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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 March 31, 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
April 28, 2008.
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1st INDEPENDENCE FINANCIAL GROUP, INC.
FORM 10-Q
For the Quarter Ended March 31, 2008
INDEX
Part I - Financial Information
Item 1. Financial Statements Page Number
-----------
Condensed Consolidated Balance Sheets as of March 31, 2008
(unaudited) and December 31, 2007 3
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2008 and 2007 (unaudited) 4
Condensed Consolidated Statements of Comprehensive Income
for the three months ended March 31, 2008 and 2007 (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2008 and 2007 (unaudited) 6
Notes to Condensed Consolidated Financial Statements (unaudited) 7-10
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11-15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Item 4. Controls and Procedures 16
Part II - Other Information
Item 1. Legal Proceedings 17
Item 6. Exhibits 17
Signatures 18
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Balance Sheets
(in thousands except share data)
(Unaudited)
March 31, December 31,
2008 2007
--------------- --------------
Assets
Cash and and due from banks $ 13,775 $ 11,118
Interest-bearing demand deposits 8,221 7,789
Federal funds sold 3,558 13,711
--------------- --------------
Cash and cash equivalents 25,554 32,618
Inerest-bearing deposits 100 100
Available-for-sale securities at fair value 14,689 15,045
Held-to-maturity securities, fair value of $1,752 and
$1,750 at March 31, 2008 and December 31, 2007, respectively 1,703 1,745
Loans held for sale 1,077 2,874
Loans, net of allowance for loan losses of $6,579 and
$7,140 at March 31, 2008 and December 31, 2007, respectively 266,925 268,448
Premises and equipment, net 7,540 7,954
Federal Home Loan Bank (FHLB) stock 2,341 2,313
Bank owned life insurance 3,702 3,647
Goodwill 8,286 8,286
Other real estate owned 388 58
Interest receivable and other assets 4,366 4,630
--------------- --------------
Total assets $ 336,671 $ 347,718
=============== ==============
Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand $ 18,489 $ 15,491
Savings, NOW and money market 152,734 102,064
Time 107,722 137,030
--------------- --------------
Total deposits 278,945 254,585
Short-term borrowings 1,007 36,011
Long-term debt 20,279 20,279
Interest payable and other liabilities 1,226 1,567
--------------- --------------
Total liabilities 301,457 312,442
--------------- --------------
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
March 31, 2008 and December 31, 2007, respectively 296 296
Additional paid-in capital 39,922 39,898
Retained earnings 9,506 9,767
Unearned ESOP compensation (134) (166)
Accumulated other comprehensive (loss) 199 56
Treasury stock, at cost, common,
969,835 shares and 969,835 shares at March 31, 2008 and
December 31, 2007, respectively (14,575) (14,575)
--------------- --------------
Total stockholders' equity 35,214 35,276
--------------- --------------
Total liabilities and stockholders' equity $ 336,671 $ 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)
Three months ended March 31,
-----------------------------------
2008 2007
-------------- --------------
Interest and dividend income
Interest and fees on loans $4,284 $5,125
Interest on securities
Taxable 160 166
Tax exempt 43 45
Interest on federal funds sold 152 76
Dividends 35 43
Interest on deposits with financial institutions 65 78
-------------- --------------
Total interest and dividend income 4,739 5,533
-------------- --------------
Interest expense
Deposits 2,149 2,591
FHLB advances 266 359
Other 169 177
-------------- --------------
Total interest expense 2,584 3,127
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Net interest income 2,155 2,406
Provision for loan losses - 175
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Net interest income after provision for loan losses 2,155 2,231
-------------- --------------
Noninterest income
Service charges 146 120
Gain on loan sales 357 201
(Loss) on disposal of premises and equipment (27) (1)
Gain on disposal of other real estate owned 109 -
Increase in cash value of life insurance 55 52
Other 97 80
-------------- --------------
Total noninterest income 737 452
-------------- --------------
Noninterest expense
Salaries and employee benefits 1,268 1,228
Net occupancy expense 456 425
Data processing fees 220 208
Professional fees 665 170
Marketing expense 20 65
Other 471 460
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Total noninterest expense 3,100 2,556
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Income (loss) before income taxes (208) 127
Income tax expense (benefit) (105) 17
-------------- --------------
Net income (loss) $ (103) $ 110
============== ==============
Net income (loss) per share
Basic ($0.05) $0.06
Diluted (0.05) 0.06
Weighted average shares outstanding
Basic 1,980 1,967
Diluted 1,980 1,978
Cash dividends declared per share $0.08 $0.08
See notes to condensed consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Comprehensive Income
(in thousands)
(Unaudited)
Three months ended March 31,
------------------------------------
2008 2007
-------------- -----------------
Net income (loss) $(103) $ 110
Other comprehensive income, net of tax
Change in unrealized gains and losses on available-for-sale securities 143 21
Less reclassification adjustment for realized gains (losses) included in net income - -
-------------- -----------------
Other comprehensive income 143 21
-------------- -----------------
Comprehensive income $ 40 $ 131
============== =================
See notes to condensed consolidated financial statements.
1ST INDEPENDENCE FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Three months ended March 31,
-------------------------------
2008 2007
------------- ------------
Cash Flows from Operating Activities:
Net income (loss) $ (103) $ 110
Adjustments to reconcile net income (loss) to net cash provided by
operations:
Depreciation 197 175
Provision for loan losses - 175
Gain on loan sales (357) (201)
Origination of loans held for sale (17,830) (11,343)
Proceeds from loans held for sale 19,984 11,622
Compensation expense on stock options 4 31
ESOP compensation 43 53
Amortization of unearned compensation on restricted stock 9 8
Amortization of premiums and discounts on securities 5 6
Loss on disposal of premises and equipment 27 1
Deferred income tax expense 278 251
FHLB stock dividend (29) -
Amortization of loan fees (30) (58)
Amortization of intangibles, net 10 65
Increase in cash value of life insurance (55) (52)
Changes in:
Decrease (increase) in interest receivable and other assets 652 (159)
(Decrease) in interest payable and other liabilities (278) (210)
------------- ------------
Net cash provided by operating activities 2,527 474
------------- ------------
Cash Flows from Investing Activities:
Purchases of available-for-sale securities - (1,000)
Proceeds from maturities of available-for-sale securities 567 568
Proceeds from maturities of held-to-maturity securities 40 90
Net decrease (increase) in loans 619 (1,243)
Purchases of premises and equipment (15) (246)
------------- ------------
Net cash provided by (used in) investing activities 1,211 (1,831)
------------- ------------
Cash Flows from Financing Activities:
Net increase in deposits 24,360 1,084
Net (decrease) in short-term borrowings (35,004) (15,868)
Proceeds from issuance of long-term debt - 10,000
Repurchase and retirement of common stock - (37)
Cash dividends paid (158) (157)
------------- ------------
Net cash (used in) financing activities (10,802) (4,978)
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Net (decrease) in cash and cash equivalents (7,064) (6,335)
Cash and cash equivalents at beginning of period 32,618 23,579
------------- ------------
Cash and cash equivalents at end of period $ 25,554 $ 17,244
============= ============
Supplemental Cash Flow Information:
Interest paid $ 2,867 $ 3,153
Income taxes paid 45 25
Real estate acquired in settlement of loans 935 -
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 ended March 31, 2008 and March 31, 2007, the Company
recorded $4,000 and $31,000, respectively, in employee stock-based compensation
expense, which is included in salaries and employee benefits. As of March 31,
2008 and March 31, 2007, there was $17,000 and $60,000, respectively, of
unrecognized stock-compensation expense for previously granted unvested options
that will be recognized over a weighted-average period of 1.3 and 1.7 years,
respectively.
3. Allowance for Loan Losses
An analysis of the changes in the allowance for loan losses for the three months
ended March 31 follows (in thousands):
2008 2007
---- ----
Beginning balance $7,140 $3,745
Provision for loan losses - 175
Loans charged off (565) (983)
Recoveries 4 1
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Ending balance $6,579 $2,938
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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
March 31,
-------------------
2008 2007
---- ----
Income (numerator) amounts used for basic and diluted per share computations:
Net income (loss) ($103) $110
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Shares (denominator) used for basic per share computations:
Weighted average shares of common stock outstanding 1,980 1,967
====== =====
Shares (denominator) used for diluted per share computations:
Weighted average shares of common stock outstanding 1,980 1,967
Plus: dilutive effect of stock options - 11
------ -----
Adjusted weighted average shares 1,980 1,978
====== =====
Net income (loss) per share data:
Basic ($0.05) $0.06
====== =====
Diluted ($0.05) $0.06
====== =====
Options to purchase 63,050 common shares, which equates to 8,338 incremental
common equivalent shares for the three months ended March 31, 2008 were excluded
from the diluted calculations above as their effect would have been
antidilutive. In addition, options to purchase 17,000 common shares for the
three months ended March 31, 2007 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. 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, and is subject to the approval of the Company's stockholders, receipt of
certain regulatory approvals, and certain other customary conditions. 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 March 31, 2008,
no accrual has been made for these charges.
6. Recently Issued Accounting Standards
In September 2006, the 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.
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 March
31, 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 $14,689 $ - $14,689 $ -
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
quarter of 2008 had a carrying amount of $15,710,000 with specific loss
exposures of $1,952,000 an increase of $1,112,000 from December 31, 2007.
The increase in specific loss exposures was the result of several loans added
to nonaccrual status which had impairments. During the first quarter of 2008,
the Company charged-off $565,000 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
March 31, 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 $13,758 $ - $ - $13,758
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 March 31, 2008, the
Company had total assets, deposits and stockholders' equity of $336.7 million,
$278.9 million, and $35.2 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 March 31, 2008 of
($103,000) or ($0.05) per diluted share compared to net income of $110,000 or
$0.06 per diluted share for the comparable period in 2007. The decrease in net
income and net income per diluted share for the three-month period was primarily
due to a decrease in net interest income after taxes of $166,000 and an increase
in noninterest expenses after taxes of $359,000 (including $324,000 after taxes
of legal and other professional fees relating to the proposed merger with
MainSource) in the first three months of 2008 compared to the first three months
of 2007. Partially offsetting these factors was an increase in noninterest
income after taxes of $188,000 and a decrease of $116,000 after taxes in the
provision for loan losses in the first three months of 2008 compared to the
first three months 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 for the three months ended March 31, 2008 a
decrease of $0.2 million or 10% from $2.4 million for the comparable period of
2007. On an annualized basis, the net interest spread and net interest margin
were 2.38% and 2.67% for the current quarter, compared to 2.75% and 3.19% for
the same period of 2007. The decrease in the net interest margin was primarily
due to the reversal of $307,000 of interest income on certain loans which were
placed on nonaccrual during the first quarter 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. Changes in volume resulted in an increase in net interest income
of $42,000 for the first quarter of 2008 compared to the same period in 2007,
and changes in interest rates and the mix including the reversals discussed
above resulted in a decrease in net interest income of $293,000 for the first
quarter of 2008 versus the comparable period 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 March 31,
2008, if interest rates increased 200 basis points and decreased 200 points,
respectively, the Bank's net interest income would increase by 6.3% and increase
by 6.2%, respectively.
Provision for Loan Losses
The Company had no provision for loan losses for the three months ended March
31, 2008 after recording a provision of $4,323,000 in the fourth quarter of 2007
and a provision of $175,000 in the first quarter of 2007. As discussed in the
Company's 2007 Form 10-K, the increase in the provision in 2007 including the
significant amount in the fourth quarter 2007 compared to 2006 reflects the
increased risk in the loan portfolio related to the current economic weakness
and the additional stress this places on borrowers. Nonperforming loans were
$16.0 million at March 31, 2008 and $6.4 million at December 31, 2007, or 5.86%
and 2.33%, respectively, of total loans. The increase in nonperforming loans
continues to be primarily due to an increase in nonperforming real estate
construction and development loans, primarily in the 1-4 family markets. While
nonperforming loans increased during the first quarter of 2008, classified loans
remained stable as the majority of new nonperforming loans had already been
identified by the Company during the fourth quarter of 2007. The allowance for
loan losses was $6.6 million and $7.1 million at March 31, 2008 and December 31,
2007, or 2.41% and 2.59%, respectively, of total loans. Net charge-offs were
$561,000 in the first quarter of 2008 compared to $982,000 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 $737,000 for the three months ended March 31, 2008,
compared to $452,000 for the same period in 2007. The gain on loan sales
increased $156,000 for the first quarter of 2008 versus the first quarter of
2007 as lower interest rates increased secondary market mortgage activity. The
gain on loan sales was $357,000 for the three months ended March 31, 2008,
compared to $201,000 for the comparable period in 2007. Service charge income
was $146,000 for the three months ended March 31, 2008, compared to $120,000 for
the comparable period in 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 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 $27,000 loss on the disposal of
premises and equipment in the first quarter 2008 compared to a loss of $1,000 in
the comparable period in 2007. Other noninterest income increased $17,000 to
$97,000 for the first quarter 2008.
Noninterest Expense
Noninterest expense was $3.1 million for the quarter ended March 31, 2008
compared to $2.6 million for the same period in 2007. Contributing to the
increase were increases in salaries and employee benefits 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. Partially
offsetting these increases in salaries and employee benefits was a reduction in
the accrual for incentive compensation and stock option expense. Additional
factors contributing to the overall increase in noninterest expenses were an
increase in net occupancy expenses primarily related to the opening of the new
Marengo, Indiana branch in early January 2008, an increase in data processing
expenses which was primarily due to the growth of the Bank's services and its
continuing commitment to upgrade systems productivity and $385,000 of legal and
other professional fees recorded in the first quarter of 2008 relating to the
proposed merger with MainSource. 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
marketing expenses.
Income Tax Expense (Benefit)
The effective income tax rate on income (loss) before income taxes was (50.5%)
for the three months ended March 31, 2008 compared to 13.4% for the same period
in 2007. The change in the effective tax rate for the quarter 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 $336.7 million at March 31, 2008 compared to
$347.7 million at December 31, 2007, a decrease of 11.0 million or 3.2%. Cash
and cash equivalents decreased $7.0 million, loans held for sale went down $1.8
million, net loans decreased $1.5 million, investments decreased $0.4 million,
premises and equipment went down $0.4 million and interest receivable and other
assets decreased $0.3 million, while other real estate owned went up $0.3
million and bank owned life insurance increased $0.1 million.
Loans gross of the allowance for loan losses were $273.5 million at March 31,
2008, compared to $275.6 million at December 31, 2007, a decrease of $2.1
million or 0.1%. The decrease was primarily due to decreases in the real estate
construction loan portfolio, real estate residential loan portfolio and the
other consumer loan portfolio, which decreased $6.7 million or 10.3%, $1.3
million or 1.2% and $1.3 million or 28.6%, respectively, coupled with a
partially offsetting increase in commercial loans which increased $7.3 million
or 29.0%. All loan categories remained the same as a percentage of total loans,
except commercial loans which increased from approximately 9% to 12% of total
loans, real estate construction loans, which decreased from approximately 23% to
21% of total loans 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 increased $24.4 million or 9.6% to $278.9 million at March 31, 2008
compared to $254.6 million at December 31, 2007. This increase was attributable
to an increase in savings, NOW and money market deposits of $50.7 million and
demand deposits of $3.0 million which more than offset a decrease in time
deposits of $29.3 million. The increase in savings, NOW and money market
deposits resulted primarily from the effects of a general marketing campaign
promoting a more competitively priced NOW account product to municipalities in
an effort to reduce the Company's dependency on higher costing time deposits.
Short-term borrowings decreased $35.0 million to $1.0 million at March 31, 2008,
compared to $36.0 million at December 31, 2007 while long-term debt was $20.3
million both at March 31, 2008 and December 31, 2007. The decrease in short-term
borrowings was due to the Company successfully attracting municipal deposits
reducing the need for short-term FHLB advances. 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 March 31, 2008, unused loan commitments and performance
letters of credit were $47,273,000 and $2,836,000, 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 March 31, 2008 and December 31, 2007, brokered deposits were $14.5 million
and $38.2 million, respectively. The weighted average cost and maturity of
brokered deposits were 4.85% and four months at March 31, 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 March 31, 2008 and December 31, 2007, the Bank had total FHLB advances
outstanding of $11.0 million and $46.0 million, respectively, with $11.0 million
and $11.0 million, respectively, included in long-term debt in the accompanying
condensed consolidated balance sheet and the remaining amount if any included in
short-term borrowings. Additionally, the Bank had $60.0 million of unused
commitments under its line of credit with the FHLB and sufficient collateral to
borrow an additional $63.1 million.
The Company's liquidity depends primarily on dividends paid to it as sole
shareholder of the Bank. At March 31, 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. At April 1, 2008 the Bank's retained net losses, less
dividends declared during the preceding two years was approximately $819,000.
The Company currently has assets at the holding company to allow it to pay the
quarterly dividend of $0.08 per share which was declared on April 17, 2008 to be
paid on May 15, 2008 and has requested regulatory approval for a dividend from
the Bank 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 March 31,
2008 the rate on the variable rate obligations was 5.76% compared to 8.50% at
March 31, 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 7.10% for the
first quarter of 2008 compared to 7.34% for the same period in 2007.
Stockholders' equity was $35.2 million at March 31, 2008 compared to $35.3
million at December 31, 2007. The individual items within stockholders' equity
that changed were a net loss of ($103,000), cash dividends declared of $158,000
($0.08 per share), an increase in other comprehensive income, net of tax of
$143,000 and an increase of $56,000 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 March 31, 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
March 31, 2008 December 31, 2007 Capitalized
-------------- ----------------- -----------
Total risk-based capital to risk-weighted assets
Consolidated company 14.4% 14.5% N/A%
Bank 14.1 13.9 10.0
Tier 1 capital to risk-weighted assets
Consolidated company 13.1 13.2 N/A
Bank 12.8 12.6 6.0
Tier 1 capital to average assets
Consolidated company 10.3 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 March 31, 2008. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are 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.
(b) Changes in Internal Control over Financial Reporting
In response to the material weakness described in Item 9A of the Company's Form
10-K for the year ended December 31, 2007, the Company implemented the following
actions: (1) sought to thoroughly understand the nature of the issues through
discussions with the Company's independent registered accounting firm, with a
third party firm who regularly consults with the Company regarding the quarterly
calculation of the adequacy of the allowance for loan losses and with the Audit
Committee of the Board of Directors, (2) implemented procedures requiring that
any changes to the quarterly analysis of the adequacy in loan losses must be
communicated in writing and approved by senior management and the Audit
Committee of the Board of Directors, and (3) implemented more timely independent
monitoring of the quarterly analysis of the adequacy in the allowance for loan
losses. As a result of taking the above actions and evaluating the operating
effectiveness of the added controls during the first quarter of 2008, management
of the Company has concluded that it has remediated the material weakness
described in Item 9A of the Company's Form 10-K for the year ended December 31,
2007.
Other than as described in the previous paragraph, 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
March 31, 2008 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
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 March 31, 2008.
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).
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: May 6, 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).
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").