-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AiNNvojEFCGwAfo5qkaoFUAL/EgquOdNp9LsRvZCoNW/9RyhrHwBBmY0gQVV18yX D85vpkFdy1rb1LrW75/1uw== 0000926274-04-000105.txt : 20040312 0000926274-04-000105.hdr.sgml : 20040312 20040312145244 ACCESSION NUMBER: 0000926274-04-000105 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040312 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MAINSOURCE FINANCIAL GROUP CENTRAL INDEX KEY: 0000720002 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 351562245 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-12422 FILM NUMBER: 04665786 BUSINESS ADDRESS: STREET 1: 201 N BROADWAY STREET 2: PO BOX 87 CITY: GREENSBURG STATE: IN ZIP: 47240 BUSINESS PHONE: 8126630157 MAIL ADDRESS: STREET 1: 201 NORTH BROADWAY STREET 2: P O BOX 87 CITY: GREENSBURG STATE: IN ZIP: 47240 FORMER COMPANY: FORMER CONFORMED NAME: INDIANA UNITED BANCORP DATE OF NAME CHANGE: 19920703 10-K 1 msf-03k.txt SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2003 Commission file number 0-12422 MAINSOURCE FINANCIAL GROUP, INC. (Exact name of registrant as specified in its charter) Indiana 35-1562245 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 201 North Broadway Greensburg, Indiana 47240 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (812) 663-0157 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act Common shares, no-par value (Title of Class) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The aggregate market value (not necessarily a reliable indication of the price at which more than a limited number of shares would trade) of the voting stock held by non-affiliates of the registrant was $163,655,506 as of June 30, 2003. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes [X] No [ ] As of March 10, 2002, there were outstanding 7,051,173 common shares, without par value, of the registrant. DOCUMENTS INCORPORATED BY REFERENCE Part of Form 10-K Documents Into Which Incorporated --------- ----------------------- 2003 Annual Report to Shareholders Part II (Items 5 through 8) Definitive Proxy Statement for Annual Part III (Items 10 through 14) Meeting of Shareholders to be held April 21, 2004 EXHIBIT INDEX: Page 10-11 FORM 10-K TABLE OF CONTENTS - -------------------------------------------------------------------------------- Part I Page Item 1 Business 3 Item 2 Properties 9 Item 3 Legal Proceedings 9 Item 4 Submission of Matters to a Vote of Security Holders 9 Part II Item 5 Market For the Registrant's Common Equity and Related 9 Stockholder Matters Item 6 Selected Financial Data 9 Item 7 Management's Discussion and Analysis of Financial 9 Condition and Results of Operations Item 7A Quantitative and Qualitative Disclosures About Market Risk 9 Item 8 Financial Statements and Supplementary Data 9 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 10 Item 9A Controls and Procedures 10 Part III Item 10 Directors and Executive Officers of the Registrant See below Item 11 Executive Compensation See below Item 12 Security Ownership of Certain Beneficial Owners and See below Management Item 13 Certain Relationships and Related Transactions See below Item 14 Principal Accountant Fees and Services See below Part IV Item 15 Exhibits, Financial Statement Schedules, and Reports 10 on Form 8-K Pursuant to General Instruction G, the information called for by Items 10-14 is omitted by MainSource Financial Group, Inc. since MainSource Financial Group, Inc. will file with the Commission a definitive proxy statement to shareholders pursuant to regulation 14A not later than 120 days after the close of the fiscal year containing the information required by Items 10-14. 2 PART I ITEM 1. BUSINESS - ------------------- (Dollars in thousands except per share data) GENERAL MainSource Financial Group, Inc. ("the Company") is a multi-bank holding company based in Greensburg, Indiana. The Company's Common Stock is traded on NASDAQ's National Market System under the symbol MSFG. As of December 31, 2003, the Company owned four banking subsidiaries: MainSource Bank, Regional Bank, Capstone Bank, and First Community Bank & Trust (together "the Banks"). Through its non-bank affiliates, the Company provides services incidental to the business of banking. Since its formation in 1982, the Company has acquired and established various institutions and financial services companies and may acquire additional financial institutions and financial services companies in the future. For further discussion of the business of the Company see Management's Discussion and Analysis in Part II, Item 7. The Company operates 58 branch banking offices in Indiana and Illinois as well as five insurance offices in Indiana and one in Kentucky. As of December 31, 2003, the Company had consolidated assets of $1,442,729, consolidated deposits of $1,191,310 and shareholders' equity of $105,424. Through its Banks, the Company offers a broad range of financial services, including: accepting time and transaction deposits; making consumer, commercial, agribusiness and real estate mortgage loans; renting safe deposit facilities; providing general agency personal and business insurance services; providing personal and corporate trust services; and providing other corporate services such as letters of credit and repurchase agreements. The lending activities of the Banks are separated into primarily the categories of commercial/agricultural, real estate and consumer. Loans are originated by the lending officers of the Banks subject to limitations set forth in lending policies. The Board of Directors of the Banks reviews and approves loans up to the Banks' legal lending limits, monitors concentrations of credit, problem and past due loans and charge-offs of uncollectible loans and formulates loan policy. The Banks maintain conservative loan policies and underwriting practices in order to address and manage loan risks. These policies and practices include granting loans on a sound and collectible basis, serving the legitimate needs of the community and the general market area while obtaining a balance between maximum yield and minimum risk, ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan, developing and maintaining adequate diversification of the loan portfolio as a whole and of the loans within each category and developing and applying adequate collection policies. Commercial loans include secured and unsecured loans, including real estate loans, to individuals and companies and to governmental units within the market area of the Banks for a myriad of business purposes. Agricultural loans are generated in the Banks' markets. Most of the loans are real estate loans on farm properties. Loans are also made for agricultural production and such loans are generally reviewed annually. 3 Residential real estate lending has been the largest component of the loan portfolio for many years. All affiliate banks generate residential mortgages for their own portfolios. However, the Company elects to sell the majority of its fixed rate mortgages into the secondary market while maintaining the servicing. At December 31, 2003, the Company was servicing a $498 million portfolio. By originating loans for sale in the secondary market, the Company can more fully satisfy customer demand for fixed rate residential mortgages and increase fee income. The principal source of revenues for the Company is interest and fees on loans, which accounted for 61.8% of total revenues in 2003, 65.2% in 2002 and 69.6% in 2001. The Company's investment securities portfolio is primarily comprised of U. S. Treasuries, federal agencies, state and municipal bonds, mortgage-backed securities and corporate securities. The Company has classified 99.2% of its investment portfolio as available for sale, with market value changes reported separately in shareholders' equity. Funds invested in the investment portfolio generally represent funds not immediately required to meet loan demand. The Company's investment portfolio accounted for 15.7% of total revenues in 2003, 17.3% in 2002 and 16.1% in 2001. As of December 31, 2003, the Company had not identified any securities as being "high risk" as defined by the FFIEC Supervisory Policy Statement on Securities Activities. The primary sources of funds for the Banks are deposits generated in local market areas. To attract and retain stable depositors, the Banks market various programs for demand, savings and 4 time deposit accounts. These programs include interest and non-interest bearing demand and individual retirement accounts. Currently, national retailing and manufacturing subsidiaries, brokerage and insurance firms and credit unions are fierce competitors within the financial services industry. Mergers between financial institutions within Indiana and neighboring states, which became permissible under the Interstate Banking and Branching Efficiency Act of 1994, have also added competitive pressure. The Company's Banks are located in predominantly non-metropolitan areas and their business is centered in loans and deposits generated within markets considered largely rural in nature. In addition to competing vigorously with other banks, thrift institutions, credit unions and finance companies located within their service areas, they also compete, directly and indirectly, with all providers of financial services. EMPLOYEES As of December 31, 2003, the Company and its subsidiaries had approximately 614 full-time equivalent employees to whom it provides a variety of benefits and with whom it enjoys excellent relations. REGULATION AND SUPERVISION OF THE COMPANY The Company is a bank holding company ("BHC") within the meaning of the Bank Holding Company Act of 1956, as amended ("Act"). This Act subjects BHC's to regulations of the Federal Reserve Board ("FRB") and restricts the business of BHC's to banking and related activities. Under the Act, a BHC is, with limited exceptions, prohibited from acquiring direct or indirect ownership or control of voting stock of any company that is not a bank or engaging in any activity other than managing or controlling banks. A BHC may, however, own shares of a company engaged in activities, which the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. These activities include: operating a savings association, mortgage company, finance company, credit card or factoring company; performing certain data processing operations; providing investment and financial advice; and, acting as an insurance agent for certain types of credit-related insurance. Acquisitions by the Company of banks and savings associations are subject to federal and state regulation. Any acquisition by the Company of more than five percent of the voting stock of any bank requires prior approval of the FRB. Acquisition of savings associations is also subject to the approval of the OTS. Indiana law permits BHCs to acquire BHCs and banks out of state on a reciprocal basis, subject to certain limitations. Under current law, the Company may acquire banks, and may be acquired by BHCs, located in any state in the United States that permits reciprocal entry by Indiana BHCs. Under the Act, BHCs may acquire savings associations without geographic restrictions. A BHC and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with the extension of credit, lease or sale of property, or the provision of any property or service. 5 The Company is under the jurisdiction of the Securities and Exchange Commission ("SEC") and state securities commission for matters relating to the offering and sale of its securities. The Company is subject to the SEC's rules and regulations relating to periodic reporting, reporting to shareholders, proxy solicitation and insider trading. The Company's liquidity is principally derived from dividends paid on the common stock of its subsidiaries. The payment of these dividends is subject to certain regulatory restrictions. Under FRB policy, the Company is expected to act as a source of financial strength to, and commit resources to support, its affiliates. As a result of such policy, the Company may be required to commit resources to its affiliate banks in circumstances where it might not otherwise do so. REGULATION AND SUPERVISION OF THE SUBSIDIARY BANKS The Company's affiliate banks are supervised, regulated and examined by their respective state regulatory banking agencies and the Federal Deposit Insurance Corporation ("FDIC"). A cease-and-desist order may be issued against the banks, if the respective agency finds that the activities of the bank represent an unsafe and unsound banking practice or violation of law. The deposits of all three banking subsidiaries are insured to the maximum extent permitted by law by the Bank Insurance Fund ("BIF") of the FDIC. Branching by banks in Indiana is subject to the jurisdiction, and requires the prior approval, of the bank's primary federal regulatory authority and, if the branching bank is a state bank, of the DFI. Under Indiana law, banks may branch anywhere in the state. The Company is a legal entity separate and distinct from its subsidiary Banks. There are various legal limitations on the extent to which the Banks can supply funds to the Company. The principal source of the Company's funds consists of dividends from its subsidiary Banks. State and Federal law restrict the amount of dividends that may be paid by banks. In addition, the Banks are subject to certain restrictions on extensions of credit to the Company, on investments in the stock or other securities of the Company and in taking such stock or securities as collateral for loans. LEGISLATION The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") represented a comprehensive and fundamental change to banking supervision and mandates the development of additional regulations governing almost every aspect of the operations, management and supervision of banks and BHCs. FDICIA also included several supervisory reforms related to the frequency of regulatory examinations and audit requirements. FDICIA also required the adoption of safety and soundness standards on matters such as loan underwriting and documentation, and compensation and other employee benefits; mandated consumer protection disclosures with respect to deposit accounts; and the establishment of a risk-based deposit insurance system. The federal banking agencies have issued guidelines establishing standards for safety and soundness, for operational and managerial standards and compensation standards. The federal banking agencies have issued guidelines for asset quality and earnings. FDICIA requires banking regulators to take prompt corrective actions with respect to depository institutions that fall below certain capital levels and prohibit any depository institution from making a capital distribution that would cause it to be considered undercapitalized. Banking regulators were also required to revise their capital standards to take into account interest rate risk. A policy statement has been proposed providing a supervisory framework to measure and monitor interest 6 rate risk at individual banks. Banks may use an internal model that provides a measure of the change in a bank's economic value. The results of the supervisory and internal models would be one factor regulators would consider in their assessment of capital adequacy. Other factors will also be considered. Certain regulations define relevant capital measures for five capital categories. A "well capitalized" institution is one that has a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 8%, a leverage ratio of at least 5% and is not subject to regulatory direction to maintain a specific level for any capital measure. An "adequately capitalized" institution is one that has ratios greater than 8%, 4% and 4%. An institution is "undercapitalized" if its respective ratios are less than 8%, 4% and 4%. "Significantly undercapitalized" institutions have ratios of less than 6%, 3% and 3%. An institution is deemed to be "critically undercapitalized" if it has a ratio of tangible equity to total assets that is 2% or less. Institutions with capital ratios at levels of "undercapitalized" or lower are subject to various limitations that, in most situations, will reduce the competitiveness of the institution. The Riegle Community Development and Regulatory Improvement Act of 1994 ("1994 Act") made several changes in existing law affecting bank holding companies. These include a reduction in the minimum post-approval antitrust review waiting period for depository institution mergers and acquisitions, and the substitution of a notice for an application when a bank holding company proposes to engage in, or acquire a company to engage in, non-bank activities. The 1994 Act also contains seven titles pertaining to community development and home ownership protection, small business capital formation, paperwork reduction and regulatory improvement, money laundering and flood insurance. No regulations have yet been approved. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Branching Act") substantially changed the geographic constraints applicable to the banking industry. In general, the Branching Act permits BHCs that are adequately capitalized and adequately managed to acquire banks located in any other state, subject to certain total deposit limitations. Effective June 1, 1997, the Branching Act also allows banks to establish interstate branch networks through acquisitions of other banks. Establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state is also allowed if authorized by state law. Institutions must maintain a loan activity-to-deposit ratio within a state at least equal to one-half of the average percentage for all banks in the state or the institution's federal regulator may close the branch and restrict the institution from opening new branches in the state. The Branching Act allowed individual states to "opt out" of certain provisions by enacting appropriate legislation prior to June 1, 1997. The monetary policies of regulatory authorities have a significant effect on the operating results of banks and BHCs. The nature of future monetary policies and the effect of such policies on the future business and earnings of the Company and its subsidiaries cannot be predicted. The Federal Reserve Board has adopted procedures for bank holding companies and foreign banks with U.S. offices to be treated as financial holding companies. Financial holding companies may engage in a broad range of securities, insurance and other financial activities under the Gramm-Leach-Bliley Act. Bank holding companies and foreign banks that meet the relevant qualifications may file elections to become financial holding companies at any time. The Company has chosen not to become a financial holding company and remains a bank holding company. 7 CAPITAL REQUIREMENTS The Company and its subsidiary Banks must meet certain minimum capital requirements mandated by the FRB, FDIC and DFI. These regulatory agencies require BHCs and banks to maintain certain minimum ratios of primary capital to total assets and total capital to total assets. The FRB requires BHCs to maintain a minimum Tier 1 leverage ratio of 3 percent capital to total assets; however, for all but the most highly rated institutions which do not anticipate significant growth, the minimum Tier 1 leverage ratio is 3 percent plus an additional cushion of 100 to 200 basis points. As of December 31, 2003, the Company's leverage ratio of capital to total assets was 6.0%. The FRB and FDIC each have approved the imposition of "risk-adjusted" capital ratios on BHCs and financial institutions. The Company's Tier 1 Capital to Risk-Weighted Assets Ratio was 9.2% and its Total Capital to Risk-Weighted Assets Ratio was 11.3% at December 31, 2003. The Company's Banks had capital to asset ratios and risk-adjusted capital ratios at December 31, 2003, in excess of the applicable regulatory minimum requirements. STATISTICAL DISCLOSURES The following statistical data should be read in conjunction with Management's Discussion and Analysis (Item 7), Selected Financial Data (Item 6) and the Financial Statements and Supplementary Data (Item 8). VOLUME/RATE ANALYSIS OF CHANGES IN NET INTEREST INCOME The table on page 8a analyzes the change in net interest income due to rate and volume. Changes due to both rate and volume have been allocated in proportion to the absolute dollar value of rate and volume changes. AVERAGE DEPOSITS The table on page 8b discloses the average deposits for the Company for 2003, 2002 and 2001, and the maturity schedule of the over $100 certificates of deposit at December 31, 2003. MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES OF COMMERCIAL AND CONSTRUCTION LOANS AT DECEMBER 31, 2003 Maturities and sensitivity to changes in interest rates of commercial and construction loans at December 31, 2003 are disclosed in the table on page 8c. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES The table on page 8d discloses the allocation of the allowance for loan losses to the major loan categories. INVESTMENT SECURITIES The composition and maturity of the investment portfolio is depicted in the table on page 8e. CONTRACTUAL OBLIGATIONS The table on page 8f discloses the contractual obligations of the Company at December 31, 2003. 8
Volume/Rate Analysis of Changes in Net Interest Income (Tax Equivalent Basis) - ---------------------------------------------- --------------------------------- --------------------------------- 2003 OVER 2002 2002 OVER 2001 - ---------------------------------------------- --------------------------------- --------------------------------- Volume Rate Total Volume Rate Total - ---------------------------------------------- --------------------------------- --------------------------------- Interest income Loans $ 2,672 $ (5,450) $ (2,778) $ (2,564) $ (7,740) $(10,304) Securities 4,826 (6,141) (1,315) 2,823 (3,132) (309) Federal funds sold and money market funds (426) (109) (535) (440) (972) (1,412) Short-term investments 16 (14) 2 (47) (28) (75) - ---------------------------------------------- --------------------------------- --------------------------------- Total interest income 7,088 (11,714) (4,626) (228) (11,872) (12,100) - ---------------------------------------------- --------------------------------- --------------------------------- Interest expense Interest-bearing DDA, savings, and money market accounts $ 376 $ (2,390) $ (2,014) $ 841 $ (4,505) $ (3,664) Certificates of deposit 1,749 (3,717) (1,968) (3,316) (8,854) (12,170) Borrowings 1,091 (592) 499 787 (489) 298 Subordinated debentures 365 (762) (397) 30 (18) 12 - ---------------------------------------------- --------------------------------- --------------------------------- Total interest expense 3,581 (7,461) (3,880) (1,658) (13,866) (15,524) - ---------------------------------------------- --------------------------------- --------------------------------- Change in net interest income $ 3,507 $ (4,253) (746) $ 1,430 $ 1,994 3,424 -------------------- -------------------- Change in tax equivalent adjustment 72 142 - ---------------------------------------------- --------------------------------- --------------------------------- Change in net interest income before tax equivalent adjustment $ (818) $ 3,282 - ---------------------------------------------- --------------------------------- ---------------------------------
8a Average Deposits
- ---------------------------------------------- -------------------- -------------------- 2003 2002 2001 - ---------------------------------------------- -------------------- -------------------- Amount Rate Amount Rate Amount Rate - ---------------------------------------------- -------------------- -------------------- Demand $ 111,480 $ 94,054 $ 85,317 Interest Bearing Demand 258,213 0.60% 236,802 1.06% 182,557 1.55% Savings 218,414 0.69 206,882 1.18 218,792 2.69 Certificates of Deposit 526,304 2.96 478,643 3.67 545,458 5.45 - ------------------------------------ ---------- ---------- Totals $1,114,411 1.67% $1,016,381 2.22% $1,032,124 3.72% ========== ========== ==========
As of December 31, 2003, certificates of deposit and other time deposits of $100 or more mature as follows: 3 months or less 4-6 months 6-12 months over 12 months Total ---------------- ---------- ----------- -------------- ----- Amount $56,903 $19,808 $27,715 $36,901 $141,327 Percent 40% 14% 20% 26% 8b Maturities and Sensitivity to Changes in Interest Rates of Commercial and Construction Loans at December 31, 2003 - --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------- Due: Within 1 Year 1 - 5 Years Over 5 years Total - --------------------------------------------------------------------------------------------------------- Loan Type Commercial and industrial $ 51,155 $ 36,903 $ 53,513 141,571 Agricultural production financing and other loans to farmers 18,829 4,541 2,527 25,897 Construction and development 29,938 263 4,485 34,686 - --------------------------------------------------------------------------------------------------------- Totals $ 99,922 $ 41,707 $ 60,525 $202,154 - --------------------------------------------------------------------------------------------------------- Percent 49% 21% 30% 100% - --------------------------------------------------------------------------------------------------------- Rate Sensitivity Fixed Rate $ 36,887 $ 17,795 $ 6,301 $ 60,983 Variable Rate 98,199 35,716 7,256 141,171 - --------------------------------------------------------------------------------------------------------- Totals $135,086 $ 53,511 $ 13,557 $202,154 - ---------------------------------------------------------------------------------------------------------
8c Allocation of the Allowance for Loan Losses
2003 2002 2001 2000 1999 ------------------- ------------------ ------------------- ----------------- ------------------ Percent Percent Percent Percent Percent of loans of loans of loans of loans of loans to total to total to total to total to total December 31 Amount loans Amount loans Amount loans Amount loans Amount loans - ---------------------------------------------------------------------------------------------------------------------------------- Real estate Residential $ 1,230 37% $ 2,097 41% $ 2,159 43% $ 1,076 47% $ 598 46% Farm real estate 704 4 776 6 301 6 442 6 397 6 Commercial 3,907 21 2,715 21 2,453 20 1,004 16 829 15 Construction and development 658 4 647 5 858 7 909 6 965 7 - ----------------------- --------------- --------------- --------------- --------------- --------------- Total real estate 6,499 66 6,235 73 5,771 75 3,431 75 2,789 74 - ----------------------- --------------- --------------- --------------- --------------- --------------- Commercial Agribusiness 491 3 388 3 368 3 965 3 1,011 3 Other commercial 3,003 19 1,810 14 1,349 11 1,204 12 812 11 - ----------------------- --------------- --------------- --------------- --------------- --------------- Total Commercial 3,494 22 2,198 17 1,717 14 2,169 15 1,823 14 - ----------------------- --------------- --------------- --------------- --------------- --------------- Consumer 1,053 12 951 10 952 11 1,349 10 1,413 12 Unallocated 463 133 554 1,767 1,693 - ----------------------- --------------- --------------- --------------- --------------- --------------- Total $11,509 100% $ 9,517 100% $ 8,994 100% $ 8,716 100% $ 7,718 100% - ----------------------- --------------- --------------- --------------- --------------- ---------------
8d INVESTMENT SECURITIES The composition and maturity of the investment portfolio is depicted in the table on page 8e. Investment Securities (Carrying Values at December 31)
Beyond Within 10 Total 1 Year 2-5 Yrs 6-10 Yrs Years 2003 - -------------------------------------------------------------------------------------------------- Available for sale Federal agencies $ 4,049 $ 88,818 $ -- $ -- $ 92,867 State and municipal 6,327 24,006 19,364 11,627 61,324 Mortgage-backed securities -- 9,798 106,025 139,718 255,541 Equity and other securities -- 1,625 500 10,254 12,379 - -------------------------------------------------------------------------------------------------- Total available for sale $ 10,376 $124,247 $125,889 $161,599 $422,111 ================================================================================================== Weighted average yield* 4.74% 3.21% 4.47% 3.70% 3.81% Held to Maturity - -------------------------------------------------------------------------------------------------- State and municipal $ 237 $ 1,126 $ 1,319 $ -- $ 2,682 Other securities -- 749 -- -- 749 - -------------------------------------------------------------------------------------------------- Total held to maturity $ 237 $ 1,875 $ 1,319 $ -- $ 3,431 ================================================================================================== Weighted average yield* 7.91% 6.39% 6.29% -- 6.45%
Amounts in the table above are based on scheduled maturity dates. Variable interest rates are subject to change not less than annually based upon certain interest rate indexes. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. As of December 31, 2003, there are no corporate bonds and other securities which represent more than 10% of shareholders' equity. *Adjusted to reflect income related to securities exempt from Federal income taxes 8e Contractual Obligations as of December 31, 2003
Less than 1 - 3 3 - 5 More than Total 1 Year Years Years 5 Years -------- -------- -------- -------- -------- Notes Payable $ 12,500 $ 3,400 $ 5,200 $ 3,900 $ -- FHLB Advances 62,751 10,549 10,163 15,703 26,336 Subordinated Debentures 29,898 -- -- -- 29,898 Total Deposits 1,191,310 1,013,369 135,809 25,505 16,627 ---------- ---------- -------- -------- -------- Total $1,296,459 $1,027,318 $151,172 $ 45,108 $ 72,861 ========== ========== ======== ======== ========
8f ITEM 2. PROPERTIES - ------------------- (Dollars in Thousands) MainSource Financial Group owns no physical properties. In February 2002, the Company entered into a five-year lease of approximately 28,000 square feet of space to be used as an operations center in Greensburg, Indiana. Its subsidiaries own, or lease, all of the facilities from which they conduct business. All leases are comparable to other leases in the respective market areas and do not contain provisions detrimental to the Company or its subsidiaries. As of December 31, 2003 the Company had 58 banking locations of which MainSource Bank has 33, Regional has 6, Capstone has 8, and First Community has 10. In addition, the Company operates five insurance offices in Indiana and one in Kentucky. At December 31, 2003, the Company had approximately $23 million invested in premises and equipment. ITEM 3. LEGAL PROCEEDINGS - -------------------------- The subsidiaries may be parties (both plaintiff and defendant) to ordinary litigation incidental to the conduct of business. Management is presently not aware of any material claims. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ No matters were submitted during the fourth quarter of 2003 to a vote of security holders, through the solicitation of proxies or otherwise. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - -------------------------------------------------------------------------- The information required under this item is incorporated by reference to the information provided in the "Shareholder Information" section on the inside back cover page of the Company's Annual Report to Shareholders filed with this report as Exhibit 13. ITEM 6. SELECTED FINANCIAL DATA - -------------------------------- The information required under this item is incorporated by reference to the information provided on page 9 of the Company's Annual Report to Shareholders filed with this report as Exhibit 13. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------ The information required under this item is incorporated by reference to the information provided on pages 10 through 20 of the Company's Annual Report to Shareholders filed with this report as Exhibit 13. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - -------------------------------------------------------------------- The information required under this item is incorporated by reference to the information provided on page 20 of the Company's Annual Report to Shareholders filed with this report as Exhibit 13. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - --------------------------------------------------- The financial statements and supplementary data required under this item are incorporated herein by reference to the information provided on pages 22 through 39 of the Company's Annual Report to Shareholders filed with this report as Exhibit 13. 9 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------------------------------------------------------------------------ In connection with its audits for the three most recent fiscal years ended December 31, 2003, there have been no disagreements with the Company's independent certified public accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. ITEM 9A. CONTROLS & PROCEDURES - ------------------------------- As of the end of the period covered be this report, an evaluation was carried out under the supervision and with the participation of the Company's management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms as of such date. PART IV ITEM 15--EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. Included in (a) 1. Financial statements Annual Report MainSource Financial Group and Subsidiaries Report of Independent Auditors 22 Consolidated balance sheets at December 31, 2003 and 2002 23 Consolidated statements of income, years ended December 24 31, 2003, 2002 and 2001 Consolidated statements of shareholders' equity, years 25 ended December 31, 2003, 2002 and 2001 Consolidated statements of cash flows, years ended 26 December 31, 2003, 2002 and 2001 Notes to consolidated financial statements 27-39 (a) 2. Financial statement schedules All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or related notes. (a) 3. Exhibits: 3.1 Restated Articles of Incorporation 3.2 Amended and Restated Bylaws dated April 28, 1998 (incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K of the registrant for the fiscal year ended December 31,1998 filed March 29, 1999 with the Commission (Commission File No. 0-12422)). 4.1 Indenture dated as of December 19, 2002 between the Registrant, as issuer, and State Street Bank and Trust Company of Connecticut, N.A., as trustee, re: floating rate junior subordinated deferrable interest debentures due 2032 (incorporated by reference to Exhibit 4.6 to the Annual Report on Form 10-K of the registrant for the fiscal year ended December 31, 2002 filed March 28, 2003 with the Commission (Commission File No. 0-12422)). 4.2 Amended and Restated Declaration of Trust dated as of December 19, 2002 among State Street Bank and Trust Company of Connecticut, N.A., as institutional trustee, the Registrant, as sponsor, and James L. Saner Sr., Donald A. Benziger and James M. Anderson, as administrators (incorporated by reference to Exhibit 4.7 to the Annual Report on Form 10-K of the registrant for the fiscal year ended December 31, 2002 filed March 28, 2003 with the Commission (Commission File No. 0-12422)). 4.3 Guarantee Agreement dated as of December 19, 2002 between the Registrant, and State Street Bank and Trust Company of Connecticut, N.A (incorporated by reference to Exhibit 4.8 to the Annual Report on Form 10-K of the registrant for the fiscal year ended December 31, 2002 filed March 28, 2003 with the Commission (Commission File No. 0-12422)). 4.4 Indenture dated as of April 1, 2003 between the Registrant, as issuer, and U.S. Bank, N.A., as trustee, re: floating rate junior subordinated deferrable interest debentures due 2033 (incorporated by reference to Exhibit 4.1 to the Quarterly Report on Form 10-Q of the registrant for the quarter ended June 30, 2003 filed August 14, 2003 with the Commission (Commission File No. 0-12422)). 4.5 Amended and Restated Declaration of Trust dated as of April 1, 2003 among U.S. Bank, N.A., as institutional trustee, the Registrant, as sponsor, and James L. Saner Sr., Donald A. Benziger and James M. Anderson, as administrators (incorporated by reference to Exhibit 4.2 to the Quarterly Report on Form 10-Q of the registrant for the quarter ended June 30, 2003 filed August 14, 2003 with the Commission (Commission File No. 0-12422)). 4.6 Guarantee Agreement dated as of April 1, 2003 between the Registrant, and U.S. Bank, N.A (incorporated by reference to Exhibit 4.3 to the Quarterly Report on Form 10-Q of the registrant for the quarter ended June 30, 2003 filed August 14, 2003 with the Commission (Commission File No. 0-12422)). 4.7 Indenture dated as of June 12, 2003 between the Registrant, as issuer, and The Bank of New York, as trustee, re: rate junior subordinated deferrable interest debentures due (incorporated by reference to Exhibit 4.4 to the Quarterly Report on Form 10-Q of the registrant for the quarter ended June 30, 2003 filed August 14, 2003 with the Commission (Commission File No. 0-12422)). 4.8 Amended and Restated Declaration of Trust dated as of June 12, 2003 among The Bank of New York, as institutional trustee, the Registrant, as sponsor, and James L. Saner Sr., Donald A. Benziger and James M. Anderson, as administrators (incorporated by reference to Exhibit 4.5 to the Quarterly Report on Form 10-Q of the registrant for the quarter ended June 30, 2003 filed August 14, 2003 with the Commission (Commission File No. 0-12422)). 10 4.9 Guarantee Agreement dated as of June 12, 2003 between the Registrant, and The Bank of New York (incorporated by reference to Exhibit 4.6 to the Quarterly Report on Form 10-Q of the registrant for the quarter ended June 30, 2003 filed August 14, 2003 with the Commission (Commission File No. 0-12422)). 10.1 Registrant's 2003 Stock Option Plan 10.2 Form of Stock Option Agreement Under 2003 Stock Option Plan for Directors of Registrant dated May 19, 2003. 10.3 Form of Executive Severance Agreement dated January 16, 2001 between the Registrant and James L. Saner, Sr. (incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K of the registrant for the fiscal year ended December 31, 2000 filed March 30, 2001 with the Commission (Commission File No. 0-12422)). 10.4 Form of Executive Severance Agreement dated January 16, 2001 between the Registrant and Donald A. Benziger (incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K of the registrant for the fiscal year ended December 31, 2000 filed March 30, 2001 with the Commission (Commission File No. 0-12422)). 10.5 Form of Executive Severance Agreement dated January 16, 2001 between the Registrant and John C. Parker (incorporated by reference to Exhibit 10.4 to the Annual Report on Form 10-K of the registrant for the fiscal year ended December 31, 2002 filed March 28, 2003 with the Commission (Commission File No. 0-12422)). 13 2003 Annual Report to Shareholders (Except for the pages and information thereof expressly incorporated by reference in this Form 10-K, the Annual Report to Shareholders is provided solely for the information of the Securities and Exchange Commission and is not deemed "filed" as part of this Form 10-K). 14 Code of Ethical Conduct 21 List of subsidiaries of the Registrant. 23.1 Consent of Crowe Chizek and Company LLC 31.1 Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 by Chief Executive Officer 31.2 Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 by Chief Financial Officer The following exhibits accompany this periodic report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (the "2002 Act"). These exhibits shall be deemed only to accompany this periodic report are not part of this periodic report, shall not be deemed filed purposes of the Securities Exchange Act of 1934, and may not be for any purpose other than compliance with the 2002 Act. 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Executive Officer 32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Financial Officer (b) Reports on Form 8-K During the quarter ended December 31, 2003, the Company filed two reports on Form 8-K. The Form 8-K dated November 26, 2003 reported under "Item 5. Other Events" that the Company's Board of Directors had approved a 5% stock dividend to be paid on January 9, 2004 to shareholders of record as of December 22, 2003. The Form 8-K dated December 17, 2003 reported under "Item 5. Other Events" that the Company had executed a definitive agreement that will lead to the merger of Peoples Financial Corp. into MainSource Financial Group, Inc. 11 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned; thereunto duly authorized, on the 10th day of March, 2004. MAINSOURCE FINANCIAL GROUP, INC. /s/ James L. Saner, Sr. ------------------------------ James L. Saner, Sr., President And Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed by the following persons on behalf of the registrant and in the capacities with the Company and on the dates indicated. Signature Capacity Date --------- -------- ---- /s/ William G. Barron - -------------------------------- William G. Barron Director March 10, 2004 /s/ Dale J. Deffner - -------------------------------- Dale J. Deffner Director March 10, 2004 /s/ Don Dunevant - -------------------------------- Don Dunevant Director March 10, 2004 /s/ Philip A. Frantz - -------------------------------- Philip A. Frantz Director March 10, 2004 /s/ Rick S. Hartman - -------------------------------- Rick S. Hartman Director March 10, 2004 /s/ Robert E. Hoptry - -------------------------------- Robert E. Hoptry Director March 10, 2004 Chairman of the Board /s/ James M. Anderson - -------------------------------- James M. Anderson Controller & March 10, 2004 Principal Accounting Officer /s/ Donald A. Benziger - -------------------------------- Donald A. Benziger Senior Vice March 10, 2004 President & Chief Financial Officer /s/ James L. Saner, Sr. - -------------------------------- James L. Saner, Sr. Director March 10, 2004 President & Chief Executive Officer EX-3.1 3 ex3-1.txt EXHIBIT 3.1 RESTATED ARTICLES OF INCORPORATION OF MAINSOURCE FINANCIAL GROUP, INC. ARTICLE I --------- Name The Corporation's name is MainSource Financial Group, Inc. ARTICLE II ---------- Authorized Shares ----------------- The total number of shares that the Corporation shall have the authority to issue is 25,400,000 shares, which shall be divided into the following classes: 25,000,000 Common Shares; and 400,000 Preferred Shares. The designations, voting powers and relative rights and preferences of the shares shall be as follows: A. Common Shares ------------- 1. Rank. The Common Shares are subject to all the preferences, limitations and relative rights of Preferred Shares designated in any resolution or resolutions adopted by the Board of Directors pursuant to authority expressly vested in it by the provisions of Section B of this Article II (the "Designated Preferred Shares"). 2. Voting. Holders of Common Shares are entitled to one (1) vote for each Common Share held with respect to all matters properly submitted for the vote of holders of Common Shares. 3. Dividends and Other Distributions. Except for and subject to the preferences, limitations and relative rights of any Designated Preferred Shares, the holders of Common Shares shall have exclusively all other rights of shareholders, including without limitation (i) the right to receive dividends, when, as and if declared by the Board of Directors out of funds legally available therefor, and (ii) in the event of any distribution of assets upon liquidation, dissolution or winding up of the Corporation or otherwise, the right to receive ratably all of the assets and funds of the Corporation remaining after payment to the creditors of the Corporation. . 1 B. Preferred Shares. ---------------- 1. Issuance by Board Resolutions; Series. The Board of Directors of the Corporation shall have authority by resolution to issue from time to time Preferred Shares in one or more series. Each series shall be distinctly designated by number, letter or title. All shares of any one series of Preferred Shares shall be alike in every particular. The powers, preferences and voting, relative, participating, optional and other rights of each such series, and the qualifications, limitations or restrictions thereof, if any, may differ from those of any and all other series at any time outstanding. 2. Preferences and Rights. Subject to the provisions of subparagraph 3 of this Paragraph B of Article II, the Board of Directors of the Corporation is hereby expressly granted authority to fix by resolution or resolutions adopted prior to the issuance of any shares of each particular series of Preferred Shares, the designation, powers, preferences and voting, relative participating, optional and other rights, and the qualifications, limitations and restrictions thereof, if any, of such series, including, but without limiting the generality of the foregoing, the following: (a) The distinctive designation of, and the number of Preferred Shares that shall constitute, the series, which number from time to time may be increased (except as otherwise fixed by the Board of Directors) or decreased (but not below the number of shares thereof then outstanding) from time to time by action of the Board of Directors. (b) The rate and time at which, and the terms and conditions upon which, dividends on the shares of the series shall be paid, whether the dividends shall be cumulative or non-cumulative, and if cumulative, from what date or dates, and the preferences or relation, if any, of such dividends to the dividends payable on any shares of any other series or class of shares of the Corporation; (c) Whether shares of the series shall be subject to redemption, and if so subject, whether they shall be subject to redemption (i) at the option of the Corporation, the shareholder, another person and/or upon the occurrence of a designated event, (ii) for cash, indebtedness, securities (including, without limitation, Common Shares) or other property, or any combination thereof, and (iii) for a designated amount or for an amount determined in accordance with a designated formula or by reference to extrinsic data or events; and, as to any shares of a series subject to redemption, such other terms and conditions on which the shares of the series may be redeemed; (d) Whether the holders of the shares of the series shall be entitled to the benefit of a sinking fund or redemption or purchase account to be applied to the purchase or redemption of the shares of the series and, if so entitled, the amount of such fund and the terms and conditions relative to the operation thereof; (e) Whether the shares of the series shall be convertible into, or exchangeable for, any Common Shares or other Preferred Shares of the Corporation or any other securities and, of so convertible or exchangeable, whether the conversion or exchange (i) is at the option of the 2 Corporation, the shareholder, another person and/or upon the occurrence of a designated event, (ii) shall be for cash, indebtedness, securities (including, without limitation, Common Shares) or other property, or any combination thereof, and (iii) shall be for a designated amount or at a designated ratio, or for an amount or at a ratio determined in accordance with a designated formula or by reference to extrinsic data or events; and, as to any shares of a series so convertible or exchangeable, such other terms and conditions on which the shares of the series may be converted or exchanged; (f) The rights, if any, of the holders of the shares of the series upon voluntary or involuntary liquidation, merger, consolidation, distribution or sale of assets, dissolution or winding-up of the Corporation. (g) Whether the shares of the series shall have priority over or parity with or be junior to the shares of any other class or series, or shall be entitled to the benefit of limitations restricting (i) the creation of indebtedness of the Corporation, (ii) the issuance of shares of any other class or series having priority over or being on a parity with the shares of such series, or (iii) the payment of dividends on, the making of other distributions with respect to, or the purchase or redemption of shares of any other class or series on parity with or ranking junior to the shares of any such series as to dividends or other distributions, and the terms of any such restrictions, or any other restrictions with respect to shares of any class or series on parity with or ranking junior to the shares of such series in any respect; (h) Whether and in what circumstances shares of a series shall have voting rights, which voting rights, if any, may be general, special, conditional or limited (and, in the case of special, conditional or limited voting rights, may confer upon holders of such series in certain circumstances the exclusive right to elect a majority of the members of the Board of Directors); and, as to any shares of a series having voting rights, the number of votes each holder shall be entitled to cast per each share of the series and whether holders of the series are entitled to vote separately or together with the holders of one or more other series of Preferred Shares on all or some matters as a separate voting group; and (i) Any other powers, preferences, privileges and relative, participating, optional, or other special rights of such series, and the qualifications, limitations or restrictions thereof, to the fullest extent now and hereafter permitted by law. 3. Issuance of Preferred Shares. Subject to the following provisions of this subparagraph 3, shares of any series of Preferred Shares may be issued from time to time as the Board of Directors shall determine and on such terms and for such consideration as shall be fixed by the Board of Directors. The relative powers, preferences and rights of each series of Preferred Shares in relation to the powers, preferences and rights of each other series of Preferred Shares shall be as fixed from time to time by the Board of Directors in the resolution or resolutions adopted pursuant to authority granted in this Paragraph B of Article II. Except as otherwise provided by law, the consent by class or series vote or otherwise of the holders of such of the series of the Preferred Shares as are from time to time outstanding shall not be required for the issuance by the Board of Directors of any other series of Preferred Shares, whether the powers, preferences and rights of such other series shall be fixed by the Board of Directors as senior to, or on a parity with, the powers, preferences and rights of such outstanding series, or any of them; 3 provided, however, that the Board of Directors may provide in such resolution or resolutions adopted with respect to any series of Preferred Shares that the consent of the holders of a majority (or such greater proportion as shall be therein fixed) of the outstanding shares of such series voting thereon shall be required for the issuance of any or all other series of Preferred Shares. ARTICLE III ----------- Board of Directors ------------------ The affairs of the Corporation shall be managed and conducted by a Board of Directors. The number of directors shall be determined in the manner prescribed from time to time by the bylaws of the Corporation. ARTICLE IV ---------- Indemnification and Insurance ----------------------------- A. Right to Indemnification. Each person who was or is made a party or is threatened to be made a party to or is involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative and whether formal or informal (hereinafter a "proceeding"), by reason of the fact that he or she, or a person of whom he or she is the legal representative, is or was a director or officer of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other entity, including service with respect to any employee benefit plan, whether the basis of such proceeding is alleged action in an official capacity as a director, officer, employee or agent or in any other capacity while serving as a director or officer, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Indiana Business Corporation Law ("IBCL"), as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than said law permitted the Corporation to provide prior to such amendment), against all expense, liability and loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid or to be paid in settlement) reasonably incurred or suffered by such person in connection therewith, and such indemnification shall continue as to a person who has ceased to be a director or officer, and shall inure to the benefit of his or her heirs, executors and administrators; provided, however, that nothing in this Paragraph A or elsewhere in this Article IV shall obligate the Corporation to indemnify or hold harmless any such director or officer with respect to or in connection with any proceeding in which there is asserted any claim, counterclaim or crossclaim directly by the Corporation against any such director or officer, or any proceeding in which there is asserted any claim, counterclaim or crossclaim directly or indirectly (including any claim made by or in the right of the Corporation) by any such director or officer against the Corporation and/or any of its directors, officers, employees or agents. The right to indemnification conferred in this paragraph A of Article IV shall be a contract right and shall include the right to require the Corporation to pay for or reimburse any such director or officer the reasonable expenses incurred in advance of the final disposition of the proceeding; provided, however, that the Corporation shall have no 4 obligation to pay for or reimburse such expenses unless the director or officer seeking such payment or reimbursement furnishes the Corporation a written affirmation of such person's good faith belief that such person has met the requisite standard of conduct for indemnification provided in the IBCL and furnishes the Corporation a written undertaking, executed personally or on such person's behalf, to repay the advance if it is ultimately determined that such person is not entitled to be indemnified under this Paragraph A of Article IV or otherwise; and provided further, however, that nothing in this Paragraph A or elsewhere in this Article IV shall obligate the Corporation to pay for or reimburse the expenses incurred by any such director or officer that relate in any way to a proceeding in which there is asserted any claim, counterclaim or crossclaim directly by the Corporation against any such director or officer or any proceeding in which there is asserted any claim, counterclaim or crossclaim directly or indirectly (including any claim made by or in the right of the Corporation) by any such director or officer against the Corporation and/or any of its directors, officers, employees or agents. The Corporation may, by action of its Board of Directors, provide indemnification to employees and agents of the Corporation with the same scope and effect as the foregoing indemnification of directors and officers. B. Right of Claimant to Bring Suit. If a claim under paragraph A of this Article IV is not paid in full by the Corporation within 30 days after a written claim has been received by the Corporation, the claimant may, at any time thereafter, bring suit against the Corporation to recover the unpaid amount of the claim and, if successful in whole or in part, the claimant shall be entitled to be paid also the expense of prosecuting such claim. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in defending any proceeding in advance of its final disposition where the required written affirmation of good faith belief and undertaking has been tendered to the Corporation and the proceeding for which such expenses have been incurred is not a proceeding to which the "provided further, however" underlined proviso in Paragraph A, a prohibition against an advancement for such expenses, is applicable) that the claimant has not met the standard of conduct that makes it permissible under the IBCL for the Corporation to indemnify the claimant for the amount claimed, but the burden of proving such defense shall be on the Corporation. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel or its shareholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because he or she has met the applicable standard of conduct set forth in the IBCL, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel or its shareholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that the claimant has not met the applicable standard of conduct. C. Non-Exclusivity of Rights. The right to indemnification and the payment or reimbursement of expenses incurred in a proceeding in advance of its final disposition conferred in this Article IV shall not be exclusive of any other right that any person may have or hereafter acquire under any statute, bylaw, contract or other agreement, vote of shareholders or disinterested directors, or otherwise. D. Insurance. The Corporation may maintain insurance, at its expense, to protect itself and any --------- director, officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust or other entity (including any employee benefit plan) against any such expense, liability or loss, whether or not the Corporation would have the power to indemnify such person against such expense, liability or loss under the IBCL. 5 EX-10.1 4 ex10-1.txt EXHIBIT 10.1 MainSource Financial Group, Inc. 2003 Stock Option Plan 1. Purpose. The purpose of this Plan is to promote share ownership by key employees, directors, and outside service providers of MainSource Financial Group, Inc and its Affiliates, thereby reinforcing a mutuality of interest with other shareholders, and to enable MainSource Financial Group, Inc. to attract, retain and motivate key employees, directors, and outside service providers by permitting them to share in its growth. 2. Definitions. As used in this Plan: (1) "Affiliate" means (a) a corporation that, for purposes of Section 422 of the Code, is a parent or subsidiary of the Company, and (b) any other entity in which the Company has a substantial equity investment, as designated by the Board. (2) "Board" means the Board of Directors of the Company and, to the extent of any delegation by the Board to a committee (or subcommittee thereof) pursuant to Section 11 of this Plan, such committee (or subcommittee). (3) "Code" means the Internal Revenue Code of 1986, as amended. (4) "Common Shares" means the common shares of Main Source Financial Group, Inc. (5) "Company" means MainSource Financial Group, Inc., an Indiana corporation. (6) "Date of Grant" means the date specified by the Board on which a grant of Options shall become effective (which date shall not be earlier than the date on which the Board takes action with respect thereto). (7) "Director" means a member of the Board of Directors of the Company. (8) "Exchange Act" means the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder, as such law, rules and regulations may be amended. (9) "Fair Market Value" means, as of any given day, the per share closing price of a Common Share on NASDAQ on the day preceding the day such determination is being made or, if there was no closing price reported on such day, on the most recently preceding day on which such a closing price was reported; or if the Common Shares are not listed or admitted to trading on NASDAQ on the day as of which the determination is being made, the amount determined by the Board to be the fair market value of a Common Share on such day. -1- (10) "Incentive Stock Options" means Options that are intended to qualify as "incentive stock options" under Section 422 of the Code or any successor provision. (11) "NASDAQ" means The NASDAQ Stock Market. (12) "Optionee" means a Participant named in an agreement evidencing an outstanding Option. (13) "Option Price" means the purchase price payable on exercise of an Option. (14) "Option" means the right to purchase Common Shares upon exercise of an option granted pursuant to Section 4 of this Plan. (15) "Participant" means a person who is selected by the Board to receive benefits under this Plan and who is at the time a key employee or outside service provider of the Company or an Affiliate, a Director, or a member of the board of directors of an Affiliate of the Company, or who has agreed to commence serving in any of such capacities within 30 days of the Date of Grant. (16) "Plan" means this MainSource Financial Group, Inc. 2003 Stock Option Plan, as it may be amended from time to time. (17) "Rule 16b-3" means Rule 16b-3 under the Exchange Act (or any successor rule to the same effect) as in effect from time to time. 3. Shares Available. (1) Subject to adjustment as provided in Section 5 of this Plan, the total number of Common Shares that may be issued and sold under Options granted pursuant to this Plan shall not exceed 350,000 Common Shares. Such shares may be treasury shares or shares of original issue or a combination of the foregoing. (2) Notwithstanding anything in this Section 3 or elsewhere in this Plan to the contrary, and subject to the exception provided in the following proviso and adjustment as provided in Section 5 of this Plan, no individual Participant shall be granted Options under this Plan for more than 35,000 Common Shares during any twelve-month period; provided, however, that this limitation shall not apply to a grant of Options to a Participant not previously an employee or Director of the Company or an Affiliate of the Company, as an inducement material to the individual's entering into employment with the Company or an Affiliate of the Company. (3) Any Common Shares issued and sold under Options may be subject to such restrictions on transfer as the Board may provide in a Stock Option Agreement. (4) Each grant shall specify the number of Common Shares to which it pertains, subject to the limitations set forth in Section 3 of this Plan, if any. -2- (5) Each grant shall specify an Option Price per share, which may not be less than the Fair Market Value on the Date of Grant. (6) The Option Price shall be payable (i) in cash or by other consideration acceptable to the Company, (ii) by the actual or constructive transfer to the Company of Common Shares owned by the Optionee for at least 6 months having a value at the time of exercise equal to the total Option Price, or (iii) by a combination of such methods of payment. (7) Any grant may provide for deferred payment of the Option Price from the proceeds of sale through a broker on a date satisfactory to the Company of some or all of the Common Shares to which such exercise relates. (8) Any grant may provide for payment of the Option Price in installments, with interest on the unpaid balance payable at such rate necessary to avoid imputed interest or original interest discount under the Code. (9) Successive grants may be made to the same Optionee whether or not any Options previously granted to such Optionee remains unexercised. (10) Each grant shall specify the period or periods of continuous service by the Optionee with the Company or any of its Affiliates that is necessary before the Options or installments thereof will become exercisable and may provide for earlier exercise of the Option, including, without limitation, in the event of a change in control of the Company or similar event. (11) Options granted under this Plan may be (i) options that are intended to qualify under particular provisions of the Code, including, without limitation, Incentive Stock Options, (ii) options that are not intended so to qualify under the Code, or (iii) combinations of the foregoing. (12) Except as otherwise determined by the Board, no Option shall be transferable by the Optionee except by will or the laws of descent and distribution. Except as otherwise determined by the Board, Options shall be exercisable during the Optionee's lifetime only by the Optionee or, in the event of the Optionee's legal incapacity to do so, the Optionee's guardian or legal representative acting on behalf of the Optionee in a fiduciary capacity under state law and court supervision. (13) No Option shall be exercisable more than 10 years from the Date of Grant. (14) An Optionee may exercise an Option in whole or in part at any time and from time to time during the period within which an Option may be exercised. To exercise an Option, an Optionee shall give written notice to the Company specifying the number of Common Shares to be purchased and provide payment of the Option Price and any other documentation that may be required by the Company. (15) An Optionee shall be treated for all purposes as the owner of record of the number of Common Shares purchased pursuant to exercise of the Option (in whole or in part) as of the date the conditions set forth in this Section are satisfied and the Option is exercised. -3- (16) To the extent required for "Incentive Stock Option" status under Section 422 of the Code, the aggregate Fair Market Value (determined as of the Date of Grant) of the Common Shares with respect to which Incentive Stock Options are exercisable for the first time by the Optionee during any calendar year under the Plan and/or any other stock option plan of the Company (within the meaning of Section 424 of the Code) shall not exceed $100,000. (17) The Board may permit Optionees to elect to defer the issuance of Common Shares under this Plan pursuant to such rules, procedures, or programs as it may establish for purposes of this Plan. The Board also may provide that deferred issuances and settlements include the payment or crediting of dividend equivalents or interest on the deferral amounts. 4. Options. The Board may, from time to time and upon such terms and conditions as it may determine, authorize the granting of Options to Participants. Each such grant shall be subject to all of the requirements contained in the following provisions and to such other terms as the Board may from time to time provide in a Stock Option Agreement: 5. Adjustments. The Board may make or provide for such adjustments in the Option Price and in the number or kind of shares or other securities covered by outstanding options as the Board in its sole discretion may in good faith determine to be equitably required in order to prevent dilution or enlargement of the rights of Optionees that would otherwise result from any (a) stock dividend, stock split, combination of shares, recapitalization or other change in the capital structure of the Company, (b) merger, consolidation, separation, reorganization, partial or complete liquidation, issuance of rights or warrants to purchase stock, or (c) other corporate transaction or event having an effect similar to any of the foregoing. Moreover, in the event of any such transaction or event, the Board, in its discretion, may provide in substitution for any or all outstanding options under this Plan such alternative consideration as it, in good faith, may determine to be equitable in the circumstances and may require in connection therewith the surrender of all options so replaced. The Board may also make or provide for such adjustments in the number of shares specified in Section 3 of this Plan as the Board in its sole discretion, exercised in good faith, may determine is appropriate to reflect any transaction or event described in this Section. Notwithstanding anything herein to the contrary, the Company may, in its sole discretion, accelerate the timing of the exercise provisions of any Option in the event of a tender offer for the Company's Common Shares, the adoption of a plan of merger or consolidation under which a majority of the Common Shares of the Company would be eliminated, or a sale of substantially all of the Company's assets. Alternatively, the Company may, in its sole discretion, cancel any or all Options upon any of the foregoing events and provide for the payment to Participants in cash of an amount equal to the value or appreciated value, whichever is applicable, of the Option, as determined in good faith by the Board, at the close of business on the date of such event. 6. Stock Option Agreement. The form of each Stock Option Agreement shall be prescribed, and any Stock Option Agreement evidencing an outstanding Option may with the concurrence of the affected Optionee be amended, by the Board, provided that the terms and conditions of each Stock Option Agreement and amendment are not inconsistent with this Plan -4- and that no amendment shall adversely affect the rights of the Optionee with respect to any outstanding Option without the Optionee's consent. 7. Cancellation of Options. The Board may, with the concurrence of the affected Optionee, cancel any option granted under this Plan. In the event of any such cancellation, the Board may authorize the granting of new options (which may or may not cover the same number of Common Shares that had been the subject of any prior option) in such manner, at such Option Price and subject to the same terms, conditions and discretion as would have been applicable under this Plan had the canceled options not been granted. 8. Withholding. No later than the date as of which an amount first becomes includible in the gross income of the Optionee for applicable income tax purposes with respect to any Option under the Plan, the Optionee shall pay to the Company, or make arrangements satisfactory to the Board regarding the payment of, any Federal, state or local taxes of any kind required by law to be withheld with respect to such amount. Unless otherwise determined by the Board, the minimum required withholding obligations may be settled with Common Shares, including Common Shares that are part of the award that gives rise to the withholding requirement. The obligations of the Company under this Plan shall be conditional on such payment or arrangements and the Company shall, to the extent permitted by law, have the right to deduct any such taxes from any payment of any kind otherwise due to the Optionee. 9. Governing Law. The Plan and all Options granted and actions taken thereunder shall be governed by and construed in accordance with the laws of the State of Indiana. 10. Fractional Shares. The Company shall not be required to issue any fractional Common Shares pursuant to this Plan. The Board may provide for the elimination of fractions or for the settlement of fractions for cash. 11. Administration. This Plan shall be administered by the Board, which may from time to time delegate all or any part of its authority under this Plan to a committee of not less than two Directors appointed by the Board. The members of the committee shall be "Non-Employee Directors" within the meaning of Rule 16b-3. To the extent of any such delegation, references in this Plan to the Board shall also refer to the committee. A majority of the members of the committee shall constitute a quorum, and any action taken by a majority of the members of the committee who are present at any meeting of the committee at which a quorum is present, or any actions of the committee that are unanimously approved by the members of the committee in writing, shall be the acts of the committee. The Board shall have the authority to delegate responsibility and authority for the operation and administration of this Plan, appoint employees and officers of the Company and Affiliates to act on its behalf, and employ persons to assist in fulfilling its responsibilities under this Plan. In addition, the Board shall have complete authority to interpret all provisions of the Plan; to prescribe the form of Agreements; to adopt, amend, and rescind rules and regulations pertaining to the administration of the Plan; and to make all other determinations necessary or advisable for the administration of the Plan, including, without limitation, determinations of fact. The express grant in the Plan of any specific power to the Board shall not be construed as limiting the power or authority of the Board. Any decision made, or action taken, by the Board in connection with the administration of the Plan shall be final and conclusive. No member of the Board shall be liable for any act done in good faith with -5- respect to the Plan or any Agreement or Option. All expenses of administering the Plan shall be borne by the Company. 12. Amendment. This Plan may be amended from time to time by the Board; provided, however, that any amendment that must be approved by the shareholders of the Company in order to comply with applicable law or the rules of NASDAQ, or if the Common Shares are not quoted on NASDAQ, the principal national securities exchange upon which the Common Shares are traded or quoted, shall not be effective unless and until such approval has been obtained. Presentation of this Plan or any amendment hereof for shareholder approval shall not be construed to limit the Company's authority to offer similar or dissimilar benefits under other plans without shareholder approval. 13. Effective Date. This Plan shall be effective immediately; provided, however, that the effectiveness of this Plan is conditioned on its approval by the shareholders of the Company at a meeting duly held in accordance with Indiana law within 12 months after the date this Plan is adopted by the Board. All awards under this Plan shall be null and void if the Plan is not approved by the shareholders within such 12-month period. 14. Term. No Option shall be granted pursuant to this Plan on or after the tenth anniversary of the date this Plan is adopted by the Board, but awards granted prior to such tenth anniversary may extend beyond that. The date this Plan is adopted by the Board shall be January 21, 2003. 15. Awards in Substitution for Awards Granted by Other Companies. To the extent not otherwise provided in the Plan, Options may be granted under this Plan in substitution for awards held by employees of a company who become employees of the Company or an Affiliate as a result of the acquisition, merger or consolidation of the employer company by or with the Company or an Affiliate. The terms, provisions and benefits of the substitute awards so granted may vary from those set forth in or authorized by this Plan to such extent as the Board at the time of the grant may deem appropriate to conform, in whole or in part, to the terms, provisions and benefits of awards in substitution for which they are granted. Executed this 21st day of January, 2003 but effective as provided above. MAINSOURCE FINANCIAL GROUP, INC. By:_________________________________ Robert E. Hoptry, Chairman of the Board -6- EX-10.2 5 ex10-2.txt EXHIBIT 10.2 NONQUALIFIED STOCK OPTION AGREEMENT ----------------------- This AGREEMENT (the "Agreement") is made as of May 19, 2003, by and between MainSource Financial Group, Inc., an Indiana corporation (the "Company"), and _______________ (the "Optionee"). Now, therefore, the parties hereto agree as follows: 1. Grant of Stock Option. Subject to and upon the terms, conditions, and restrictions set forth in this Agreement and in the MainSource Financial Group 2003 Option Plan (the "Plan"), the Company hereby grants to the Optionee as of the date of this Agreement ( the "Date of Grant") a stock option (the "Option") to purchase 1,000 Common Shares (the "Optioned Shares"). The Option may be exercised from time to time in accordance with the terms of this Agreement. The price, at which the Optioned Shares may be purchased pursuant to this Option, shall be $23.20 per share, subject to adjustment as hereinafter provided (the "Option Price"). The Option is intended to be a nonqualified stock option and shall not be treated as an "incentive stock option" within the meaning of that term under Section 422 of the Code, or any successor provision thereto. 2. Term of Option. The term of the Option shall commence on the Date of Grant and, unless earlier terminated in accordance with Section 6 hereof, shall expire ten (10) years from the Date of Grant. 3. Right to Exercise. Subject to expiration or earlier termination, the number of Optioned Shares specified in this Agreement shall become exercisable in whole or in part at any time and from time to time on or after the Date of Grant. In no event shall the Optionee be entitled to acquire a fraction of one Optioned Share pursuant to this Option. The Optionee shall be entitled to the privileges of ownership with respect to Optioned Shares purchased and delivered to him upon the exercise of all or part of this Option. 4. Option Nontransferable. The Option granted hereby shall be neither transferable nor assignable by an Optionee other than by will or by the laws of descent and distribution and may be exercised, during the lifetime of the Optionee, only by the Optionee, or in the event of his or her legal incapacity, by his or her guardian or legal representative acting on behalf of the Optionee in a fiduciary capacity under state law and court supervision. 5. Notice of Exercise; Payment. (1) To the extent then exercisable, the Option may be exercised by written notice to the Company stating the number of Optioned Shares for which the Option is being exercised and the intended manner of payment. Payment equal to the aggregate Option Price of the Optioned Shares being exercised shall be tendered in full with the notice of exercise to the Company in cash in the form of currency or check or other cash equivalent acceptable to the Company. The requirement of payment in cash shall be deemed satisfied if the Optionee makes arrangements that are satisfactory to the Company with a broker that is a member of the National Association of Securities Dealers, Inc. to sell a sufficient number of Optioned Shares which are being 1 purchased pursuant to the exercise, so that the net proceeds of the sale transaction will at least equal the amount of the aggregate Option Price, and pursuant to which the broker undertakes to deliver to the Company the amount of the aggregate Option Price not later than the date on which the sale transaction will settle in the ordinary course of business. (2) The Optionee may also tender the Option Price by (i) the actual or constructive transfer to the Company of nonforfeitable, nonrestricted Common Shares that have been owned by the Optionee for (x) more than one year prior to the date of exercise and for more than two years from the date on which the option was granted, if they were originally acquired by the Optionee pursuant to the exercise of an Incentive Stock Option, or (y) more than six months prior to the date of exercise, if they were originally acquired by the Optionee other than pursuant to the exercise of an Incentive Stock Option, or (ii) by any combination of the foregoing methods of payment, including a partial tender in cash and a partial tender in nonforfeitable, nonrestricted Common Shares. (3) Within ten (10) days after notice, the Company shall direct the due issuance of the Optioned Shares so purchased. (4) Nonforfeitable, nonrestricted Common Shares that are transferred by the Optionee in payment of all or any part of the Option Price shall be valued on the basis of their Fair Market Value. (5) As a further condition precedent to the exercise of this Option, the Optionee shall comply with all regulations and the requirements of any regulatory authority having control of, or supervision over, the issuance of Common Shares and in connection therewith shall execute any documents which the Board shall in its sole discretion deem necessary or advisable. The date of such notice shall be the exercise date. 6. Termination of Agreement. The Agreement and the Option granted hereby shall terminate automatically and without further notice on the earliest of the following dates: (1) One (1) year after the Optionee's death if the Optionee dies while serving as a director of the Company or an Affiliate; (2) One (1) year after the date of the Optionee's permanent and total disability that is confirmed by a licensed physician's statement, if the Optionee becomes permanently and totally disabled while serving as a director of the Company or an Affiliate; (3) Except as provided on a case-by-case basis, sixty (60) days after the date the Optionee ceases to be a director of the Company or an Affiliate for any reason other than as described in this Section; or (4) Ten (10) years from the Date of Grant. This Agreement shall not be exercisable for any number of Optioned Shares in excess of the number of Optioned Shares exercisable, pursuant to Sections 3 and 9 hereof, on the date of termination of employment. 2 7. Taxes and Withholding. If the Company shall be required to withhold any federal, state, local or foreign tax in connection with the exercise of the Option, and the amounts available to the Company for such withholding are insufficient, the Optionee shall pay the tax or make provisions that are satisfactory to the Company for the payment thereof. The Optionee may elect to satisfy all or any part of any such withholding obligation by surrendering to the Company a portion of the Optioned Shares that are issued or transferred to the Optionee upon the exercise of the Option, and the Optioned Shares so surrendered by the Optionee shall be credited against any such withholding obligation at the Fair Market Value of such shares on the date of such surrender. The Company will pay any and all issue and other taxes in the nature thereof which may be payable by the Company in respect of any issue or delivery upon a purchase pursuant to this Option. 8. Compliance with Law. The Company shall make reasonable efforts to comply with all applicable federal and state securities laws; provided, however, notwithstanding any other provision of this Agreement, the Option shall not be exercisable if the exercise thereof would result in a violation of any such law. 9. Adjustments. The Board may make or provide for such adjustments in the number of Optioned Shares covered by this Option, in the Option Price applicable to such Option, and in the kind of shares covered thereby, as the Board may determine is equitably required to prevent dilution or enlargement of the Optionee's rights that otherwise would result from (a) any stock dividend, stock split, combination of shares, recapitalization, or other change in the capital structure of the Company, (b) any merger, consolidation, spin-off, split-off, spin-out, split-up, reorganization, partial or complete liquidation, or other distribution of assets or issuance of rights or warrants to purchase securities, or (c) any other corporate transaction or event having an effect similar to any of the foregoing. In the event of any such transaction or event, the Board may provide in substitution for this Option such alternative consideration as it may determine to be equitable in the circumstances and may require in connection therewith the surrender of this Option. 10. Relation to Other Benefits. Any economic or other benefit to the Optionee under this Agreement shall not be taken into account in determining any benefits to which the Optionee may be entitled under any profit-sharing, retirement, or other benefit or compensation plan maintained by the Company. 11. Amendments. Any amendment to the Plan shall be deemed to be an amendment to this Agreement to the extent that the amendment is applicable hereto; provided, however, that no amendment shall adversely affect the rights of the Optionee under this Agreement without the Optionee's consent. 12. Severability. In the event that one or more of the provisions of this Agreement shall be invalidated for any reason by a court of competent jurisdiction, any provision so invalidated shall be deemed to be separable from the other provisions hereof, and the remaining provisions hereof shall continue to be valid and fully enforceable. 3 13. Relation to Plan. This Agreement is subject to the terms and conditions of the Plan. In the event of any inconsistent provisions between this Agreement and the Plan, the Plan shall govern. Capitalized terms used herein without definition shall have the meanings assigned to them in the Plan. The Board acting pursuant to the Plan, as constituted from time to time, shall, except as expressly provided otherwise herein, have the right to determine any questions, which arise in connection with this option or its exercise. 14. Successors and Assigns. The provisions of this Agreement shall inure to the benefit of, and be binding upon, the successors, administrators, heirs, legal representatives and assigns of the Optionee, and the successors and assigns of the Company. 15. Governing Law. The interpretation, performance, and enforcement of this Agreement shall be governed by the laws of the State of Indiana, without giving effect to the principles of conflict of laws thereof. 16. Notices. Any notice to the Company provided for herein shall be in writing to the Company, marked Attention: Corporate Secretary, and any notice to the Optionee shall be addressed to said Optionee at his or her address currently on file with the Company. Except as otherwise provided herein, any written notice shall be deemed to be duly given if and when delivered personally or deposited in the United States mail, first class registered mail, postage and fees prepaid, and addressed as aforesaid. Any party may change the address to which notices are to be given hereunder by written notice to the other party as herein specified (provided that for this purpose any mailed notice shall be deemed given on the third business day following deposit of the same in the United States mail). IN WITNESS WHEREOF, the Company has caused this Agreement to be executed on its behalf by its duly authorized officer and Optionee has also executed this Agreement in duplicate, as of the day and year first above written. MAINSOURCE FINANCIAL GROUP, INC. By: -------------------------------------------- James L. Saner, Sr., Chief Executive Officer ----------------------------------------------- Optionee 4 EX-13 6 ex13.txt EXHIBIT 13 MAINSOURCE FINANCIAL GROUP --------------- 2003 ANNUAL REPORT MainSource Financial Group About the Company Contents Financial Highlights 1 Report to Shareholders 2 Year in Review 4 Selected Financial Data 9 Management's Discussion and Analysis 10 Report of Management on Responsibility for Financial Information 21 Independent Auditor's Report 22 Consolidated Financial Statements 23 Notes to Consolidated Financial Statements 27 Directors and Officers 40 Shareholder Information 41 Corporate Profile MainSource Financial Group (the "Company") is an Indiana-based, multi-bank holding company. Its focus is to provide complete financial services in the more personalized style of a community bank. These services go beyond traditional community-bank products and services and include insurance, investment brokerage, mutual funds, wealth management and financial planning. At 2003 year-end, MainSource Financial Group owned four affiliate banks: MainSource Bank with 33 branch offices in southeastern Indiana; First Community Bank & Trust with 10 branch offices in south-central Indiana; Regional Bank with six branch offices in southern Indiana; and Capstone Bank with seven branch offices in eastern Illinois and one in Indiana. MainSource also owned an insurance agency and an investment and trust operation. MainSource Insurance operated five insurance offices in Indiana and one in Kentucky; MainSource Wealth Management operated three offices in Indiana and one in Illinois. Both MainSource Insurance and Wealth Management provide their services to all of the Company's banking offices. An acquisition is pending with Peoples Financial Corp. of Linton, Indiana, which has 7 banking offices southwest of Indianapolis. The acquisition is expected to close in the second quarter of 2004. Stock Data The common shares of the Company are listed on The Nasdaq Stock Market. The trading symbol is MSFG. In newspaper listings, MainSource Financial shares are frequently listed as MainSrce. Log on to our website at www.mainsourcefinancial.com for additional information. [MAP APPEARS HERE] MainSource Financial Group Offices: MainSource Bank o Capstone Bank o Regional Bank First Community Bank & Trust Co. o MainSource Insurance MainSource Financial Group Financial Highlights (Dollar amounts in thousands except per share data)
Percent December 31 2003 2002 Change - ----------------------------------------------------------------------------------------- At Year End Total assets $ 1,442,729 $ 1,251,760 + 15.3% Loans, excluding held for sale 855,471 740,167 + 15.6 Allowance for loan losses 11,509 9,517 + 20.9 Total deposits 1,191,310 1,034,307 + 15.2 Shareholders' equity 105,424 99,771 + 5.7 Results of Operations Net interest income $ 44,232 $ 45,050 - 1.8% Non-interest income 19,443 14,379 + 35.2 Provision for loan losses 1,325 2,995 - 55.8 Net income 15,305 14,011 + 9.2 Per Common Share * Earnings per share (basic and diluted) $ 2.16 $ 1.96 + 10.2% Dividends paid 0.686 0.626 + 9.6 Book value - end of period 14.91 13.99 + 6.6 Market price - end of period 30.67 22.87 + 34.1 Financial Ratios Return on average assets 1.14% 1.16% - 1.7% Return on average common shareholders' equity 15.07 14.90 + 1.1 Allowance for loan losses to total loans (year end) 1.35 1.29 + 4.7
* Adjusted for stock dividends 1 MainSource Financial Group Report to Shareholders [PHOTO APPEARS HERE] James L. Saner, Sr., President and CEO We just completed the finest year in our history, surpassing virtually every benchmark by which banks are commonly measured. Earnings rose for the fifth year in a row to set a new record of $15.3 million, which was 9.2 percent ahead of the old record of $14.0 million set the year before. Earnings per share rose 10.2 percent to $2.16 from $1.96 in 2002. In addition, we completed one acquisition and embarked on another. Finally, our stock price advanced again, reaching $30.67* at year-end 2003, a 34.1 percent gain over 2002's closing price of $22.87*. Shareholders realized a total return of 37.1 percent in 2003 -- a combination of the 34.1 percent increase in our stock's market value plus cash dividends totaling 68.6 cents per share, an increase of 9.6 percent over the 2002 cash dividend. The 2003 annual cash dividend increase marks the 15th consecutive year for such an increase. In addition, we also declared and paid a five-percent stock dividend, the fourth such stock dividend in as many years. In 2003, we completed the acquisition of First Community Bancshares, Inc., a community bank holding company based in Bargersville, Indiana. It operates 10 branches in four Indiana counties, generally to the west of the markets served by our MainSource Bank operation. We promptly started integrating some of its back office operations into our holding company. We expect when this conversion is completed, First Community's earnings contribution, which was modest in 2003, will continue to add shareholder value because of the increased efficiencies our systems provide. Acquisition Strategy and Philosophy In pursuing any acquisition, we look for banks with strong local identity and deep, personal involvement with their communities, solid management and room for healthy gains in efficiency. Our goal is to improve the operations of these banks, add to their lending capacity and increase the variety of their product/service menus while retaining their local character. It is a strategy that we believe provides us with a decisive, competitive edge in smaller, community-banking markets. By increasing these smaller banks' lending * Adjusted for stock dividends 2 capacity and providing them with more sophisticated financial products, we expect these acquisitions will provide increased organic growth. With regard to enhancing our friendly and professional community approach to banking, I believe we have only scratched the surface as to what that concept really entails. Ultimately, it means having employees who choose to put down permanent roots in the same communities as our customers. It also means finding employees that embody the value system that differentiates one small town from another. If the predominate activity in one community is manufacturing, for example, then it makes good sense for our local bank to employ some people with similar backgrounds. That establishes a mutual bond, which will help our employees understand intuitively the issues that are most important to their customers. Consequently, it is essential to employ individuals that match the needs of each community we serve, even though each community may have far differing needs from another. In this regard, I believe it is far easier to train a motivated, hard-working person in the ways of banking than it is to take bankers from large, metropolitan areas and expect them to adapt to the values and lifestyle of a small, Midwestern community. New Stock Purchase Program Effective February 1, 2004, our board of directors authorized the repurchase of up to 170,000 shares of common stock, which is approximately 2.5 percent of the common shares. The 12-month authorization replaces a repurchase plan that expired at the end of January, 2004. The net effect of these repurchase plans enables us to use these shares for acquisitions and other general corporate purposes, and they also reduce the number of shares outstanding, which has a beneficial effect on calculating earnings per share. Throughout 2003, we continued to address corporate governance compliance issues required by the Sarbanes-Oxley Act of 2002. In effect, the Act requires us to formalize many of the practices and code of ethics we have had in place for more than a decade. We believe that this ongoing compliance undertaking, which also mandates company-wide standardization of processes and procedures, has the potential to drive even greater operating efficiencies. Looking ahead, I am increasingly confident about the strength of the current economic recovery and its potential for MainSource. We enjoyed a strong fourth quarter, with year-over-year gains in both net interest income and non-interest income. Long-term prospects seem positive in numerous ways. Our insurance and annuity operations gained momentum as the 2003 year progressed, and they appear poised for further growth in 2004. With the strengthening of the economy, commercial lending operations hold the promise of significant growth in 2004. Finally, the ongoing integration of our newly acquired banks should provide further gains in overall efficiency. As 2003 drew to a close, our efforts to improve the return on our investment portfolio began to bear fruit. Our move to reposition a portion of our portfolio with slightly longer maturities meshed with market gains in the latter half of 2003. Given the size of our portfolio, approximately $400 million, we stand to reap significant benefits from even small increases in yield. Finally, our strategic plan calls for a continued emphasis on developing and enhancing customer relationships. With its implementation already in place and our vigorous efforts to improve our non-performing assets, I feel confident MainSource is well positioned to build upon its record of success in 2004. In closing, I would like to thank our shareholders for their continued confidence, our employees for their efforts, our directors for their leadership and our customers for their patronage that made 2003 our finest year ever. James L. Saner, Sr. President and Chief Executive Officer March 1, 2004 3 MainSource Financial Group Year in Review This year in review: Overall, an outstanding year. Earnings per share were up more than 10 percent, and this double digit growth has been achieved for the past four years in a row. MainSource Financial finished the year on a great note. Our return on equity exceeded 15 percent; our stock price soared; and our four-year record of double-digit growth in earnings per share reflected the consistency and predictability we provide our investors. Highlights of 2003: o Net income per share gained 10.2 percent to $2.16 from $1.96. Net income increased 9.2 percent to $15.3 million from $14.0 million. o Return on average shareholders' equity increased to 15.1 percent from 14.9 percent. o Net interest margin, on a fully-taxable equivalent basis, equaled 3.73 percent. 2003 o Stock price up 34.1% o Return on equity at 15.07% o Net income per share up 10.2% o Net income up 9.2% o Acquired First Community Bancshares, which added 10 banking offices in south central Indiana. [CHART APPEARS HERE] Return on Average Equity 03 15.07% 02 14.90% 01 13.24% [PHOTO APPEARS HERE] Doing business with our friends and neighbors in small towns in Indiana, Illinois and Kentucky is a cornerstone to our banking philosophy. 4 o Return on average assets was 1.14 percent. o Total assets increased by $191 million, rising to $1.44 billion. o Total deposits rose by $157 million to $1.19 billion. o Total loans, excluding those held for sale, grew to $855 million. o Non-interest income rose 35.2 percent to $19.4 million. Lending--2003 Our lending operations adjusted to changing market conditions as 2003 progressed. Refinancing of residential mortgages was strong for the first eight months of last year and then gradually slowed by year end. Conversely, new mortgage loans were modest at the start of 2003 but increased during the year, growing quite strong by year's end. With mortgage rates now more stable, we expect to make more new mortgage loans and fewer refinancings in 2004, but most likely at overall lower volumes. The shift in mortgage activity was offset by an increase in commercial lending applications as the year concluded. We anticipate an increase in commercial loan volume will occur as 2004 unfolds. Interest Rates and Margins The long, steady decline in interest rates finally appears to have ended, after reaching 40-year lows. Our net interest margin stabilized by the end of the year, at 3.73 percent. As a result, net interest income declined to $44.2 million for 2003 from $45.1 million in 2002. [PHOTO APPEARS HERE] Earning the trust of our customers enables us to provide them with better personal financial management through a variety of our other banking products and services. [PHOTO APPEARS HERE] More than anything else, banking is about people, not numbers--something many large banks simply don't understand. 5 MainSource Financial Group Year in Review, continued Being a good neighbor in a small community means more than just giving money to charities. It means getting involved personally. Each year our employees participate in a "Day of Caring." This is a day when they roll up their sleeves to clean the homes of battered women, paint the houses of economically-deprived individuals, or help remodel shelters for the disadvantaged. In addition, MainSource gave to organizations such as the United Fund and made a contribution to help underwrite a new maternity ward for Decatur County Memorial Hospital in Greensburg, Indiana. However, it is impossible to discuss net interest margins in a vacuum. In some ways, low rates proved beneficial because the refinancing of mortgage loans and applications for new loans became the order of the day. Fees earned on mortgage banking in 2003 amounted to $5.7 million, an increase of $0.9 million from the previous year. The gain in fees from mortgage activity offset the decline in net interest income. This illustrates how MainSource management adapts to a variety of conditions and guides the corporation toward increased prosperity, regardless of economic trends or current interest rates. Cross Selling Gains We scored solid gains in our insurance and annuity businesses last year. Our associates became increasingly adept at addressing customers' total financial-services needs by offering them more non-traditional banking products. Customers not satisfied with current CD yields, for example, often opted for our line of annuity products. As a result, we increased our annuity business at a much faster rate during the second half of 2003 than we did during the first two quarters. First Community Bancshares Acquisition Acquired in June, 2003, First Community added to earnings, income, deposits and assets, and increased the number of customers, as well. Its 10 banking locations provided us with an established presence in Johnson County, which is to the immediate south of Marion County (Indianapolis) and the second-fastest growing county in Indiana. We expect to completely assimilate First Community during 2004. This should increase its earning power because of increases in efficiencies. As we continue to provide it with our more sophisticated banking products and expand its lending capacity, we expect this acquisition may well prove to be our most profitable to date. 6 [PHOTO APPEARS HERE] We believe our approach --building upon our friendly and professional, community-bank operating style while adding the sophisticated products of a one-stop financial-services shop -- is a powerful formula. By increasing the lending authority and product offerings of our acquired banks, we become more formidable competitors and can dominate other smaller banks in our markets. By providing sophisticated financial services and traditional banking products to our customers and delivering them through highly trained and professional employees utilizing the personal, small-town touch, we are able to compete more effectively through our branch locations than those of the larger, mega-city banks. [CHART APEARS HERE] Net Income ($ in Millions) 03 $15.3 02 $14.0 01 $11.2 [CHART APEARS HERE] Total Assets ($ in Billions) 03 $1.44 02 $1.25 01 $1.18 [CHART APEARS HERE] Non-interest Income ($ in Millions) 03 $19.4 02 $14.4 01 $11.5 7 MainSource Financial Group Proposed Acquisition With the acquisition of First Community Bancshares in 2003 and the pending acquisition of Peoples Financial Corp. in 2004, we will have increased the number of our banking locations by 31 percent in less than two years. Proposed Merger of Peoples Financial Corp. On December 16, 2003, we announced a pending merger with Peoples Financial Corp. of Linton, Indiana. It is a $120 million bank holding company that operates seven banking locations in Greene County. Greene County lies southwest of Marion County, which is the home of Indianapolis. This proposed acquisition will expand our footprint westward into more rural areas, but with promising growth potential. It will also give us proximity to communities bordered by Bloomington, Terre Haute and Vincennes, Indiana. Within this area are sizable commercial accounts that can be tapped by expanding People's lending authority. With a strong management team already in place, Peoples is expected to be accretive to our earnings in 2004. [CHART APPEARS HERE] Stock Price (adjusted for all stock dividends) 03 $30.67 02 $22.87 01 $15.91 [PHOTO APPEARS HERE] The proposed Peoples Financial transaction affirms our commitment to the community-banking philosophy as Peoples and its employees maintain strong ties to their communities. 8 Selected Financial Data (Dollar amounts in thousands except per share data)
December 31 2003 2002 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------- Results of Operations Net interest income $ 44,232 $ 45,050 $ 41,768 $ 39,089 $ 35,817 Provision for loan losses 1,325 2,995 2,136 1,658 1,826 Non-interest income 19,443 14,379 11,486 9,591 7,605 Non-interest expense 40,448 35,610 34,311 33,168 29,903 Income before income tax 21,902 20,824 16,807 13,854 11,693 Income tax 6,597 6,813 5,630 4,000 3,605 Net income 15,305 14,011 11,177 9,854 8,088 Dividends paid on common stock 4,857 4,485 4,114 4,121 3,932 Per Common Share* Earnings per share (basic) $ 2.16 $ 1.96 $ 1.56 $ 1.38 $ 1.14 Earnings per share (diluted) 2.16 1.96 1.56 1.38 1.14 Dividends paid ** 0.686 0.626 0.574 0.539 0.527 Book value - end of period 14.91 13.99 12.26 10.93 9.57 Market price - end of period 30.67 22.87 15.91 12.74 15.43 At Year End Total assets $1,442,729 $1,251,760 $1,178,392 $1,216,936 $1,110,252 Securities 425,542 351,143 276,304 294,395 290,337 Loans, excluding held for sale 855,471 740,167 760,785 790,550 710,661 Allowance for loan losses 11,509 9,517 8,894 8,716 7,718 Total deposits 1,191,310 1,034,307 1,014,687 1,053,570 940,905 Notes payable 12,500 2,400 4,062 6,510 6,885 Federal Home Loan Bank advances 62,751 50,235 20,346 22,463 24,484 Subordinated debentures 29,898 30,425 22,425 22,425 22,425 Shareholders' equity 105,424 99,771 87,872 78,005 68,172 Financial Ratios Return on average assets 1.14% 1.16% 0.93% 0.85% 0.76% Return on average common shareholders' equity 15.07 14.90 13.24 13.76 11.67 Allowance for loan losses to total loans (year end, excluding held for sale) 1.35 1.29 1.17 1.10 1.09 Shareholders' equity to total assets (year end) 7.31 7.97 7.46 6.41 6.14 Average equity to average total assets 7.57 7.77 7.04 6.20 6.55 Dividend payout ratio 31.73 32.01 36.81 41.82 48.62
* Adjusted for stock dividends ** Dividends paid by MainSource Financial Group without restatement for pooling of interests 9 MainSource Financial Group Management's Discussion and Analysis (Dollar amounts in thousands except per share data) Forward-Looking Statements Except for historical information contained herein, the discussion in this Annual Report includes certain forward-looking statements based upon management expectations. Factors which could cause future results to differ from these expectations include the following: general economic conditions; legislative and regulatory initiatives; monetary and fiscal policies of the federal government; deposit flows; the cost of funds; general market rates of interest; interest rates on competing investments; demand for loan products; demand for financial services; changes in accounting policies or guidelines; and changes in the quality or composition of the Company's loan and investment portfolios. The forward-looking statements included in the Management's Discussion and Analysis ("MD&A") relating to certain matters involve risks and uncertainties, including anticipated financial performance, business prospects, and other similar matters, and reflect management's best judgment based on factors currently known. Actual results and experience could differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements as a result of a number of factors, including but not limited to those discussed in the MD&A. Overview MainSource Financial Group, Inc. ("Company") is a bank holding company whose principal activity is the ownership and management of its four wholly owned subsidiary banks ("Banks"): MainSource Bank headquartered in Greensburg, Indiana, Regional Bank ("Regional"), headquartered in New Albany, Indiana, Capstone Bank ("Capstone"), headquartered in Watseka, Illinois, and First Community Bank & Trust ("First Community"), headquartered in Bargersville, Indiana. All four banks operate under state charters and are subject to regulation by their respective state regulatory agencies and the Federal Deposit Insurance Corporation. MainSource Insurance (formerly The Insurance Group, Inc.) is a wholly owned subsidiary of MainSource Bank operating five offices in Indiana and one in Kentucky and is subject to regulation by the Kentucky and Indiana Departments of Insurance. The Company also has wholly owned subsidiaries to hold investment securities. These investment subsidiaries are incorporated in Nevada. Additionally, the Company owns IUB Reinsurance Company, Ltd., a credit life reinsurance company. In November 2003, the Company formed MSB Realty, Inc., which holds real estate backed assets of MainSource Bank. Business Strategy The Company operates under the broad tenets of a long-term strategic plan ("Plan") designed to improve the Company's financial performance, expand its competitive position and enhance long-term shareholder value. The Plan is premised on the belief of the Company's board of directors that it can best promote long-term shareholder interests by pursuing strategies which will continue to preserve its community-focused philosophy. The dynamics of the Plan assure continually evolving goals, with the enhancement of shareholder value being the constant, overriding objective. The extent of the Company's success will depend upon how well it anticipates and responds to competitive changes within its markets, the interest rate environment and other external forces. The Company continued its history of external growth through acquisitions. In June 2003, the Company acquired First Community Bancshares and its wholly-owned subsidiary, First Community Bank & Trust, in a cash transaction. Funding for this acquisition was derived from the issuance of $7,000 of floating rate subordinated debentures, a $13,000 note payable, and internal cash. First Community is headquartered in Bargersville, Indiana and operates ten branches in four counties in south central Indiana with total assets of approximately $160 million. In 2003, the Company also purchased one branch in Illinois that added $20 million in deposits and $6 million in loans. The Company is continuously reviewing acquisition targets including branches, whole banks, and other financial service related entities focusing on the four-state Midwest region of Indiana, Illinois, Kentucky, and Ohio. During 2003, the Company continued its focus on becoming a complete financial services provider for its customers. The Company invested heavily in the information technology and data processing areas in order to position itself to support more products and services, to allow for future growth, and to stay competitive in the current environment. In 2003, the Company utilized these technologies in conjunction with its MCIF system to fuel internal growth through marketing to its existing customer base. The Company emphasized the cross-selling of insurance and annuity products through its branch system. The insurance division of the Company has grown steadily throughout the past several years and the Company views this area as a potential source of increasing non-interest income. In addition to the insurance division, the Company's wealth management division has experienced steady growth. As of December 31, 2003, MainSource Wealth Management, which operates as a division of MainSource Bank, had assets under management of approximately $138 million. In 2004, the Company will continue to emphasize its wide array of both traditional and non-traditional financial products and services. As the economy rebounds, the Company believes that 2004 will see increased activity in its lending areas and an increase in the yield on its investment portfolio. Management expects that these items will be partially offset by a decrease in mortgage banking as the refinancing boom that occurred throughout most of 2002 and 2003 appears to have slowed. Also, during the second quarter of 2004, the Company expects to close on the acquisition of Peoples Financial Corp., Inc. With its seven offices in southwest Indiana, this transaction will further expand the Company's footprint in the southern part of the state. Table 2 - Non-interest Income and Expense
Percent Change 2003 2002 2001 03/02 02/01 - ----------------------------------------------------------------------------------------------- Non-interest income Insurance commissions $ 2,400 $ 2,156 $ 1,993 11.3% 8.2% Fiduciary activities 602 561 506 7.3 10.9 Mortgage banking 5,671 4,757 2,767 19.2 71.9 Service charges on deposit accounts 5,092 4,011 3,835 27.0 4.6 Securities gains/(losses) 1,300 319 (111) 307.5 (387.4) Other 4,378 2,575 2,496 70.0 3.2 - ----------------------------------------------------------------------------------------------- Total non-interest income $ 19,443 $ 14,379 $ 11,486 35.2% 25.2% - ----------------------------------------------------------------------------------------------- Non-interest expense Salaries and employee benefits $ 22,421 $ 20,381 $ 19,061 10.0% 6.9% Net occupancy 2,753 2,414 2,247 14.0 7.4 Equipment 3,488 2,873 2,489 21.4 15.4 Telephone 1,287 1,038 855 24.0 21.4 Intangible amortization 909 828 1,966 9.8 (57.9) Stationery, printing, and supplies 916 973 839 (5.9) 16.0 Other 8,674 7,103 6,854 22.1 3.6 - ----------------------------------------------------------------------------------------------- Total non-interest expense $ 40,448 $ 35,610 $ 34,311 13.6% 3.8% - -----------------------------------------------------------------------------------------------
Results of Operations Net income was $15,305 in 2003, $14,011 in 2002, and $11,177 in 2001. Earnings per common share on a fully diluted basis were $2.16 in 2003, $1.96 in 2002 and $1.56 in 2001. The 10.2% increase in 2003 earnings per share over 2002 was primarily due to the acquisition of First Community in June 2003, strong mortgage banking activity, and gains on the sales of investment securities. As detailed in Note 7 to the consolidated financial statements, in 2002 the Company adopted Statements of Financial Accounting Standards (FAS) No. 142 and 147, which changed the method of accounting for intangible assets. The adoption of these standards resulted in a reduction of goodwill amortization in 2002, increasing net income $710, or $0.10 per share. In addition, the Company realized gains related to the sales of investment securities and the merchant credit card program of $.04, net of tax. The change in goodwill and sales of securities and the merchant credit card program contributed $0.14 per share in 2002, representing approximately one-third of the increase in earnings per share versus 2001. Other key measures of the financial performance of the Company are return on average shareholders' equity and return on average assets. Return on average shareholders' equity was 15.07% in 2003, 14.90% in 2002, and 13.24% in 2001. The Company's return on average assets was 1.14% in 2003, 1.16% in 2002, and .93% in 2001. The current levels of return on shareholders' equity and return on assets are representative of the Company's continuing effort to improve profitability. The Company believes that its steady improvement in performance validates its strategic course of action and will continue to provide increased shareholder value. Net Interest Income Net interest income and net interest margin are influenced by the volume and yield or cost of earning assets and interest-bearing liabilities. Tax equivalent net interest income of $45,655 in 2003 decreased slightly from $46,403 in 2002 (See Table 3). As rates stayed low throughout 2003, the Company's yield on earning assets decreased to 5.64% in 2003 from 6.60% in 2002. Partially offsetting the decrease in yield, the Company aggressively repriced its deposits and borrowings and was able to significantly reduce its cost of funds to 2.09 % in 2003 from 2.70% in 2002. The overall effect was a decrease in the Company's spread, which represents the difference between the yield on earning assets versus the cost of funds. The Company's spread in 2003 was 3.55% compared to 3.90% in 2002. Provision for Loan Losses The Company expensed $1,325 in provision for loan losses in 2003. This level of provision allowed the Company to maintain an adequate allowance for loan losses. This topic is discussed in detail under the heading "Loans, Credit Risk and the Allowance and Provision for Loan Losses". Non-interest Income Non-interest income increased in 2003 to $19,443 compared to $14,379 in 2002, which represents an increase of $5,064 and 35.2%. The acquisition of First Community added a total of $926, contributing approximately 18% of the increase in 2003. In addition to the acquisition of First Community, the Company realized increases in several areas. As interest rates remained at historically low 11 MainSource Financial Group Management's Discussion and Analysis (Dollar amounts in thousands except per share data) levels throughout much of 2003, the Company realized a significant increase in its mortgage banking activity. Mortgage banking income, which consists of gains and losses on loan sales and service fee income, net of mortgage servicing right amortization, was $5,671 in 2003 compared to $4,757 in 2002, an increase of 19.2%. As many customers refinanced their existing loans, the Company elected to sell the majority of these loans into the secondary market while maintaining the servicing rights. The Company also realized net gains on sales of investment securities in 2003 of $1,300 compared to gains of $319 in 2002. Other non-interest income increased in 2003 versus 2002 as the Company realized increases in the following areas: annuity fees ($360), cash surrender value of company-owned life insurance policies ($418), gains on the sales of various OREO properties ($245), and contingency fees from insurance companies ($165). Non-interest income increased in 2002 to $14,379 compared to $11,486 in 2001, which represents a 25.2% increase. With the low interest rate environment in 2002, the Company realized a significant increase in its mortgage banking activity. Mortgage banking income was $4,757 in 2002 compared to $2,767 in 2001, an increase of $1,990, or 71.9%. The Company also realized net gains on sales of investment securities in 2002 of $319 compared to net losses in 2001 of $111. Non-interest Expense Total non-interest expense increased 13.6% in 2003 to $40,448 compared to $35,610 in 2002, or an increase of $4,838. The largest component of non-interest expense is salaries and benefits. These expenses increased 10.0%, or $2,040, in 2003 due primarily to the acquisition of First Community, which added $1,435 of employee costs. The remaining increase would be attributable to normal merit increases (see Table 2 for detail of non-interest expense). Other non-interest expense increased in 2003 compared to 2002 as the Company incurred approximately $850 of costs related to the redemption of trust preferred securities in the first quarter of 2003. These costs related to the Company's investment in trusts formed to issue trust preferred securities and are a result of accelerated amortization of debt issuance costs by the trusts. Total non-interest expense increased 3.8% in 2002 to $35,610 compared to $34,311 in 2001, or an increase of $1,299. The largest component of non-interest expense is salaries and benefits. These expenses increased 6.9%, or $1,320, in 2002 due to branch acquisitions, which increased the number of employees, an increase in health care expense and normal merit increases (see Table 2 for detail of non-interest expense). Due to the adoption of FAS 142 and 147, the Company's intangible amortization decreased in 2002, as goodwill is no longer amortized. [CHART APPEARS HERE] Net Income ($ in Millions) 03 $15.3 02 $14.0 01 $11.2 [CHART APPEARS HERE] Non-interest Expense ($ in Millions) 03 $40.4 02 $35.6 01 $34.3 [CHART APPEARS HERE] Non-interest Income ($ in Millions) 03 $19.4 02 $14.4 01 $11.5 12 Income Taxes The effective tax rate was 30.1% in 2003, 32.7% in 2002, and 33.5% in 2001. The decrease in the Company's effective tax rate in 2003 was a result of higher levels of tax-exempt income from securities and company-owned life insurance policies. Balance Sheet At December 31, 2003, total assets were $1,442,729 compared to $1,251,760 at December 31, 2002, an increase of $190,969. The increase was primarily attributable to the acquisition of First Community, which accounted for approximately $160 million in assets. Loans, Credit Risk and the Allowance and Provision for Loan Losses Loans remain the Company's largest concentration of assets and continue to represent the greatest potential risk. The loan underwriting standards observed by the Company's subsidiaries are viewed by management as a means of controlling problem loans and the resulting charge-offs. The Company's conservative loan underwriting standards have historically resulted in higher loan quality and generally lower levels of net charge-offs than peer bank averages. The Company also believes credit risks may be elevated if undue concentrations of loans in specific industry segments and to out-of-area borrowers are incurred. Accordingly, the Company's board of directors regularly monitors such concentrations to determine compliance with its loan concentration policy. The Company believes it has no undue concentrations of loans. Total loans (excluding those held for sale) increased by approximately $115 million from year-end 2002. The increase was primarily related to the acquisition of First Community. Excluding the acquisition of First Community, the Company's total loan portfolio remained relatively flat as the increase in commercial loans of approximately $20 million was offset by a decrease in the Company's residential real estate portfolio. As interest rates remained low throughout 2003, many customers refinanced their existing residential mortgage loans. The Company, in turn, elected not to retain new fixed rate loans in its own portfolio and instead, sold these in the secondary market while maintaining the servicing. Despite this decrease, residential real estate loans continue to represent the largest portion of the total loan portfolio. Such loans represented 36.9% and 40.7% of total loans at December 31, 2003 and 2002, respectively. The Company regards its ability to identify and correct loan quality problems as one of its greatest strengths. Loans are placed on "non-accrual" status when, in management's judgment, the collateral value and/or the borrower's financial condition does not justify accruing interest. As a general rule, commercial and real estate loans are reclassified to nonaccrual status at or before becoming 90 days past due. Interest previously recorded, but not deemed collectible, is reversed and charged against current income. Subsequent interest payments collected on nonaccrual loans may thereafter be recognized as interest income or may be applied as a reduction of the loan's principal balance, as circumstances warrant. Non-performing assets were $17.3 million as of December 31, 2003 compared to $10.9 million as of December 31, 2002 and represented 1.20% of total assets at December 31, 2003 versus 0.87% one year ago. Approximately $4.0 million of non-performing assets were obtained in the First Community acquisition. Management believes that these assets were adequately provided for in its allowance for loan losses at the time of acquisition. Of the $17.3 million of non-performing assets at year-end 2003, approximately 52% are collateralized by residential real estate properties, which have historically resulted in low levels of charge-offs. The provision for loan losses was $1,325 in 2003, $2,995 in 2002, and $2,136 in 2001. The decrease in the Company's provision in 2003 was primarily due to the decrease in net charge-offs in 2003 and the upgrade of several credits to a more favorable risk rating. As a percentage of average loans, net chargeoffs equaled .18%, .31%, and .25% in 2003, 2002 and 2001, respectively. Management maintains a list of loans warranting either the assignment of a specific reserve amount or other special administrative attention. This watch list, together with a listing of all classified loans, nonaccrual loans and delinquent loans, is reviewed monthly by the board of directors of each subsidiary. Additionally, the Company evaluates its consumer and residential real estate loan pools for probable losses incurred based on historical trends, adjusted by current delinquency and non-performing loan levels. The ability to absorb loan losses promptly when problems are identified is invaluable to a banking organization. Most often, losses incurred as a result of prompt, aggressive collection actions are much lower than losses incurred after prolonged legal proceedings. Accordingly, the Company observes the practice of quickly initiating stringent collection efforts in the early stages of loan delinquency. The adequacy of the allowance for loan losses in each subsidiary is reviewed at least quarterly. The determination of the provision amount in any period is based upon management's continuing review and evaluation of loan loss experience, changes in the composition of the loan portfolio, classified loans including non-accrual and impaired loans, current economic conditions, the amount of loans presently outstanding, and the amount and composition of loan growth. The Company's allowance for loan losses was $11,509 at December 31, 2003 compared to $9,517 at the end of 2002. The increase in the allowance is primarily attributable to the acquisition of First Community, which had a reserve of $2,078 at the date of acquisition. 13 MainSource Financial Group Management's Discussion and Analysis (Dollar amounts in thousands except per share data) Table 3 - Average Balance Sheet and Net Interest Analysis (Taxable Equivalent Basis)*
2003 2002 2001 - -------------------------------------------------------------------------------------------------------------------------- Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate - -------------------------------------------------------------------------------------------------------------------------- Assets Short-term investments $ 1,224 $ 7 0.57% $ 288 $ 5 1.74% $ 2,172 $ 80 3.68% Federal funds sold and money market accounts 15,679 192 1.22 38,002 727 1.91 50,534 2,139 4.23 Securities Taxable 352,813 11,480 3.25 264,675 12,970 4.90 227,759 13,683 6.01 Non-taxable* 52,820 3,341 6.33 47,611 3,166 6.65 34,933 2,762 7.91 - -------------------------------------------------------------------------------------------------------------------------- Total securities 405,633 14,821 3.65 312,286 16,136 5.17 262,692 16,445 6.26 Loans ** Commercial 430,992 29,462 6.83 402,283 29,308 7.29 377,386 31,680 8.39 Residential real estate 218,461 14,543 6.66 237,709 17,627 7.42 296,709 24,194 8.15 Consumer 151,127 10,005 6.62 124,626 9,853 7.91 121,866 11,218 9.21 - -------------------------------------------------------------------------------------------------------------------------- Total loans 800,580 54,010 6.75 764,618 56,788 7.43 795,961 67,092 8.43 - -------------------------------------------------------------------------------------------------------------------------- Total earning assets 1,223,116 69,030 5.64 1,115,194 73,656 6.60 1,111,359 85,756 7.72 - -------------------------------------------------------------------------------------------------------------------------- Cash and due from banks 38,413 36,912 29,981 Unrealized gains (losses) on securities 3,750 4,801 2,102 Allowance for loan losses (11,065) (9,404) (9,143) Premises and equipment, net 21,500 18,521 16,883 Intangible assets and goodwill 34,206 23,363 23,482 Accrued interest receivable and other assets 32,199 21,358 25,246 ------------------------------------------------------------------------- Total assets $1,342,119 $ 1,210,745 $ 1,199,910 - -------------------------------------------------------------------------------------------------------------------------- Liabilities Interest-bearing deposits DDA, savings and money market accounts $ 476,627 $ 3,050 0.64% $ 443,684 $ 5,064 1.14% $ 401,349 $ 8,728 2.17% Certificates of deposit 526,304 15,578 2.96 478,643 17,546 3.67 545,458 29,716 5.45 - -------------------------------------------------------------------------------------------------------------------------- Total interest- bearing deposits 1,002,931 18,628 1.86 922,327 22,610 2.45 946,807 38,444 4.06 Short-term borrowings 18,565 172 0.93 17,769 372 2.09 19,149 611 3.19 Subordinated debentures 26,845 1,638 6.10 22,758 2,035 8.94 22,425 2,023 9.02 Notes payable and FHLB borrowings 67,706 2,935 4.33 45,497 2,236 4.91 26,362 1,699 6.44 - -------------------------------------------------------------------------------------------------------------------------- Total interest- bearing liabilities 1,116,047 23,373 2.09 1,008,351 27,253 2.70 1,014,743 42,777 4.22 Demand deposits 111,480 94,054 85,317 Other liabilities 13,013 14,283 15,452 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,240,540 1,116,688 1,115,512 Shareholders' equity 101,579 94,057 84,398 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $1,342,119 23,373 1.91*** $1,210,745 27,253 2.44 ***$1,199,910 42,777 3.85*** - -------------------------------------------------------------------------------------------------------------------------- Net interest income $45,657 3.73**** $46,403 4.16**** $42,979 3.87**** - -------------------------------------------------------------------------------------------------------------------------- Conversion of tax exempt income to a fully taxable equivalent basis using a marginal rate of 35% $ 1,425 $ 1,353 $ 1,211
* Adjusted to reflect income related to securities and loans exempt from Federal income taxes. ** Nonaccruing loans have been included in the average balances. *** Total interest expense divided by total earning assets. **** Net interest income divided by total earning assets. 14 Table 4 - Loan Portfolio
December 31 2003 2002 2001 2000 1999 - -------------------------------------------------------------------------------------------- Types of loans Commercial $141,571 $ 98,526 $ 83,143 $ 77,648 $ 65,426 Agricultural production financing and other loans to farmers 25,897 25,105 20,726 20,744 22,107 Commercial real estate mortgage 183,938 156,277 150,677 138,132 104,150 Residential real estate mortgage 315,848 301,232 328,107 389,622 326,720 Farm real estate 37,107 43,762 46,524 49,284 44,367 Construction and development 34,686 34,987 53,753 40,813 50,721 Consumer 99,724 72,702 69,957 64,548 87,270 State and political 16,700 7,576 7,898 9,759 9,900 - -------------------------------------------------------------------------------------------- Total loans $855,471 $740,167 $760,785 $790,550 $710,661 - --------------------------------------------------------------------------------------------
Securities Securities offer flexibility in the Company's management of interest rate risk, and are the primary means by which the Company provides liquidity and responds to changing maturity characteristics of assets and liabilities. The Company's investment policy prohibits trading activities and does not allow investment in high-risk derivative products or junk bonds. As of December 31, 2003, 99.2% of the securities are classified as "available for sale" ("AFS") and are carried at fair value with unrealized gains and losses, net of taxes, excluded from earnings and reported as a separate component of shareholders' equity. A net unrealized gain of $2,185 was recorded to adjust the AFS portfolio to current market value at December 31, 2003 compared to a net unrealized gain of $7,065 at December 31, 2002. The remaining 0.8% of the investment portfolio is classified as "held to maturity" ("HTM") and is carried at book value. The majority of the Company's HTM portfolio consists of tax-exempt municipal bonds. For 2003 the tax equivalent yield of the investment securities portfolio was 3.65%, compared to 5.17% and 6.26% for 2002 and 2001, respectively. The average life of the Company's investment security portfolio was 2.82 years at December 31, 2003. During 2003 portfolio income was negatively impacted by the drop in interest rates in the first half of the year as significant premium amortization on mortgage related securities resulted in a lower yield on the investment portfolio. Management targeted callable agencies and low premium mortgage products for reinvestment to help stabilize earnings while keeping the average life of the portfolio short. Throughout 2003 management enhanced the return of the portfolio by selectively selling and buying securities that provided gains and maintained the strategic position of the portfolio. At the beginning of 2004 the portfolio remains defensively positioned, maintaining a bias against price and extension risk. Sources of Funds The Company relies primarily on customer deposits and securities sold under agreement to repurchase ("repurchase agreements"), along with shareholders' equity to fund earning assets. Federal Home Loan Bank ("FHLB") advances are used to provide additional funding. The Company also attempts to purchase local deposits through branch acquisitions. Deposits generated within local markets provide the major source of funding for earning assets. Average total deposits were 91.1% of total average earning assets in 2003 and 2002. Total interest-bearing deposits averaged 90.0% and 90.7% of average total deposits during 2003 and 2002. Management is continuing efforts to increase the Loan Loss Reserves ($ in Millions) [CHART APPEARS HERE] 03 $11.5 02 $9.5 01 $8.9 15 MainSource Financial Group Management's Discussion and Analysis (Dollar amounts in thousands except per share data) percentage of transaction-related deposits to total deposits due to the positive effect on earnings. Repurchase agreements are high denomination investments utilized by public entities and commercial customers as an element of their cash management responsibilities. During 2003, repurchase agreements averaged $16,680. Another source of funding is the Federal Home Loan Bank (FHLB). The Company had FHLB advances of $62,751 outstanding at December 31, 2003. These advances have interest rates ranging from 1.30% to 6.58% (see note 10 to the consolidated financial statements for the maturity schedule of these advances). The Company averaged $56,721 in FHLB advances during 2003 compared to $41,890 during 2002. In February 1999 the Company borrowed $8,000 at a floating rate based upon LIBOR. These funds were used to fund branch acquisitions. At year-end 2003, the balance on this note was $800 with an effective interest rate of 2.41%. In June 2003 the Company borrowed $13,000 at a floating rate based on LIBOR. These funds were used in the cash acquisition of First Community. At year-end 2003, the balance on this note was $11,700 with an effective interest rate of 2.56%. Capital Resources The Federal Reserve Board and other regulatory agencies have adopted risk-based capital guidelines that assign risk weightings to assets and off-balance sheet items. The Company's core capital ("Tier 1") consists of common shareholders' equity adjusted for unrealized gains or losses on available for sale (AFS) securities plus limited amounts of Trust Preferred Securities less goodwill and intangible assets. Total capital consists of core capital, certain debt instruments and a portion of the allowance for loan losses. At December 31, 2003, Tier 1 capital to average assets was 6.0%. Total capital to risk-weighted assets was 11.3%. Both ratios exceed all required ratios established for bank holding companies. Risk-adjusted capital levels of each of the Company's subsidiary banks exceed regulatory definitions of well-capitalized institutions. The Trust Preferred Securities qualify as Tier 1 capital or core capital with respect to the Company under the risk-based capital guidelines established by the Federal Reserve. Under such guidelines, capital received from the proceeds of the sale of these securities cannot constitute more than 25% of the total Tier 1 capital of the Company. Consequently, the amount of Trust Preferred Securities in excess of the 25% limitation constitutes Tier 2 capital, or supplementary capital, of the Company. Common shareholders' equity is impacted by the Company's decision to categorize a portion of its securities portfolio as available for sale (AFS). Securities in this category are carried at fair value, and common shareholders' equity is adjusted to reflect unrealized gains and losses, net of taxes. The Company declared and paid common dividends of $.686 per share in 2003, $.626 in 2002 and $.574 in 2001. Book value per common share increased to $14.91 at December 31, 2003 compared to $13.99 at the end of 2002. The net adjustment for AFS securities increased book value per share by $.17 at December 31, 2003 and by $.64 at December 31, 2002. Depending on market conditions, the adjustment for AFS securities can cause significant fluctuations in equity. The Company declared its fourth consecutive annual five percent stock dividend for shareholders of record as of December 22, 2003. All financial information used throughout this report has been adjusted to reflect these transactions. In January 2002, the Company announced the commencement of a twelve-month common stock repurchase plan that authorized the repurchase of approximately 2.5% of its outstanding common shares. The Company renewed this plan in January 2003 and again in January 2004. The purchase of stock will generally occur in the open market but may involve unsolicited negotiated transactions. Table 5 - Underperforming Loans
2003 2002 2001 2000 1999 - --------------------------------------------------------------------------------------- Nonaccruing loans $14,626 $ 7,695 $10,406 $ 3,454 $ 4,187 Accruing loans contractually past due 90 days or more 196 245 766 532 978 - --------------------------------------------------------------------------------------- Total $14,822 $ 7,940 $11,172 $ 3,986 $ 5,165 - --------------------------------------------------------------------------------------- % of total loans 1.73% 1.07% 1.47% 0.50% 0.73%
[CHART APPEARS HERE] Book Value Per Share 03 $14.91 02 $13.99 01 $12.26 16 Table 6 - Summary of the Allowance for Loan Losses
2003 2002 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------------- Balance at January 1 $ 9,517 $8,894 $8,716 $7,718 $ 6,600 Charge-offs Commercial 588 1,715 1,392 403 321 Commercial real estate mortgage - - 100 107 458 Residential real estate mortgage 555 473 266 164 77 Consumer 777 583 621 443 589 - ------------------------------------------------------------------------------------------------------------------------- Total Charge-offs 1,920 2,771 2,379 1,117 1,445 Recoveries Commercial 160 116 127 201 278 Commercial real estate mortgage 43 5 24 7 - Residential real estate mortgage 54 127 40 35 63 Consumer 252 151 230 214 396 - ------------------------------------------------------------------------------------------------------------------------- Total Recoveries 509 399 421 457 737 Net Charge-offs 1,411 2,372 1,958 660 708 Addition resulting from acquisition 2,078 - - - - Provision for loan losses 1,325 2,995 2,136 1,658 1,826 - ------------------------------------------------------------------------------------------------------------------------- Balance at December 31 $11,509 $9,517 $8,894 $8,716 $ 7,718 - ------------------------------------------------------------------------------------------------------------------------- Net Charge-offs to average loans 0.18% 0.31% 0.25% 0.09% 0.11% Provision for loan losses to average loans 0.17 0.39 0.27 0.22 0.28 Allowance to total loans at year end 1.35 1.29 1.17 1.10 1.09 - -------------------------------------------------------------------------------------------------------------------------
Liquidity Liquidity management involves maintaining sufficient cash levels to fund operations and to meet the requirements of borrowers, depositors and creditors. Higher levels of liquidity bear higher corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets and higher interest expense involved in extending liability maturities. Liquid assets include cash and cash equivalents, loans and securities maturing within one year and money market instruments. In addition, the Company holds approximately $390 million of AFS securities maturing after one year, which can be sold to meet liquidity needs. Maintaining a relatively stable funding base, which is achieved by diversifying funding sources, supports liquidity, extends the contractual maturity of liabilities, and limits reliance on volatile short-term purchased funds. Short-term funding needs may arise from declines in deposits or other funding sources, funding of loan commitments and requests for new loans. The Company's strategy is to fund assets to the maximum extent possible with core deposits, which provide a sizable source of relatively stable low-cost funds. The Company defines core deposits as all deposits except certificates of deposits greater than $100. Average core deposits funded approximately 81.2% of total earning assets during 2003 and approximately 81.8% in 2002. Management believes the Company has sufficient liquidity to meet all reasonable borrower, depositor and creditor needs in the present economic environment. The Company has not received any directives from regulatory authorities that would materially affect liquidity, capital resources or operations. MainSource Financial Group Management's Discussion and Analysis (Dollar amounts in thousands except per share data) Table 7 - Rate Sensitivity Analysis at December 31, 2003
Over 5 Years or 3 Months 1 Year 2 Years 5 Years Insensitive Total - ---------------------------------------------------------------------------------------------------------------------------- Interest-earning assets Loans $ 273,957 $ 195,240 $ 134,908 $ 149,615 $ 103,716 $ 857,436 Securities 28,438 89,847 87,900 141,694 77,663 425,542 Federal funds sold and money market fund 6,290 -- -- -- -- 6,290 Interest-bearing deposits in banks 201 -- -- -- -- 201 Restricted stock 6,639 -- -- -- -- 6,639 - ---------------------------------------------------------------------------------------------------------------------------- Total Interest-earning assets 315,525 285,087 222,808 291,309 181,379 1,296,108 - ---------------------------------------------------------------------------------------------------------------------------- Other assets -- -- -- -- 158,130 158,130 Allowance for loan losses -- -- -- -- (11,509) (11,509) - ---------------------------------------------------------------------------------------------------------------------------- Total assets $ 315,525 $ 285,087 $ 222,808 $ 291,309 $ 328,000 $ 1,442,729 - ---------------------------------------------------------------------------------------------------------------------------- Interest-bearing liabilities Interest-bearing demand $ 311,333 -- -- -- -- $ 311,333 Savings 224,318 -- -- -- -- 224,318 Certificates of deposit 121,965 $ 227,740 $ 109,374 $ 52,810 $ 16,670 528,559 Short term borrowings 27,508 -- -- -- -- 27,508 Notes payable 12,500 -- -- -- -- 12,500 Federal Home Loan Bank advances 10,768 -- 10,000 16,277 25,706 62,751 Subordinated debentures 29,898 -- -- -- -- 29,898 - ---------------------------------------------------------------------------------------------------------------------------- Total Interest-bearing liabilities 738,290 227,740 119,374 69,087 42,376 1,196,867 - ---------------------------------------------------------------------------------------------------------------------------- Demand deposits -- -- -- -- 127,100 127,100 Other liabilities -- -- -- -- 13,338 13,338 Stockholders' equity -- -- -- -- 105,424 105,424 - ---------------------------------------------------------------------------------------------------------------------------- Total Liabilities and stockholders' equity $ 738,290 $ 227,740 $ 119,374 $ 69,087 $ 288,238 $ 1,442,729 - ---------------------------------------------------------------------------------------------------------------------------- Rate sensitivity gap (assets less liabilities) $(422,765) $ 57,347 $ 103,434 $ 222,222 - ---------------------------------------------------------------------------------------------------------------------------- Rate sensitivity gap (cumulative) (422,765) (365,418) (261,984) (39,762) - ---------------------------------------------------------------------------------------------------------------------------- Percent of total assets (cumulative) (29.30)% (25.33)% (18.16)% (2.76)% Rate sensitive assets/liabilities (cumulative) 42.74% 62.17% 75.86% 96.56% - ----------------------------------------------------------------------------------------------------------------------------
Interest Rate Sensitivity At year-end 2003, the Company held approximately $601,000 in assets comprised of securities, loans, short-term investments, and federal funds sold, which were interest sensitive in one year or less time horizons. The Company's interest rate sensitivity analysis for the year ended December 31, 2003 appears in Table 7. A significant assumption that creates the large negative gap in the 0 to 3 month category is that all interest-bearing demand and savings accounts are subject to immediate repricing. While it is true that, contractually, those accounts are subject to immediate repricing, the rates paid on those accounts are generally not tied to specific indices and are influenced by market conditions and other factors. Accordingly, a general movement in interest rates, either up or down, may not have any immediate effect on the rates paid on these deposit accounts. The foregoing table illustrates only one source of information about sensitivity to interest rate movements. Our asset and liability management process also uses simulations that take into account the time that various assets and liabilities may reprice and the degree to which various categories of such assets and liabilities will respond to general interest rate movements. Interest rate risk can only be represented by a measurement of the effects of changing interest rates given the capacity for and magnitude of change on specific assets and liabilities. Management believes that the Company has taken steps to position itself to react to changes occurring in the current rate environment. Short-term interest rates are at historically low levels and 18 the Company expects them to remain relatively stable with a possible slight upward bias toward the latter half of 2004. The Company continues to monitor the repricing characteristics of its balance sheet so as to maintain an acceptable net interest margin during interest rate fluctuations. General economic conditions improved significantly during the second half of 2003 and most forecasts expect increased economic growth for 2004. Management believes that this would result in a higher level of loan growth than the Company realized during 2002 and 2003. Assuming a stable to moderately higher rate environment, the Company does not foresee its earnings materially impacted for 2004. However, if rates decline further, the Company believes that its earnings may be adversely impacted as its net interest margin declines. Asset/liability management strategies are developed by the Company to manage market risk. Market risk is the risk of loss in financial instruments including investments, loans, deposits and borrowings arising from adverse changes in prices/rates. Interest rate risk is the Company's primary market risk exposure and represents the sensitivity of earnings to changes in market interest rates. Strategies are developed that impact asset/liability committee activities based on interest rate risk sensitivity, board policy limits, desired sensitivity gaps and interest rate trends. Table 8 provides information about the Company's significant financial instruments at December 31, 2003 that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted average interest rates by maturity dates. The table presents only a static measurement of asset and liability volumes based on maturity, cash flow estimates and interest rates. It does not reflect the differences in the timing and degree of repricing of assets and liabilities due to interest rate changes. In analyzing interest rate sensitivity, management considers these differences and incorporates other assumptions and factors, such as balance sheet growth and prepayments, to better measure interest rate risk. The Company cannot make any assurances as to the outcome of these assumptions, nor can it assess the impact of customer product preference changes and competitive factors as well as other internal and external variables. In addition, this analysis cannot reflect actions taken by the asset/liability management committees; therefore, this analysis should not be relied upon as indicative of expected operating results. Effects of Changing Prices The Company's asset and liability structure is substantially different from that of an industrial company in that most of its assets and liabilities are monetary in nature. Management believes the impact of inflation on financial results depends upon the Company's ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction at the same time, or at the same magnitude, as the prices of other goods and services. As discussed previously, management relies on its ability to manage the relationship between interest-sensitive assets and liabilities to protect against wide interest rate fluctuations, including those resulting from inflation. Critical Accounting Policies The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States and conform to general practices within the banking industry. These policies require estimates and assumptions. Changes in underlying factors, assumptions, or estimates in any of these areas could have a material impact on the Company's future financial condition and results of operations. In management's opinion, some of these areas have a more significant impact than others on the Company's financial reporting. These areas currently include accounting for the allowance for loan losses and goodwill. Allowance for Loan Losses -- The level of the allowance for loan losses is based upon management's evaluation of the loan and lease portfolios, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, and other pertinent factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The level of allowance maintained is believed by management to be adequate to cover losses inherent in the portfolio. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off. Goodwill -- Statement of Financial Accounting Standards No. 141 "Business Combinations" and No. 142 "Goodwill and Other Intangible Assets" were issued in June of 2001 and were effective for fiscal years beginning after December 15, 2001. Under these rules, goodwill and intangible assets deemed to have indefinite lives, if any, will no longer be amortized, but will be subject to annual impairment tests in accordance with the Statements. The Company has selected June 30 as its date for annual impairment testing. New Accounting Matters See Note 1 to the Consolidated Financial Statements regarding the adoption of new accounting standards in 2003. In December 2003, the Accounting Standards Executive Committee issued SOP 03-3, Accounting for Certain Loans and Debt Securities Acquired in a Transfer. Beginning in 2005, this SOP will change the accounting for loans purchased. As a result, an allowance for loan losses will not be recorded for loans acquired in business combinations; rather, loans will be recorded net of purchase accounting adjustments for credit risk. 19 MainSource Financial Group Management's Discussion and Analysis (Dollar amounts in thousands except per share data) Table 8 - Principal Cash Flows
There Fair December 31 2004 2005 2006 2007 2008 after Total Value - -------------------------------------------------------------------------------------------------------------------------- Assets Securities Fixed rate $ 29,021 $ 88,684 $ 96,372 $ 143,039 $ 21,135 $ 39,146 $417,397 $417,717 Average interest rate 3.97% 3.51% 3.55% 3.47% 4.03% 5.95% 3.79% Variable rate - 836 347 2,857 99 4,006 8,145 8,077 Average interest rate - 2.40% 5.08% 4.93% 3.43% 3.41% 3.91% Loans Fixed rate $ 56,360 $ 25,190 $ 26,921 $ 29,497 $ 32,904 $ 87,900 $258,772 $262,034 Average interest rate 3.77% 4.56% 5.48% 5.54% 5.39% 5.93% 5.17% Variable rate 109,703 8,806 16,946 10,047 13,690 439,472 598,664 603,232 Average interest rate 3.32% 3.17% 3.03% 3.37% 2.78% 6.12% 5.35% Liabilities Deposits NOW, money market and savings deposits Variable rate $535,651 - - - - - $535,651 $538,592 Average interest rate 0.59% - - - - - 0.59% Certificates of deposit Fixed rate $310,886 $104,227 $ 25,319 $ 18,941 $ 17,791 $ 5,079 $482,223 $489,546 Average interest rate 2.61% 3.28% 3.40% 4.57% 3.74% 4.51% 2.94% Variable rate 39,406 5,318 1,223 247 139 3 46,336 46,336 Average interest rate 1.43% 2.77% 2.78% 4.45% 3.60% - 1.65% Borrowings Variable rate $ 27,508 - - - - - $ 27,508 $ 27,508 Average interest rate 0.81% - - - - - 0.81% FHLB advances Fixed rate $ 10,605 $ 10,031 $ 132 $ 16,277 - $ 25,706 $ 62,751 $ 63,519 Average interest rate 3.22% 6.58% 6.20% 4.58% - 4.04% 4.45% Long-term debt Variable rate $ 3,400 $ 2,600 $ 2,600 $ 2,600 $ 1,300 - $ 12,500 $ 12,500 Average interest rate 2.52% 2.56% 2.56% 2.56% 2.56% - 2.55% Subordinated debentures Variable rate - - - - - $ 29,898 $ 29,898 $ 29,898 Average interest rate - - - - - 4.00% 4.00%
20 MainSource Financial Group Report of Management on Responsibility for Financial Information The consolidated financial statements and related financial information presented in this annual report have been prepared by the management of MainSource Financial Group, Inc. in accordance with generally accepted accounting principles, and include amounts based on management's best estimates and judgments at the time of preparation. In presenting this financial information, management is responsible for its integrity, content and consistency of preparation. To meet this responsibility, management maintains a system of internal control, policies and administrative procedures designed to provide reasonable assurance that transactions are recorded accurately. As an integral part of internal control, the Company maintains a professional staff of internal auditors who monitor compliance with regulations, policies and procedures, and assess the effectiveness of internal control. In addition, the Company's audit committee, which is comprised entirely of outside directors, meets periodically with management, internal auditors and/or independent auditors and banking regulators have unrestricted access to the audit committee. Management believes the Company's system provides a basis for the preparation of reliable financial statements. The Company's consolidated financial statements have been audited by Crowe, Chizek and Company LLC. Their responsibility is to express an opinion as to the integrity of the company's consolidated financial statements and, in performing their audit, to evaluate the Company's internal control to the extent they deem necessary in order to issue such an opinion. As described further in their report that follows, their opinion is based on their audit, which was conducted in accordance with auditing standards generally accepted in the United States of America and is believed by them to provide a reasonable basis for their opinion. The selection of Crowe, Chizek and Company LLC was approved by the Board of Directors and ratified by shareholders. James L. Saner, Sr. President and Chief Executive Officer Donald A. Benziger Senior Vice President and Chief Financial Officer 21 MainSource Financial Group Report of Independent Auditors Shareholders and Board of Directors MainSource Financial Group Greensburg, Indiana We have audited the accompanying consolidated balance sheets of MainSource Financial Group as of December 31, 2003 and 2002 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MainSource Financial Group as of December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. /s/ Crowe Chizek and Company LLC Indianapolis, Indiana January 30, 2004 22 MainSource Financial Group Consolidated Balance Sheets (Dollar amounts in thousands except per share data)
December 31 2003 2002 - ------------------------------------------------------------------------------------------------------------------ Assets Cash and due from banks $ 50,564 $ 54,548 Money market fund 6,290 22,869 Federal funds sold - 500 - ------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents 56,854 77,917 Interest bearing time deposits 201 - Securities Available for sale 422,111 346,468 Held to maturity (fair value of $3,683 and $4,939) 3,431 4,675 - ------------------------------------------------------------------------------------------------------------------ Total securities 425,542 351,143 Loans held for sale 1,965 15,715 Loans, net of allowance for loan losses of $11,509 and $9,517 843,962 730,650 Restricted stock, at cost 6,639 5,690 Premises and equipment, net 22,886 19,258 Goodwill 36,047 20,708 Intangible assets 5,347 5,005 Cash surrender value of life insurance 22,203 4,061 Other assets 21,083 21,613 - ------------------------------------------------------------------------------------------------------------------ Total assets $1,442,729 $1,251,760 - ------------------------------------------------------------------------------------------------------------------ Liabilities Deposits Non-interest bearing $ 127,100 $ 104,282 Interest bearing 1,064,210 930,025 - ------------------------------------------------------------------------------------------------------------------ Total deposits 1,191,310 1,034,307 Short-term borrowings 27,508 19,529 Federal Home Loan Bank advances 62,751 50,235 Subordinated debentures 29,898 30,425 Notes payable 12,500 2,400 Other liabilities 13,338 15,093 - ------------------------------------------------------------------------------------------------------------------ Total liabilities 1,337,305 1,151,989 - ------------------------------------------------------------------------------------------------------------------ Shareholders' equity Preferred stock, no par value Authorized shares - 400,000 Issued and outstanding - none -- -- Common stock, $.50 stated value: Authorized shares - 25,000,000 Issued shares - 6,824,405 and 6,500,084 Outstanding shares - 6,729,256 and 6,469,873 3,413 3,251 Common stock to be distributed, 341,220 and 325,004 shares 170 163 Treasury stock - 95,149 and 30,211 shares, at cost (2,190) (694) Additional paid-in capital 53,478 43,025 Retained earnings 49,338 49,529 Accumulated other comprehensive income 1,215 4,497 - ------------------------------------------------------------------------------------------------------------------ Total shareholders' equity 105,424 99,771 - ------------------------------------------------------------------------------------------------------------------ Total liabilities and shareholders' equity $1,442,729 $1,251,760 - ------------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 23 MainSource Financial Group Consolidated Statements of Income (Dollar amounts in thousands except per share data)
For the years ended December 31 2003 2002 2001 - -------------------------------------------------------------------------------------------------------- Interest income: Loans Taxable $53,279 $56,088 $66,394 Tax exempt 475 455 454 Securities Taxable 11,480 12,970 13,683 Tax exempt 2,172 2,058 1,795 Federal funds sold and money market funds 192 727 2,139 Deposits with financial institutions 7 5 80 - -------------------------------------------------------------------------------------------------------- Total interest income 67,605 72,303 84,545 Interest expense: Deposits 18,628 22,610 38,444 Short-term borrowings 172 372 611 Subordinated debentures 1,638 2,035 2,023 Other borrowings 2,935 2,236 1,699 - -------------------------------------------------------------------------------------------------------- Total interest expense 23,373 27,253 42,777 Net interest income 44,232 45,050 41,768 Provision for loan losses 1,325 2,995 2,136 - -------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 42,907 42,055 39,632 Non-interest income: Insurance commissions 2,400 2,156 1,993 Mortgage banking 5,671 4,757 2,767 Fiduciary activities 602 561 506 Service charges on deposit accounts 5,092 4,011 3,835 Net realized gains/(losses) on securities 1,300 319 (111) Other income 4,378 2,575 2,496 - -------------------------------------------------------------------------------------------------------- Total non-interest income 19,443 14,379 11,486 Non-interest expense: Salaries and employee benefits 22,421 20,381 19,061 Net occupancy expenses 2,753 2,414 2,247 Equipment expenses 3,488 2,873 2,489 Intangibles amortization 909 828 1,966 Telecommunications 1,287 1,038 855 Stationery printing and supplies 916 973 839 Other expenses 8,674 7,103 6,854 - -------------------------------------------------------------------------------------------------------- Total non-interest expense 40,448 35,610 34,311 Income before income tax 21,902 20,824 16,807 Income tax expense 6,597 6,813 5,630 - -------------------------------------------------------------------------------------------------------- Net income $15,305 $14,011 $11,177 - -------------------------------------------------------------------------------------------------------- Net income per share (basic and diluted) $ 2.16 $ 1.96 $ 1.56
See notes to consolidated financial statements. 24 MainSource Financial Group Consolidated Statements of Shareholders' Equity (Dollar amounts in thousands except per share data)
Accumulated Other Additional Compre- Compre- Common Stock Paid-in Retained hensive hensive Shares Amount Capital Earnings Income Total Income - -------------------------------------------------------------------------------------------------------------------------- Balance, January 1, 2001 6,167,048 $ 3,084 $ 29,739 $46,176 $ (994) $ 78,005 Net income 11,177 11,177 $11,177 Unrealized gains on securities, net 2,424 2,424 2,424 ------- Total comprehensive income $13,601 ------- Cash dividends - $.574 per share (4,114) (4,114) Stock dividend and fractional shares 308,852 155 5,271 (5,433) (7) Issuance of common stock in acquisition 24,184 12 375 387 - ------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001 6,500,084 3,251 35,385 47,806 1,430 87,872 Net income 14,011 14,011 $14,011 Unrealized gains on securities, net 3,067 3,067 3,067 ------- Total comprehensive income $17,078 ------- Cash dividends - $.626 per share (4,485) (4,485) Stock dividend and fractional shares 325,004 163 7,640 (7,803) - Purchase of treasury stock (30,211) (694) (694) - ------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002 6,794,877 2,720 43,025 49,529 4,497 99,771 Net income 15,305 15,305 $15,305 Unrealized loss on cash flow hedge, net (117) (117) (117) Unrealized losses on securities, net (3,165) (3,165) (3,165) ------- Total comprehensive income $12,023 ------- Cash dividends - $.686 per share (4,857) (4,857) Stock dividend and fractional shares 340,537 170 10,453 (10,639) (16) Purchase of treasury stock (64,938) (1,497) (1,497) - ------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003 7,070,476 $ 1,393 $ 53,478 $49,338 $1,215 $105,424 - -------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 25 MainSource Financial Group Consolidated Statements of Cash Flows (Dollar amounts in thousands)
Years ended December 31 2003 2002 2001 - -------------------------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 15,305 $ 14,011 $ 11,177 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,325 2,995 2,136 Depreciation and amortization 2,629 2,246 1,971 Amortization of mortgage servicing rights 1,863 649 1,117 Securities amortization, net 4,093 1,623 546 Amortization of intangibles 909 828 1,966 Increase in cash surrender value of life insurance policies (571) (208) (179) Investment securities gains/losses (1,300) (319) 111 Change in loans held for sale 12,062 7,541 (21,373) Change in other assets and liabilities 3,526 (496) 1,354 - -------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by operating activities 39,841 28,870 (1,174) Investing Activities Net change in short-term investments (201) 599 (5) Proceeds from maturities and payments on securities held to maturity 1,288 3,532 4,556 Purchases of securities available for sale (379,327) (227,229) (199,629) Proceeds from maturities and payments on securities available for sale 182,311 121,805 205,928 Proceeds from sales of securities available for sale 117,382 30,586 10,507 Purchases of restricted stock - (581) (1,842) Loan originations and payments, net 4,197 36,646 27,807 Purchases of premises and equipment (1,960) (3,408) (1,888) Cash (paid) received from branch acquisitions, net 12,203 37,054 (655) Cash paid for bank acquisition, net (12,836) - - Purchase of life insurance policies (15,000) - - Proceeds from sale of premises and equipment - - 635 - -------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by investing activities (91,943) (996) 45,414 Financing Activities Net change in deposits 21,869 (44,475) (38,883) Net change in short-term borrowings 7,229 4,051 (5,167) Repayment of notes payable (2,900) (1,662) (2,448) Proceeds from issuance of notes payable 13,000 - - Proceeds from FHLB advances - 40,000 - Repayment of FHLB advances (1,262) (10,111) (2,117) Redemption of trust preferred securities (22,425) - - Proceeds from issuance of trust preferred securities 21,898 8,000 - Purchase of treasury shares (1,497) (694) - Cash dividends and fractional stock dividends (4,873) (4,485) (4,121) - -------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities 31,039 (9,376) (52,736) Net change in cash and cash equivalents (21,063) 18,498 (8,496) Cash and cash equivalents, beginning of period 77,917 59,419 67,915 - -------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 56,854 $ 77,917 $ 59,419 - -------------------------------------------------------------------------------------------------------------------------- Supplemental Information Interest paid $ 23,683 $ 27,835 $ 44,435 Income tax paid 4,150 6,793 6,076 Loan balances transferred to foreclosed real estate 1,896 3,658 -
See note 2 regarding noncash transactions included in acquisitions. See notes to consolidated financial statements. 26 MainSource Financial Group Notes to Consolidated Financial Statements (Dollar amounts in thousands except per share data) 1. Summary of Significant Accounting Policies Nature of Operations and Principles of Consolidation: The consolidated financial statements include MainSource Financial Group, Inc. and its wholly owned subsidiaries, together referred to as "the Company". Intercompany transactions and balances are eliminated in consolidation. The Company's wholly owned subsidiaries include MainSource Bank, Regional Bank ("Regional"), Capstone Bank ("Capstone"), First Community Bank and Trust ("First Community"), and IUB Reinsurance Company, Ltd. As further discussed in Note 12, statutory trusts that had previously been consolidated with the Company are now reported separately. MainSource Insurance, Inc. is a wholly owned subsidiary of MainSource Bank. The Company provides financial services through its offices in Indiana, Illinois, and Kentucky. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets and real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by both residential and commercial real estate. Other financial instruments which potentially represent concentrations of credit risk include deposit accounts in other financial institutions and federal funds sold. Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported and disclosed in the financial statements, and future results could differ. The allowance for loan losses, loan servicing rights, and fair values of financial instruments are particularly subject to change. Cash Flows: Cash and cash equivalents include cash, deposits with other financial institutions under 90 days, and federal funds sold. Net cash flows are reported for loan and deposit transactions. Securities: Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income. Restricted stock, such as Federal Home Loan Bank stock, is carried at cost. Interest income includes amortization of purchase premium or discount. Gains and losses on sales are based on the amortized cost of the security sold. Securities are written down to fair value when a decline in fair value is not temporary. Loans Held for Sale: Loans originated and intended for sale in the secondary market are carried at the lower of cost or market in the aggregate. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Interest income is not reported when full loan repayment is in doubt, typically when the loan is impaired or payments are past due over 90 days. Loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential real estate, consumer, and credit card loans, and are not separately identified for impairment disclosure. Other loans are evaluated individually for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Foreclosed Assets: Assets acquired through or instead of loan foreclosure are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed. Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 39 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 10 years. 27 MainSource Financial Group Notes to Consolidated Financial Statements (Dollar amounts in thousands except per share data) Company Owned Life Insurance: The Company has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at its cash surrender value, or the amount that can be realized. Servicing Assets: Servicing assets represent the allocated value of retained servicing rights on loans sold. Servicing assets are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the assets, using groupings of the underlying loans as to product type and interest rates. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping. Goodwill and Other Intangible Assets: Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Upon adopting new accounting guidance in 2002, the Company ceased amortizing goodwill. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. Other intangible assets consist of core deposit intangibles arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, generally, ten years. Long-term Assets: Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance. Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Derivatives: All derivative instruments are recorded at their fair values. If derivative instruments are designated as hedges of fair values, both the change in the fair value of the hedge and the hedged item are included in current earnings. Fair value adjustments related to cash flow hedges are recorded in other comprehensive income and reclassified to earnings when the hedged transaction is reflected in earnings. Ineffective portions of hedges are reflected in earnings as they occur. Mortgage Banking Income: Mortgage banking income consists of gains on loan sales and servicing fee income, net of mortgage servicing right amortization. Stock Compensation: Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation. December 31 2003 2002 2001 - -------------------------------------------------------------------------------- Net income as reported $ 15,305 $ 14,011 $ 11,177 Deduct: Stock-based compensation expense, net, determined under fair value based method 29 -- -- - -------------------------------------------------------------------------------- Pro forma net income $ 15,276 $ 14,011 $ 11,177 - -------------------------------------------------------------------------------- Basic earnings per share as reported $ 2.16 $ 1.96 $ 1.56 Pro forma basic earnings per share $ 2.16 $ 1.96 $ 1.56 Diluted earnings per share as reported $ 2.16 $ 1.96 $ 1.56 Pro forma diluted earnings per share $ 2.16 $ 1.96 $ 1.56 The pro forma effects are computed using option pricing models, with the following weighted-average assumptions for 2003 as of grant date: risk-free interest rate 2.80%, expected option life 6.54 years, expected stock price volatility 18.60% and dividend yield 2.90%. No options were granted in 2002 or 2001. Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements. Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale and unrealized gains and losses on cash flow hedges, which are also recognized as a separate component of equity. Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss 28 can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements. Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the banks to the holding company or by the holding company to shareholders. These restrictions pose no practical limit on the ability of the bank or holding company to pay dividends at historical levels. Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Operating Segments: While the Company's chief decision-makers monitor the revenue streams of the various Company products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company's financial service operations are considered by management to be aggregated in one reportable operating segment. Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. Adoption of New Accounting Standards: During 2003, the Company adopted FASB Statement 143, Accounting for Asset Retirement Obligations, FASB 145, Rescission of FASB Statement 4, 44 and 64, Amendment of FAS Statement 13, and Technical Corrections, FASB Statement 146, Accounting for Cost Associated with Exit or Disposal Activities, FASB Statement 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, FASB Statement 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities, FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, and FASB Interpretation 46, Consolidation of Variable Interest Entities. Adoption of the new standards did not materially affect the Company's operating results or financial condition. 2. Business Combinations Whole Bank Acquisition: In June 2003, the Company acquired 100% of the outstanding shares of First Community Bancshares, parent of First Community Bank and Trust. Operating results of this acquisition are included in the consolidated financial statements since the date of the acquisition. As a result of this acquisition, the Company expects to further solidify its market share in the south central Indiana market, expand its customer base to enhance deposit fee income, provide an opportunity to market additional products and services to new customers, and reduce operating costs through economies of scale. In addition, the acquisition helped to prevent another institution from entering the market. The aggregate purchase price was $24.2 million in cash. The purchase price resulted in approximately $15.0 million in goodwill, and $1.1 million in core deposit intangible. The core deposit intangible asset will be amortized over 10 years, using an accelerated method. Goodwill will not be amortized but will instead be evaluated periodically for impairment. Goodwill and the core deposit intangible asset are not deductible for tax purposes. The following table summarizes the estimated fair value of assets acquired and liabilities assumed at the date of acquisition. Cash $ 11,448 Securities available for sale 3,826 Loans, net 114,819 Goodwill 14,521 Core deposit intangible 1,080 Other assets 10,526 - ------------------------------------------------------------------------------ Total assets acquired 156,220 Deposits (115,481) Borrowings (14,527) - ------------------------------------------------------------------------------ Other liabilities (1,964) Total liabilities assumed (131,972) Net assets acquired $ 24,248 - ------------------------------------------------------------------------------ The following table presents pro forma information as if the acquisition had occurred at the beginning of 2003 and 2002. The pro forma information includes adjustments for interest income on loans and securities acquired, amortization of intangibles arising from the transaction, depreciation expense on property acquired, interest expense on deposits and borrowings acquired, and the related income tax effects. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transactions been effected on the assumed dates. December 31 2003 2002 - ------------------------------------------------------------------------------ Net interest income $ 46,523 $ 50,611 Net income 14,146 14,175 Earnings per share (basic and diluted) 2.00 1.98 Branch Purchase: In February, 2003, the Company purchased a branch office facility in Illinois and assumed related deposits from another financial institution. Approximately $6.4 million of loans were acquired, $19.6 million of deposits were assumed, $0.2 million in fixed assets acquired, and $12.2 million in liquid assets were received. The transaction resulted in amortizable core deposit intangible assets of $0.2 million and non-amortizable goodwill of $0.8 million. The core deposit intangible will be amortized over 10 years, using an accelerated method, and the goodwill and core deposit intangible assets will be deducted for tax purposes over 15 years using the straight line method. The Company acquired the branch at this premium to further solidify its market share in the eastern Illinois market, expand its customer base to enhance deposit fee income, provide an opportunity to market additional products and services to new customers, and improve customer convenience by adding a new location. Operating results of the branch are included since the date of the acquisition. The pro forma information for this acquisition is not significantly different from actual results. 29 MainSource Financial Group Notes to Consolidated Financial Statements (Dollar amounts in thousands except per share data) Pending Acquisition: In December 2003, the Company executed a definitive agreement to acquire Peoples Financial Corp, Inc. ("Peoples"). Peoples has seven bank offices in southwest Indiana with total assets of approximately $120 million. The transaction, which is subject to approval by regulatory agencies and Peoples' shareholders, is expected to close in the second quarter of 2004. 3. Restriction on Cash and Due From Banks The Banks are required to maintain reserve funds in cash or on deposit with the Federal Reserve Bank. The reserve required at December 31, 2003 and 2002 was $14,588 and $13,089, respectively. 4. Securities The fair value of securities available for sale and related gross gains/losses recognized in accumulated other comprehensive income (loss) were as follows: Gross Gross Fair Unrealized Unrealized Value Gains Losses - ----------------------------------------------------------------------- 2003 - ------------------------------- Available for Sale Federal agencies $ 92,867 $ 1,409 $ (36) State and municipal 61,324 1,899 (152) Mortgage-backed securities 255,541 1,297 (1,710) Equity and other securities 12,379 103 (625) - ----------------------------------------------------------------------- Total available for sale $422,111 $ 4,708 $ (2,523) - ----------------------------------------------------------------------- 2002 - ------------------------------- Available for Sale Federal agencies $ 80,483 $ 2,928 $ -- State and municipal 49,027 1,682 (5) Mortgage-backed securities 194,490 2,901 (54) Equity and other securities 22,468 227 (614) - ----------------------------------------------------------------------- Total available for sale $346,468 $ 7,738 $ (673) - ----------------------------------------------------------------------- The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows: Gross Gross Unrecog- Unrecog- Carrying nized nized Fair Amount Gains Losses Value - ---------------------------------------------------------------------- 2003 - ------------------------------- Held to Maturity State and municipal $2,682 $ 122 $ -- $2,804 Other securities 749 130 -- 879 - ---------------------------------------------------------------------- Total held to maturity $3,431 $ 252 $ -- $3,683 - ---------------------------------------------------------------------- 2002 - ------------------------------- Held to Maturity State and municipal $3,977 $ 119 $ -- $4,096 Other securities 698 145 -- 843 - ---------------------------------------------------------------------- Total held to maturity $4,675 $ 264 $ -- $4,939 - ---------------------------------------------------------------------- Contractual maturities of securities for 2003 were as follows. Securities not due at a single maturity date are shown separately. Available Held to Maturity for Sale - ---------------------------------------------------------------------- Carrying Fair Fair Amount Value Value - ---------------------------------------------------------------------- Within one year $ 237 $ 238 $ 10,376 Two through five years 1,875 2,069 112,824 Six through ten years 1,319 1,376 19,364 After ten years -- -- 11,627 Mortgage-backed securities -- -- 255,541 Equity and other securities -- -- 12,379 - ---------------------------------------------------------------------- Total investment securities $3,431 $3,683 $422,111 - ---------------------------------------------------------------------- Gross proceeds from sales of securities available for sale during 2003, 2002 and 2001 were $117,382, $30,586, and $10,507. Gross gains of $1,443, $373, and $72 and gross losses of $143, $65, and $232 were realized on those sales in 2003, 2002 and 2001, respectively. In addition, the Company also realized $11 and $49 of gains on called securities in 2002 and 2001, respectively. Securities with a carrying value of $50,560 and $59,337 were pledged at December 31, 2003 and 2002 to secure certain deposits and for other purposes as permitted or required by law. Below is a summary of securities with unrealized losses as of year-end 2003, presented by length of time the securities have been in an unrealized loss position. Fair Unrealized Less than 12 months Value Losses - --------------------------------------------------------------------- Federal agencies $ 32,512 $ (36) State and municipal 8,061 (152) Mortgage-backed securities 144,882 (1,710) Equity and other securities -- -- - --------------------------------------------------------------------- $ 185,455 $ (1,898) - --------------------------------------------------------------------- Fair Unrealized 12 months or longer Value Losses - --------------------------------------------------------------------- Federal agencies $ -- $ -- State and municipal -- -- Mortgage-backed securities -- -- - --------------------------------------------------------------------- Equity and other securities 5,594 (625) $ 5,594 $ (625) - --------------------------------------------------------------------- Fair Unrealized Total Value Losses - --------------------------------------------------------------------- Federal agencies $ 32,512 $ (36) State and municipal 8,061 (152) Mortgage-backed securities 144,882 (1,710) Equity and other securities 5,594 (625) - --------------------------------------------------------------------- $ 191,049 $ (2,523) - --------------------------------------------------------------------- Unrealized losses on equity and other securities have not been recognized into income because management has the intent and ability to hold for the foreseeable future. The fair value of debt securities is expected to recover as the securities approach their maturity date. 30 Unrealized losses on mortgage-backed securities have not been recognized into income as the decline in fair value is largely due to increases in market interest rates. The fair value is expected to recover as the bonds approach their maturity date and/or market rates decline. 5. Loans and Allowance December 31 2003 2002 - ------------------------------------------------------------------------ Commercial and industrial loans $158,271 $105,093 Agricultural production financing 25,897 25,105 Farm real estate 37,107 43,762 Commercial real estate 101,022 84,024 Hotel 83,997 73,262 Residential real estate 315,848 301,232 Construction and development 33,605 34,987 Consumer 99,724 72,702 - ------------------------------------------------------------------------ Total loans 855,471 740,167 Allowance for loan losses (11,509) (9,517) - ------------------------------------------------------------------------ Net loans $843,962 $730,650 - ------------------------------------------------------------------------ December 31 2003 2002 2001 - ------------------------------------------------------------------------ Allowance for loan losses Balances, January 1 $ 9,517 $ 8,894 $ 8,716 Addition resulting from acquisition 2,078 - - Provision for losses 1,325 2,995 2,136 Recoveries on loans 509 399 421 Loans charged off (1,920) (2,771) (2,379) - ------------------------------------------------------------------------ Balances, December 31 $ 11,509 $ 9,517 $ 8,894 - ------------------------------------------------------------------------ December 31 2003 2002 2001 - ------------------------------------------------------------------------ Impaired loans with an allowance $ 6,954 $ 2,267 $ 5,989 Impaired loans with no allocated allowances - - - - ------------------------------------------------------------------------ Total impaired loans $ 6,954 $ 2,267 $ 5,989 - ------------------------------------------------------------------------ Allowance allocated for impaired loans $ 1,086 $ 269 $ 898 - ------------------------------------------------------------------------ Average balance of impaired loans $ 4,997 $ 2,866 $ 4,174 Interest income recognized on impaired loans - - - Cash basis interest included above - - - Nonperforming loans were as follows: December 31 2003 2002 - ------------------------------------------------------------------------ Loans past due over 90 days still on accrual $ 196 $ 245 Nonaccrual loans 14,626 7,695 - ------------------------------------------------------------------------ Total nonperforming loans $ 14,822 $ 7,940 - ------------------------------------------------------------------------ Nonperforming loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. 6. Premises & Equipment December 31 2003 2002 - ------------------------------------------------------------------------- Land $ 3,731 $ 3,037 Buildings 21,556 18,312 Equipment 21,451 18,507 - ------------------------------------------------------------------------- Total cost 46,738 39,856 Accumulated depreciation (23,852) (20,598) - ------------------------------------------------------------------------- Net $ 22,886 $ 19,258 - ------------------------------------------------------------------------- Depreciation expense was $2,629, $2,246 and $1,971 for 2003, 2002 and 2001. 7. Goodwill and Intangible Assets Goodwill Upon adopting new accounting guidance in 2002, unidentifiable intangibles from bank branch acquisitions were reclassified to goodwill. The change in the carrying amount of goodwill for the year is as follows: 2003 2002 - --------------------------------------------------------------------------- Beginning of year $ 20,708 $ 2,673 Reclassified from unidentifiable intangible asset - 15,295 Goodwill from acquisitions during year 15,339 2,740 - --------------------------------------------------------------------------- End of year $ 36,047 $ 20,708 - --------------------------------------------------------------------------- Upon adopting new accounting guidance, goodwill was no longer amortized starting in 2002. The effect of not amortizing goodwill is summarized as follows: 2003 2002 2001 - --------------------------------------------------------------------------- Reported net income $ 15,305 $ 14,011 $11,177 Add back: goodwill amortization, net of tax - - 710 - --------------------------------------------------------------------------- Adjusted net income $ 15,305 $ 14,011 $11,887 - --------------------------------------------------------------------------- Basic and diluted earnings per share: Reported net income $ 2.16 $ 1.96 $ 1.56 Goodwill amortization, net of tax - - .10 - --------------------------------------------------------------------------- Adjusted net income $ 2.16 $ 1.96 $ 1.66 - --------------------------------------------------------------------------- Acquired Intangible Assets 2003 2002 - --------------------------------------------------------------------------- Core deposit intangibles $ 9,804 $ 8,553 Accumulated amortization (4,457) (3,548) - --------------------------------------------------------------------------- Core deposit intangibles, net $ 5,347 $ 5,005 - --------------------------------------------------------------------------- 31 MainSource Financial Group Notes to Consolidated Financial Statements (Dollar amounts in thousands except per share data) Aggregate amortization expense was $909, $828, and $1,700 for 2003, 2002 and 2001. Estimated amortization expense for each of the next five years: 2004 $ 916 2005 908 2006 899 2007 887 2008 779 8. Deposits December 31 2003 2002 - ------------------------------------------------------------------ Non-interest bearing $ 127,100 $ 104,282 Interest bearing demand 311,333 260,120 Savings deposits 224,318 196,056 Certificates and other time deposits of $100 or more 141,327 93,192 Other certificates and time deposits 387,232 380,657 - ------------------------------------------------------------------ Total deposits $1,191,310 $1,034,307 - ------------------------------------------------------------------ Certificates and other time deposits maturing in years ending after December 31, 2003: 2004 $ 350,618 2005 109,374 2006 26,435 2007 19,152 2008 6,353 Thereafter 16,627 - ------------------------------------------------------------------- Total $ 528,559 - ------------------------------------------------------------------- 9. Short-Term Borrowings December 31 2003 2002 - ------------------------------------------------------------------- Short-term borrowings consisted of the following at year-end: Federal funds purchased $ 7,460 $ - Securities sold under repurchase agreements 20,048 19,529 - ------------------------------------------------------------------- Total short-term borrowings $27,508 $19,529 - ------------------------------------------------------------------- Securities sold under repurchase agreements ("agreements") consist of obligations secured by U.S. Treasury and Federal agency securities, and a safekeeping agent holds such collateral. The maximum amount of outstanding agreements at any month-end during 2003 and 2002 totaled $20,048 and $19,529. The daily average of such agreements during 2003 and 2002 totaled $16,680 and $17,372. The weighted average rate was 0.71% and 1.15% at December 31, 2003 and 2002, while the weighted average rate during 2003 and 2002 was approximately 0.88% and 1.64%, respectively. The majority of the agreements at December 31, 2003 mature within 30 days. 10. Federal Home Loan Bank Advances Federal Home Loan Bank ("FHLB") advances at year end were: 2003 2002 - ------------------------------------------------------------------- Maturities January 2004 through August 2012, with rates from 1.3% to 6.6%, averaging 4.5% $62,751 $ - Maturities March 2003 through August 2012, with rates from 3.3% to 6.6%, averaging 5.0% - 50,235 - ------------------------------------------------------------------- $62,751 $50,235 - ------------------------------------------------------------------- The FHLB advances are secured by first mortgage loans totaling approximately 145% of the advance under a blanket security agreement. The advances are subject to restrictions or penalties in the event of prepayment. Maturities over the next five years are: 2004 $10,549 2005 10,031 2006 132 2007 15,703 2008 - Thereafter 26,336 11. Notes payable Notes payable include a term note secured by the common stock of MainSource Bank and Regional Bank with a balance of $800 and $2,400 at December 31, 2003 and 2002. The note requires semi-annual principal payments of $800 plus quarterly interest payments. Interest accrues at LIBOR+1.20%, which resulted in a rate of 2.41% at December 31, 2003. The loan matures July 1, 2004. Notes payable also include a term note secured by the common stock of MainSource Bank and First Community Bank & Trust with a balance of $11,700 at December 31, 2003. The note requires semi-annual principal payments of $1,300 plus quarterly interest payments. Interest accrues at LIBOR+1.40%, which resulted in a rate of 2.56% at December 31, 2003. The loan matures June 30, 2008. The Company has certain debt covenants related to these notes payable. As of December 31, 2003 the Company was in compliance with all of these covenants. 12. Subordinated Debentures and Trust Preferred Securities The Company formed three separate trusts in 2002 and 2003 that issued floating rate trust preferred securities as part of pooled offerings of such securities. The Company issued subordinated debentures to the trusts in exchange for the proceeds of the offerings, which debentures represent the sole asset of the trusts. Other than the items detailed below, the terms of the subordinated debentures are generally the same. Interest payments are payable quarterly in arrears and the Company has the option to defer payments from time to time for a period not to exceed 20 consecutive quarters. The subordinated debentures mature in 30 years from issuance and can be called anytime after five years at par. The following table summarizes the other terms of each issuance. 32 Date of Rate as of Maturity Issuance Amount Variable Rate 12/31/03 Date - --------------------------------------------------------------------- Trust 1 12/2002 $ 8,248 LIBOR +3.25% 4.42% 12/2032 Trust 2 4/2003 14,433 LIBOR +3.25% 4.41% 4/2033 Trust 3 6/2003 7,217 LIBOR +3.15% 4.32% 6/2033 An interest rate swap was utilized to obtain a five-year fixed rate of 6.65% on the first $14,000 of the $14,433 issue. Prior to 2003, the trusts were consolidated in the Company's financial statements, with the trust preferred securities issued by the trusts reported in liabilities as "guaranteed preferred beneficial interests" and the subordinated debentures eliminated in consolidation. Under new accounting guidance, FASB Interpretation No. 46, as revised in December 2003, 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 and held by the trusts, as these are no longer eliminated in consolidation. Since the amount of the subordinated debentures and the trust preferred securities was substantially the same, the effect of no longer consolidating the trust does not significantly change the amounts reported as the Company's assets, liabilities, equity, or interest expense. Accordingly, the amounts previously reported as "guaranteed preferred beneficial interests" in liabilities have been recaptioned "subordinated debentures" and continue to be presented in liabilities on the balance sheet. 13. Loan Servicing Loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of loans serviced for others totaled $498,385 and $395,359 at December 31, 2003 and 2002. Mortgage servicing rights are included in other assets on the consolidated balance sheets. The fair value of capitalized mortgage servicing assets is based on comparable market values and expected cash flows, with impairment assessed based on portfolio characteristics including product type and interest rates. No valuation allowance was necessary during 2003 or 2002. The fair value of capitalized mortgage servicing rights was $3,395 and $2,498 at year end 2003 and 2002. 2003 2002 - -------------------------------------------------------------------- Mortgage servicing assets Balances, January 1 $2,134 $1,105 Additions resulting from acquisition 143 - Servicing assets capitalized 2,204 1,678 Amortization of servicing assets (1,863) (649) - -------------------------------------------------------------------- Balance, December 31 $2,618 $2,134 - -------------------------------------------------------------------- 14. Income Tax Retained earnings of Regional Bank include approximately $2,162 for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions as of December 31, 1987 for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses including redemption of Regional Bank stock or excess dividends, or loss of "bank" status for Regional Bank would create income for tax purposes only, which would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amount for Regional at December 31, 2003 was approximately $757. Income tax expense (benefit) was as follows: Year Ended December 31 2003 2002 2001 - -------------------------------------------------------------------- Income tax expense Currently payable $4,749 $5,899 $5,378 Deferred 2,102 914 252 Net operating loss carryforward (254) - - - -------------------------------------------------------------------- Total income tax expense $6,597 $6,813 $5,630 - -------------------------------------------------------------------- Reconciliation of federal statutory to actual tax expense Federal statutory income tax rate 35% 35% 35% Federal statutory income tax $7,666 $7,288 $5,883 Tax exempt interest (893) (838) (672) Effect of state income taxes 397 483 351 Non-deductible expenses 52 42 109 Tax exempt income on life insurance (219) (73) (66) Low income housing credits (175) - - Other (231) (89) 25 - -------------------------------------------------------------------- Income tax expense $6,597 $6,813 $5,630 - -------------------------------------------------------------------- The components of the net deferred tax asset (liability) are as follows: December 31 2003 2002 - -------------------------------------------------------------------- Assets Allowance for loan losses $ 4,556 $ 3,781 Deferred compensation 452 486 Fair value adjustments on assets acquired 472 - Accrued expenses 323 350 Alternative minimum tax credits 106 - Net operating loss carryforward 189 - Net unrealized appreciation on interest rate swap 78 - Other 338 170 - -------------------------------------------------------------------- Total assets $ 6,514 $ 4,787 - -------------------------------------------------------------------- Liabilities Accretion on securities $ (17) $ (23) Depreciation (1,282) (798) Fair value adjustments on assets acquired - (354) Intangibles (1,538) (466) Mortgage servicing rights (1,037) (844) Deferred loan fees/costs (237) (327) FHLB stock dividends (160) (19) Unrealized gain on securities available for sale (853) (2,568) Other (780) (309) - -------------------------------------------------------------------- Total liabilities $(5,904) $(5,708) - -------------------------------------------------------------------- Net deferred tax asset $ 610 $ (921) - -------------------------------------------------------------------- 33 MainSource Financial Group Notes to Consolidated Financial Statements (Dollar amounts in thousands except per share data) 15. Other Comprehensive Income
Before-Tax Tax (Expense) Net-of-Tax Year Ended December 31, 2003 Amount /Benefit Amount - --------------------------------------------------------------------------------------------------------------------------- Unrealized holding losses on available for sale securities $(3,580) $ 1,260 $(2,320) Unrealized holding losses on interest rate swap and cap (195) 78 (117) Less: reclassification adjustment for gains realized in net income 1,300 (455) 845 - --------------------------------------------------------------------------------------------------------------------------- Other comprehensive income $(5,075) $ 1,793 $(3,282) - --------------------------------------------------------------------------------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Year Ended December 31, 2002 Amount /Benefit Amount - --------------------------------------------------------------------------------------------------------------------------- Unrealized holding gains on available for sale securities $ 5,156 $(1,882) $3,274 Less: reclassification adjustment for gains realized in net income 319 (112) 207 - --------------------------------------------------------------------------------------------------------------------------- Other comprehensive income $ 4,837 $(1,770) $3,067 - --------------------------------------------------------------------------------------------------------------------------- Before-Tax Tax (Expense) Net-of-Tax Year Ended December 31, 2001 Amount /Benefit Amount - --------------------------------------------------------------------------------------------------------------------------- Unrealized holding gains on available for sale securities $ 3,707 $(1,355) $2,352 Less: reclassification adjustment for losses realized in net income (111) 39 (72) - --------------------------------------------------------------------------------------------------------------------------- Other comprehensive income $ 3,818 $(1,394) $2,424 - ---------------------------------------------------------------------------------------------------------------------------
16. Financial Instruments with Off-Balance Sheet Risk and Derivative Instruments In the normal course of business there are outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying financial statements. The Banks' exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Banks use the same credit policies in making such commitments as they do for instruments that are included in the consolidated balance sheet. Financial instruments whose contract amount represents credit risk as of December 31 were as follows: 2003 2002 - --------------------------------------------------------------- Commitments to extend credit $152,494 $139,685 Standby letters of credit 2,936 1,766 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments are predominantly short-term or variable in rate. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Collateral held varies, but may include accounts receivable, inventory, property and equipment and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. During 2003, the Company entered into an interest rate swap and cap. Both the interest rate swap and the cap have a 60 month term and a notional principal balance of $14,000. The interest rate swap and cap were designated to hedge a portion of the subordinated debentures. Under the interest rate swap agreement, the Company made fixed rate payments at 6.65%, and received variable payments based on LIBOR. Net settlement expense or benefit is included in interest expense. The interest rate cap requires the counter-party to pay the Company the excess of 3-month LIBOR over 12%. No payments are currently required under the agreement. The fair values for the interest rate swap and cap were $146 and $49 at year end and were included in other liabilities. Both the interest rate swap and cap expire in April 2008. 17. Stock Dividends On November 26, 2003, the Company announced a 5% stock dividend to be paid on January 9, 2004 to shareholders of record as of December 22, 2003. The stock dividend was recorded in 2003, and all share and per share amounts have been retroactively adjusted for all prior years to reflect this stock dividend. On December 17, 2002, the Company announced a 5% stock dividend to be paid on January 17, 2003 to shareholders of record as of December 31, 2002. The stock dividend was recorded in 2002, and all share and per share amounts have been retroactively adjusted for all prior years to reflect this stock dividend. On December 19, 2001, the Company announced a 5% stock dividend to be paid on January 25, 2002 to shareholders of record as of December 31, 2001. The stock dividend was recorded in 2001, and all share and per share amounts have been retroactively adjusted for all prior years to reflect this stock dividend. 34 18. Dividends and Capital Restrictions Without prior approval, the Banks are restricted by state regulations and regulatory agencies as to the maximum amount of dividends the Banks can pay to the parent in any calendar year to their retained net profits (as defined) for that year and the two preceding years. At December 31, 2003, total shareholders' equity of the Banks was $141,610 of which $130,938 was restricted or limited from dividend distribution to the Company. As a practical matter, the Banks may restrict dividends to a lesser amount because of the need to maintain an adequate capital structure. 19. Dividend Reinvestment Plan The Company maintains an Automatic Dividend Reinvestment Plan. The plan enables shareholders to elect to have their cash dividends on all or a portion of shares held automatically reinvested in additional shares of the Company's common stock. The stock is purchased by the Company's transfer agent on the open market and credited to participant accounts at fair market value. Dividends are reinvested on a quarterly basis. 20. Regulatory Capital Banks and bank holding companies are subject to various regulatory capital requirements administered by the federal banking agencies and are assigned to a capital category. The assigned capital category is largely determined by three ratios that are calculated according to the regulations. The ratios are intended to measure capital relative to assets and credit risk associated with those assets and off-balance sheet exposures. The capital category assigned to an entity can also be affected by qualitative judgments made by regulatory agencies about the risk inherent in the entity's activities that are not part of the calculated ratios. There are five capital categories defined in the regulations, ranging from well capitalized to critically undercapitalized. Classification in any of the undercapitalized categories can result in actions by regulators that could have a material effect on operations. At December 31, 2003 and 2002, the most recent regulatory notifications categorized the banks as well capitalized under the regulatory framework for prompt corrective actions. There are no conditions or events since that notification that management believes have changed the institutions' category.
Required for To Be Well Actual Adequate Capital Capitalized December 31, 2003 Amount Ratio Amount Ratio Amount Ratio - ------------------------------------------------------------------------------------------------------------------------ MainSource Financial Group Total capital (to risk-weighted assets) $103,223 11.3% $ 73,011 8.0% N/A N/A Tier 1 capital (to risk-weighted assets) 83,753 9.2 36,505 4.0 N/A N/A Tier 1 capital (to average assets) 83,753 6.0 55,914 4.0 N/A N/A MainSource Bank Total capital (to risk-weighted assets) $ 63,280 11.8% $ 43,061 8.0% $53,826 10.0% Tier 1 capital (to risk-weighted assets) 56,552 10.5 21,530 4.0 32,296 6.0 Tier 1 capital (to average assets) 56,552 7.1 32,033 4.0 40,041 5.0 Regional Total capital (to risk-weighted assets) $ 17,991 11.2% $ 12,853 8.0% $16,066 10.0% Tier 1 capital (to risk-weighted assets) 16,330 10.2 6,426 4.0 9,640 6.0 Tier 1 capital (to average assets) 16,330 6.7 9,710 4.0 12,137 5.0 Capstone Total capital (to risk-weighted assets) $ 14,352 15.9% $ 7,233 8.0% $ 9,042 10.0% Tier 1 capital (to risk-weighted assets) 13,418 14.8 3,617 4.0 5,425 6.0 Tier 1 capital (to average assets) 13,418 6.7 8,011 4.0 10,014 5.0 First Community Total capital (to risk-weighted assets) $ 13,699 11.5% $ 9,544 8.0% $11,930 10.0% Tier 1 capital (to risk-weighted assets) 12,208 10.2 4,772 4.0 7,158 6.0 Tier 1 capital (to average assets) 12,208 8.4 5,840 4.0 7,300 5.0
35 MainSource Financial Group Notes to Consolidated Financial Statements (Dollar amounts in thousands except per share data)
Required for To Be Well Actual Adequate Capital Capitalized December 31, 2002 Amount Ratio Amount Ratio Amount Ratio - ------------------------------------------------------------------------------------------------------------------------ MainSource Financial Group Total capital (to risk-weighted assets) $109,503 14.1% $ 62,243 8.0% N/A N/A Tier 1 capital (to risk-weighted assets) 92,516 11.9 31,121 4.0 N/A N/A Tier 1 capital (to average assets) 92,516 7.6 49,061 4.0 N/A N/A MainSource Bank Total capital (to risk-weighted assets) $ 60,536 11.3% $ 43,048 8.0% $53,810 10.0% Tier 1 capital (to risk-weighted assets) 53,887 10.1 21,524 4.0 32,286 6.0 Tier 1 capital (to average assets) 53,887 6.8 31,608 4.0 39,510 5.0 Regional Total capital (to risk-weighted assets) $ 17,341 11.6% $ 11,930 8.0% $14,912 10.0% Tier 1 capital (to risk-weighted assets) 15,543 10.4 5,965 4.0 8,947 6.0 Tier 1 capital (to average assets) 15,543 6.4 9,748 4.0 12,186 5.0 Capstone Total capital (to risk-weighted assets) $ 12,866 15.4% $ 6,704 8.0% $ 8,381 10.0% Tier 1 capital (to risk-weighted assets) 11,818 14.1 3,352 4.0 5,028 6.0 Tier 1 capital (to average assets) 11,818 6.4 7,425 4.0 9,281 5.0
21. Employee Benefit Plans The Company has a defined-contribution retirement plan in which substantially all employees may participate. The Company matches a portion of employees' contributions and makes additional Company contributions based on employee compensation and Company profitability. Expense was $1,284 in 2003, $1,138 in 2002, and $1,337 in 2001. 22. Related Party Transactions The Company has entered into transactions with certain directors, executive officers, significant stockholders and their affiliates or associates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The aggregate amount of loans, as defined, to such related parties were as follows: Balances, January 1, 2003 $ 9,048 Changes in composition of related parties (1,483) New loans, including renewals and advances 6,734 Payments, etc. including renewals (7,089) - ------------------------------------------------------------- Balances, December 31, 2003 $ 7,210 - ------------------------------------------------------------- Deposits from related parties held by the company at December 31, 2003 and 2002 totaled $5,980 and $4,360. 23. Stock Option Plans Options to buy stock were granted to directors and officers of the Company under the Company's Stock Option Plan, which was adopted in 2003 and provides for the issue of up to 367,500 options. Exercise price is the market price at date of grant, so there is no compensation expense recognized in the income statement. The maximum option term is ten years, and options vest immediately for the directors' grant and over four years for the officers' grant. The weighted average remaining contractual life is 9.4 years. A summary of the activity in the plan is as follows: Year Ended December 31 2003 - ---------------------------------------------------------------- Weighted Average Exercise Options (restated for stock dividend) Shares Price - ---------------------------------------------------------------- Outstanding, beginning of year - - Granted 36,225 $22.10 Exercised or redeemed - - - ---------------------------------------------------------------- Outstanding, end of year 36,225 $22.10 Options exercisable at year end 11,183 $22.10 Weighted average fair value of options granted during the year $3.56 36 24. Earnings Per Share Earnings per share were computed as follows:
Weighted Average Per-Share Year Ended December 31, 2003 Income Shares Amount - -------------------------------------------------------------------------------------------------------- Basic Earnings Per Share Net income available to common shareholders $15,305 7,084,408 $2.16 Effect of dilutive stock options 2,089 --------- Diluted Earnings Per Share Net income available to common shareholders and assumed conversions $15,305 7,086,497 $2.16 - -------------------------------------------------------------------------------------------------------- Year Ended December 31, 2002 - -------------------------------------------------------------------------------------------------------- Basic Earnings Per Share Net income available to common shareholders $14,011 7,146,391 $1.96 Effect of dilutive stock options - --------- Diluted Earnings Per Share Net income available to common shareholders and assumed conversions $14,011 7,146,391 $1.96 - -------------------------------------------------------------------------------------------------------- Year Ended December 31, 2001 - -------------------------------------------------------------------------------------------------------- Basic Earnings Per Share Net income available to common shareholders $11,177 7,160,222 $1.56 Effect of dilutive stock options - --------- Diluted Earnings Per Share Net income available to common shareholders and assumed conversions $11,177 7,160,222 $1.56 - --------------------------------------------------------------------------------------------------------
37 MainSource Financial Group Notes to Consolidated Financial Statements (Dollar amounts in thousands except per share data) 25. Fair Values of Financial Instruments
December 31, 2003 December 31, 2002 - -------------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value - -------------------------------------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 56,854 $ 56,854 $ 77,917 $ 77,917 Interest-bearing time deposits 201 201 - - Securities available for sale 422,111 422,111 346,468 346,468 Securities held to maturity 3,431 3,683 4,675 4,939 Loans including loans held for sale, net 845,927 865,266 746,365 772,126 Restricted stock 6,639 6,639 5,690 5,690 Interest receivable 6,938 6,938 5,171 5,171 Liabilities Deposits (1,191,310) (1,201,574) (1,034,307) (1,035,483) Borrowings Short-term (27,508) (27,508) (19,529) (19,529) FHLB advances (62,751) (63,519) (50,235) (52,386) Notes payable (12,500) (12,500) (2,400) (2,400) Interest payable (3,192) (3,192) (3,502) (3,502) Subordinated debentures (29,898) (29,898) (30,425) (30,582) Interest rate swap (195) (195) - -
The methods and assumptions used to estimate fair value are described as follows. Carrying amount is the estimated fair value of cash and cash equivalents, interest-bearing time deposits, restricted stock, accrued interest receivable and payable, demand deposits, short-term borrowings, variable rate notes payable and subordinated debentures, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, or if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of loans held for sale is based on market quotes. Fair value of FHLB advances is based on current rates for similar financing. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements, and are not considered significant. 26. Quarterly Financial Data (Unaudited) Interest Net Interest Net Earnings Per Share Income Income Income Basic Fully Diluted - -------------------------------------------------------------------------------- 2003 First quarter $16,732 $10,714 $3,505 $0.50 $0.50 Second quarter 16,524 10,720 3,734 0.52 0.52 Third quarter 17,216 11,304 3,849 0.54 0.54 Fourth quarter 17,133 11,494 4,217 0.60 0.60 2002 First quarter $18,365 $11,063 $3,336 $0.47 $0.47 Second quarter 18,127 11,169 3,318 0.47 0.47 Third quarter 18,292 11,693 3,419 0.47 0.47 Fourth quarter 17,519 11,125 3,938 0.55 0.55 38 27. Parent Only Condensed Financial Statements
Parent Only Condensed Balance Sheets December 31 2003 2002 - -------------------------------------------------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 1,744 $ 15,131 Securities available for sale 1,057 1,057 Investment in subsidiaries 142,945 112,717 Other assets 3,290 6,182 - -------------------------------------------------------------------------------------------------------------------------- Total assets $149,036 $135,087 - -------------------------------------------------------------------------------------------------------------------------- Liabilities Subordinated debentures $ 29,898 $ 31,367 Notes payable 12,500 2,400 Other liabilities 1,186 1,523 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities 43,584 35,290 Shareholders' equity 105,452 99,797 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $149,036 $135,087 - -------------------------------------------------------------------------------------------------------------------------- Parent Only Condensed Statements of Income Year ended December 31 2003 2002 2001 - -------------------------------------------------------------------------------------------------------------------------- Income Dividends from subsidiaries $ 14,250 $ 18,261 $ 11,020 Fees from subsidiaries 7,813 6,370 4,016 Other income 207 170 207 - -------------------------------------------------------------------------------------------------------------------------- Total income 22,270 24,801 15,243 Expenses Interest expense 1,898 2,172 2,395 Salaries and benefits 4,869 4,854 3,890 Professional fees 582 573 503 Other expenses 5,085 3,882 1,967 - -------------------------------------------------------------------------------------------------------------------------- Total expenses 12,434 11,481 8,755 Income before income tax and equity in undistributed income of subsidiaries 9,836 13,320 6,488 Income tax expense (benefit) (1,877) (1,995) (1,844) - -------------------------------------------------------------------------------------------------------------------------- Income before equity in undistributed income of subsidiaries 11,713 15,315 8,332 Equity in undistributed income of subsidiaries 3,592 (1,304) 2,845 - -------------------------------------------------------------------------------------------------------------------------- Net income $ 15,305 $ 14,011 $ 11,177 - -------------------------------------------------------------------------------------------------------------------------- Parent Only Condensed Statements of Cash Flows Year ended December 31 2003 2002 2001 - -------------------------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 15,305 $ 14,011 $ 11,177 Undistributed income of subsidiaries (3,592) 1,304 (2,845) Changes in other assets and liabilities 3,228 (291) 989 - -------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 14,941 15,024 9,321 Investing Activities Capital contributed to subsidiary (5,600) (4,348) - Cash paid for acquisition (24,283) - - Purchases of equipment (705) (1,720) (1,764) Purchase of securities available for sale - (208) - - -------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (30,588) (6,276) (1,764) Financing Activities Payments on long-term debt (2,900) (1,600) (2,400) Payments on subordinated debentures (23,119) - - Proceeds from issuance of subordinated debentures 21,650 8,248 - Proceeds from issuance of long-term debt 13,000 - - Purchase of treasury shares (1,497) (694) - Cash dividends and fractional stock dividends (4,874) (4,485) (4,121) - -------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities 2,260 1,469 (6,521) - -------------------------------------------------------------------------------------------------------------------------- Net change in cash and cash equivalents (13,387) 10,217 1,036 Cash and cash equivalents, beginning of period 15,131 4,914 3,878 - -------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 1,744 $ 15,131 $ 4,914 - --------------------------------------------------------------------------------------------------------------------------
39 MainSource Financial Group Directors and Officers MainSource Financial Group Directors Robert E. Hoptry, Chairman Retired President and CEO MainSource Financial Group William G. Barron, CCIM Chairman and President Wm. G. Barron Enterprises, Inc. Dale J. Deffner Retired Partner Deffner and Tebbe Don Dunevant, M.D. Family Physician Portage Medical Group Philip A. Frantz Attorney at Law; Partner Coldren and Frantz Rick S. Hartman, CPA President The HRH Group, Ltd. James L. Saner, Sr. President and CEO MainSource Financial Group MainSource Financial Group Senior Management James L. Saner, Sr. President and CEO Donald A. Benziger Senior Vice President and CFO John C. Parker Senior Vice President of Operations James M. Anderson Principal Accounting Officer - -------------------------------------------------------------------------------- MainSource Bank Directors Daryl R. Tressler, Chairman President and CEO MainSource Bank John G. Seale, CPA Partner, Rettig, Blankman, Mack and Seale Accounting Firm Norman L. Winkler Farmer Philip A. Frantz Attorney at Law; Partner Coldren and Frantz Robert E. Hoptry Retired President and CEO MainSource Financial Group David L. Miers President Miers Farm Corporation Lawrence R. Rueff, D.V.M. President Swine Veterinary Services MainSource Bank Senior Management Daryl R. Tressler Chairman, President and CEO Keith Lindauer Senior Vice President - Commercial Lending Dawn M. Schwering Senior Vice President - Retail Services Mark W. Dunevant Senior Vice President - Mortgage Lending Daniel F. Anderson Senior Vice President - Wealth Management Regional Bank Directors Michael K. Bauer, Chairman President and CEO Regional Bank William G. Barron, CCIM Chairman and President Wm. G. Barron Enterprises, Inc. D.J. Hines President Schuler Bauer Realty Michael J. Kapfhammer President Buckhead Mountain Grill Edward J. Zoeller President E.M. Cummings Veneer, Inc. Regional Bank Senior Management Michael K. Bauer Chairman, President and CEO John Baumann Vice President - Retail Services Larry W. Brumley Senior Vice President - Commercial Lending Capstone Bank Directors Wm. Brent Hoptry, Chairman President and CEO Capstone Bank Rick S. Hartman, CPA President The HRH Group, Ltd. Roy A. Koester Farmer Ronald H. Kinzinger Part owner R&R, Inc. James M. Anderson Principal Accounting Officer MainSource Financial Group Capstone Bank Senior Management Wm. Brent Hoptry Chairman, President and CEO William J. Krones Senior Vice President - Lending Georgann J. Buttefield Vice President - Retail Services MainSource Insurance Directors James L. Saner, Sr., Chairman President and CEO MainSource Financial Group C. Todd Anderson President MainSource Insurance William G. Barron, CCIM Chairman and President Wm. G. Barron Enterprises, Inc. Daryl R. Tressler Chairman, President and CEO MainSource Bank Jerry Vollmer Sales Manager - Indiana MainSource Insurance MainSource Insurance Senior Management C. Todd Anderson President Sales Manager - Kentucky Jerry Vollmer Vice President Sales Manager - Indiana First Community Bank & Trust Co. Directors Albert R. Jackson, III, Chairman President and CEO John G. Hall Mayor City of North Vernon Larry Gesse Partner Rogers and Gesse Attorneys At Law James L. Saner, Sr. President and CEO MainSource Financial Group Donald A. Benziger Senior Vice President and CFO MainSource Financial Group First Community Bank & Trust Co. Senior Management Albert R. Jackson, III Chairman, President and CEO Wm. Dean Jackson Executive Vice President - Retail Services Richard Morris Senior Vice President - Commercial Lending 40 MainSource Financial Group Shareholder Information Annual Meeting Wednesday, April 21, 2004, 10:00 AM MainSource Financial Group Operations Center o 1927 Greensburg Crossing o Greensburg, IN 47240 Corporate Address MainSource Financial Group 201 North Broadway o P. O. Box 87 o Greensburg, Indiana 47240 Tel: 812-663-0157 Fax : 812-663-4812 www.mainsourcefinancial.com Form 10-K Copies of the Company's 2003 Form 10-K filed with the Securities and Exchange Commission are available without charge to all shareholders upon request. Please direct requests to the attention of the Chief Financial Officer. The Form 10-K and other SEC filings can also be accessed from the Company's website. Transfer Agent Investor Relations Department Registrar and Transfer Company 10 Commerce Drive o Cranford, New Jersey 07016-9982 Tel: 800-368-5948 Common Shares The Common shares of the Company are listed on The Nasdaq Stock Market(R). The trading symbol is MSFG. In newspaper listings, Company shares are frequently listed as MainSrce. Market Makers Market Makers in the Company's common stock include: Stifel, Nicolaus & Company, Inc. J.J.B. Hilliard/W.L. Lyons, Inc. NatCity Investments, Inc. Howe Barnes Investments, Inc. FTN Financial Securities The range of known per share prices by calendar quarter, based on actual transactions, excluding commissions, is shown below. 2003 Q4 Q3 Q2 Q1 2002 Q4 Q3 Q2 Q1 - -------------------------------------- -------------------------------------- High $31.76 $25.71 $24.59 $24.35 $23.76 $22.77 $22.86 $18.27 Low $25.47 $23.10 $21.90 $21.43 $20.83 $20.23 $18.15 $15.51 Last Sale $30.67 $24.68 $23.16 $22.38 $22.87 $21.58 $21.94 $18.05 The following dividends per share were paid by MainSource Financial Group: 2003 Q4 Q3 Q2 Q1 2002 Q4 Q3 Q2 Q1 - -------------------------------------- -------------------------------------- $0.171 $0.171 $0.171 $0.171 $0.163 $0.154 $0.154 $0.154 Amounts have been adjusted to reflect the 5% stock dividends declared in 2002 and 2003. 41 EX-14 7 ex14.txt EXHIBIT 14 MainSource Financial Group, inc. Code of Ethical Conduct All officers, directors and employees of MainSource Financial Group (the "Company") are obligated at all times to comply with the laws, rules and regulations of the United States and of each jurisdiction (local and foreign) in which the Company does business. This Code of Ethical Conduct (the "Code") has been adopted by the Company as evidence of the Company's commitment to the principles of HONESTY, INTEGRITY AND RESPONSIBILITY as a code of behavior for all employees, officers, directors, affiliates and associates of the Company. The implementation of this Code is intended to engender the TRUST, RESPECT AND CONFIDENCE of customers, clients, suppliers, regulators, creditors, stockholders and the general public. By accepting a position or affiliation with the Company, each officer, director and employee is charged with the responsibility of upholding the Company's commitment to ethical corporate behavior and agrees to comply with this Code. This Code covers a wide range of business practices and procedures. It does not purport to summarize all laws, rules and regulations that may be applicable to the Company and its employees, officers and directors or cover every issue that may arise, but it sets out basic principles to guide all employees and directors. This Code is intended to convey the overriding commitment of the Company that its business and affairs be conducted at the highest level of honest and appropriate corporate behavior. The Company's Executive Officers, including the chief executive officer, the chief financial officer, and others performing similar functions, and the Company's Board of Directors hold an important and elevated role in corporate governance. The Company's Executive Officers and the Board of Directors are charged with both the responsibility and authority to protect, promote and preserve the interests of all of the stakeholders, including stockholders, creditors, customers, employees, and suppliers. All Executive Officers and Directors, as models for all employees of the Company, must behave in such manner as to deter wrongdoing and to promote honest and ethical conduct in all aspects of the Company's business and operations. For purposes of this Code, "Covered Person" means each employee, officer, Executive Officer and Director of the Company; "Executive Officers" include the President, Chief Executive Officer, Chief Financial Officer, each Vice President, each person in an executive position for each subsidiary or division of the Company, and all other persons occupying similar policy-making positions: and "Director" means each member of the Board of Directors of the Company or any of its affiliates or subsidiaries. HONESTY Each Covered Person shall exhibit and promote the highest standards of honest and ethical conduct in his/her professional and personal behavior. The Board of Directors and the Executive Officers are mandated to publicize and support this Code within the Company. The standards for honest and ethical behavior for all Covered Persons include, but are not limited to, the avoidance of conflicts of interest, the prohibition on the misuse of corporate opportunities, the prohibition on the misuse of corporate assets, the preservation of the Company's confidential information, the requirement to deal fairly with Company customers, suppliers and competitors, and the prohibition of trading while in possession of inside information. Code of Ethical Conduct 03/04 Page 2 Avoidance of Conflicts of Interest o A "conflict of interest" exists or may exist whenever a Covered Person's private interests are adverse to, interfere with, or influence the objective judgment and actions of the Covered Person (or appear to do any of the foregoing) with respect to the business interests of the Company. A conflict situation can arise when a Covered Person takes actions or has interests that conflict with or otherwise may make it difficult to perform his or her Company duties objectively and effectively. Conflicts of interest may also arise when a Covered Person or an affiliate (including a family member) of such Covered Person receives improper personal benefits from any Company action or omission to act which are substantially attributable to such Covered Person's position with the Company. Examples of potential conflicts of interest include employment with or substantial equity holdings in a competitor. o Conflicts of interest are prohibited as a matter of Company policy. To the extent that any Covered Person is or becomes aware of a potential or actual conflict of interest between such Covered Person's interests and the actions or potential actions of the Company, the Covered Person shall promptly report such potential or actual conflict of interest to his/her supervisor with the intended purpose of completing a report to the Company's Director of Human Resources. Any Covered Person who becomes aware of a potential or actual conflict of interest with respect to the interests of another Covered Person is also directed to make a report. Any report of a potential or actual conflict of interest may, at the option of the Covered Person making the report, be made directly to the Corporate CEO or the Director of Human Resources. o Kickbacks, bribes, rebates or other forms of illegal consideration are never acceptable, and must never be either offered or accepted by anyone acting on behalf of the Company or in connection with the performance of his or her duties. At the same time, business entertainment and gifts in a commercial setting intended to create good will and sound working relationships, and not to gain unfair advantage with customers or other parties, are acceptable if reasonable in amount and form. The giving or receipt of business-related gifts or entertainment, such as customary holiday gifts, is acceptable as long as the gift is not a cash gift, is consistent with customary business practices and is nominal in value, and does not violate any applicable laws or regulations. For the purposes of this Code, "nominal" should be considered as meaning less than $100. Covered Persons dealing with government agencies should be particularly alert to any agency rules limiting or prohibiting gifts or other favors. Covered Persons should discuss with their supervisor any gifts or proposed gifts that they are not certain are appropriate. o Covered Persons may not accept a fiduciary or co-fiduciary appointment unless he/she is acting on behalf of a family member or has first received approval from the Corporate CEO. A "fiduciary appointment" is an appointment as an administrator, executor, guardian, custodian for a minor, trustee or managing agent. A Covered Person also may not act as a deputy or co-tenant of a safe deposit box, or act as an agent or attorney-in-fact (including signor or co-owner) on a customer's account unless for a family member or if approval is first received from the Corporate CEO. Code of Ethical Conduct 03/04 Page 3 Prohibition on Misuse of Corporate Opportunities o Each Covered Person is prohibited from (i) appropriating for himself/herself or any of his/her affiliates or family member's business opportunities that properly belong to the Company or are discovered by the Covered Person through the performance of duties on behalf of the Company, and (ii) using his/her position for personal gain. Prohibition on Misuse of Corporate Assets o All Company assets should be used for the legitimate business purposes of the Company only, although incidental personal use of Company equipment may be permissible. However, use of Company assets, time or property for personal political activities is never permissible. o Company policy expressly prohibits the creation and maintenance of secret or unrecorded assets or liabilities. The use of Company funds (whether inside or outside the United States) for illegal purposes or for illegal political contributions to candidates, political action committees or political parties is expressly prohibited. Preservation of the Company's Confidential Information o The Company's "Confidential Information" shall mean all proprietary information belonging to the Company, whether in written or electronic form, and used by the Company in the conduct of its business, including, without limitation, data, technology, source code, know-how, inventions, discoveries, designs, processes, formulations, models, equipment, algorithms, software programs, documents, specifications, information concerning research and development work, trade and business secrets, customer information, supplier lists, financial records, and information which relates to current, planned or proposed products, marketing and business plans, forecasts, projections and analyses, and financial information. Confidential Information does not include information in the public domain or generally known in the industry in which the Company operates, unless such availability has been caused by a violation of this non-disclosure policy. o Each Covered Person shall hold all Confidential Information in strict confidence and shall take such steps to safeguard the Confidential Information from unauthorized disclosure. o The Company and its subsidiaries are periodically reviewed by regulatory examiners. Certain reports made by these agencies are the property of the agencies and are strictly confidential. Giving information from those reports to anyone not associated with the Company is a criminal offense. o If a Covered Person believes that disclosure of Confidential Information is required by applicable law or judicial process, such Covered Person shall first notify and consult with the Company's CEO prior to any such disclosure. Code of Ethical Conduct 03/04 Page 4 Prohibition of Trading on Inside Information o Pursuant to Federal law and Company policy, no Covered Person shall purchase or sell any security of the Company while in possession of material information about the Company, whether positive or negative, which has not yet been publicly disseminated. The prohibition on the use of such "inside information" applies to any Covered Person at any level within the Company and extends to persons not employed by the Company if they have access to such information including if such persons are "tipped" by a Covered Person. This same prohibition applies to trading in the stock of other publicly held companies on the basis of material, non-public information gained through position with the Company. o Material, non-public information is any information that could reasonably be expected to affect the price of a stock. Anyone considering buying or selling stock because of inside information they possess should assume that such information is material. It is also important to keep in mind that any trade that becomes the subject of an investigation by the government will be viewed after-the-fact with the benefit of hindsight. Covered persons who are unsure whether a potential trade could run afoul of these rules should contact the Corporate CFO or CEO. o The laws and regulations governing transactions in Company securities are extensive and complex. At times, the Board of Directors of the Company will issue alerts notifying each Covered Person that no transactions in Company securities may occur during a certain period. At other times, each Covered Person should consult with the Company's Chief Financial Officer prior to entering into any transaction involving Company securities. Competition and Fair Dealing o We seek to outperform our competition fairly and honestly, and in compliance with all applicable laws, including antitrust laws. Stealing proprietary information, possessing trade secret information that was obtained without the owner's consent, inducing past or present employees of other companies to disclose such proprietary, trade secret or other confidential information, and similar practices, are prohibited. Covered Persons should endeavor to respect the rights of and deal fairly with the Company's customers, suppliers, competitors and employees. No Covered Person should take unfair advantage of anyone through manipulation, concealment, abuse of privileged information, misrepresentation of material facts, or any other intentional unfair-dealing practice. o Covered Persons are expected to fully comply with all applicable antitrust laws. To that end, Covered Persons should never discuss business strategy or similar issues with competitors of the Company. In addition, to avoid even the appearance of an improper agreement or understanding, communications with competitors should be kept to a minimum. There should be a legitimate business reason for any such communication. INTEGRITY OF COMPANY FINANCIAL RECORDS AND REPORTS As a public company, the Company is required to make periodic filings with the Securities and Exchange Commission ("SEC") reporting on the Company's results of operations and general financial condition. It is the Company's policy that these reports are filed with Code of Ethical Conduct 03/04 Page 5 complete and accurate information and on a timely basis. The Company has established and maintains sufficient reporting systems and procedures to ensure such full, fair, accurate, timely and understandable disclosure in filings with the SEC and in other communications with the Company's stockholders and the general public. o It is Company policy that all Company books, records, accounts and financial statements be maintained in reasonable detail, and that business transactions be timely, completely and accurately recorded on the Company's books and records in accordance with applicable legal and other requirements and the Company's disclosure controls and procedures and system of internal controls. Financial records should, in addition, be maintained in accordance with generally accepted accounting principles and established company financial policy. o It is against Company policy to evade the Company's system of internal controls and to perpetuate unrecorded transactions, assets or liabilities. o Depending upon their position within the Company, each Covered Person may be required to provide necessary financial and other information concerning such Covered Person's areas of responsibility, and each Covered Person agrees to provide accurate and complete information in response to such request on a timely basis. Covered Persons should notify their supervisor or the person to whom the information was supplied upon learning of any inaccuracy or deficiency in such previously-supplied information. o Further, each Covered Person is expected to comply, within the scope of his or her duties, with the Company's disclosure controls and procedures implemented by the Company to ensure that material information relating to the Company is timely recorded, processed, summarized and reported in accordance with all applicable SEC and other applicable rules and regulations. In addition, employees should report to his/her supervisor any information regarding the Company that he or she believes might be material, but may not be known at higher levels within the Company. Directors should report such matters to the Corporate CEO. o Employees who become aware of any omission, inaccuracy or falsification regarding Company financial or other business records, or the information supporting such records, should report the situation to his/her supervisor, while Directors should report such matters to the Corporate CEO. o Furthermore, Covered Persons shall also report any concerns or complaints regarding questionable accounting or auditing matters of the Company. Such reports may be made on a confidential, anonymous basis directly to the Corporation's Audit Committee by following the process and procedure as put forth in the Employee Handbook. o The retention or proper disposal of Company records shall be in accordance with established enterprise financial policies and applicable legal and regulatory requirements. Code of Ethical Conduct 03/04 Page 6 COMPLIANCE WITH APPLICABLE LAWS, RULES AND REGULATIONS Obeying the law, both in letter and in spirit, is the foundation on which the Company's ethical standards are built. All Covered Persons must respect and obey the laws, rules and regulations applicable to the Company's business and operations, including those regarding equal opportunity, harassment in the workplace, political activities, insider trading in securities and all applicable banking regulations. Violating any of them could subject a Covered Person or the Company to criminal and/or civil penalties. Although not all Covered Persons are expected to know the details of all of these laws, rules and regulations, it is important to know enough to determine when to seek advice from supervisors, managers or other appropriate personnel. As appropriate, the Company will hold information and training sessions to promote compliance with applicable laws, rules and regulations. While this Code cannot address all laws, rules and regulations applicable to the Company, some of the most material ones, to the extent not addressed above, are discussed below. Criminal Laws Covered Persons are subject to a number of criminal laws. For example, a Covered Person may not: o corruptly accept or solicit anything of value intending to be influenced or rewarded in connection with the Company's business or in return for confidential information; o intentionally fail to make currency transaction reports or other filings required by the Bank Secrecy Act, or other applicable laws or regulations; o knowingly engage in financial transactions involving the proceeds of an illegal activity. This is referred to as money laundering; o using Company funds or assets to finance campaigns for political office; o making a loan or giving a gift to someone who has the authority to examine the Company or its affiliates; o using a computer to gain unauthorized access to customer records; and o making false statements to government officials. Equal Opportunity; Discrimination and Harassment o It is the Company's policy, in compliance with applicable federal, state and local laws, to provide equal opportunity in all aspects of employment, and we will not tolerate any illegal discrimination or harassment of any kind. Decisions regarding employment, training, compensation and advancement will be made on the basis of qualification, merit and business needs, regardless of race, religion, sex, national origin, age, or other protected characteristic. Examples of impermissible harassment include derogatory comments based on sex, racial or ethnic characteristics, religion, national origin and similar characteristics, and unwelcome sexual advances. WAIVERS OF THE CODE o Any waivers of this Code for employees must be made in writing to the Corporate CEO. Any waivers of the Code for Executive Officers and Directors may be made Code of Ethical Conduct 03/04 Page 7 only by the board of directors, and must be promptly disclosed to stockholders in accordance with applicable SEC and NASDAQ rules and regulations. REPORTING ANY VIOLATIONS OF COMPANY POLICY OR ILLEGAL OR UNETHICAL BEHAVIOR o Covered Persons are required to report violations or suspected violations of this Code, other Company policies or any applicable law, regulatory requirement or other rule or regulation applicable to the Company promptly after becoming aware of such violation or potential violation. Employees may make reports to either their supervisor or if they feel more comfortable, to the Company's internal compliance officer. Directors should report violations or suspected violations to the Corporate CEO. To the extent possible, the identity of persons making such reports will be kept secret and their anonymity will be protected if the circumstances so warrant. o While reporting a known or suspected violation will not absolve a Covered Person from the consequences of his or her misconduct, it may be considered in determining an appropriate disciplinary response. In addition, failure to report violations of which one is aware is itself a violation of this Code and could result in disciplinary action as discussed further below, including possible termination of employment. o Employees are encouraged to talk to supervisors or other appropriate personnel if they have questions about this Code or its applicability or about the appropriateness of observed behavior and when in doubt about the best course of action in a particular situation. Directors should consult with the Corporation's CEO on such matters. Covered Persons are expected to cooperate in internal investigations of misconduct. o The Company will not permit any form of retaliation against any person who, in good faith, reports known or suspected violations of this Code or any other illegal or unethical behavior, even if such report turns out to be in error. Any such retaliation is itself a violation of this Code and will subject the person(s) involved to disciplinary action, as discussed below. DISCIPLINARY MEASURES o Violations of the Code or other policies, or of applicable laws, rules and regulations, may result in disciplinary measures against the violator. Such measures, depending on the nature and severity of the violation, whether the violation was a single or repeated occurrence, and whether the violation appears to have been intentional or inadvertent, may include written notices to the individual involved, censure by the Board, demotion or re-assignment, suspension with or without pay or benefits and termination of employment. Directors may be asked to resign from the Board. o Disciplinary action will also apply to supervisors who, with respect to those employees reporting to them, know that prohibited conduct is contemplated by such employees and do nothing to prevent it, or know that prohibited conduct has been engaged in by such employees and fail to take appropriate corrective action. Supervisors may also be subject to disciplinary action for their failure to effectively monitor the actions of their subordinates. Code of Ethical Conduct 03/04 Page 8 o In addition, Covered Persons should keep in mind that violations of legal and regulatory requirements may carry their own civil and criminal penalties, including fines and imprisonment. GENERAL This Code may be amended by the Board of Directors, subject to the disclosure requirements under Federal securities laws. The date indicated at the bottom of this Code of Ethical Conduct indicates the date on which this Code has been adopted by the Company, and the latest date through which this Code has been amended. MainSource Financial Group MainSource Bank _______________________ Date: _______ _______________________ Date: _______ James L. Saner, Sr. Daryl R. Tressler President & CEO President & CEO Regional Bank Capstone Bank _______________________ Date: _______ _______________________ Date: _______ Michael K. Bauer W. Brent Hoptry President & CEO President & CEO First Community bank & trust _______________________ Date: ______ Albert R. Jackson, III President & CEO EX-21 8 ex-21.txt EXHIBIT (21)--SUBSIDIARIES OF THE REGISTRANT Name State of Incorporation Mainsource Bank Indiana Regional Bank Indiana Kentucky United Bancorp, Inc. Kentucky IUB Illinois Holdings, Inc. Indiana Capstone Bank, N.A. Illinois IUB Reinsurance Co., Ltd. Turks and Caicos MainSource Insurance, Inc. Indiana MSB Investments of Nevada, Inc. Nevada RB Investments, Inc. Nevada MainSource Statutory Trust I Connecticut MainSource Statutory Trust II Connecticut MainSource Statutory Trust III Delaware Peoples Holdings, Inc. Indiana FCBY Merger Corp. Indiana First Community Bank and Trust Indiana IUB Capital Trust Delaware First Community Real Estate Management, Inc. Indiana RB Holdings, Inc. Nevada MSB Holdings of Nevada, Inc. Nevada MSB of Nevada, LLC Nevada MSB Realty, Inc. Maryland RB of Nevada, LLC Nevada EX-23.1 9 ex23-1.txt EXHIBIT 23.1 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement on Form S-8 of Mainsource Financial Group, Inc. (No. 33-45395) of our report, dated January 30, 2004, on the consolidated financial statements of MainSource Financial Group as of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003 included in the Annual Report on Form 10-K. /s/ Crowe Chizek and Company LLC Indianapolis, Indiana March 12, 2003 EX-31.1 10 ex31-1.txt EXHIBIT 31.1 Sarbanes-Oxley Act of 2002. Section 302 Certification of Chief Executive Officer I, James L. Saner, Sr., certify that: 1. I have reviewed this annual report on Form 10-K 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)) 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) Evaluated the effectiveness of the registrant's disclosure controls and proceduresand 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 (c) 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: March 10, 2004 James L. Saner, Sr. - ------------------- [Signature] President & Chief Executive Officer - ----------------------------------- [Title] EX-31.2 11 ex31-2.txt EXHIBIT 31.2 Sarbanes-Oxley Act of 2002. Section 302 Certification of Chief Financial Officer I, Donald A. Benziger, certify that: 1. I have reviewed this annual report on Form 10-K 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)) 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) Evaluated the effectiveness of the registrant's disclosure controls and proceduresand 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 (c) 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: March 10, 2004 Donald A. Benziger - ------------------ [Signature] Senior Vice President & Chief Financial Officer - ----------------------------------------------- [Title] EX-32.1 12 ex32-1.txt EXHIBIT 32.1 SARBANES-OXLEY ACT OF 2002, SECTION 906 CERTIFICATION BY CHIEF EXECUTIVE OFFICER As an accompaniment to the Annual Report of MainSource Financial Group, Inc. (the "Company") on Form 10-K for the period ending December 31, 2003 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. /s/ James L. Saner, Sr. - ------------------------ EX-32.2 13 ex32-2.txt EXHIBIT 32.2 SARBANES-OXLEY ACT OF 2002, SECTION 906 CERTIFICATION BY CHIEF FINANCIAL OFFICER As an accompaniment to the Annual Report of MainSource Financial Group, Inc. (the "Company") on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Donald A. Benziger, Chief Financial 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. /s/ Donald A. Benziger - ------------------------ -----END PRIVACY-ENHANCED MESSAGE-----