FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED SEPTEMBER 30, 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 Exchange Act). Yes X No
--- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
As of November 8, 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
- ------------------------------------------------------------------------------
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 13
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
Item 4. Controls and Procedures 21
PART II. OTHER INFORMATION
Item 6. Exhibits 22
Signatures 24
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands except per share data)
(Unaudited)
September 30, December 31,
2005 2004
--------------- ---------------
Assets
Cash and due from banks $ 51,129 $ 71,607
Money market and federal funds sold 782 4,662
--------------- ---------------
Cash and cash equivalents 51,911 76,269
Interest bearing time deposits - 304
Investment securities
Available for sale 472,363 425,443
Held to maturity (fair value of
$0 and $3,414) - 3,243
--------------- ---------------
Total investment securities 472,363 428,686
Loans held for sale 2,010 824
Loans, net of allowance for loan
losses of $12,463 and $11,698 964,937 917,307
Restricted stock, at cost 10,929 7,902
Premises and equipment, net 28,131 25,766
Goodwill 55,560 40,642
Purchased intangible assets 5,544 6,429
Cash surrender value of life insurance 25,135 24,776
Interest receivable and other assets 22,990 20,474
--------------- ---------------
Total assets $ 1,639,510 $ 1,549,379
=============== ===============
Liabilities
Deposits
Noninterest bearing $ 166,009 $ 145,999
Interest bearing 1,152,822 1,080,368
--------------- ---------------
Total deposits 1,318,831 1,226,367
Short-term borrowings 54,884 57,175
Federal Home Loan Bank (FHLB) advances 61,627 90,981
Subordinated debentures 29,898 29,898
Notes payable - 9,100
Other liabilities 12,737 12,538
--------------- ---------------
Total liabilities 1,477,977 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 - 13,755,409 and
11,196,357
Outstanding shares - 13,471,128
and 10,985,121 6,880 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 105,102 73,451
Retained earnings 55,277 47,371
Accumulated other comprehensive income (866) 97
--------------- ---------------
Total shareholders' equity 161,533 123,320
--------------- ---------------
Total liabilities and
shareholders' equity $ 1,639,510 $ 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
Three months ended Nine months ended
September 30, September 30,
(Dollar amounts in thousands 2005 2004 2005 2004
except per share data) --------------------- ---------- ---------
Interest income
Loans, including fees $ 15,871 $ 15,022 $ 45,670 $ 41,953
Investment securities 4,661 3,948 12,994 11,207
Other interest income 66 15 160 46
--------------------- ---------- ---------
Total interest income 20,598 18,985 58,824 53,206
--------------------- ---------- ---------
Interest expense
Deposits 5,061 3,948 13,924 11,856
Subordinated debentures 493 1,095 1,423 2,847
Other borrowings 1,415 442 3,958 1,247
--------------------- ---------- ---------
Total interest expense 6,969 5,485 19,305 15,950
--------------------- ---------- ---------
Net interest income 13,629 13,500 39,519 37,256
Provision for loan losses 480 270 940 330
--------------------- ---------- ---------
Net interest income after
Provision for loan losses 13,149 13,230 38,579 36,926
Non-interest income
Insurance commissions 435 706 1,545 2,095
Mortgage banking 805 701 2,030 2,419
Trust and investment product
fees 282 228 846 670
Service charges on deposit
accounts 1,964 1,931 5,435 5,189
Net realized gains on securities 18 44 242 817
Increase in CSV of BOLI 222 254 663 766
Interchange income 506 474 1,469 1,342
Other income 713 445 2,133 1,394
--------------------- ---------- ---------
Total non-interest income 4,945 4,783 14,363 14,692
--------------------- ---------- ---------
Non-interest expense
Salaries and employee benefits 6,835 6,388 20,597 19,468
Net occupancy expenses 870 824 2,593 2,344
Equipment expenses 952 1,047 2,967 2,911
Intangibles amortization 295 296 885 762
Telecommunications 434 409 1,233 1,173
Stationery printing and supplies 271 253 685 722
Other expenses 2,416 2,430 7,070 6,927
--------------------- ---------- ---------
Total non-interest expense 12,073 11,647 36,030 34,307
--------------------- ---------- ---------
Income before income tax 6,021 6,366 16,912 17,311
Income tax expense 1,489 1,760 4,264 4,751
--------------------- ---------- ---------
Net income $ 4,532 $ 4,606 $ 12,648 $ 12,560
===================== ========== =========
Comprehensive income $ 4,134 $ 9,382 $ 11,759 $ 12,857
===================== ========== =========
Cash dividends declared per share $ 0.13 $ 0.12 $ 0.39 $ 0.35
Net income per share - basic and
diluted $ 0.34 $ 0.40 $ 1.03 $ 1.11
The accompanying notes are an integral part of these consolidated financial
statements.
4
MAINSOURCE FINANCIAL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOW
(Dollars in thousands)
Nine months ended
September 30,
2005 2004
- ------------------------------------------------------------------------------------------------------- ---------------
Operating Activities
Net income $ 12,648 $ 12,560
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 940 330
Depreciation and amortization 2,313 2,210
Securities amortization, net 1,063 1,932
Amortization of core deposit intangibles 885 762
Increase in cash surrender value of life insurance policies (663) (527)
Gain on life insurance benefit (85) -
Investment securities gains (242) (817)
Change in loans held for sale (1,186) (170)
Change in other assets and liabilities (2,132) 1,711
-------------- ---------------
Net cash provided by operating activities 13,541 17,991
Investing Activities
Net change in short-term investments 304 -
Proceeds from maturities and payments
on securities held to maturity 277 237
Purchases of securities available for sale (164,517) (132,136)
Proceeds from maturities and payments
on securities available for sale 92,313 74,621
Proceeds from sales of securities available for sale 25,534 69,764
Purchases of restricted stock (2,834) (640)
Proceeds from life insurance benefit 400 -
Loan originations and payments, net 5,765 (8,618)
Purchases of premises and equipment (2,949) (1,790)
Cash received/(paid) for bank acquisitions, net 112,885 (342)
-------------- ---------------
Net cash provided (used) by investing activities 67,178 1,096
Financing Activities
Net change in deposits (92,240) (56,727)
Net change in short-term borrowings (2,291) 13,795
Repayment of long-term debt (9,100) (2,100)
Proceeds from FHLB advances 220,000 78,500
Repayment of FHLB advances (249,354) (41,860)
Proceeds from stock issue 32,667 -
Purchase of treasury shares (27) (1,153)
Cash dividends and fractional stock dividends (4,760) (4,003)
Proceeds from exercise of stock options 28 28
-------------- ---------------
Net cash provided (used) by financing activities (105,077) (13,520)
-------------- ---------------
Net change in cash and cash equivalents (24,358) 5,567
Cash and cash equivalents, beginning of year 76,269 56,854
-------------- ---------------
Cash and cash equivalents, end of year $ 51,911 $ 62,421
============== ===============
See Note 3 regarding non-cash transactions 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 For the nine months
ended ended
--------------------- ---------------------
9/30/2005 9/30/2004 9/30/2005 9/30/2004
--------- --------- --------- ---------
Net income as reported $4,532 $4,606 $12,648 $12,560
Deduct: Stock-based compensation
expense determined under fair
value based method 39 20 119 71
--------- --------- --------- ---------
Pro forma net income $4,493 $4,586 $12,529 $12,489
Basic earnings per share as
reported $0.34 $0.40 $1.03 $1.11
Pro forma basic earnings per share $0.33 $0.40 $1.02 $1.11
Diluted earnings per share as
reported $0.34 $0.40 $1.03 $1.11
Pro forma diluted earnings
per share $0.33 $0.40 $1.02 $1.10
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%.
7
NOTE 3 - ACQUISITIONS
In August 2005, the Company consummated its acquisition of The Madison Bank &
Trust Company ("Madison"). As of the date of acquisition, Madison had four
branches in Jefferson County and one in Ohio County. Simultaneous to the
closing, the Company closed one of the acquired branches in Jefferson County and
two of its existing branches in Jefferson County. As a result of this
acquisition, the Company expects to expand its geographical presence in southern
Indiana, increase its customer base to enhance deposit fee income, provide an
opportunity to market additional products and services to new customers, and
reduce operating costs through economies of scale. As of the date of
acquisition, the acquired company had $142,046 of cash and cash equivalents,
$54,335 of net loans, and $184,704 of deposits. Goodwill of $16,249 was also
recorded. As of the date of this report, the Company was in the process of
obtaining third party valuations and completing fair value estimates for certain
assets acquired and liabilities assumed, and the allocation of the purchase
price is subject to refinement. This would include a core deposit intangible
that would reduce goodwill. The results of operations for this acquisition have
been included since the transaction date which was August 26, 2005.
In March 2005, the Company disposed of the Kentucky division of MainSource
Insurance to its previous owners. The consideration received by the Company was
shares of the Company's common stock with an approximate value of $1,380.
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 August 2005, the Company executed a definitive agreement to acquire Union
Community Bancorp ("Union"). Union, which has approximately $265,000 in assets,
operates six Indiana offices located in Montgomery, Fountain, Warren and
Tippecanoe Counties. The transaction is expected to close in the first quarter
of 2006.
In September 2005, the Company executed a definitive agreement to acquire
Peoples Ohio Financial Corporation ("Peoples"). Peoples, which has approximately
$200,000 in assets, operates six Ohio offices located in Miami and Northern
Montgomery Counties. The transaction is expected to close in the first quarter
of 2006.
In October 2005, the Company executed a definitive agreement to acquire HFS
Bank, F.S.B. ("HFS"). HFS, which has approximately $236,000 in assets, operates
a total of six offices in Hobart, Portage, Griffith and Crown Point, Indiana.
The transaction is expected to close in the second quarter of 2006.
8
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 September 30, 2005 Value Gains Losses
- -----------------------------------------------------------------------------------------
Available for Sale
US Treasury & Federal agencies $73,368 $145 ($936)
State and municipal 120,726 $1,941 (601)
Mortgage-backed securities 260,730 $525 (3,245)
Equity and other securities 17,539 $535 (84)
- -----------------------------------------------------------------------------------------
Total available for sale $472,363 $3,146 ($4,866)
- -----------------------------------------------------------------------------------------
As of December 31, 2004
- -----------------------------------------------------------------------------------------
Available for Sale
US Treasury & 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 September 30, 2005 Amount Gains Losses Value
- ----------------------------------------------------------------------------------------------------------
Held to Maturity
State and municipal $- $- $- $-
Other securities - - - -
- ----------------------------------------------------------------------------------------------------------
Total held to maturity $- $- $- $-
- ----------------------------------------------------------------------------------------------------------
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
- ----------------------------------------------------------------------------------------------------------
During the third quarter of 2005, management transferred all held-to-maturity
securities to the available-for-sale category. The redesignation resulted in the
transfer of securities with an amortized cost of $3,005 and a fair value of
$3,113 from held-to-maturity to available-for-sale. This transfer resulted in an
increase to shareholders' equity of $70 as of September 30, 2005.
9
NOTE 5 - LOANS AND ALLOWANCE
September 30, December 31,
2005 2004
- --------------------------------------------------------------------------------
Commercial and industrial loans $ 146,993 $ 154,717
Agricultural production financing 27,287 22,647
Farm real estate 37,383 38,281
Commercial real estate 160,242 133,360
Hotel 59,593 80,234
Residential real estate 375,661 353,515
Construction and development 46,002 37,821
Consumer 124,239 108,430
------------- ---------------
Total loans 977,400 929,005
------------- ---------------
Allowance for loan lossess (12,463) (11,698)
- --------------------------------------------------------------------------------
Net loans $ 964,937 $ 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 1,500 1,775
Provision for losses 940 330
Recoveries on loans 213 259
Loans charged off (1,888) (1,974)
- --------------------------------------------------------------------------------
Balances, September 30 $ 12,463 $ 11,899
- --------------------------------------------------------------------------------
10
NOTE 6 - DEPOSITS
September 30, December 31,
2005 2004
-------------- --------------
Non-interest-bearing demand $ 166,009 $ 145,999
Interest-bearing demand 307,109 310,306
Savings 323,904 304,230
Certificates of deposit of $100 or more 155,094 117,361
Other certificates and time deposits 366,715 348,471
-------------- --------------
Total deposits $ 1,318,831 $ 1,226,367
============== ==============
11
NOTE 7 - EARNINGS PER SHARE
Earnings per share (EPS) were computed as follows:
For the three months ended September 30, 2005 September 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 $4,532 13,431,432 $0.34 $4,606 11,548,090 $0.40
---------- ------------ ------------- --------
Effect of dilutive shares 12,059 11,866
--------------- ---------------
Diluted earnings per share $4,532 13,443,491 $0.34 $4,606 11,559,956 $0.40
========== =============== ============ ============= =============== ========
For the nine months ended September 30, 2005 September 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 $12,648 12,239,519 $1.03 $12,560 11,294,121 $1.11
---------- ------------ ------------- --------
Effect of dilutive shares 14,655 15,308
--------------- ---------------
Diluted earnings per share $12,648 12,254,174 $1.03 $12,560 11,309,429 $1.11
========== =============== ============ ============= =============== ========
Stock options for 128,425 shares of common stock were not considered in
computing diluted earnings per common share for the three months and nine months
ended September 30, 2005 because they were antidilutive.
12
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Item 2.
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 September 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 October 2005, the Company merged
Peoples into MainSource Bank.
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 $28,490. On July 8, 2005, the Company sold 260,860
additional shares pursuant to the over allotment option on the public offering,
resulting in additional net proceeds of approximately $4,177.
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") 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 third quarter of 2005 was $4,532 compared to $4,606 for the
third quarter of 2004. Diluted earnings per share for the third quarter totaled
$0.34 in 2005, which includes the effect of the Company's two million shares of
common stock issued in its public offering in June and July of 2005. The Company
was not able to fully utilize the new capital generated from the offering until
the close of its acquisition of Madison, which occurred on August 26, 2005. The
funds dedicated to this acquisition were invested in highly-liquid, low-yield
investments. Excluding the effect of the additional shares issued in the
offering and the merger expenses related to the aforementioned acquisition, the
Company's earnings per share would have been $0.38 for the third quarter of 2005
compared to $0.40 for the same period a year ago. The results of operations for
the Madison acquisition have been included since the transaction date. For the
nine months ended September 30, 2005, the Company reported earnings per share of
$1.03, which represents a 7.2% decrease versus the $1.11 reported for the same
period a year ago.
13
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Net Interest Income
The volume and yield of earning assets and interest-bearing liabilities
influence net interest income. Net interest income reflects the mix of
interest-bearing and non-interest-bearing liabilities that fund earning assets,
as well as interest spreads between the rates earned on these assets and the
rates paid on interest-bearing liabilities. Third quarter net interest income of
$13,629 in 2005 was an increase of 1.0% versus the third quarter of 2004.
Average earning assets increased 2.7% while net interest margin, on a
fully-taxable equivalent basis, declined slightly and was 3.93% for the third
quarter of 2005 compared to 3.97% for the same period a year ago. On a year to
date basis, net interest income increased to $39,519 in 2005 from $37,256 in
2004. This increase was primiarly attributable to the full year effect of the
Peoples acquisition and a slight increase in the Company's interest margin. For
the nine months ended September 30, 2005, the Company's net interest margin was
3.93% versus 3.85% a year ago.
Provision for Loan Losses
See "Loans, Credit Risk and the Allowance and Provision for Probable Loan
Losses" below.
Non-interest Income
Third quarter non-interest income for 2005 was $4,945 compared to $4,783 for the
third quarter of 2004. This increase was primarily attributable to an increase
in mortgage banking income of $104 and an increase in other income primarily
related to the Company's newly-formed title insurance agency. Offsetting this
increase was a decrease in insurance commissions due to the sale of the Kentucky
division of MainSource Insurance during the first quarter of 2005.
For the nine months ended September 30, 2005, non-interest income was $14,363
compared to $14,692 for the same period a year ago. The 2.2% decrease was
primarily attributable to a decrease in insurance commissions due to the sale of
the Kentucky division of MainSource Insurance. In addition, as interest rates
moved higher over the last year the Company incurred a decrease in mortgage
banking income and lower gains on sales of investment securities. Offsetting
these decreases were increases in trust and investment product fees, service
charges on deposit accounts, and other income. The increase in other income was
primarily due to income at the newly-formed title and mortgage companies, an
increase in contingency income at the Company's insurance division, and the full
year effect of the Peoples acquisition.
14
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 $12,073 for the third quarter of 2005 compared to
$11,647 for the same period a year ago. This 3.7% increase was primarily in
employee-related expenses and was attributable to normal employee merit
increases, staff increases associated with the acquisition of Madison, and
increased benefit costs.
For the nine months ended September 30, 2005, non-interest expense was $36,030
compared to $34,307 for the same period in 2004. The year over year increase of
$1,723 was primarily in employee-related expenses. Employee costs increased
$1,129, or 5.8%, for the nine months ended September 30, 2005 compared to the
same period a year ago. This increase was mainly attributable to the full year
effect of the Peoples acquisition which occurred in June 2004, normal merit
increases, and increased benefit costs. Occupancy expenses also increased by
$249, or 10.6%, due to the full year effect of the Peoples acquisition.
Income Taxes
The effective tax rate for the first nine months was 25.2% for 2005 compared to
27.4% 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.
15
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Financial Condition
Total assets at September 30, 2005 were $1,639,510 compared to $1,549,379 as of
December 31, 2004. Average earning assets represented 90.2% of average total
assets for the first nine months of 2005 and 2004. Average loans represented
76.3% of average deposits in the first nine months of 2005 and 75.2% 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
60.1% and 60.5% for the nine-month periods ended September 30, 2005 and 2004
respectively.
The increase in deposits of $92,464 from December 31, 2004 to September 30, 2005
was due primarily to the acquisition of Madison. This increase was partially
offset by a decrease in time deposits as the Company has elected to not
aggressively pursue these higher-cost deposits given its relatively flat loan
growth.
Shareholders' equity was $161,533 on September 30, 2005 compared to $123,320 on
December 31, 2004. Book value (shareholders' equity) per common share was $11.99
at September 30, 2005 versus $10.68 at year-end 2004. Accumulated other
comprehensive income decreased book value per share by $0.06 at September 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.
16
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Residential real estate loans continue to represent a significant portion of the
total loan portfolio. Such loans represented 38.4% of total loans at September
30, 2005 and 38.1% at December 31, 2004.
On September 30, 2005, the Company had $2,010 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 $15,391, or 0.94% of total assets, as of September
30, 2005, compared to $14,326, or 0.93% of total assets, as of June 30, 2005,
and $17,548, or 1.18% of assets at March 31, 2005. The allowance for loan losses
was $12,463 as of September 30, 2005 and represented 1.28% of total outstanding
loans compared to $11,698 as of December 31, 2004 or 1.26% of total outstanding
loans. The allowance for loan losses balance as of September 30, 2005 includes
$1,500 acquired in the Madison acquisition and is subject to adjustment upon
completion of final purchase price allocation.
The provision for loan losses was $480 in the third quarter of 2005 compared to
$270 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. Although charge-offs have been relatively high for
2005 compared to the provision expense, the majority of these charge-offs were
allocated for in previous periods. The adequacy of the allowance for loan losses
in each subsidiary is reviewed at least quarterly. The determination of the
provision amount in any period is based on management's continuing review and
evaluation of loan loss experience, changes in the composition of the loan
portfolio, current economic conditions, the amount of loans presently
outstanding, and information about specific borrower situations. The allowance
for loan losses as of September 30, 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
17
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
liabilities. The Company's investment policy prohibits trading activities and
does not allow investment in high-risk derivative products, junk bonds or
foreign investments.
As of September 30, 2005, $472,363 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 $1,720 was recorded to
adjust the AFS portfolio to current market value at September 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 87.2% and 89.2% of total average
earning assets for the nine-month periods ending September 30, 2005 and 2004.
Total interest-bearing deposits averaged 88.4% and 89.3% of average total
deposits for the nine-month periods ending September 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 $61,627 outstanding at September 30, 2005.
These advances have interest rates ranging from 2.36% to 6.27%. Approximately
$20,000 of these advances was 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 $15,000 maturing in 2007,
$5,000 maturing in 2010 and $20,000 maturing in 2012.
Capital Resources
Total shareholders' equity was $161,533 at September 30, 2005, which was an
increase of $38,213 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. In July 2005, the
Company sold additional shares of common stock pursuant to the over allotment
option granted in the offering, raising additional net proceeds of approximately
$4,177.
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 September 30, 2005, Tier 1 capital to total average assets was
8.52%.
18
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS
(Dollar amounts in thousands except per share data)
Tier 1 capital to risk-adjusted assets was 12.39%. Total capital to
risk-adjusted assets was 13.58%. 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 third
quarter of 2005 versus $0.12 for the third quarter of 2004. For the nine months
ended September 30, 2005, the Company declared and paid common dividends of
$0.39 per share compared to $0.35 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 78.1% of total earning assets for the nine months ended
September 30, 2005 and 78.5% 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.
At September 30, 2005, the Company held $647,778 in assets comprised of
securities, loans, and short-term investments, which were interest sensitive in
one year or less time horizons.
19
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 September 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.
20
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 Principal
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 Principal Financial Officer have concluded that the
Company's disclosure controls and procedures were, to the best of their
knowledge, effective to ensure that information required to be disclosed by the
Company in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms as of such date.
There was no change in the Company's internal control over financial reporting
that occurred during the Company's third fiscal quarter of 2005 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
21
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
PART II. OTHER INFORMATION
Item 6. 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 to the Current Report on Form 8-K of the
registrant filed September 22, 2005 with the Commission
(Commission File No. 0-12422)).
22
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 Principal
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 Principal Financial
Officer
23
MAINSOURCE FINANCIAL GROUP, INC.
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MAINSOURCE FINANCIAL GROUP, INC.
November 8, 2005
/s/ James L. Saner, Sr.
-------------------------------------------------
James L. Saner Sr.
President and Chief Executive Officer
November 8, 2005
/s/ James M. Anderson
-------------------------------------------------
James M. Anderson
Administrative Vice President & Principal Accounting Officer
24
EXHIBIT 31.1
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
I, James L. Saner, Sr. certify that:
1. I have reviewed this quarterly report on Form 10-Q of MainSource Financial
Group;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 8, 2005
/s/ James L. Saner, Sr.
- -----------------------
James L. Saner, Sr.
President and Chief Executive Officer
EXHIBIT 31.2
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer
I, James M. Anderson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MainSource Financial
Group;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 8, 2005
/s/ James M. Anderson
- -----------------------
James M. Anderson
Administrative Vice President
and Principal Accounting Officer
Exhibit 32.1
SECTION 1350 CERTIFICATION BY CHIEF EXECUTIVE OFFICER
As an accompaniment to the Quarterly Report of MainSource Financial Group, Inc.
(the "Company") on Form 10-Q for the period ending September 30, 2005 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, James L. Saner Sr., Chief Executive Officer of the Company, certify, pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that to my knowledge:
o The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934, and
o The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company
as of and for the periods presented.
This certification is based on inquiries that I have made, or have caused to be
made, in a good faith effort on my part to be a responsible and competent chief
executive officer serving the Company and its many constituencies.
This certification merely accompanies and is not part of the Report, shall not
be deemed filed for purposes of the Securities Exchange Act of 1934, and may not
be used for any purpose other than compliance with 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Date: November 8, 2005
/s/ James L. Saner, Sr.
- ------------------------
James L. Saner, Sr.
Exhibit 32.2
SECTION 1350 CERTIFICATION BY PRINCIPAL FINANCIAL OFFICER
As an accompaniment to the Quarterly Report of MainSource Financial Group, Inc.
(the "Company") on Form 10-Q for the period ending September 30, 2005 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, James M. Anderson, Principal Accounting Officer of the Company, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that to my knowledge:
o The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934, and
o The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company
as of and for the periods presented.
This certification is based on inquiries that I have made, or have caused to be
made, in a good faith effort on my part to be a responsible and competent
principal financial officer serving the Company and its many constituencies.
This certification merely accompanies and is not part of the Report, shall not
be deemed filed for purposes of the Securities Exchange Act of 1934, and may not
be used for any purpose other than compliance with 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Date: November 8, 2005
/s/ James M. Anderson
- -----------------------
James M. Anderson