authorities that would materially affect liquidity, capital resources
or operations.
Interest Rate Risk
Asset/liability management strategies are developed by the Company to manage
market risk. Market risk is the risk of loss in financial instruments including
investments, loans, deposits and borrowings arising from adverse changes in
prices/rates. Interest rate risk is the Company's primary market risk exposure,
and represents the sensitivity of earnings to changes in market interest rates.
Effective asset/liability management requires the maintenance of a proper ratio
between maturing or repriceable interest-earning assets and interest-bearing
liabilities. It is the policy of the Company that the cumulative gap divided by
total assets must be not greater than plus or minus 20% at the 3-month, 6-month,
and 1-year time horizons.
16
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
At June 30, 2005, the Company held $665,822 million in assets comprised of
securities, loans, short-term investments, and federal funds sold, which were
interest sensitive in one year or less time horizons.
17
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk of the Company encompasses exposure to both liquidity and interest
rate risk and is reviewed monthly by the Asset/Liability Committee and the Board
of Directors. There have been no material changes in the quantitative and
qualitative disclosures about market risks as of June 30, 2005 from the analysis
and disclosures provided in the Company's Annual Report on Form 10-K for the
year ended December 31, 2004.
18
Item 4. Controls and Procedures
As of the end of the quarterly period covered by this report, an evaluation was
carried out under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the Company's disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities
Exchange Act of 1934 ("Exchange Act")). Based on their evaluation, the Company's
Chief Executive Officer and Chief Financial Officer have concluded that the
Company's disclosure controls and procedures were, to the best of their
knowledge, effective to ensure that information required to be disclosed by the
Company in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms as of such date.
There was no change in the Company's internal control over financial reporting
that occurred during the Company's second fiscal quarter of 2005 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
19
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of shareholder of the Company was held on May 25,
2005.
(b) The sole matter voted upon at the meeting and the votes cast with
respect to such matter are as follows:
Proposals and Vote Tabulations
Votes Cast
Election of Directors
---------------------------
Director For Withheld
- -------- ---------------------------
William G. Barron 10,428,305 107,511
Brian J. Crall 10,470,863 64,953
Philip A. Frantz 10,368,112 167,704
Rick S. Hartman 10,359,763 176,053
D.J. Hines 10,471,266 64,550
Robert E. Hoptry 10,465,296 70,520
Douglas I. Kunkel 10,402,630 133,187
James L. Saner, Sr. 10,475,721 60,095
Item 6. Exhibits
2.1 Agreement and Plan of Merger dated as of March 10, 2005, among the
Registrant, MainSource Bank, National City Corporation and The Madison
Bank & Trust Company (incorporated by reference to Exhibit 2.1 to the
Quarterly Report on Form 10-Q of the registrant for the quarter ended
March 31, 2005, filed May 9, 2005 with the commission (Commission File
0-12422)).
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)).
20
31.1 Certification pursuant to Rule 13a-14(a)/15d-14(a) by Chief Executive
Officer
31.2 Certification pursuant to Rule 13a-14(a)/15d-14(a) by Chief Financial
Officer
The following exhibits shall not be deemed filed for purposes of
Section 18 of the Securities Exchange Act of 1934, and are not incorporated by
reference into any filing under the Securities Act or the Exchange Act, except
to the extent the Company specifically incorporates them by reference.
32.1 Certification pursuant to Section 1350 by Chief Executive Officer
32.2 Certification pursuant to Section 1350 by Chief Financial Officer
21
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MAINSOURCE FINANCIAL GROUP, INC.
August 8, 2005
/s/ James L. Saner, Sr.
-------------------------------------------------
James L. Saner Sr.
President and Chief Executive Officer
August 8, 2005
/s/ Donald A. Benziger
-------------------------------------------------
Donald A. Benziger
Senior Vice President & Chief Financial Officer
August 8, 2005
/s/ James M. Anderson
-------------------------------------------------
James M. Anderson
Administrative Vice President & Principal Accounting Officer
23