Indiana Banks and Opinion and Investing Column

KIM: MainSource story shows community banks' volatility

August 20, 2011

KimCan you name a community bank based in Greensburg with $2.8 billion in assets, 80 branches and the equivalent of 924 full-time employees? I didn’t know MainSource Bank existed until it made a major commitment to Bartholomew County in late 2009, following the demise of market leader Irwin Union Bank.

(Disclosure, I served on the local community advisory board of IUB and have been a member of MainSource’s similar board since 2010. I receive a nominal stipend for my service. My employer, Kirr Marbach & Co. LLC, does not own shares in the bank’s parent, MainSource Financial Group Inc., nor do I).

While I am agnostic on the stock, I think MainSource’s story is compelling for what it says about community banks during the financial crisis and what the future might look like.

First, by and large, community banks did not participate in the activities that led to the financial crisis. They didn’t produce, package, securitize and sell subprime mortgages. They didn’t have trading operations that made huge bets with the banks’ capital. They didn’t use “special purpose entities” to obfuscate risk by moving it off the balance sheet.

The business that remained was commercial real estate and construction and development loans. These, too, went south in a hurry during the crisis, leading to 157 Federal Deposit Insurance Corp.-backed banks failing in 2010 and 64 thus far in 2011.

Fortunately, while MainSource has endured its fair share of pain in its loan portfolio, credit quality has taken a turn for the better recently. This has led to lower provisions for loan losses.

In the second quarter of this year, MainSource reported unaudited net income of $7.6 million. Its earnings per share, 34 cents, were the highest in three years. It was a big improvement from the second quarter of 2010, when MainSource earned $2.2 million, or 7 cents per share.

Primarily driving the earnings increase was the decrease in loan loss provision expense to $4.0 million, compared with $12.8 million in the second quarter of 2010, and $5.6 million in this year’s first quarter.

On the credit-quality front, non-performing assets were $57.0 million at the end of the second quarter, down $36.3 million from the same quarter a year earlier and down $23.4 million from the first quarter.

MainSource CEO Archie Brown is pleased with strengthening credit quality, but said he expects continued progress to be “lumpy.” With the loan-loss reserve now covering almost 100 percent of non-performing loans, Brown believes the loan-loss provision should be lower in the second half of this year, and even lower in 2012.

Brown expects the combination of tepid loan demand, regulatory pressure on fees, and skyrocketing costs related to compliance with new rules to make it increasingly difficult for banks smaller than $1 billion in assets to remain independent.

MainSource’s strategy involves continuing improvement in credit quality, increasing the growth rate of checking accounts, restructuring commercial banking to increase sales focus, and implementing cost-reduction and revenue-enhancement initiatives recommended by a third-party consultant. 

Brown believes profitability and capital will grow nicely in the next 12 to 18 months. By then, he hopes MainSource will be able to repay the $57 million it received from the Troubled Asset Relief Program, and be ready to make acquisitions.

Will MainSource get there? I certainly like the bank’s chances.•

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Kim is the chief operating officer and chief complianceofficer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Ind. He can be reached at (812) 376-9444 or Mickey@kirrmarr.com.

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