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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-26570
1ST INDEPENDENCE FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 61-1284899
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8620 Biggin Hill Lane
Louisville, Kentucky 40220-4117
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502)753-0500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer |_| Accelerated filer |_|
Non-accelerated filer |_| Smaller reporting company |X|
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The registrant had 1,995,744 shares of common stock outstanding at
July 28, 2008.
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1st INDEPENDENCE FINANCIAL GROUP, INC.
FORM 10-Q
For the Quarter Ended June 30, 2008
INDEX
Part I - Financial Information
Item 1. Financial Statements Page Number
-----------
Condensed Consolidated Balance Sheets as of June 30, 2008
(unaudited) and December 31, 2007 3
Condensed Consolidated Statements of Operations for the three
months and six months ended June 30, 2008 and 2007 (unaudited) 4
Condensed Consolidated Statements of Comprehensive Income (Loss) for
the three months and six months ended June 30, 2008 and 2007
(unaudited) 5
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 2008 and 2007 (unaudited) 6
Notes to Condensed Consolidated Financial Statements (unaudited) 7-11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12-16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Item 4. Controls and Procedures 17
Part II - Other Information
Item 1. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 6. Exhibits 18
Signatures 19
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Balance Sheets
(in thousands except share data)
(Unaudited)
June 30, December 31,
2008 2007
--------------- --------------
Assets
Cash and and due from banks $ 7,467 $ 11,118
Interest-bearing demand deposits 7,403 7,789
Federal funds sold 11,631 13,711
--------------- --------------
Cash and cash equivalents 26,501 32,618
Inerest-bearing deposits 100 100
Available-for-sale securities at fair value 15,166 15,045
Held-to-maturity securities, fair value of $1,666 and
$1,750 at June 30, 2008 and December 31, 2007, respectively 1,643 1,745
Loans held for sale 1,664 2,874
Loans, net of allowance for loan losses of $8,255 and
$7,140 at June 30, 2008 and December 31, 2007, respectively 254,979 268,448
Premises and equipment, net 7,350 7,954
Federal Home Loan Bank (FHLB) stock 2,371 2,313
Bank owned life insurance 3,758 3,647
Goodwill 8,286 8,286
Other real estate owned 58 58
Interest receivable and other assets 5,056 4,630
--------------- --------------
Total assets $ 326,932 $ 347,718
=============== ==============
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand $ 17,302 $ 15,491
Savings, NOW and money market 77,322 102,064
Time 138,891 137,030
--------------- --------------
Total deposits 233,515 254,585
Short-term borrowings 48,648 36,011
Long-term debt 10,279 20,279
Interest payable and other liabilities 1,094 1,567
--------------- --------------
Total liabilities 293,536 312,442
--------------- --------------
Commitments and contingencies - -
Stockholders' equity
Preferred stock, $0.10 par value, 500,000 shares authorized, no
shares issued or outstanding - -
Common stock, $0.10 par value, 5,000,000 shares authorized,
1,995,744 shares and 1,995,744 shares outstanding at
June 30, 2008 and December 31, 2007, respectively 296 296
Additional paid-in capital 39,957 39,898
Retained earnings 7,850 9,767
Unearned ESOP compensation (101) (166)
Accumulated other comprehensive income (loss) (31) 56
Treasury stock, at cost, common,
969,835 shares and 969,835 shares at June 30, 2008 and
December 31, 2007, respectively (14,575) (14,575)
--------------- --------------
Total stockholders' equity 33,396 35,276
--------------- --------------
Total liabilities and stockholders' equity $ 326,932 $ 347,718
=============== ==============
See notes to condensed consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Operations
(in thousands except per share data)
(Unaudited) (Unaudited)
Three months ended June 30, Six months ended June 30,
---------------------------- -------------------------
2008 2007 2008 2007
----------- ---------- -------- ----------
Interest and dividend income
Interest and fees on loans $3,989 $5,201 $ 8,273 $10,326
Interest on securities
Taxable 153 162 313 328
Tax exempt 43 45 86 90
Interest on federal funds sold 61 101 213 177
Dividends 36 53 71 96
Interest on deposits with financial institutions 41 76 106 154
----------- ---------- -------- ----------
Total interest and dividend income 4,323 5,638 9,062 11,171
----------- ---------- -------- ----------
Interest expense
Deposits 1,591 2,732 3,740 5,323
FHLB advances 358 280 624 639
Other 143 181 312 358
----------- ---------- -------- ----------
Total interest expense 2,092 3,193 4,676 6,320
----------- ---------- -------- ----------
Net interest income 2,231 2,445 4,386 4,851
Provision for loan losses 2,354 20 2,354 195
----------- ---------- -------- ----------
Net interest income after provision for loan losses (123) 2,425 2,032 4,656
----------- ---------- -------- ----------
Noninterest income
Service charges 146 149 292 269
Gain on loan sales 162 251 519 452
(Loss) on disposal of premises and equipment (4) - (31) -
Gain (loss) on disposal of other real estate owned 36 (4) 145 (5)
Increase in cash value of life insurance 56 52 111 104
Other 112 86 209 166
----------- ---------- -------- ----------
Total noninterest income 508 534 1,245 986
----------- ---------- -------- ----------
Noninterest expense
Salaries and employee benefits 1,137 1,210 2,405 2,438
Net occupancy 403 398 859 823
Data processing fees 252 202 472 410
Professional fees 175 117 840 287
Marketing (13) 16 7 81
Other 820 879 1,291 1,339
----------- ---------- -------- ----------
Total noninterest expense 2,774 2,822 5,874 5,378
----------- ---------- -------- ----------
Income (loss) before income taxes (2,389) 137 (2,597) 264
Income tax expense (benefit) (891) 12 (996) 29
----------- ---------- -------- ----------
Net income (loss) $(1,498) $ 125 $(1,601) $ 235
=========== ========== ======== ==========
Net income (loss) per share
Basic ($0.76) $0.06 ($0.81) $0.12
Diluted (0.76) 0.06 (0.81) 0.12
Weighted average shares outstanding
Basic 1,983 1,968 1,982 1,968
Diluted 1,983 1,979 1,982 1,979
Cash dividends declared per share $0.08 $0.08 $0.08 $0.16
See notes to condensed consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(Unaudited) (Unaudited)
Three months ended June 30, Six months ended June 30,
------------------------ --------------------------
2008 2007 2008 2007
--------- ----------- ----------- ----------
Net income (loss) $(1,498) $ 125 $(1,601) $ 235
Other comprehensive income (loss), net of tax
Change in unrealized gains and losses on
available-for-sale securities (230) (153) (87) (132)
Less reclassification adjustment for realized gains
included in net income - - - -
-------- --------- --------- ---------
Other comprehensive income (loss) (230) (153) (87) (132)
-------- --------- --------- ---------
Comprehensive income (loss) $(1,728) $ (28) $(1,688) $ 103
======== ========= ========= =========
See notes to condensed consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Six months ended June 30,
-------------------------------
2008 2007
------------- ------------
Cash Flows from Operating Activities:
Net income (loss) $ (1,601) $ 235
Adjustments to reconcile net income (loss) to net cash provided by
operations:
Depreciation 387 347
Provision for loan losses 2,354 195
Gain on loan sales (519) (452)
Origination of loans held for sale (32,092) (26,545)
Proceeds from loans held for sale 33,821 26,835
Compensation expense on stock options 8 43
ESOP compensation 98 106
Amortization of unearned compensation on restricted stock 18 15
Amortization of premiums and discounts on securities 9 12
Loss on disposal of premises and equipment 31 -
Deferred income taxes (347) 46
FHLB stock dividend (58) -
Amortization of loan fees (84) (117)
Amortization of intangibles, net 21 130
Increase in cash value of life insurance (111) (104)
Changes in:
Decrease (increase) in interest receivable and other assets 907 (23)
(Decrease) increase in interest payable and other liabilities (292) 702
------------- ------------
Net cash provided by operating activities 2,550 1,425
------------- ------------
Cash Flows from Investing Activities:
Purchases of available-for-sale securities (1,495) (1,995)
Proceeds from maturities of available-for-sale securities 1,233 1,131
Proceeds from maturities of held-to-maturity securities 100 152
Net decrease in loans 10,264 4,079
Purchases of premises and equipment (18) (372)
------------- ------------
Net cash provided by investing activities 10,084 2,995
------------- ------------
Cash Flows from Financing Activities:
Net (decrease) increase in deposits (21,071) 13,480
Net increase (decrease) in short-term borrowings 12,637 (25,584)
Proceeds from issuance of long-term debt - 10,000
Repayment of long-term debt (10,000) -
Repurchase and retirement of common stock - (37)
Cash dividends paid (317) (315)
------------- ------------
Net cash (used in) financing activities (18,751) (2,456)
------------- ------------
Net (decrease) increase in cash and cash equivalents (6,117) 1,964
Cash and cash equivalents at beginning of period 32,618 23,579
------------- ------------
Cash and cash equivalents at end of period $ 26,501 $ 25,543
============= ============
Supplemental Cash Flow Information:
Interest paid $ 4,862 $ 6,090
Income taxes paid 60 25
Real estate acquired in settlement of loans 935 2,271
Premises and equipment donated to Town of Marengo, Indiana 155 -
See notes to condensed consolidated financial statements.
1st INDEPENDENCE FINANCIAL GROUP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of 1st
Independence Financial Group, Inc. (the "Company") are presented in accordance
with the requirements of Form 10-Q and accounting principles generally accepted
in the United States of America for interim financial information. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. These condensed consolidated financial statements and
notes thereto included in this report should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
Form 10-K annual report for the year ended December 31, 2007 filed with the
United States Securities and Exchange Commission ("SEC'). In the opinion of
management, all adjustments necessary to make the financial statements not
misleading and to fairly present the financial position, results of operations
and cash flows for the reporting interim periods have been made and were of a
normal recurring nature. The results of operations for the period are not
necessarily indicative of the results to be expected for the full year. The
condensed consolidated balance sheet of the Company as of December 31, 2007 has
been derived from the audited consolidated balance sheet of the Company as of
that date.
The unaudited condensed financial statements include the accounts of the Company
and its wholly-owned subsidiary, 1st Independence Bank, Inc. (the "Bank") and
1st Independence Mortgage, a division of the Bank.
2. Stock-Based Compensation
For the three months and six months ended June 30, 2008 the Company recorded
$4,000 and $8,000, respectively, and for the three months and six months ended
June 30, 2007 the Company recorded $12,000 and $43,000, respectively, in
employee stock-based compensation expense, which is included in salaries and
employee benefits. As of June 30, 2008 and June 30, 2007, there was $13,000 and
$51,000, respectively, of unrecognized stock-compensation expense for previously
granted unvested options that will be recognized over a weighted-average period
of 1.1 and 1.6 years, respectively.
3. Allowance for Loan Losses
An analysis of the changes in the allowance for loan losses for the six months
ended June 30 follows (in thousands):
2008 2007
---- ----
Beginning balance $7,140 $3,745
Provision for loan losses 2,354 195
Loans charged off (1,247) (984)
Recoveries 8 8
------ ------
Ending balance $8,255 $2,964
====== ======
4. Net Income Per Share Computations
The following is a reconciliation of the numerator and denominator of the basic
and diluted per share computations (in thousands except per share data):
Three months ended
June 30,
2008 2007
---- ----
Income (numerator) amounts used for basic and diluted per share computations:
Net income (loss) ($1,498) $125
====== ====
Shares (denominator) used for basic per share computations:
Weighted average shares of common stock outstanding 1,983 1,968
===== =====
Shares (denominator) used for diluted per share computations:
Weighted average shares of common stock outstanding 1,983 1,968
Plus: dilutive effect of stock options - 11
----- -----
Adjusted weighted average shares 1,983 1,979
===== =====
Net income (loss) per share data:
Basic ($0.76) $0.06
===== =====
Diluted ($0.76) $0.06
===== =====
Six months ended
June 30,
2008 2007
---- ----
Income (numerator) amounts used for basic and diluted per share computations:
Net income (loss) ($1,601) $235
====== ====
Shares (denominator) used for basic per share computations:
Weighted average shares of common stock outstanding 1,982 1,968
===== =====
Shares (denominator) used for diluted per share computations:
Weighted average shares of common stock outstanding 1,982 1,968
Plus: dilutive effect of stock options - 11
----- -----
Adjusted weighted average shares 1,982 1,979
===== =====
Net income (loss) per share data:
Basic ($0.81) $0.12
===== =====
Diluted ($0.81) $0.12
===== =====
Options to purchase 63,050 and 63,050 common shares, which equates to 10,222
and 9,280 incremental common equivalent shares for the three months and six
months ended June 30, 2008, respectively, were excluded from the diluted
calculations above as their effect would have been antidilutive. In addition,
options to purchase 16,500 common shares for both the three months and six
months ended June 30, 2007, respectively, were excluded from the diluted
calculations above because the exercise prices on the options were greater than
the average market price for the period.
5. Merger Agreement
On February 27, 2008, the Company announced that it had entered into an
Agreement and Plan of Merger with MainSource Financial Group, Inc.
("MainSource"). The Merger Agreement provides that the Company's stockholders
would receive $5.475 in cash and 0.881036 shares of MainSource common stock for
each share of the Company's stock owned before the merger, subject to adjustment
as described in the Merger Agreement. Based on MainSource's February 26, 2008
closing price of $14.60 per share, the transaction values the Company at $18.34
per share or $37.0 million in the aggregate, including the cashout value of the
Company's in-the-money stock options. The stock portion of the consideration
furnished to the Company's stockholders is intended to qualify as a tax-free
transaction. The merger is currently expected to close in the third quarter of
2008 after being approved by the Company's stockholders at a special stockholder
meeting that was held on August 7, 2008. While the Company believes the
transaction will occur, there can be no assurance. If the transaction is
terminated, the Company could incur certain costs. Upon the closing of the
proposed transaction, the Company will record a number of charges including
certain change-in-control payments to certain officers that will have a material
impact on the consolidated financial statements. At June 30, 2008, no accrual
has been made for these charges.
As of June 30, 2008, the Company's consolidated tangible stockholders' equity
was $25,035,000. The Company will incur additional merger-related and other
expenses prior to the consummation of the merger which are estimated to be, but
not limited to, approximately $335,000. If the calculation of the Company's
consolidated tangible stockholder' equity for purposes of the merger agreement
had occurred as of June 30, 2008 after taking into account the additional fees
and expenses currently estimated in connection with the merger as described
above, the Company's consolidated tangible stockholder' equity would have been
approximately $24,814,000. As a result, the cash portion of the merger
consideration would have been reduced from $5.475 per share to $4.530 per share.
The actual reduction to the cash portion of the merger consideration will depend
on the extent to which the Company's operating earnings from June 30, 2008 until
end of the month prior to the month in which the closing occurs offset
merger-related and other expenses or losses the Company incurs through such
date (see note 8 for additional information).
6. Recently Issued Accounting Standards
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 157, "Fair Value Measurements,"
("SFAS 157") which is effective for fiscal years beginning after November 15,
2007 and for interim periods within those years. SFAS 157 defines fair value,
establishes a framework for measuring fair value and expands the related
disclosure requirements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements. The Statement
indicates, among other things, that a fair value measurement assumes that the
transaction to sell an asset or transfer a liability occurs in the principal
market for the asset or liability or, in the absence of a principal market, the
most advantageous market for the asset or liability. SFAS 157 defines fair value
based upon an exit price model. Relative to SFAS 157, in February 2008 the FASB
issued FASB Staff Positions (FSP) 157-1, 157-2, and continued to redeliberate
proposed FSP 157-c. FSP 157-1 amends SFAS 157 to exclude Financial Accounting
Standards No. 13, "Accounting for Leases," and its related interpretive
accounting pronouncements that address leasing transactions, while FSP 157-2
delays the effective date of SFAS 157 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis. FSP 157-c would clarify
the principles in SFAS 157 on the fair value measurement of liabilities. Public
comments on FSP 157-c were due in February 2008. The Company adopted this
Standard in the first quarter of 2008 as required and the adoption did not have
a material impact on the Company's financial position, results of operations or
cash flows (see note 7 for additional information).
In February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities"
("SFAS 159"), which permits entities to choose to measure many financial
instruments and certain other items at fair value. The objective is to improve
financial reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and
liabilities using different measurement techniques. SFAS 159 requires additional
disclosures related to the fair value measurements included in the entity's
financial statements. This Statement was effective for financial statements
issued for fiscal years beginning after November 15, 2007. The Company adopted
this Standard in the first quarter of 2008 as required and the adoption did not
have a material impact on the Company's financial position, results of
operations or cash flows.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141 (revised 2007), "Business Combinations" ("SFAS 141(R)"), which replaces
Statement of Financial Accounting Standards No. 141, "Business Combinations"
("SFAS 141"). SFAS 141(R) retains the underlying concepts of SFAS 141 in that
all business combinations are still required to be accounted for at fair value
under the acquisition method of accounting but SFAS 141(R) changed the method of
applying the acquisition method in a number of significant aspects. Acquisition
costs will generally be expensed as incurred; noncontrolling interests will be
valued at fair value at the acquisition date; in-process research and
development will be recorded at fair value as an indefinite-lived intangible
asset at the acquisition date; restructuring costs associated with a business
combination will generally be expensed subsequent to the acquisition date; and
changes in deferred tax asset valuation allowances and income tax uncertainties
after the acquisition date generally will affect income tax expense. SFAS 141(R)
is effective on a prospective basis for all business combinations for which the
acquisition date is on or after the beginning of the first annual period
subsequent to December 15, 2008, with the exception of the accounting for
valuation allowances on deferred taxes and acquired tax contingencies. SFAS
141(R) amends SFAS 109 such that adjustments made to valuation allowances on
deferred taxes and acquired tax contingencies associated with acquisitions that
closed prior to the effective date of SFAS 141(R) would also apply the
provisions of SFAS 141(R). Early adoption is not permitted. The Company is
currently evaluating the potential impact this Statement may have on the
Company's future financial position, results of operations and cash flows.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 160, "Noncontrolling Interests in Consolidated Financial Statements--an
amendment of ARB No. 51." ("SFAS 160"). SFAS 160 is effective for fiscal years,
and interim periods within those fiscal years, beginning on or after December
15, 2008, with earlier adoption prohibited. The Statement requires the
recognition of a noncontrolling interest (minority interest) as equity in the
consolidated financial statements and separate from the parent's equity. The
amount of net income attributable to the noncontrolling interest will be
included in consolidated net income on the face of the income statement. The
Statement also amends certain of ARB No. 51's consolidation procedures for
consistency with the requirements of SFAS 141(R). This Statement also includes
expanded disclosure requirements regarding the interests of the parent and its
noncontrolling interest. The Company is currently evaluating the potential
impact this Statement may have on the Company's financial position, results of
operations and cash flows, but does not believe the impact of the adoption will
be material.
In March 2008, the FASB issued Statement of Financial Accounting Standards No.
161, "Disclosures about Derivative Instruments and Hedging Activities - an
amendment of FASB Statement No. 133." ("SFAS 161"). SFAS 161requires companies
to provide enhanced disclosures regarding derivative instruments and hedging
activities. The Statement requires companies to better convey the purpose of
derivative use in terms of the risks that such company is intending to manage.
Disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under SFAS No.
133 and its related interpretations, and (c) how derivative instruments and
related hedged items affect a company's financial position, financial
performance, and cash flows are required. This Statement retains the same scope
as SFAS No. 133 and is effective for fiscal years and interim periods beginning
after November 15, 2008. The Company is currently evaluating the potential
impact of this Statement but does not expect the adoption of SFAS No. 161 to
have a material impact, if any, on the Company's financial position, results of
operations and cash flows.
In April 2008, the FASB issued FSP No. FAS 142-3, "Determination of the Useful
Life of Intangible Assets." ("FSP No. FAS 142-3"). FSP No. FAS 142-3 amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under SFAS
No. 142, "Goodwill and Other Intangible Assets." The Company is required to
adopt FSP No. FAS 142-3 effective at the beginning of 2010. The Company is
currently evaluating the potential impact of FSP No. FAS 142-3 but does not
expect the adoption to have a material impact, if any, on the Company's
financial position, results of operations and cash flows.
In May 2008, the FASB issued FSP No. APB 14-1, "Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement)." ("FSP No. APB 14-1"). FSP No. APB 14-1 requires that issuers of
convertible debt instruments that may be settled in cash upon conversion
separately account for the liability and equity components in a manner that will
reflect the entity's nonconvertible debt borrowing rate when interest cost is
recognized in subsequent periods. The Company is required to adopt FSP No. APB
14-1 retrospectively, effective at the beginning of 2010. The Company is
currently evaluating the potential impact of FSP No. APB 14-1 but does not
expect the adoption to have a material impact, if any, on the Company's
financial position, results of operations and cash flows.
In May 2008, the FASB issued Statement of Financial Accounting Standards No.
162, "The Hierarchy of Generally Accepted Accounting Principles." ("SFAS 162").
SFAS 162 identifies the sources of accounting principles and the framework for
selecting the principles used in the preparation of financial statements that
are presented in conformity with generally accepted accounting principles. SFAS
162 becomes effective 60 days following the SEC's approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present
Fairly in Conformity With Generally Accepted Accounting Principles." The Company
does not expect that the adoption of SFAS 162 will have a material impact on the
Company's financial position, results of operations and cash flows.
7. Fair Value Measurements
Effective January 1, 2008, the Company adopted Statement of Financial Accounting
Standards No. 157, "Fair Value Measurements," ("SFAS 157"). SFAS 157 defines
fair value, establishes a framework for measuring fair value and expands
disclosures about fair value measurements. SFAS 157 has been applied
prospectively as of the beginning of the period.
SFAS 157 defines fair value as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. SFAS 157 also establishes a fair value
hierarchy which requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value. The standard
describes three levels of inputs that may be used to measure fair value:
Level 1 Quoted prices in active markets for identical assets or liabilities
Level 2 Observable inputs other than Level 1 prices, such as quoted prices
for similar assets or liabilities; quoted prices in active markets
that are not active; or other inputs that are observable or can be
corroborated by observable market data for substantially the full
term of the assets or liabilities.
Level 3 Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets
or liabilities
Following is a description of the valuation methodologies used for instruments
measured at fair value, as well as the general classification of such
instruments pursuant to the valuation hierarchy.
Available-for-sale securities
Where quoted market prices are available in an active market, securities are
classified within Level 1 of the valuation hierarchy. If quoted market prices
are not available, then fair values are estimated by using pricing models,
quoted prices of securities with similar characteristics or discounted cash
flows. Level 2 securities include all of the Company's available-for-sale
securities, consisting of mortgage-backed and municipal securities.
The following table presents the fair value measurements of assets and
liabilities measured at fair value on a recurring basis and the level within the
SFAS 157 fair value hierarchy in which the fair value measurements fall at June
30, 2008 (in thousands):
Fair Value Measurements Using
-----------------------------------------------------------
Quoted Prices in Significant Significant
Active Markets for Other Observable Unobservable
Identical Assets Inputs Inputs
Fair Value (Level 1) (Level 2) (Level 3)
-------------------------------------------------------------------------------
Available-for-sale securities $15,166 $ - $15,166 $ -
Impaired loans
Loans for which it is probable that the Company will not collect all principal
and interest due according to contractual terms are measured for impairment in
accordance with the provisions of Statement of Financial Accounting Standards
No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114").
If the impaired loan is identified as collateral dependent, then the fair
value method of measuring the amount of impairment is utilized. This method
requires obtaining a current appraisal of the collateral and applying a
discount factor to the value based on management's overall assessment of the
property.
Certain impaired loans are reported at the fair value of the underlying
collateral if repayment is expected solely from the collateral. Collateral
values are estimated using Level 2 inputs based on independent appraisals
of the underlying collateral or using Level 3 inputs based on customized
discounting criteria.
Management establishes a specific reserve for loans that have an estimated
fair value that is below the carrying value. Impaired loans for which the
specific reserve was adjusted in accordance with SFAS 114 during the first
six months of 2008 had a carrying amount of $17,805,000 with specific loss
exposures of $3,043,000 an increase of $2,203,000 from December 31, 2007.
The increase in specific loss exposures was the result of several loans
identified as having impairments since December 31, 2007 and the increase in
the specific reserve amounts on several other impaired loans that had been
considered impaired at December 31, 2007. During the six months of 2008, the
Company charged-off $1,123,000 of impaired loans to the allowance for loan
losses.
The following table presents the fair value measurements of assets and
liabilities measured at fair value on a nonrecurring basis and the level within
the SFAS 157 fair value hierarchy in which the fair value measurements fall at
June 30, 2008 (in thousands):
Fair Value Measurements Using
-----------------------------------------------------------
Quoted Prices in Significant Significant
Active Markets for Other Observable Unobservable
Identical Assets Inputs Inputs
Fair Value (Level 1) (Level 2) (Level 3)
-------------------------------------------------------------------------------
Impaired loans $14,762 $ - $ - $14,762
8. Contingent Liability
In connection with its due diligence, MainSource Financial Group, Inc.
("MainSource") requested that certain environmental tests be conducted on the
Company's properties (see note 5 for additional information). The results of
such tests, generally Phase I site assessments, which were received in August
2008, indicate the presence of contaminated soil on certain of the Company's
properties. MainSource provided certain reports to the Company. Additional
environmental studies have been requested in order to determine the extent of
the contamination and whether remediation will be required.
For environmental contingencies such as this one, it is the Company's policy to
record a liability when it is probable that an asset has been impaired or a
liability has been incurred and the amount of loss can be reasonably estimated.
The Company has not recorded a liability for this environmental contingency
because no determination can be made at this time as to its final outcome and
the liability of the Company, if any, is not reasonably estimable.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This section should be read in conjunction with the condensed consolidated
financial statements and notes thereto included in Item 1 of Part I of this
report in addition to the consolidated financial statements of the Company and
the notes thereto included in the Company's Form 10-K for the year ended
December 31, 2007, including note 1 which describes the Company's significant
accounting policies including its use of estimates. See the caption entitled
"Application of Critical Accounting Policies" in this section for further
information.
Forward-Looking Statements
The following discussion contains statements which are forward-looking rather
than historical fact. These forward-looking statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995
and involve known and unknown risks, uncertainties and other factors, which may
cause the Company's actual results to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Such statements are subject to certain risks and
uncertainties including among other things, changes in general economic
conditions; interest rates, deposit flows, loan demand, real estate values,
competition and demand for financial services and loan, deposit, and investment
products in the Company's local markets; changes in the quality and composition
of the loan or investment portfolios; changes in accounting principles,
policies, or guidelines; changes in legislation and regulation; changes in the
monetary and fiscal policies of the U.S. Government, including policies of the
U.S. Treasury and the Federal Reserve Board; war or terrorist activities; and
other economic, competitive, governmental, regulatory, geopolitical, and
technological factors affecting the Company's operations, pricing, and services,
expected cost savings, synergies and other financial benefits from the Company's
proposed merger with MainSource Financial Group, Inc. might not be realized
within the expected time frames and costs or difficulties relating to
integration matters might be greater than expected, the timing of the closing of
the proposed merger, and other risks as detailed in the Company's various
filings with the United States Securities and Exchange Commission. The Company
wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. Except as
required by applicable law or regulation, the Company undertakes no obligation
to update these forward-looking statements to reflect events or circumstances
that occur after the date on which such statements were made.
General
The Company provides commercial and retail banking services, including
commercial real estate loans, one-to-four family residential mortgage loans via
1st Independence Mortgage, home equity loans and lines of credit and consumer
loans as well as certificates of deposit, checking accounts, money-market
accounts and savings accounts within its market area. At June 30, 2008, the
Company had total assets, deposits and stockholders' equity of $326.9 million,
$233.5 million, and $33.4 million, respectively. The Company's business is
conducted principally through the Bank. Unless otherwise indicated, all
references to the Company refer collectively to the Company and the Bank.
Application of Critical Accounting Policies
The discussion and analysis of the Company's financial condition and results of
operation is based upon the Company's unaudited condensed consolidated financial
statements, which have been prepared in conformity with accounting principles
generally accepted in the United States of America for interim financial
information and with the instructions for Form 10-Q. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The Company's most critical accounting policies require
the use of estimates relating to other than temporary impairment of securities,
the allowance for loan losses and the valuation of goodwill. See the caption
entitled "Critical Accounting Policies" in the Management's Discussion and
Analysis of Financial Condition and Results of Operations section of the
Company's Form 10-K for the year ended December 31, 2007 for additional
information.
Overview
The Company recorded a net loss for the quarter ended June 30, 2008 of
($1,498,000) or ($0.76) per diluted share compared to net income of $125,000 or
$0.06 per diluted share for the comparable period in 2007. For the six months
ended June 30, 2008 the Company recorded a net loss of ($1,601,000) or ($0.81)
per diluted share compared to net income of $235,000 or $0.12 per diluted share
for the comparable period in 2007. The decrease in net income and net income per
diluted share for the six-month period was primarily due to an increase of
$1,425,000 after taxes in the provision for loan losses, a decrease in net
interest income after taxes of $307,000 and an increase in noninterest expenses
after taxes of $327,000 (including $356,000 after taxes of legal and other
professional fees relating to the proposed merger with MainSource and $221,000
after taxes recorded in the second quarter of 2008 relating to a settlement
agreement for the termination of a lease) in the first half of 2008 compared to
the first six months of 2007 (which included a $259,000 after taxes litigation
settlement recorded in the second quarter of 2007). Partially offsetting these
factors was an increase in noninterest income after taxes of $171,000 in the
first half of 2008 compared to the first six months of 2007. The decrease in net
income and net income per diluted share for the quarter was primarily due to an
increase of $1,540,000 after taxes in the provision for loan losses, a decrease
in net interest income after taxes of $141,000 and a decrease in noninterest
income after taxes of $17,000. Partially offsetting these factors was a decrease
in noninterest expenses after taxes of $32,000 (including $221,000 after taxes
relating to a settlement agreement for the termination of a lease previously
discussed) in the second quarter of 2008 compared to the comparable period in
2007 (which included a $259,000 after taxes litigation settlement recorded in
the second quarter of 2007).
Results of Operations
Net Interest Income
Net interest income is the most significant component of the Company's revenues.
Net interest income is the difference between interest income on
interest-earning assets (primarily loans and investment securities) and interest
expense on interest-bearing liabilities (deposits and borrowed funds). Net
interest income depends on the volume and rate earned on interest-earning assets
and the volume and rate paid on interest-bearing liabilities.
Net interest income was $2.2 million and $4.4 million, respectively, for the
three months and six months ended June 30, 2008, a decrease of $0.2 million or
9% and $0.5 million or 10%, respectively, from $2.4 million and $4.9 million,
respectively, for the comparable periods of 2007. On an annualized basis, the
net interest spread and net interest margin were 2.65% and 2.93%, respectively,
for the current quarter, compared to 2.78% and 3.20% for the same period of
2007. For the six months ended June 30, 2008 the net interest spread and net
interest margin were 2.51% and 2.79%, respectively, compared to 2.76% and 3.20%
for the first half of 2007. The decrease in the net interest margin was
primarily due to the reversal of $318,000 (of which $11,000 was during the
second quarter) of interest income on certain loans which were placed on
nonaccrual during the first half of 2008. This reversal more than offset the
effects of the decreasing rate environment where we generally had a faster
decrease in interest rates on interest-bearing liabilities compared to the rates
on interest-earning assets and an increase in the volume of net earning assets.
Also contributing to the decrease in net interest margin was a decrease in the
volume of net earning assets. Changes in volume resulted in a decrease in net
interest income of $0.03 million and $0.06 million, respectively, for the second
quarter and first half of 2008 compared to the same periods in 2007, and changes
in interest rates and the mix including the reversals discussed above resulted
in a decrease in net interest income of $0.18 million and $0.41 million,
respectively, for the second quarter and first half of 2008 versus the
comparable periods in 2007.
The Bank, like many other financial institutions, is vulnerable to an increase
in interest rates to the extent that interest-bearing liabilities mature or
reprice more rapidly than interest-earning assets. Historically, the lending
activities of commercial banks emphasized the origination of short to
intermediate term variable rate loans that are more closely matched with the
deposit maturities and repricing of interest-bearing liabilities which occur
closer to the same general time period. While having interest-bearing
liabilities that reprice more frequently than interest-earning assets is
generally beneficial to net interest income during periods of declining interest
rates, it is generally detrimental during periods of rising interest rates.
To reduce the effect of interest rate changes on net interest income, the Bank
has adopted various strategies to improve matching interest-earning asset
maturities to interest-bearing liability maturities. The principal elements of
these strategies include; originating variable rate commercial loans that
include interest rate floors; originating one-to-four family residential
mortgage loans with adjustable rate features, or fixed rate loans with short
maturities; maintaining interest-bearing demand deposits, federal funds sold,
and U.S. government securities with short to intermediate term maturities;
maintaining an investment portfolio that provides stable cash flows, thereby
providing investable funds in varying interest rate cycles; lengthening the
maturities of our time deposits and borrowings when it would be cost effective;
and attracting low cost checking and transaction accounts, which tend to be less
interest rate sensitive when interest rates increase.
The Bank measures its exposure to changes in interest rates using an overnight
upward and downward shift (shock) in the Treasury yield curve. As of June 30,
2008, if interest rates increased 200 basis points and decreased 150 basis
points, respectively, the Bank's net interest income would increase by 2.1% and
3.4%, respectively.
Provision for Loan Losses
The Company recorded a provision for loan losses of $2,354,000 for both the
three months and six months ended June 30, 2008 compared to $20,000 and
$195,000, respectively, for the same periods in 2007. As discussed in the
Company's 2007 Form 10-K, the increase in the provision in 2007 compared to 2006
including the significant provision recorded in the fourth quarter 2007
($4,323,000) reflected the increased risk in the loan portfolio related to the
current economic weakness and the additional stress this places on borrowers.
The additional provision recorded in the second quarter of 2008 resulted from
both increases in allocations for certain specific loans due to further credit
deterioration and an increase in the overall loss reserve in response to certain
negative trends in the Bank's loan portfolio and the continuing decline of
regional and national economic conditions. Nonperforming loans were $13.5
million at June 30, 2008 and $6.4 million at December 31, 2007, or 5.12% and
2.33%, respectively, of total loans. The allowance for loan losses was $8.3
million and $7.1 million at June 30, 2008 and December 31, 2007, or 3.14% and
2.59%, respectively, of total loans. Net charge-offs were $1,239,000 in the
first six months of 2008 compared to $976,000 in the same period in 2007. The
net charge-offs in 2008 were primarily due to real estate construction and
development loans while the net charge-offs in 2007 were primarily due to three
large borrowers in the residential construction and commercial and industrial
portfolios. The charge-offs for both periods had been adequately reserved for in
previous periods.
The Company maintains the allowance for loan losses at a level that it considers
to be adequate to provide for credit losses inherent in its loan portfolio.
Management determines the level of the allowance by performing a quarterly
analysis that considers concentrations of credit, past loss experience, current
economic conditions, the amount and composition of the loan portfolio (including
nonperforming and potential problem loans), estimated fair value of underlying
collateral, loan commitments outstanding, and other information relevant to
assessing the risk of loss inherent in the loan portfolio. As a result of
management's analysis, a range of the potential amount of the allowance for loan
losses is determined.
The Company will continue to monitor the adequacy of the allowance for loan
losses and make additions to the allowance in accordance with the analysis
referred to above. Because of uncertainties inherent in estimating the
appropriate level of the allowance for loan losses, actual results may differ
from management's estimate of credit losses and the related allowance.
Noninterest Income
Noninterest income was $0.5 million for the three months ended June 30, 2008,
compared to $0.5 million for the same period in 2007 and $1.2 million for the
six months ended June 30, 2008, compared to $1.0 million for the first half of
2007. The gain on loan sales was down for the second quarter of 2008 but up for
the first half of 2008 versus the same periods of 2007 as lower interest rates
increased secondary market mortgage activity for most of the first half, but
slowing somewhat in the second quarter of 2008 versus a fairly strong second
quarter of 2007. The gain on loan sales was $162,000 for the three months ended
June 30, 2008, compared to $251,000 for the comparable period in 2007 and
$519,000 for the first half of 2008 compared to $452,000 for the first half of
2007. Service charge income was $146,000 for the three months ended June 30,
2008, compared to $149,000 for the comparable period in 2007 and $292,000 for
the first half of 2008 compared to $269,000 for the first half of 2007. The
Company continually evaluates its deposit product offerings with the intention
of continuing to expand its offerings to the consumer and business depositor.
Currently, the Company is pursuing a strategy to increase its core deposit base
by expanding the Company's offering of remote deposit capture products as well
as wholesale lockbox products for current and prospective business depositors.
Other factors which contributed to the six-month period increase in noninterest
income was a $109,000 gain on the disposal of other real estate in the first
quarter of 2008 which related to the donation of the Company's former Marengo,
Indiana branch land and building to the Town of Marengo. The Bank opened its new
Marengo branch in January 2008. A factor which limited the increase in
noninterest income was a $31,000 loss on the disposal of premises and equipment
in the first half of 2008 compared to no activity in the comparable period in
2007. Other noninterest income increased $26,000 to $112,000 for the second
quarter of 2008 and $43,000 to $209,000 for the first half of 2008 compared to
the comparable periods in 2007.
Noninterest Expense
Noninterest expense was $2.8 million for the quarter ended June 30, 2008
compared to $2.8 million for the same period in 2007 and $5.9 million for the
six months ended June 30, 2008 compared to $5.4 million for the first half of
2007. Contributing to the six-month increase were $428,000 of legal and other
professional fees recorded in the first half of 2008 (including $43,000 recorded
in the second quarter of 2008) relating to the proposed merger with MainSource,
an increase in net occupancy expenses primarily related to the opening of the
new Marengo, Indiana branch in early January 2008 and an increase in data
processing expenses which was primarily due to the loss of processing discounts
provided by the Bank's third party service bureau as a result of the Bank's
notification of its intent to cancel the contract with the provider. Another
factor was additional professional audit fees related to the audit of the annual
financial statements for the year ended December 31, 2007. Partially offsetting
these increases was a decrease in salaries and employee benefits due to a
reduction in the accrual for incentive compensation and stock option expense
which more than offset increases due to management additions relating to the
hiring of an experienced commercial lending team in the second quarter of 2007,
increased health care costs and an increase in commissions related to the higher
activity in mortgage loan sales. Additional items previously discussed that were
recorded as other noninterest expenses were the $335,000 settlement agreement
for the termination of a lease recorded in the second quarter of 2008 and the
$404,000 litigation settlement recorded in the second quarter of 2007. An
additional factor which partially offset the overall six-month increase in
noninterest expenses was a decrease in marketing expenses.
Income Tax Expense (Benefit)
The effective income tax rate on income (loss) before income taxes was (37.3%)
for the three months ended June 30, 2008 compared to 8.8% for the same period in
2007 and (38.4%) for the first six months of 2008 compared to 11.0% for the
first half of 2007. The change in the effective tax rate for the quarter and six
months is primarily due to the change in the income before taxes and the effect
of nondeductible expenses relating to the proposed merger with MainSource.
Financial Condition
The Company's total assets were $326.9 million at June 30, 2008 compared to
$347.7 million at December 31, 2007, a decrease of 20.8 million or 6.0%. Cash
and cash equivalents decreased $6.1 million, loans held for sale went down $1.2
million, net loans decreased $13.4 million, premises and equipment went down
$0.6 million, while interest receivable and other assets increased $0.4 million,
bank owned life insurance increased $0.1 million and investments and other real
estate owned remained the same.
Loans gross of the allowance for loan losses were $263.2 million at June 30,
2008, compared to $275.6 million at December 31, 2007, a decrease of $12.4
million or 4.5%. The decrease was primarily due to decreases in the real estate
construction loan portfolio, real estate residential loan portfolio, real estate
commercial loan portfolio and the other consumer loan portfolio, which decreased
$9.9 million or 15.3%, $3.0 million or 2.7%, $1.2 million or 0.2% and $1.6
million or 35.9%, respectively, coupled with a partially offsetting increase in
commercial loans and home equity loans which increased $2.5 million or 10.1% and
$0.8 million or 6.6%, respectively. All loan categories changed as a percentage
of total loans, except real estate commercial loans which remained at 22%. The
categories that increased as a percentage of total loans where commercial loans
which increased from 9% to 10%, real estate residential loans which increased
from 40% to 41% and home equity loans which increased from 4% to 5%. The
categories that decreased as a percentage of total loans were real estate
construction loans, which decreased from 23% to 21% and other consumer loans
which decreased from 2% to 1%. The Company has continued its practice of selling
all qualifying originations of residential real estate loans in the secondary
market through 1st Independence Mortgage, a division of the Bank, rather than
being retained for the Company's loan portfolio. The Company continues to
identify opportunities to cross sell its other products, including home equity
and consumer loans for its loan portfolio resulting from customer relationships
established through the origination of loans by 1st Independence Mortgage.
Deposits decreased $21.1 million or 8.3% to $233.5 million at June 30, 2008
compared to $254.6 million at December 31, 2007. This decrease was attributable
to a decrease in savings, NOW and money market deposits of $24.7 million which
more than offset small increases in time deposits of $1.9 million and demand
deposits of $1.8 million. The decrease in savings, NOW and money market deposits
resulted primarily from a decrease in municipalities' deposits in the Indiana
market due to a delay in the issuance of real estate property tax bills normally
payable in May and November of each year.
Short-term borrowings increased $12.6 million to $48.6 million at June 30, 2008,
compared to $36.0 million at December 31, 2007 while long-term debt decreased
$10.0 million to $10.3 million at June 30, 2008 compared to $20.3 million at
December 31, 2007. The increase in short-term borrowings was primarily due to
short-term borrowings being used to fund a portion of the decrease in
municipalities' deposits discussed in the preceding paragraph and a portion of
the decrease in long-term debt due to the maturity of a $10.0 million long-term
FHLB advance. The Company uses short-term borrowings, primarily short-term FHLB
advances, to fund short-term liquidity needs and manage net interest margin.
Off-Balance Sheet Arrangements
In the normal course of operations, the Company engages in financial
transactions that contain credit, interest rate, and liquidity risk that are not
recorded in the financial statements such as loan commitments and performance
letters of credit. As of June 30, 2008, unused loan commitments and performance
letters of credit were $40,561,000 and $2,728,000, respectively.
Since many of the unused loan commitments are expected to expire or be only
partially used, the total amount of commitments does not necessarily represent
future cash requirements.
Liquidity and Capital Resources
Liquidity to meet borrowers' credit and depositors' withdrawal demands is
provided by maturing assets, short-term liquid assets that can be converted to
cash and the ability to attract funds from depositors. Additional sources of
liquidity include brokered deposits, advances from the FHLB and other short-term
borrowings, such as federal funds purchased and securities sold under repurchase
agreements.
At June 30, 2008 and December 31, 2007, brokered deposits were $37.9 million and
$38.2 million, respectively. The weighted average cost and maturity of brokered
deposits were 3.50% and four months at June 30, 2008 compared to 4.67% and four
months at December 31, 2007. The Company plans to continue using brokered
deposits for the foreseeable future to support loan demand when pricing for
brokered deposits is more favorable than short-term borrowings.
At June 30, 2008 and December 31, 2007, the Bank had total FHLB advances
outstanding of $48.0 million and $46.0 million, respectively, with $1.0 million
and $11.0 million, respectively, included in long-term debt in the accompanying
condensed consolidated balance sheet and the remaining amount included in
short-term borrowings. Additionally, the Bank had $23.0 million of unused
commitments under its line of credit with the FHLB and sufficient collateral to
borrow an additional $9.5 million.
The Company's liquidity depends primarily on dividends paid to it as sole
shareholder of the Bank. At June 30, 2008, the Bank was no longer able to pay
dividends to the Company without regulatory approval due to the net loss
incurred in the Bank in the fourth quarter of 2007 primarily due to the
substantial increase in the provision for loan losses and the goodwill
impairment charge and the net loss incurred in the second quarter of 2008 due
primarily to the additional increase in the provision for loan losses. At July
1, 2008 the Bank's retained net losses, less dividends declared during the
preceding two years was approximately $2,911,000. The Company requested and
received regulatory approval to pay an $800,000 dividend from the Bank to the
Company in May 2008. The dividend was obtained to cover the additional cash flow
needs of the holding company prior to closing the transaction with MainSource
(see note 5 for additional information regarding the pending acquisition of the
Company by MainSource). In addition, see subsequent paragraph discussing the
Company's and the Bank's current risk based capital ratios.
The Company has $9.3 million of subordinated debentures outstanding, which are
included in long-term debt in the accompanying condensed consolidated balance
sheet. Effective March 26, 2008, the entire $9.3 million are now variable rate
obligations as the $5.2 million of debentures that had been at a fixed rate of
6.40% now switch to variable rate obligations. Thus all $9.3 million of the
debentures are now variable rate obligations with interest rates that reprice
quarterly (March 26, June 26, September 26 and December 26), and are tied to the
three-month London Interbank Offering Rate ("LIBOR") plus 3.15%. At June 30,
2008 the rate on the variable rate obligations was 5.96% compared to 8.51% at
June 30, 2007 on the $4.1 million of variable rate obligations and 6.40% for the
$5.2 million of fixed rate obligations. The weighted average rate on the entire
$9.3 million of subordinated debentures outstanding was 5.77% and 6.43% for the
second quarter and first six months of 2008 compared to 7.33% and 7.34%,
respectively, for the same periods in 2007.
Stockholders' equity was $33.4 million at June 30, 2008 compared to $35.3
million at December 31, 2007. The individual items within stockholders' equity
that changed were a net loss of ($1,601,000), cash dividends declared of
$316,000 ($0.16 per share), a decrease in other comprehensive income, net of tax
of ($87,000) and an increase of $124,000 relating to stock option, ESOP plan
transactions and other miscellaneous equity transactions.
Bank holding companies and their subsidiary banks are required by regulators to
meet risk based capital standards. These standards, or ratios, measure the
relationship of capital to a combination of balance sheet and off-balance sheet
risks. The following table presents these ratios as of June 30, 2008 and
December 31, 2007 for the Consolidated Company and the Bank along with the
regulator's minimum ratio to be considered well capitalized.
To Be Well
June 30, 2008 December 31, 2007 Capitalized
------------- ----------------- -----------
Total risk-based capital to risk-weighted assets
Consolidated company 14.3% 14.5 N/A%
Bank 13.9 13.9 10.0
Tier 1 capital to risk-weighted assets
Consolidated company 13.1 13.2 N/A
Bank 12.6 12.6 6.0
Tier 1 capital to average assets
Consolidated company 10.5 10.5 N/A
Bank 10.1 10.1 5.0
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information required by this item is included in Item 2, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), the Company's management carried out an
evaluation, with the participation of the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the Company's disclosure
controls and procedures as of the end of the quarter ended June 30, 2008. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were not
effective to ensure that information required to be disclosed by the Company in
its reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
United States Securities and Exchange Commission's rules and forms because of
the material weakness described below. Notwithstanding this material weakness,
our management has concluded that the consolidated financial statements included
in this Form 10-Q fairly present in all material respects the Company's
financial position, results of operations and cash flows for the periods
presented in conformity with accounting principles generally accepted in the
United States of America.
(b) Changes in Internal Control over Financial Reporting
Except for the material weakness described below, there have not been any
changes in the Company's internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended
June 30, 2008 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
The Company identified a material weakness in its internal control over
financial reporting related to determining the allowance for loan losses. A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting such that there is a reasonable possibility
that a material misstatement of the annual or interim financial statements will
not be prevented or detected on a timely basis. The material weakness identified
by the Company resulted from the Company not adjusting its calculation of the
allowance for loan losses to fully account for several factors which occurred
during the second quarter of 2008 including the continued decline in the local
and national economy; exacerbation of certain negative trends in real estate
values; rapid increase in energy prices; increasing regional unemployment
levels; slowed demand for both new and existing housing; and the resulting
stress on the Bank's real estate and development portfolios. Following its
identification of the weakness, the Company determined that an additional
adjustment of approximately $2.4 million to the allowance for loan losses was
necessary. The material weakness was detected and the adjustment was recorded
prior to the issuance of the Company's June 30, 2008 consolidated financial
statements in this Form 10-Q (see Part 1 - Financial Information, Item 1 -
Financial Statements) and the announcement of the Company's second quarter
results in the Company's Form 8-K filed on July 30, 2008.
As a result of its determination that a material weakness exists, the Company
has implemented: (i) new procedures for the determination of the allowance for
loan losses requiring that certain subjective factors, such as local and
national economic trends and real estate valuations, be considered more fully
and be discussed with senior management and the audit committee of the board of
directors, and (ii) more timely independent monitoring of the adequacy of the
allowance for loan losses. While the Company believes that these actions will
remediate this material weakness, it has not yet tested the operating
effectiveness of such controls.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
The Company, from time to time, is a party to ordinary routine litigation, which
arises in the normal course of business, such as claims to enforce liens,
condemnation proceedings on properties in which the Company holds security
interests, claims involving the making and servicing of real property loans, and
other issues incident to its business. There were no potentially material
lawsuits or other legal proceedings pending or known to be contemplated against
the Company at June 30, 2008.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held a Special Meeting of Stockholders (the "Meeting"), on August 7,
2008. The purpose of the Meeting was to vote to approve the Agreement and Plan
of Merger dated February 26, 2008, by and among MainSource Financial Group, Inc.
("MainSource"), the Company and 1st Independence Bank, Inc., and the merger of
the Company with and into MainSource provided therein. The Agreement and Plan of
Merger was approved. There were 1,433,662 votes for and 2,718 votes against and
15,434 abstentions.
Item 6. Exhibits
(a) Exhibits
3.1 Certificate of Incorporation (incorporated by reference
from the Exhibits to the Company's Form S-1 Registration
Statement, initially filed on June 14, 1995,
Registration No. 33-93458).
3.2 Amended Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to the Company's Form 10-KSB
filed on December 29, 2004).
3.3 Bylaws (incorporated by reference to Exhibit 3.2 to the
Company's Form 8-K filed on August 21, 2007).
10.1 Settlement Agreement and Termination of Lease, dated
June 6, 2008 (incorporated by reference to Exhibit 10.1
to the Company's Form 8-K filed on June 9, 2008).
31.1 Rule 13a-14(a) / 15d-14(a) Certification of Principal
Executive Officer ("Section 302 Certifications").
31.2 Rule 13a-14(a) / 15d-14(a) Certification of Principal
Financial Officer ("Section 302 Certifications").
32.1 Section 1350 Certifications ("Section 906
Certifications").
SIGNATURES
Pursuant to the requirements 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.
1st INDEPENDENCE FINANCIAL GROUP, INC.
Date: August 14, 2008 By: /s/ R. Michael Wilbourn
-----------------------
R. Michael Wilbourn
Executive Vice President
and Chief Financial Officer
Exhibit Index
Exhibit
Number Description
3.1 Certificate of Incorporation (incorporated by reference
from the Exhibits to the Company's Form S-1 Registration
Statement, initially filed on June 14, 1995,
Registration No. 33-93458).
3.2 Amended Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to the Company's Form 10-KSB
filed on December 29, 2004).
3.3 Bylaws (incorporated by reference to Exhibit 3.2 to the
Company's Form 8-K filed on August 21, 2007).
10.1 Settlement Agreement and Termination of Lease, dated
June 6, 2008 (incorporated by reference to Exhibit 10.1
to the Company's Form 8-K filed on June 9, 2008).
31.1 Rule 13a-14(a) / 15d-14(a) Certification of Principal
Executive Officer ("Section 302 Certifications").
31.2 Rule 13a-14(a) / 15d-14(a) Certification of Principal
Financial Officer ("Section 302 Certifications").
32.1 Section 1350 Certifications ("Section 906
Certifications").