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| MSFG > SEC Filings for MSFG > Form 10-Q on 11-May-2009 | All Recent SEC Filings |
11-May-2009
Quarterly Report
Overview
MainSource Financial Group, Inc. ("MainSource" or the "Company") is a financial holding company whose principal activity is the ownership and management of its three wholly owned subsidiary banks ("Banks"): MainSource Bank headquartered in Greensburg, Indiana, MainSource Bank of Illinois headquartered in Kankakee, Illinois, and MainSource Bank - Ohio headquartered in Troy, Ohio. The banks operate under state charters and are subject to regulation by their respective state regulatory agencies and the Federal Deposit Insurance Corporation. Non-banking subsidiaries include MainSource Insurance, LLC and MainSource Title, LLC. Both of these subsidiaries are subject to regulation by the Indiana Department of Insurance. The Company also owns all of the outstanding stock of MainSource Bank - Hobart, although substantially all of the assets of that bank were transferred to MainSource Bank in May, 2007.
Forward-Looking Statements
Except for historical information contained herein, the discussion in this report includes certain forward-looking statements based upon management expectations. Actual results and experience could differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The Company disclaims any intent or obligation to update such forward looking statements. Factors which could cause future results to differ from these expectations include the following: general economic conditions; legislative and regulatory initiatives; monetary and fiscal policies of the federal government; deposit flows; the cost of funds; general market rates of interest; interest rates on competing investments; demand for loan products; demand for financial services; changes in accounting policies or guidelines; changes in the quality or composition of the Company's loan and investment portfolios; the Company's ability to integrate acquisitions, the impact of our continuing acquisition strategy, and other factors, including the risk factors set forth in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2008, and in other reports we file from time to time with the Securities and Exchange Commission. The Company intends the forward looking statements set forth herein to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995.
Results of Operations
Net income for the first quarter of 2009 was $1,178 compared to $6,251 for the first quarter of 2008. The decrease in net income was primarily attributable to an increase in the allowance for loan losses (see Loans, Credit Risk and the Allowance and Provision for Probable Loan Losses below), offset by a significant increase in mortgage banking gains. Diluted earnings per common share for the first quarter totaled $0.03 in 2009, a decrease from the $0.34 per common share reported in the same period a year ago. Key measures of the financial performance of the Company are return on average shareholders' equity and return on average assets. Return on average shareholders' equity was 1.34% for the first quarter of 2009 while return on average assets was 0.16% for the same period, compared to 9.35% and 1.00% in the first quarter of 2008.
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. First quarter net interest income of $23,374 in 2009 was an increase of 18.8% versus the first quarter of 2008. Average earning assets increased $367 million with approximately $275 million coming from the August 2008 acquisition of 1st Independence Financial Group and $92 million from organic growth. The increase came primarily from the loan portfolio which grew by an average of $316 million with investment securities increasing $29 million. Also affecting margin was an increase in average demand deposits, NOW accounts, and money market accounts of $139 million with $89 million the result of the acquisition of 1st Independence. The average balance of certificates of deposit increased $15 million and FHLB advances increased $98 million. $165 million of certificates of deposit came from the 1st Independence acquisition. Net interest margin, on a fully-taxable equivalent basis, was 3.74% for the first quarter of 2009, a slight increase compared to 3.64% for the same period a year ago. Due to the slight liability-sensitive nature of the Company's balance sheet, the Company's cost of funds declined more than its yield on earning assets. On a linked quarter basis, the Company's net interest margin decreased eleven basis points due primarily to the increase in the level of non-performing loans during the first quarter of 2009.
Provision for Loan Losses
See "Loans, Credit Risk and the Allowance and provision for Probable Loan Losses" below.
Non-interest Income
First quarter non-interest income for 2009 was $9,161 compared to $7,843 for the first quarter of 2008. This year over year increase was primarily attributable to a $1,655 increase in mortgage banking income offset by a decrease in net realized gains on sales of securities of $304. The efforts of the Federal Reserve in holding mortgage rates to historically low levels have generated increased mortgage activity.
Non-interest Expense
The Company's non-interest expense was $20,478 for the first quarter of 2009 compared to $17,811 for the same period in 2008, an increase of 15.0%. Almost all components of non-interest expense increased during the first quarter of 2009 versus the first quarter of 2008 due to the acquisition of 1st Independence. The Company's employee count (on a full-time equivalent basis) increased by 105 from the same period a year ago and 6 additional branches were added from the first quarter of 2008. In addition, the Company's FDIC insurance expense increased significantly due to the increase in the premiums charged by the FDIC. This expense is expected to remain at this level for the foreseeable future. In addition, the FDIC is proposing one or more special assessments for financial institutions that could impact future premiums. The Company's efficiency ratio improved to 61.5% for the first quarter of 2009 compared to 63.8% for the same period a year ago.
Income Taxes
The effective tax rate for the first three months was negative 79.3% for 2009 compared to 16.8% for the same period a year ago. The decrease in the effective rate is due to the Company's tax exempt income and credits which remained relatively consistent with prior quarters with a significant drop in GAAP income before taxes. The Company and its subsidiaries file consolidated income tax returns.
Financial Condition
Total assets at March 31, 2009 were $2,873,051 which was a slight decrease compared to the $2,899,835 of total assets as of December 31, 2008. Average earning assets represented 89.5% of average total assets for the first three months of 2009 and 88.1% for the same period in 2008. Average loans represented 98.7% of average deposits in the first three months of 2009 and 90.9% for the comparable period in 2008. Management continues to emphasize quality loan growth to increase these averages. Average loans as a percent of average assets were 69.8% and 67.5% for the three-month periods ended March 31, 2009 and 2008 respectively.
Shareholders' equity was $358,632 on March 31, 2009 compared to $299,949 on December 31, 2008. The large increase in shareholder's equity was the result of the Company's participation in the Capital Purchase Program (see Note 8 to the Consolidated Financial Statements above). Book value (shareholders' equity) per common share was $15.04 at March 31, 2009 versus $14.90 at year-end 2008. Accumulated other comprehensive income increased book value per common share by $0.36 at March 31, 2009 and $0.15 at December 31, 2008. Depending on market conditions, the unrealized gain or loss on securities available for sale can cause fluctuations in shareholders' equity. The decrease in interest rates during the first quarter of 2009 was the primary reason for the large increase in accumulated comprehensive income as the Company's investment portfolio is comprised largely of debt instruments which increased in market value as a result of the change in interest rates.
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.
Management maintains a list of loans warranting either the assignment of a specific reserve amount or other special administrative attention. This watch list, together with a listing of all classified loans, nonaccrual loans and delinquent loans, is reviewed monthly by management and the Board of Directors of each banking subsidiary. Additionally, the Company evaluates its consumer and residential real estate loan pools for probable losses incurred based on historical trends, adjusted by current delinquency and non-performing loan levels.
The Company has both internal and external loan review personnel who annually review approximately 40% of all loans. External loan review personnel examine all commercial credit relationships over $1 million.
The ability to absorb loan losses promptly when problems are identified is invaluable to a banking organization. Most often, losses incurred as a result of prompt, aggressive collection actions are much lower than losses incurred after prolonged legal proceedings. Accordingly, the Company observes the practice of quickly initiating stringent collection efforts in the early stages of loan delinquency. The Company has established a separate group solely responsible for the collection of problem loans.
Residential real estate loans continue to represent a significant portion of the total loan portfolio. Such loans represented 43.2% of total loans at March 31, 2009 and 44.0% at December 31, 2008. On March 31, 2009, the Company had $13,649 of residential real estate loans held for sale, which was an increase from the year-end balance of $4,947. The Company generally retains the servicing rights on mortgages sold.
Non-performing loans totaled $84,690, or 4.30% of total loans, as of March 31, 2009, compared to $20,196, or 1.20% of total loans, as of March 31, 2008, and $59,310 or 2.97% of loans at December 31, 2008. The increase in non-performing loans since year-end was primarily attributable to continued deterioration in the residential construction and commercial real estate loan portfolios. 19 credit relationships over $1 million made up two-thirds of the non-performing balance. The allowance for loan losses was $43,235 as of March 31, 2009 and represented 2.19% of total outstanding loans compared to $34,583 as of December 31, 2008 or 1.73% of total outstanding loans.
The provision for loan losses was $11,400 in the first quarter of 2009 compared to $2,196 for the same period in 2008 and $9,997 in the fourth quarter of 2008. The increase in the provision in 2009 over 2008 was primarily attributable to the increase in the specific allowance allocations on the Company's residential construction and land development loans and the overall weakness in economic conditions. Net loan losses were $2,748 for the first quarter of 2009 compared to $1,104 for the same period a year ago. Over 50% of the Company's charge-offs for the first quarter of 2009 was related to four commercial loans. The remaining losses were related to small dollar 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 March 31, 2009 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 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 March 31, 2009, the Company had $535,902 of investment securities. All of these 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 gain of $11,196 was recorded to adjust the AFS portfolio to current market value at March 31, 2009, compared to an unrealized pre-tax gain of $4,843 at December 31, 2008. 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 changes in market interest rates. The fair value is expected to recover as the securities approach their maturity dates. All securities in the Company's portfolio are performing as expected with no disruption in cash flows and all rated securities are rated investment grade.
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 79.0% and 84.3% of total average earning assets for the three-month periods ending March 31, 2009 and 2008. Total interest-bearing deposits averaged 88.8% and 89.8% of average total deposits for the three-month periods ending March 31, 2009 and 2008, 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 $311,885 outstanding at March 31, 2009. These advances have interest rates ranging from 0.65% to 6.36%. Approximately $69,000 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 $19,000 maturing in 2009, $71,000 maturing in 2010, $16,000 maturing in 2011, $21,000 maturing in 2012, and $116,000 maturing in 2013 and beyond.
Capital Resources
Total shareholders' equity was $358,632 at March 31, 2009, which was an increase of $58,683 compared to the $299,949 of shareholders' equity at December 31, 2008. The increase in shareholder equity was primarily attributable to the Company's participation in the Capital Purchase Program. In January, the Company issued $57 million in preferred stock and warrants to the U.S. Treasury. The preferred stock pays cumulative dividends at a rate of 5% per year for the first five years and 9% per year thereafter. To a lesser extent, net income generated in the quarter less the cash dividend paid as well as an increase in other comprehensive income related to the improvement in fair value of investment securities caused an increase in shareholder equity.
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 March 31, 2009, Tier 1 capital to total average assets was 9.2%. Tier 1 capital to risk-adjusted assets was 12.8%. Total capital to risk-adjusted assets was 14.1%. 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's ratios exceeded the well capitalized levels before the addition of the Capital Purchase Program dollars. As shown above, the addition of these funds made these ratios even stronger.
The Company declared and paid common dividends of $0.145 per share in the first quarter of 2009 versus $0.140 for the first quarter of 2008.
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 68.4% of total earning assets for the three months ended March 31, 2009 and 73.9% for the same period in 2008.
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 and its affiliates have access to the Federal Home Loan Bank for borrowing purposes as well as access to overnight borrowings from the Federal Reserve.
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.
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