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, 2006 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 0-13368 FIRST MID-ILLINOIS BANCSHARES, INC. (Exact name of Registrant as specified in its charter) Delaware 37-1103704 (State or other jurisdiction of (I.R.S. employer identification no.) incorporation or organization) 1515 Charleston Avenue, Mattoon, Illinois 61938 61938 Address of principal executive offices) (Zip Code) (217) 234-7454 (Registrant's telephone number, including area code) 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[X] Non-accelerated filer [ ] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). [ ] Yes [X] No As of August 8, 2006, 4,330,325 common shares, $4.00 par value, were outstanding.
PART I ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets (unaudited) June 30, December 31, ------------- -------------- (In thousands, except share data) 2006 2005 ------------- -------------- Assets Cash and due from banks: Non-interest bearing $ 21,502 $ 19,131 Interest bearing 586 426 Federal funds sold 1,822 - ------------- -------------- Cash and cash equivalents 23,910 19,557 Investment securities: Available-for-sale, at fair value 191,874 155,841 Held-to-maturity, at amortized cost (estimated fair value of $1,364 and $1,442 at June 30, 2006 and December 31, 2005, respectively) 1,343 1,412 Loans held for sale 2,653 1,778 Loans 715,533 636,355 Less allowance for loan losses (6,223) (4,648) ------------- -------------- Net loans 709,310 631,707 Interest receivable 6,731 6,410 Premises and equipment, net 16,607 15,168 Goodwill, net 17,366 9,034 Intangible assets, net 5,581 2,778 Other assets 7,138 6,888 ------------- -------------- Total assets $982,513 $850,573 ============= ============== Liabilities and Stockholders' Equity Deposits: Non-interest bearing $113,106 $ 95,305 Interest bearing 667,279 553,764 ------------- -------------- Total deposits 780,385 649,069 Securities sold under agreements to repurchase 52,578 67,380 Interest payable 2,507 1,717 Other borrowings 50,000 44,500 Junior subordinated debentures 20,620 10,310 Other liabilities 3,931 5,271 ------------- -------------- Total liabilities 910,021 778,247 ------------- -------------- Stockholders' Equity Common stock, $4 par value; authorized 18,000,000 shares; issued 5,662,115 shares in 2006 and 5,633,621 shares in 2005 22,699 22,534 Additional paid-in capital 20,745 19,439 Retained earnings 64,665 60,867 Deferred compensation 2,584 2,440 Accumulated other comprehensive loss (1,603) (739) Less treasury stock at cost, 1,344,378 shares in 2006 and 1,241,359 shares in 2005 (36,598) (32,215) ------------- -------------- Total stockholders' equity 72,492 72,326 ------------- -------------- Total liabilities and stockholders' equity $982,513 $850,573 ============= ============== See accompanying notes to unaudited condensed consolidated financial statements.
Consolidated Statements of Income (unaudited) (In thousands, except per share data) <TABLE> <CAPTION> Three months ended June 30, Six months ended June 30, 2006 2005 2006 2005 ------------------ ---------------- ---------------- --------------- <S> <C> <C> <C> <C> Interest income: Interest and fees on loans $11,514 $ 9,290 $21,800 $18,072 Interest on investment securities 2,031 1,560 3,584 3,123 Interest on federal funds sold 88 15 105 84 Interest on deposits with other financial institutions 18 8 21 18 ------------------ ---------------- ---------------- --------------- Total interest income 13,651 10,873 25,510 21,297 Interest expense: Interest on deposits 4,381 2,636 7,830 5,151 Interest on securities sold under agreements to repurchase 530 336 1,011 619 Interest on other borrowings 671 526 1,270 937 Interest on subordinated debentures 304 153 494 293 ------------------ ---------------- ---------------- --------------- Total interest expense 5,886 3,651 10,605 7,000 ------------------ ---------------- ---------------- --------------- Net interest income 7,765 7,222 14,905 14,297 Provision for loan losses 211 150 404 337 ------------------ ---------------- ---------------- --------------- Net interest income after provision for loan losses 7,554 7,072 14,501 13,960 Other income: Trust revenues 600 572 1,209 1,208 Brokerage commissions 204 115 296 212 Insurance commissions 498 401 1,074 912 Service charges 1,334 1,153 2,484 2,187 Securities gains (losses), net - 81 (1) 254 Mortgage banking revenue, net 94 168 161 321 Other 685 578 1,325 1,150 ------------------ ---------------- ---------------- --------------- Total other income 3,415 3,068 6,548 6,244 Other expense: Salaries and employee benefits 3,884 3,406 7,447 6,880 Net occupancy and equipment expense 1,198 1,044 2,334 2,080 Amortization of intangible assets 191 145 329 287 Stationery and supplies 130 125 265 264 Legal and professional 344 472 631 858 Marketing and promotion 244 228 420 351 Other 1,146 1,074 2,240 2,080 ------------------ ---------------- ---------------- --------------- Total other expense 7,137 6,494 13,666 12,800 ------------------ ---------------- ---------------- --------------- Income before income taxes 3,832 3,646 7,383 7,404 Income taxes 1,310 1,284 2,457 2,607 ------------------ ---------------- ---------------- --------------- Net income $ 2,522 $ 2,362 $ 4,926 $ 4,797 ================== ================ ================ =============== Per share data: Basic earnings per share $ 0.58 $ 0.53 $ 1.13 $ 1.08 Diluted earnings per share $ 0.57 $ 0.52 $ 1.11 $ 1.06 Cash dividends per share $ 0.26 $ 0.24 $ 0.26 $ 0.24 </TABLE> See accompanying notes to unaudited condensed consolidated financial statements.
Consolidated Statements of Cash Flows (unaudited) (In thousands) <TABLE> <CAPTION> Six months ended June 30, 2006 2005 ------------ ------------ <S> <C> <C> Cash flows from operating activities: Net income $ 4,926 $ 4,797 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 404 337 Depreciation, amortization and accretion, net 853 749 92 - Stock-based compensation expense (Gain) loss on sale of securities, net 1 (254) Loss on sale of other real property owned, net 38 108 Gain on sale of loans held for sale, net (197) (378) Origination of loans held for sale (14,864) (29,543) Proceeds from sale of loans held for sale 14,186 27,769 Decrease in other assets 584 200 Increase (decrease) in other liabilities (36) 43 ------------ ------------ Net cash provided by operating activities 5,987 3,828 ------------ ------------ Cash flows from investing activities: Proceeds from sales of securities available-for-sale 5,336 38,702 Proceeds from maturities of securities available-for-sale 35,139 58,456 roceeds from maturities of securities held-to-maturity 120 120 Purchases of securities available-for-sale (24,981) (76,685) Purchases of securities held-to-maturity - (145) Net increase in loans (23,642) (17,660) Purchases of premises and equipment (753) (522) Proceeds from sales of other real property owned 274 511 Payment related to acquisition, net of cash and cash equivalents acquired (12,060) - ------------ ------------ Net cash (used in) provided by investing activities (20,567) 2,777 ------------ ------------ Cash flows from financing activities: Net increase (decrease) in deposits 23,202 (12,848) Decrease in repurchase agreements (14,802) (9,630) Proceeds from short term FHLB advances 65,600 7,000 Proceeds from long term FHLB advances 10,000 12,000 Repayment of short term FHLB advances (79,600) (7,300) Proceeds from short term debt 500 3,500 Proceeds from long term debt 15,000 - Repayment of short term debt (6,000) (2,100) Issuance of junior subordinated debentures 10,310 - Proceeds from issuance of common stock 475 653 Purchase of treasury stock (4,238) (3,303) Dividends paid on common stock (1,514) (1,431) ------------ ------------ Net cash provided by (used in) financing activities 18,933 (13,459) ------------ ------------ Increase (decrease) in cash and cash equivalents 4,353 (6,854) Cash and cash equivalents at beginning of period 19,557 23,554 ------------ ------------ Cash and cash equivalents at end of period $23,910 $16,700 ============ ============ Supplemental disclosures of cash flow information Cash paid during the period for: Interest $9,815 $7,000 Income taxes 2,360 2,809 Supplemental disclosures of noncash investing and financing activities Loans transferred to real estate owned 346 50 Dividends reinvested in common stock 757 699 Net tax benefit related to option and deferred compensation plans 147 118 </TABLE> See accompanying notes to unaudited condensed consolidated financial statements.
Notes to Consolidated Financial Statements (unaudited) Basis of Accounting and Consolidation The unaudited consolidated financial statements include the accounts of First Mid-Illinois Bancshares, Inc. ("Company") and its wholly-owned subsidiaries: Mid-Illinois Data Services, Inc. ("MIDS"), The Checkley Agency, Inc. ("Checkley"), Mansfield Bancorp, Inc. ("Mansfield") and its wholly-owned subsidiary Peoples State Bank of Mansfield ("Peoples State Bank") and First Mid-Illinois Bank & Trust, N.A. ("First Mid Bank"). All significant intercompany balances and transactions have been eliminated in consolidation. The financial information reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods ended June 30, 2006 and 2005, and all such adjustments are of a normal recurring nature. Certain amounts in the prior year's consolidated financial statements have been reclassified to conform to the June 30, 2006 presentation and there was no impact on net income or stockholders' equity. The results of the interim period ended June 30, 2006 are not necessarily indicative of the results expected for the year ending December 31, 2006. The Company operates as a one-segment entity for financial reporting purposes. The 2005 year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. The unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information required by U.S. generally accepted accounting principles for complete financial statements and related footnote disclosures although the Company believes that the disclosures made are adequate to make the information not misleading. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2005 Annual Report on Form 10-K. Website The Company maintains a website at www.firstmid.com. All periodic and current reports of the Company and amendments to these reports filed with the Securities and Exchange Commission ("SEC") can be accessed, free of charge, through this website as soon as reasonably practicable after these materials are filed with the SEC. Comprehensive Income The Company's comprehensive income for the three and six-month periods ended June 30, 2006 and 2005 was as follows (in thousands): <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ------------------------- -------------------------- 2006 2005 2006 2005 ------------ ------------ ------------ ------------- <S> <C> <C> <C> <C> Net income $2,522 $2,362 $4,926 $4,797 Other comprehensive income: Unrealized loss during the period (1,174) 805 (1,417) (636) Less realized (gain) loss during the period - (81) 1 (254) Tax effect 458 (282) 552 347 ------------ ------------ ------------ ------------- Total other comprehensive loss (716) 442 (864) (543) ------------ ------------ ------------ ------------- Comprehensive income $1,806 $2,804 $4,062 $4,254 ============ ============ ============ ============= </TABLE> New Accounting Pronouncements In February 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 155 (FAS 155), "Accounting for Certain Hybrid Financial Instruments: an amendment of FASB Statements No. 133 and 140." FAS 155 permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. FAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of FAS 155 to have a material effect on the results of operations or the statement of condition. In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 (FAS 156), "Accounting for Servicing of Financial Assets: an amendment of FASB Statement No. 140. ". FAS 140 establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. This Statement amends FAS 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. Adoption of this Statement is required as of the beginning of the first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of FAS 156 to have a material effect on the results of operations or the statement of condition. In July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109," which provides guidance on the measurement, recognition, and disclosure of tax positions taken or expected to be taken in a tax return. The Interpretation also provides guidance on derecognition, classification, interest and penalties, and disclosure. FIN 48 prescribes that a tax position should only be recognized if it is more-likely-than-not that the position will be sustained upon examination by the appropriate taxing authority. A tax position that meets this threshold is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The cumulative effect of applying the provisions of FIN 48 is to be reported as an adjustment to the beginning balance of retained earnings in the period of adoption. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact, if any, that the adoption of this Interpretation will have on its financial statements. Earnings Per Share Basic earnings per share ("EPS") is calculated as net income divided by the weighted average number of common shares outstanding. Diluted EPS is computed using the weighted average number of common shares outstanding, increased by the assumed conversion of the Company's stock options, unless anti-dilutive. The components of basic and diluted earnings per common share for the three and six-month periods ended June 30, 2006 and 2005 were as follows: <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, ------------------------------ ------------------------------ 2006 2005 2006 2005 --------------- -------------- -------------- --------------- <S> <C> <C> <C> <C> Basic Earnings per Share: Net income $2,522,000 $2,362,000 $4,926,000 $4,797,000 Weighted average common shares outstanding 4,338,642 4,431,866 4,361,079 4,441,062 --------------- -------------- -------------- --------------- Basic earnings per common share $ .58 $ .53 $1.13 $1.08 =============== ============== ============== =============== Diluted Earnings per Share: Weighted average common shares outstanding 4,338,642 4,431,866 4,361,079 4,441,062 Assumed conversion of stock options 86,827 90,799 87,850 91,957 --------------- -------------- -------------- --------------- Diluted weighted average common shares outstanding 4,425,469 4,522,665 4,448,929 4,533,019 --------------- -------------- -------------- --------------- Diluted earnings per common share $ .57 $ .52 $1.11 $1.06 =============== ============== ============== =============== </TABLE> Stock options for 72,000 shares of common stock were not considered in computing diluted earnings per share for 2006 and 2005 because they were anti-dilutive. Acquisition On May 1, 2006, the Company completed the acquisition, for $24 million in cash, of all of the outstanding common stock of Mansfield Bancorp, Inc. ("Mansfield"), and its wholly-owned subsidiary, People State Bank of Mansfield ("Peoples"), located in Mansfield, Mahomet and Weldon, Illinois, in order to expand its market presence in this area. The Company financed the purchase price through a dividend of $5 million from First Mid Bank, an issuance of $10 million of trust preferred securities and a $9.5 million draw on the Company's line of credit with The Northern Trust Company. Following the completion of the acquisition, the Company filed certain regulatory applications related to the planned post-completion mergers of Mansfield into Peoples and Peoples into First Mid Bank. Following the completion of these mergers, Mansfield and Peoples will cease to exist and Peoples' current operations will be merged into First Mid Bank's. These mergers are scheduled for completion in the third quarter of 2006. The transaction has been accounted for as a purchase, and the results of operations of Mansfield and Peoples since the acquisition date have been included in the consolidated financial statements. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of this transaction (in thousands): Cash and cash equivalents $12,193 Investment securities 52,740 Loans 55,770 Less allowance for loan losses (1,405) Premises and equipment 1,465 Goodwill 8,332 Core deposit intangibles 3,132 Other asset 1,627 ------------- Total assets acquired 133,854 ------------- Deposits 108,114 Deferred income taxes 865 Other liabilities 622 ------------- Total liabilities assumed 109,601 ------------- Net assets acquired $ 24,253 ============= Transaction costs related to the completion of the transaction were approximately $253,000. The fair value of deposits acquired in the transaction exceeded the book value, resulting in a core deposit intangible asset of $3,132,000, which is being amortized over 10 years. The total fair value of the assets and liabilities acquired exceeded the book value, resulting in goodwill of $8,332,000, which is not subject to amortization. The core deposit intangibles and goodwill are not deductible for tax purposes. The following unaudited pro forma condensed combined financial information presents the results of operations of the Company, including the effects of the purchase accounting adjustments, issuance of trust preferred securities and bank loan, had the acquisition taken place at the beginning of each period (in thousands): For the period For the period ended ended June 30, 2006 June 30, 2005 --------------- --------------- Net interest income $15,871 $15,941 Provision for loan losses 444 397 Non-interest income 6,773 6,728 Non-interest expense 14,574 14,291 --------------- --------------- Income before income taxes 7,626 7,981 Income tax expense 2,659 2,705 --------------- --------------- Net income $ 4,967 $ 5,276 =============== =============== Earnings per share Basic $1.14 $1.19 Diluted $ 1.12 $1.16 Basic weighted average shares outstanding 4,361,079 4,441,062 Diluted weighted average shares outstanding 4,448,929 4,533,019 The unaudited pro forma condensed combined financial statements do not reflect any anticipated cost savings and revenue enhancements. Additionally, the income statement for the first six months of 2006 includes merger-related expenses. Accordingly, the pro forma results of operations of the Company as of and after the merger may not be indicative of the results that actually would have occurred if the merger had been in effect during the periods presented or of the results that may be attained in the future. Goodwill and Intangible Assets The Company has goodwill from business combinations, intangible assets from branch acquisitions, identifiable intangible assets assigned to core deposit relationships and customer lists of Checkley, and intangible assets arising from the rights to service mortgage loans for others. The following table presents gross carrying value and accumulated amortization by major intangible asset class as of June 30, 2006 and December 31, 2005 (in thousands): <TABLE> <CAPTION> June 30, 2006 December 31, 2005 -------------------------- ------------------------ Gross Gross Carrying Accumulated Carrying Accumulated Value Amortization Value Amortization ---------- --------------- ---------- -------------- <S> <C> <C> <C> <C> Goodwill not subject to amortization (effective 1/1/02) $21,126 $3,760 $12,794 $3,760 Intangibles from branch acquisition 3,015 1,860 3,015 1,760 Core deposit intangibles 5,937 2,574 2,805 2,440 Mortgage servicing rights 608 608 608 608 Customer list intangibles 1,904 841 1,904 746 ---------- --------------- ---------- -------------- $32,590 $9,643 $21,126 $9,314 ========== =============== ========== ============== </TABLE> The following table provides a reconciliation of the purchase price paid for the Mansfield acquisition and the amount of goodwill recorded (in thousands): Purchase price $24,000 Less: Mansfield equity (14,927) --------- 9,073 Direct acquisition costs 253 Less purchase accounting adjustments: Investments $993 Fixed assets 69 Existing goodwill 211 Core deposit intangible (3,132) -------- (1,859) Deferred taxes on purchase accounting adjustments 865 --------- Resulting goodwill from Mansfield acquisition $8,332 ========= Total amortization expense for the six months ended June 30, 2006 and 2005 was as follows (in thousands): June 30, 2006 2005 -------------- ------------- Intangibles from branch acquisition $100 $100 Core deposit intangibles 134 82 Mortgage servicing rights - 10 Customer list intangibles 95 95 -------------- ------------- $329 $287 ============== ============= Aggregate amortization expense for the current year and estimated amortization expense for each of the five succeeding years is shown in the table below (in thousands): Aggregate amortization expense: For period ended 6/30/06 $329 Estimated amortization expense: For period 07/01/06-12/31/06 $433 For year ended 12/31/07 $812 For year ended 12/31/08 $765 For year ended 12/31/09 $730 For year ended 12/31/10 $704 For year ended 12/31/11 $704 In accordance with the provisions of SFAS 142, the Company performed testing of goodwill for impairment as of September 30, 2005, and determined that, as of that date, goodwill was not impaired. Management also concluded that the remaining amounts and amortization periods were appropriate for all intangible assets. Stock Incentive Plan Prior to January 1, 2006, the Company accounted for its Stock Incentive Plan ("Plan") under the recognition and measurement provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), and related Interpretations, as permitted by Financial Accounting Standards Board ("FASB") Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). No stock option compensation cost was recognized in the Statement of Income as all options granted had an exercise price equal to the market value of the underlying common stock on the grant date. In December 2004, the FASB issued Statement No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123R"), which requires the cost resulting from stock options be measured at fair value and recognized in earnings. This Statement replaces SFAS No. 123 and supercedes APB No. 25 which permitted the recognition of compensation expense using the intrinsic value method. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R using the modified prospective application method. Under this method, the Statement applies to new awards and to awards modified, repurchased or cancelled after the effective date. Additionally, compensation cost for a portion of awards for which requisite services have not been rendered that are outstanding as of the effective date shall be recognized as the requisite service is rendered or after the effective date. As a result of this adoption, the Company's income before income taxes and net income for the six months ended June 30, 2006 have included stock option compensation cost of $92,000 and $88,000, respectively, which represents $.02 impact on basic and diluted earnings per share for the period. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 on stock-based employee compensation for the three and six- month periods ended June 30, 2005. <TABLE> <CAPTION> Three months ended Six months ended June 30, 2005 June 30, 2005 ------------------- -------------------- <S> <C> <C> Net income, as reported $2,362 $4,797 Stock based compensation expense determined under fair value based method, net of related tax effect (87) (183) ------------------- -------------------- Pro forma net income $2,275 $4,614 =================== ==================== Basic Earnings Per Share: As reported $.53 $ 1.08 Pro forma .51 1.04 Diluted Earnings Per Share: As reported $.52 $ 1.06 Pro forma .50 1.02 </TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis is intended to provide a better understanding of the consolidated financial condition and results of operations of the Company and its subsidiaries as of, and for the periods ended, June 30, 2006 and 2005. This discussion and analysis should be read in conjunction with the consolidated financial statements, related notes and selected financial data appearing elsewhere in this report. Forward-Looking Statements This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, such as discussions of the Company's pricing and fee trends, credit quality and outlook, liquidity, new business results, expansion plans, anticipated expenses and planned schedules. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are identified by use of the words "believe", "expect", "intend", "anticipate", "estimate", "project", or similar expressions. Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many uncertainties including: changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company's market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Company and its business, including additional factors that could materially affect the Company's financial results, is included in the Company's 2005 Annual Report on Form 10-K under the headings "Item 1. Business and "Item 1A. Risk Factors." New Accounting Standards Adopted During 2006 Prior to January 1, 2006, the Company accounted for its Stock Incentive Plan ("Plan") under the recognition and measurement provisions of APB No. 25, and related Interpretations, as permitted by SFAS No. 123. No stock option compensation cost was recognized in the Statement of Income as all options granted had an exercise price equal to the market value of the underlying common stock on the grant date. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R using the modified prospective application method. Under this method, the Statement applies to new awards and to awards modified, repurchased or cancelled after the effective date. Additionally, compensation cost for a portion of awards for which requisite services have not been rendered that are outstanding as of the effective date shall be recognized as the requisite service is rendered or after the effective date. As a result of this adoption, the Company's income before income taxes and net income for the three months ended June 30, 2006 have included stock option compensation cost of $43,000 and $41,000, respectively, which represents $.01 impact on basic and diluted earnings per share for the period. The Company's income before income taxes and net income for the six months ended June 30, 2006 have included stock option compensation cost of $92,000 and $88,000, respectively, which represents $.02 impact on basic and diluted earnings per share for the period. As of June 30, 2006, there was approximately $194,000 of total unrecognized compensation cost related to nonvested options under the Plan. The Company expects to recognize that cost over a weighted average period of less than four years. Overview This overview of management's discussion and analysis highlights selected information in this document and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates, you should carefully read this entire document. These have an impact on the Company's financial condition and results of operations. Net income was $4,926,000 and $4,797,000 and diluted earnings per share was $1.11 and $1.06 for the six months ended June 30, 2006 and 2005. The following table shows the Company's annualized performance ratios for the six months ended June 30, 2006 and 2005, compared to the performance ratios for the year ended December 31, 2005: Six months ended Year ended June 30, June 30, December 31, 2006 2005 2005 ------------ ---------- ------------ Return on average assets 1.10% 1.17% 1.18% Return on average equity 13.42% 13.64% 13.64% Average equity to average assets 8.23% 8.54% 8.64% Total assets at June 30, 2006 and December 31, 2005 were $982.5 million and $850.6 million, respectively. The increase in net assets was due to assets acquired of $133.9 million in the acquisition of Mansfield. Total assets excluding acquired assets decreased slightly as the result of a decrease in available-for-sale securities that matured during the first six months of 2006 and were not replaced and seasonal declines in cash and cash equivalents which were offset by an increase in loan balances, primarily residential and commercial real estate. Net loan balances were $709.3 million at June 30, 2006, an increase of $77.6 million, or 12.2%, from $631.7 million at December 31, 2005, primarily due to loans acquired in the acquisition of Mansfield and also increases in residential and commercial real estate loans. Total deposit balances increased to $780.4 million at June 30, 2006 from $649.1 million at December 31, 2005. Net interest margin, defined as net interest income divided by average interest-earning assets, was 3.58% for the six months ended June 30, 2006, down from 3.73% for the same period in 2005. The decrease in the net interest margin is attributable to a greater increase in borrowing and deposit rates compared to the increase in interest-earning asset rates. Net interest income before the provision for loan losses was $14.9 million with growth in average earning assets of $63.6 million for the six months ended June 30, 2006 compared to net interest income of $14.3 million for the same period in 2005. Noninterest income increased $304,000, or 4.9%, to $6.5 million for the six months ended June 30, 2006 compared to $6.2 million for the six months ended June 30, 2005. In addition to increased income due to the acquisition of Mansfield, the primary reason for this increase was an increase in ATM and bankcard service fees, service charges for overdrafts and insurance commissions during the first six months of 2006 compared to the same period in 2005. Noninterest expense increased 6.8%, or $866,000, to $13.7 million for the six months ended June 30, 2006 compared to $12.8 million during the same period in 2005. In addition to increases in noninterest expense due to the acquisition of Mansfield, the primary factor in the expense increase was increased salaries and benefits expense that resulted from merit increases for continuing employees, additional compensation expense recorded in accordance with the provisions of SFAS 123R, and an increase in occupancy expense for a new office location for Checkley. Following is a summary of the factors that contributed to the changes in net income (in thousands): 2006 versus 2005 Three months ended Six months ended June 30 June 30 ------------------- ------------------ Net interest income $ 543 $ 608 Provision for loan losses (61) (67) Other income, including securities transactions 347 304 Other expenses (643) (866) Income taxes (26) 150 ------------------- ------------------ Increase in net income $160 $129 =================== ================== Credit quality is an area of importance to the Company. Total nonperforming loans were $3.7 million at June 30, 2006, compared to $3.7 million at June 30, 2005 and $3.5 million at December 31, 2005. The Company's provision for loan loss for the six months ended June 30, 2006 and 2005 was $404,000 and $337,000, respectively. At June 30, 2006, the composition of the loan portfolio remained similar to the same period last year. During the six months ended June 30, 2006, net charge-offs were .07% of average loans compared to .09% for the same period in 2005. Loans secured by both commercial and residential real estate comprised 70% and 72% of the loan portfolio as of June 30, 2006 and 2005. The Company's capital position remains strong and the Company has consistently maintained regulatory capital ratios above the "well-capitalized" standards. The Company's Tier 1 capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at June 30, 2006 and 2005 was 9.72% and 11.13%, respectively. The Company's total capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at June 30, 2006 and 2005 was 10.49% and 11.90%, respectively. The Company's liquidity position remains sufficient to fund operations and meet the requirements of borrowers, depositors, and creditors. The Company maintains various sources of liquidity to fund its cash needs. See discussion under the heading "Liquidity" for a full listing of sources and anticipated significant contractual obligations. The Company enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include lines of credit, letters of credit and other commitments to extend credit. The total outstanding commitments at June 30, 2006 and 2005 were $118.8 million and $114.4 million, respectively. This increase is primarily attributable to the Mansfield acquisition. Critical Accounting Policies The Company has established various accounting policies that govern the application of U.S. generally accepted accounting principles in the preparation of the Company's financial statements. The significant accounting policies of the Company are described in the footnotes to the consolidated financial statements included in the Company's 2005 Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and assumptions, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company. The Company believes the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of its consolidated financial statements. In estimating the allowance for loan losses, management utilizes historical experience, as well as other factors, including the effect of changes in the local real estate market on collateral values, the effect on the loan portfolio of current economic indicators and their probable impact on borrowers, and increases or decreases in nonperforming and impaired loans. Changes in these factors may cause management's estimate of the allowance for loan losses to increase or decrease and result in adjustments to the Company's provision for loan losses. See heading "Loan Quality and Allowance for Loan Losses" for a more detailed description of the Company's estimation process and methodology related to the allowance for loan losses.
Results of Operations Net Interest Income The largest source of revenue for the Company is net interest income. Net interest income represents the difference between total interest income earned on earning assets and total interest expense paid on interest-bearing liabilities. The amount of interest income is dependent upon many factors, including the volume and mix of earning assets, the general level of interest rates and the dynamics of changes in interest rates. The cost of funds necessary to support earning assets varies with the volume and mix of interest-bearing liabilities and the rates paid to attract and retain such funds. The Company's average balances, interest income and expense and rates earned or paid for major balance sheet categories are set forth in the following table (dollars in thousands): <TABLE> <CAPTION> Six months ended Six months ended June 30, 2006 June 30, 2005 ------------------------------------------------------------------------ Average Average Average Average Balance Interest Rate Balance Interest Rate ------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> ASSETS Interest-bearing deposits $ 978 $ 21 4.33% $1,432 $ 18 2.50% Federal funds sold 6,340 105 3.34% 7,166 84 2.34% Investment securities Taxable 150,221 3,225 4.29% 145,833 2,659 3.65% Tax-exempt (1) 16,659 359 4.31% 20,959 464 4.43% Loans (2)(3) 661,783 21,800 6.64% 596,951 18,072 6.11% ------------------------------------------------------------------------ Total earning assets 835,981 25,510 6.15% 772,341 21,297 5.55% Cash and due from banks 17,635 18,180 Premises and equipment 15,702 15,093 Other assets 28,041 22,302 Allowance for loan losses (5,247) (4,737) ------------ --------------- Total assets $892,112 $823,179 ============ =============== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing deposits Demand deposits $233,133 $ 2,213 1.91% $228,689 $1,203 1.06% Savings deposits 61,252 143 .47% 61,537 119 .39% Time deposits 298,978 5,474 3.69% 261,010 3,829 2.96% Securities sold under agreements to repurchase 50,906 1,011 4.00% 59,608 619 2.09% FHLB advances 42,321 954 4.55% 32,453 807 5.01% Federal funds purchased 5,851 95 3.27% 635 10 3.23% Junior subordinated debt 14,069 494 7.08% 10,310 293 5.74% Other debt 7,392 221 6.03% 5,901 120 4.10% ------------------------------------------------------------------------ Total interest-bearing liabilities 713,902 10,605 3.00% 660,143 7,000 2.14% Non interest-bearing demand deposits 98,897 87,828 Other liabilities 5,913 4,873 Stockholders' equity 73,400 70,335 ------------ --------------- Total liabilities & equity $892,112 $823,179 ============ =============== Net interest income $14,905 $14,297 ============ =========== Net interest spread 3.15% 3.41% Impact of non-interest bearing funds .43% .32% ------------ ------------ Net yield on interest- earning assets 3.58% 3.73% ============ ============ </TABLE> (1) The tax-exempt income is not recorded on a tax equivalent basis. (2)Nonaccrual loans have been included in the average balances. (3) Includes loans held for sale. Changes in net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table summarizes the approximate relative contribution of changes in average volume and interest rates to changes in net interest income for the six months ended June 30, 2006, compared to the same period in 2005 (in thousands): For the six months ended June 30, 2006 compared to 2005 Increase / (Decrease) Total Change Volume (1) Rate (1) ---------------------------------------- Earning Assets: Interest-bearing deposits $ 3 $ (15) $ 18 Federal funds sold 21 (26) 47 Investment securities: Taxable 566 83 483 Tax-exempt (2) (105) (93) (12) Loans (3) 3,728 2,073 1,655 ---------------------------------------- Total interest income 4,213 2,022 2,191 ----------------------------------------- Interest-Bearing Liabilities: Interest-bearing deposits Demand deposits 1,010 24 986 Savings deposits 24 (1) 25 Time deposits 1,645 610 1,035 Securities sold under agreements to repurchase 392 (260) 652 FHLB advances 147 342 (195) Federal funds purchased 85 85 - Junior subordinated debt 201 123 78 Other debt 101 35 66 ---------------------------------------- Total interest expense 3,605 958 2,647 ---------------------------------------- Net interest income $ 608 $ 1,064 $(456) ======================================== (1) Changes attributable to the combined impact of volume and rate have been allocated proportionately to the change due to volume and the change due to rate. (2) The tax-exempt income is not recorded on a tax-equivalent basis. (3) Nonaccrual loans have been included in the average balances. Net interest income increased $608,000, or 4.3% to $14.9 million for the six months ended June 30, 2006, from $14.3 million for the same period in 2005. The increase in net interest income was due to an increase in rates and growth in earning assets, primarily composed of loan growth, which was largely offset by an increase in the cost of interest-bearing liabilities. For the six months ended June 30, 2006, average earning assets increased by $63.6 million, or 8.2%, and average interest-bearing liabilities increased $53.8 million, or 8.1%, compared with average balances for the same period in 2005. The changes in average balances for these periods are shown below: o Average loans increased by $64.8 million or 10.9%. o Average securities increased by $.1 million or 0.1%. o Average interest-bearing deposits increased by $42.1 million or 7.6%. o Average securities sold under agreements to repurchase decreased by $8.7 million or 14.6%. o Average borrowings and other debt increased by $20.3 million or 41.2%. o Net interest margin decreased to 3.58% for the first six months of 2006 from 3.73% for the first six months of 2005. To compare the tax-exempt yields on interest-earning assets to taxable yields, the Company also computes non-GAAP net interest income on a tax equivalent basis (TE) where the interest earned on tax-exempt securities is adjusted to an amount comparable to interest subject to normal income taxes assuming a federal tax rate of 34% (referred to as the tax equivalent adjustment). The net yield on interest-earning assets (TE) was 3.62% for the first six months of 2006 and 3.78% for the first six months of 2005. The TE adjustments to net interest income for June 30, 2006 and 2005 were $185,000 and $239,000, respectively. Provision for Loan Losses The provision for loan losses for the six months ended June 30, 2006 and 2005 was $404,000 and $337,000, respectively. Nonperforming loans were $3.7 million as of June 30, 2006 and 2005. Net charge-offs were $234,000 for the six months ended June 30, 2006 compared to $271,000 during the same period in 2005. For information on loan loss experience and nonperforming loans, see discussion under the "Nonperforming Loans" and "Loan Quality and Allowance for Loan Losses" sections below. Other Income An important source of the Company's revenue is derived from other income. The following table sets forth the major components of other income for the three months and six months ended June 30, 2006 and 2005 (in thousands): <TABLE> <CAPTION> Three months ended June 30, Six months ended June 30, 2006 2005 $ Change 2006 2005 $ Change ------------- ------------- ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> <C> <C> Trust $600 $572 $ 28 $1,209 $1,208 $ 1 Brokerage 204 115 89 296 212 84 Insurance commissions 498 401 97 1,074 912 162 Service charges 1,334 1,153 181 2,484 2,187 297 Security gains (losses) - 81 (81) (1) 254 (255) Mortgage banking 94 168 (74) 161 321 (160) Other 685 578 107 1,325 1,150 175 ------------- ------------- ------------- ------------- ------------- ------------- Total other income $3,415 $3,068 $ 347 $6,548 $6,244 $ 304 ============= ============= ============= ============= ============= ============= </TABLE> Following are explanations for the three months ended June 30, 2006 compared to the same period in 2005: o Trust revenues increased $28,000 or 4.9% to $600,000 from $572,000. Trust assets, at market value, were $410 million at June 30, 2006 compared to $390 million at June 30, 2005. The increase in trust revenues was due to non-recurring executor and sales fees received in the second quarter of 2006 that were not received in 2005. o Revenues from brokerage increased $89,000 or 77.4% to $204,000 from $115,000 due to greater commissions received on sales of annuities. o Insurance commissions increased $97,000 or 24.2% to $498,000 from $401,000 due to an increase in commissions received on sales of business property and casualty insurance. o Fees from service charges increased $181,000 or 15.7% to $1,334,000 from $1,153,000. This was primarily the result of an increase in the number of overdrafts and an increase in the per overdraft fee to $25 from $22.50. o The sale of securities during the three months ended June 30, 2006 resulted in no net securities gains or losses compared to the three months ended June 30, 2005 which resulted in securities gains of $81,000. o Mortgage banking income decreased $74,000 or 44.0% to $94,000 from $168,000. This decrease was due to the decreased volume of fixed rate loans originated and sold by First Mid Bank. Loans sold balances were as follows: o $7.9 million (representing 76 loans) for the second quarter of 2006. o $13.8 million (representing 139 loans) for the second quarter of 2005. First Mid Bank generally releases the servicing rights on loans sold into the secondary market. o Other income increased $107,000 or 18.5% to $685,000 from $578,000. This increase was primarily due to increased ATM service fees. Following are explanations for the six months ended June 30, 2006 compared to the same period in 2005: o Trust revenues increased $1,000 or .1% to $1,209,000 from $1,208,000. Trust assets, at market value, were $410 million at June 30, 2006 compared to $390 million at June 30, 2005. o Revenues from brokerage increased $84,000 or 39.6% to $296,000 from $212,000 due to greater commissions received on sales of annuities. o Insurance commissions increased $162,000 or 17.8% to $1,074,000 from $912,000 due to an increase in commissions received on sales of business property and casualty insurance. o Fees from service charges increased $297,000 or 13.6% to $2,484,000 from $2,187,000. This was primarily the result of an increase in the number of overdrafts and an increase in the per overdraft fee to $25 from $22.50. o The sale of securities during the six months ended June 30, 2006 resulted in net securities losses of $1,000 compared to the six months ended June 30, 2005 which resulted in securities gains of $254,000. o Mortgage banking income decreased $160,000 or 49.8% to $161,000 from $321,000. This decrease was due to the decreased volume of fixed rate loans originated and sold by First Mid Bank. Loans sold balances were as follows: o $14.0 million (representing 138 loans) for the first six months of 2006. o $27.4 million (representing 268 loans) for the first six months of 2005. First Mid Bank generally releases the servicing rights on loans sold into the secondary market. o Other income increased $175,000 or 15.2% to $1,325,000 from $1,150,000. This increase was primarily due to increased ATM service fees. Other Expense The major categories of other expense include salaries and employee benefits, occupancy and equipment expenses and other operating expenses associated with day-to-day operations. The following table sets forth the major components of other expense for the three months and six months ended June 30, 2006 and 2005 (in thousands): <TABLE> <CAPTION> Three months ended June 30, Six months ended June 30, 2006 2005 $ Change 2006 2005 $ Change ------------ ------------- ------------- ----------- ------------ ------------- <S> <C> <C> <C> <C> <C> <C> Salaries and benefits $ 3,884 $ 3,406 $ 478 $ 7,447 $ 6,880 $ 567 Occupancy and equipment 1,198 1,044 154 2,334 2,080 254 Amortization of intangibles 191 145 46 329 287 42 Stationery and supplies 130 125 5 265 264 1 Legal and professional fees 344 472 (128) 631 858 (227) Marketing and promotion 244 228 16 420 351 69 Other operating expenses 1,146 1,074 72 2,240 2,080 160 ------------ ------------- ------------- ----------- ------------ ------------- Total other expense $ 7,137 $ 6,494 $ 643 $13,666 $12,800 $ 866 ============ ============= ============= =========== ============ ============= </TABLE> Following are explanations for the three months ended June 30, 2006 compared to the same period in 2005: o Salaries and employee benefits, the largest component of other expense, increased $478,000 or 14.0% to $3,884,000 from $3,406,000. This increase is due to additional expense as a result of the acquisition of Mansfield, merit increases for continuing employees and $43,000 of additional compensation expense recorded in accordance with the provisions of SFAS 123R. There were 349 full-time equivalent employees at June 30, 2006 compared to 317 at June 30, 2005. o Occupancy and equipment expense increased $154,000 or 14.8% to $1,198,000 from $1,044,000 due to an increase in occupancy expenses for Mansfield, the new office location of Checkley and the Highland branch facility that were opened in 2005. o Expense for amortization of intangible assets increased $46,000 or 31.7% to $191,000 from $145,000 due to the additional core deposit intangible amortization expense resulting from the acquisition of Mansfield. o Other operating expenses increased $72,000 or 6.7% to $1,146,000 in 2006 from $1,074,000 in 2005 due to increases in various expenses including ATM and bankcard expenses. o All other categories of operating expenses decreased a net of $107,000 or 13.0% to $718,000 from $825,000. The decrease was primarily due to decreases in various professional fees. Following are explanations for the six months ended June 30, 2006 compared to the same period in 2005: o Salaries and employee benefits, the largest component of other expense, increased $567,000 or 8.2% to $7,447,000 from $6,880,000. This increase is due to additional expense as a result of the acquisition of Mansfield, merit increases for continuing employees and $92,000 of additional compensation expense recorded in accordance with the provisions of SFAS 123R. There were 349 full-time equivalent employees at June 30, 2006 compared to 317 at June 30, 2005. o Occupancy and equipment expense increased $254,000 or 12.2% to $2,334,000 from $2,080,000 due to an increase in occupancy expenses for Mansfield, for the new office location of Checkley and the Highland branch facility that were opened in 2005. o Expense for amortization of intangible assets increased $42,000 or 14.6% to $329,000 from $287,000 due to the additional core deposit intangible amortization expense resulting from the acquisition of Mansfield. o Other operating expenses increased $160,000 or 7.7% to $2,240,000 in 2006 from $2,080,000 in 2005 due to increases in various expenses including ATM and bankcard expenses. o All other categories of operating expenses decreased a net of $157,000 or 10.7% to $1,316,000 from $1,473,000. The decrease was primarily due to decreases in various professional fees. Income Taxes Total income tax expense amounted to $2,457,000 (33.3% effective tax rate) for the six months ended June 30, 2006, compared to $2,607,000 (35.2% effective tax rate) for the same period in 2005. The change in the effective tax rate in 2006 is due to a $142,000 reduction in the state tax expense accrual as a result of amending the 2004 state income tax return for a greater deduction in enterprise zone interest filed during the first quarter of 2006. This resulted in a $92,000 net reduction in tax expense. Additional reduction in state tax expense for 2006 resulted from an increase in deductible enterprise zone loans.
Analysis of Balance Sheets Loans The loan portfolio (net of unearned interest) is the largest category of the Company's earning assets. The following table summarizes the composition of the loan portfolio, including loans held for sale, as of June 30, 2006 and December 31, 2005 (in thousands): June 30, December 31, 2006 2005 ---------------- -------------- Real estate - residential $148,359 $117,204 Real estate - agricultural 57,114 50,730 Real estate - commercial 299,511 282,501 ---------------- -------------- Total real estate - mortgage 504,984 450,435 Commercial and agricultural 167,478 150,598 Installment 41,568 34,385 Other 4,156 2,715 --------------- --------------- Total loans $718,186 $638,133 ================ ============== Overall loans increased $80.1 million, or 12.5%. The acquisition of Mansfield resulted in an increase of approximately $55.8 million in overall loans. The remaining increase was primarily a result of an increase in residential and commercial real estate loans. Total real estate mortgage loans have averaged approximately 71% of the Company's total loan portfolio for the past several years. This is the result of the Company's focus on commercial real estate lending and long-term commitment to residential real estate lending. The balance of real estate loans held for sale amounted to $2,653,000 and $1,778,000 as of June 30, 2006 and December 31, 2005, respectively. At June 30, 2006, the Company had loan concentrations in agricultural industries of $93.9 million, or 13%, of outstanding loans and $92.3 million, or 14.5%, at December 31, 2005. In addition, the Company had loan concentrations in the following industries as of June 30, 2006 compared to December 31, 2005 (dollars in thousands): <TABLE> <CAPTION> June 30, 2006 December 31, 2005 Principal % Outstanding Principal % Outstanding balance loans Balance loans ---------------- --------------- ----------------- --------------- <S> <C> <C> <C> <C> Operators of non-residential $28,500 3.97% $22,446 3.52% buildings Apartment building owners 35,414 4.93% 40,843 6.40% Motels, hotels & tourist courts 28,920 4.03% 28,054 4.40% Subdividers & developers 27,923 3.89% 26,397 4.14% </TABLE> The Company had no further loan concentrations in excess of 25% of total risk-based capital. The following table presents the balance of loans outstanding as of June 30, 2006, by maturities (in thousands): <TABLE> <CAPTION> Maturity (1) Over 1 One year through Over or less (2) 5 years 5 years Total ---------------------------------------------------------------- <S> <C> <C> <C> <C> Real estate - residential $ 61,213 $ 70,521 $ 16,625 $148,359 Real estate - agricultural 12,738 36,572 7,804 57,114 Real estate - commercial 71,937 204,007 23,567 299,511 ---------------------------------------------------------------- Total real estate - mortgage 145,888 311,100 47,996 504,984 Commercial and agricultural 112,684 51,281 3,513 167,478 Installment 20,321 20,960 287 41,568 Other 926 2,206 1,024 4,156 ---------------------------------------------------------------- Total loans $279,819 $385,547 $ 52,820 $718,186 ================================================================ </TABLE> (1) Based on scheduled principal repayments. (2) Includes demand loans, past due loans and overdrafts. As of June 30, 2006, loans with maturities over one year consisted of approximately $363 million fixed rate loans and $75 million in variable rate loans. The loan maturities noted above are based on the contractual provisions of the individual loans. Rollovers and borrower requests are handled on a case-by-case basis. Nonperforming Loans Nonperforming loans are defined as: (a) loans accounted for on a nonaccrual basis; (b) accruing loans contractually past due ninety days or more as to interest or principal payments; and (c) loans not included in (a) and (b) above which are defined as "renegotiated loans". The Company's policy is to cease accrual of interest on all loans that become ninety days past due as to principal or interest. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The following table presents information concerning the aggregate amount of nonperforming loans at June 30, 2006 and December 31, 2005 (in thousands): June 30, December 31, 2006 2005 --------------- -------------- Nonaccrual loans $3,660 $3,458 Renegotiated loans which are performing in accordance with revised terms - - --------------- -------------- Total nonperforming loans $3,660 $3,458 =============== ============== The $202,000 increase in nonaccrual loans during the six months ended June 30, 2006 resulted from the net of $180,000 of loans added to nonaccrual through acquisition of Mansfield, $1,201,000 of additional loans put on nonaccrual status, $882,000 of loans brought current or paid-off, $127,000 of loans transferred to other real estate owned and $170,000 of loans charged-off. Interest income that would have been reported if nonaccrual and renegotiated loans had been performing totaled $73,000 and $60,000 for the periods ended June 30, 2006 and 2005, respectively. Loan Quality and Allowance for Loan Losses The allowance for loan losses represents management's estimate of the reserve necessary to adequately account for probable losses that could ultimately be realized from current loan exposures. The provision for loan losses is the charge against current earnings that is determined by management as the amount needed to maintain an adequate allowance for loan losses. In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, management relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company's credit exposure. The review process is directed by overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty. Once identified, the magnitude of exposure to individual borrowers is quantified in the form of specific allocations of the allowance for loan losses. Management considers collateral values and guarantees in the determination of such specific allocations. Additional factors considered by management in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and renegotiated loans, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates. Management considers the allowance for loan losses a critical accounting policy. Management recognizes there are risk factors that are inherent in the Company's loan portfolio. All financial institutions face risk factors in their loan portfolios because risk exposure is a function of the business. The Company's operations (and therefore its loans) are concentrated in east central Illinois, an area where agriculture is the dominant industry. Accordingly, lending and other business relationships with agriculture-based businesses are critical to the Company's success. At June 30, 2006, the Company's loan portfolio included $93.9 million of loans to borrowers whose businesses are directly related to agriculture. The balance increased $1.6 million from $92.3 million at December 31, 2005. While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio. In addition, the Company has $28.9 million of loans to motels, hotels and tourist courts. The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region. While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in non-performing loans to this business segment and potentially in loan losses. The Company also has $28.5 million of loans to operators of non-residential buildings, $35.4 million of loans to apartment building owners and $27.9 million of loans to subdividers and developers. A significant widespread decline in real estate values could result in an increase in non-performing loans to this segment and potentially in loan losses. Analysis of the allowance for loan losses as of June 30, 2006 and 2005, and of changes in the allowance for the three-month and six-month periods ended June 30, 2006 and 2005, is as follows (dollars in thousands): <TABLE> <CAPTION> Three months ended June 30, Six months ended June 30, 2006 2005 2006 2005 --------------------------------------------------------------- <S> <C> <C> <C> <C> Average loans outstanding, net of unearned income $687,923 $604,329 $661,783 $596,951 Allowance-beginning of period $ 4,729 $ 4,737 $ 4,648 $ 4,621 Allowance of Mansfield acquired in business combination 1,405 - 1,405 Charge-offs: Real estate-mortgage 24 130 48 130 Commercial, financial & agricultural 60 21 183 118 Installment 23 39 27 89 Other 45 23 75 23 --------------------------------------------------------------- Total charge-offs 152 213 333 360 Recoveries: Real estate-mortgage 2 - 4 - Commercial, financial & agricultural - 5 21 66 Installment 4 5 14 20 Other 24 3 60 3 --------------------------------------------------------------- Total recoveries 30 13 99 89 --------------------------------------------------------------- Net charge-offs (recoveries) 122 200 234 271 Provision for loan losses 211 150 404 337 --------------------------------------------------------------- Allowance-end of period $ 6,223 $ 4,687 $ 6,223 $ 4,687 =============================================================== Ratio of annualized net charge-offs to average loans .07% .13% .07% .09% =============================================================== Ratio of allowance for loan losses to loans outstanding(less unearned interest at end of period) .87% .76% .87% .76% =============================================================== Ratio of allowance for loan losses to nonperforming loans 170.0% 126.6% 170.0% 126.6% =============================================================== </TABLE> During the first six months of 2006, the Company had charge-offs of $142,000 on commercial loans of two borrowers. During the first six months of 2005, the Company had charge-offs of $53,000 on two agricultural loans of a single borrower and a charge-off of $44,000 on a commercial loan of a single borrower and a charge-off of $113,000 on a loan secured by residential real estate of a single borrower. The Company minimizes credit risk by adhering to sound underwriting and credit review policies. Management and the board of directors of the Company review these policies at least annually. Senior management is actively involved in business development efforts and the maintenance and monitoring of credit underwriting and approval. The loan review system and controls are designed to identify, monitor and address asset quality problems in an accurate and timely manner. On a quarterly basis, the board of directors and management review the status of problem loans and determine a best estimate of the allowance. In addition to internal policies and controls, regulatory authorities periodically review asset quality and the overall adequacy of the allowance for loan losses. Securities The Company's overall investment objectives are to insulate the investment portfolio from undue credit risk, maintain adequate liquidity, insulate capital against changes in market value and control excessive changes in earnings while optimizing investment performance. The types and maturities of securities purchased are primarily based on the Company's current and projected liquidity and interest rate sensitivity positions. The following table sets forth the amortized cost of the securities as of June 30, 2006 and December 31, 2005 (dollars in thousands): <TABLE> <CAPTION> June 30, 2006 December 31, 2005 ----------------------------- --------------------------- Weighted Weighted Amortized Average Amortized Average Cost Yield Cost Yield -------------- -------------- ------------- ------------- <S> <C> <C> <C> <C> U.S. Treasury securities and obligations of U.S. government corporations and agencies $137,250 4.62% $108,506 3.74% Obligations of states and political 20,568 4.30% 16,829 4.54% subdivisions Mortgage-backed securities 25,061 4.86% 20,046 4.34% Other securities 12,965 6.35% 13,083 6.21% -------------- -------------- ------------- ------------- Total securities $195,844 4.73% $158,464 4.10% ============== ============== ============= ============= </TABLE> At June 30, 2006, the Company's investment portfolio showed an increase of $37.4 million from 2005 due to securities acquired in the acquisition of Mansfield offset by various securities that matured during the first quarter of 2006 and were not immediately replaced. The amortized cost, gross unrealized gains and losses and estimated fair values for available-for-sale and held-to-maturity securities by major security type at June 30, 2006 and December 31, 2005 were as follows (in thousands): <TABLE> <CAPTION> Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains (Losses) Value ----------- ----------- ------------ ---------- <S> <C> <C> <C> <C> June 30, 2006 Available-for-sale: U.S. Treasury securities and obligations of U.S. government corporations & agencies $137,250 $ - $(2,331) $134,919 Obligations of states and political subdivisions 19,225 149 (135) 19,239 Mortgage-backed securities 25,061 19 (793) 24,287 Federal Home Loan Bank stock 4,523 - - 4,523 Other securities 8,442 465 (1) 8,906 ----------- ----------- ------------ ---------- Total available-for-sale $194,501 $ 633 $(3,260) $191,874 =========== =========== ============ ========== Held-to-maturity: Obligations of states and political subdivisions $ 1,343 $ 21 $ - $1,364 =========== =========== ============ ========== December 31, 2005 Available-for-sale: U.S. Treasury securities and obligations of U.S. government corporations & agencies $ 108,506 $ 31 $(1,500) $ 107,037 Obligations of states and political subdivisions 15,417 239 (50) 15,606 Mortgage-backed securities 20,046 25 (442) 19,629 Federal Home Loan Bank stock 5,557 - - 5,557 Other securities 7,526 486 - 8,012 ----------- ----------- ------------ ---------- Total available-for-sale $157,052 $ 781 $(1,992) $155,841 =========== =========== ============ ========== Held-to-maturity: Obligations of states and political subdivisions $ 1,412 $ 30 $ - $ 1,442 =========== =========== ============ ========== </TABLE> At June 30, 2006, there were six mortgage-backed securities with a fair value of $15,004,000 and an unrealized loss of $687,000, and eight obligations of U.S. government agencies with a fair value of $43,568,000 and an unrealized loss of $1,349,000, in a continuous unrealized loss position for twelve months or more. At June 30, 2005, there was one mortgage-backed security with a fair value of $2,730,000 and an unrealized loss of $26,000, and five obligations of U.S. government agencies with a fair value of $21,369,000 and an unrealized loss of $276,000, in a continuous unrealized loss position for twelve months or more. This position is due to short-term and intermediate rates increasing since the purchase of these securities resulting in the market value of the security being lower than book value. Management does not believe any individual unrealized loss as of June 30, 2006 or December 31, 2005 represents an other than temporary impairment. The following table indicates the expected maturities of investment securities classified as available-for-sale and held-to-maturity, presented at amortized cost, at June 30, 2006 and the weighted average yield for each range of maturities. Mortgage-backed securities are included based on their weighted average life. All other securities are shown at their contractual maturity (dollars in thousands). <TABLE> <CAPTION> One year After 1 through After 5 through After ten or less 5 years 10 years years Total -------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Available-for-sale: U.S. Treasury securities and obligations of U.S. government corporations and agencies $19,420 $ 94,261 $23,569 $ - $137,250 Obligations of state and political subdivisions 1,989 7,447 6,215 3,574 19,225 Mortgage-backed securities 949 16,643 7,469 - 25,061 Federal Home Loan Bank stock - - - 4,523 4,523 Other securities 500 - 2,500 5,442 8,442 -------------------------------------------------------------------------------- Total investments $22,858 $118,351 $39,753 $13,539 $194,501 ================================================================================ Weighted average yield 4.26% 4.53% 5.25% 5.69% 4.72% Full tax-equivalent yield 4.44% 4.65% 5.55% 6.21% 4.91% ================================================================================ Held-to-maturity: Obligations of state and political subdivisions $ 145 $ 505 $ 191 $ 502 $ 1,343 ================================================================================ Weighted average yield 5.36% 5.54% 5.48% 5.35% 5.44% Full tax-equivalent yield 7.89% 8.16% 7.82% 7.88% 7.98% ================================================================================ </TABLE> The weighted average yields are calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent yields have been calculated using a 34% tax rate. With the exception of obligations of the U.S. Treasury and other U.S. government agencies and corporations, there were no investment securities of any single issuer, the book value of which exceeded 10% of stockholders' equity at June 30, 2006. Investment securities carried at approximately $133,354,000 and $136,787,000 at June 30, 2006 and December 31, 2005, respectively, were pledged to secure public deposits and repurchase agreements and for other purposes as permitted or required by law. Deposits Funding of the Company's earning assets is substantially provided by a combination of consumer, commercial and public fund deposits. The Company continues to focus its strategies and emphasis on retail core deposits, the major component of funding sources. The following table sets forth the average deposits and weighted average rates for the three months ended June 30, 2006 and for the year ended December 31, 2005 (dollars in thousands): June 30, 2006 December 31, 2005 ----------------------------------------------------- Weighted Weighted Average Average Average Average Balance Rate Balance Rate ----------------------------------------------------- Demand deposits: Non-interest-bearing $ 98,897 - $ 89,593 - Interest-bearing 233,133 1.91% 229,532 1.30% Savings 61,252 .47% 59,830 .41% Time deposits 298,978 3.69% 271,161 3.13% ----------------------------------------------------- Total average deposits $692,260 2.28% $650,116 1.80% ===================================================== June 30, December 31, (dollars in thousands) 2006 2005 ------------------------------------------ --------------- -------------- High month-end balances of total deposits $788,122 $677,872 Low month-end balances of total deposits 651,392 627,107 The following table sets forth the maturity of time deposits of $100,000 or more at June 30, 2006 and December 31, 2005 (in thousands): June 30, December 31, 2006 2005 ---------------------------- 3 months or less $35,547 $ 15,947 Over 3 through 6 months 39,623 23,593 Over 6 through 12 months 22,425 34,944 Over 12 months 39,274 28,950 ---------------------------- Total $136,869 $103,434 ============================ During the first six months of 2006, the balance of time deposits of $100,000 or more increased by approximately $33.4 million. The increase in balances was primarily attributable to time deposits acquired in the acquisition of Mansfield, an increase in brokered CD balances and to a promotion run in the first quarter of 2006. Balances of time deposits of $100,000 or more include brokered CDs, time deposits maintained for public fund entities, and consumer time deposits. The balance of brokered CDs was $46.1 million and $38.4 million as of June 30, 2006 and December 31, 2005, respectively. The Company also maintained time deposits for the State of Illinois with balances of $3.1 million and $3.4 million as of June 30, 2006 and December 31, 2005, respectively. The State of Illinois deposits are subject to bid annually and could increase or decrease in any given year. Repurchase Agreements and Other Borrowings Securities sold under agreements to repurchase are short-term obligations of First Mid Bank. First Mid Bank collateralizes these obligations with certain government securities that are direct obligations of the United States or one of its agencies. First Mid Bank offers these retail repurchase agreements as a cash management service to its corporate customers. Other borrowings consist of Federal Home Loan Bank ("FHLB") advances, federal funds purchased and loans (short-term or long-term debt) that the Company has outstanding and junior subordinated debentures. Information relating to securities sold under agreements to repurchase and other borrowings as of June 30, 2006 and December 31, 2005 is presented below (dollars in thousands): June 30, December 31, 2006 2005 -------------- ------------- Federal funds purchased $ 4,000 $ 4,000 Securities sold under agreements to repurchase 52,578 67,380 Federal Home Loan Bank advances: Overnight 1,000 12,000 Fixed term - due in one year or less 7,000 3,000 Fixed term - due after one year 23,000 20,000 Debt: Loans due in one year or less - 5,500 Loans due after one year 15,000 - Junior subordinated debentures 20,620 10,310 -------------- ------------- Total $123,198 $122,190 ============== ============= Average interest rate at end of period 4.79% 4.27% Maximum outstanding at any month-end Federal funds purchased $ 4,000 $ 4,000 Securities sold under agreements to repurchase 56,536 67,380 Federal Home Loan Bank advances: Overnight 19,500 12,014 Fixed term - due in one year or less 7,000 20,000 Fixed term - due after one year 30,000 20,000 Debt: Loans due in one year or less 4,500 6,200 Loans due after one year 15,000 200 Junior subordinated debentures 20,620 10,310 Averages for the period (YTD) Federal funds purchased $ 5,851 $ 874 Securities sold under agreements to repurchase 50,906 57,799 Federal Home Loan Bank advances: Overnight 11,647 2,447 Fixed term - due in one year or less 5,000 13,575 Fixed term - due after one year 25,674 15,523 Debt: Loans due in one year or less 2,005 5,607 Loans due after one year 5,387 104 Junior subordinated debentures 14,069 10,310 -------------- ------------- Total $ 120,539 $106,239 ============== ============= Average interest rate during the period 4.61% 3.74% FHLB advances represent borrowings by First Mid Bank to economically fund loan demand. The fixed term advances consist of $30 million as follows: o $7 million advance at 4.00% with a 2-year maturity, due April 15, 2007 o $5 million advance at 4.58% with a 5-year maturity, due March 22, 2010 o $5 million advance at 4.00% with a 5-year maturity, due January 5, 2011 o $5 million advance at 4.03% with a 5-year maturity, due January 20, 2011 o $3 million advance at 5.98% with a 10-year maturity, due March 1, 2011, callable quarterly o $5 million advance at 4.33% with a 10-year maturity, due November 23, 2011, five year lockout, one time call November 23, 2006 At June 30, 2006, outstanding debt balances include $15,000,000 on a revolving credit agreement with The Northern Trust Company. This loan was renegotiated on April 24, 2006 in conjunction with obtaining financing for the acquisition of Mansfield. The revolving credit agreement has a maximum available balance of $22.5 million with a term of 3 years from the date of closing. The interest rate (6.27% as of June 30, 2006) is floating at 1.25% over the federal funds rate when the ratio of senior debt to Tier 1 capital is equal to or below 35% as of the end of the previous quarter and 1.50% over the federal funds rate when the ratio of senior debt to Tier 1 capital is above 35%. The loan is secured by the common stock of First Mid Bank and subject to a borrowing agreement containing requirements for the Company and First Mid Bank similar to those of the prior agreement including requirements for operating and capital ratios. The Company and is subsidiary banks were in compliance with the existing covenants at June 30, 2006 and 2005 and December 31, 2005. On February 27, 2004, the Company completed the issuance and sale of $10 million of floating rate trust preferred securities through First Mid-Illinois Statutory Trust I ("Trust I"), a statutory business trust and wholly-owned unconsolidated subsidiary of the Company, as part of a pooled offering. The Company established Trust I for the purpose of issuing the trust preferred securities. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company's investment in common equity of Trust I, a total of $10,310 000, was invested in junior subordinated debentures of the Company. The underlying junior subordinated debentures issued by the Company to Trust I mature in 2034, bear interest at nine-month London Interbank Offered Rate ("LIBOR") plus 280 basis points, reset quarterly, and are callable, at the option of the Company, at par on or after April 7, 2009 (7.87% and 6.95% at June 30, 2006 and December 31, 2005, respectively).The Company used the proceeds of the offering for general corporate purposes. On April 26, 2006, the Company completed the issuance and sale of $10 million of fixed/floating rate trust preferred securities through First Mid-Illinois Statutory Trust II ("Trust II"), a statutory business trust and wholly-owned unconsolidated subsidiary of the Company, as part of a pooled offering. The Company established Trust II for the purpose of issuing the trust preferred securities. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company's investment in common equity of Trust II, a total of $10,310 000, was invested in junior subordinated debentures of the Company. The underlying junior subordinated debentures issued by the Company to Trust II mature in 2036, bear interest at a fixed rate of 6.98% (three-month LIBOR plus 160 basis points) paid quarterly and converts to floating rate (LIBOR plus 160 basis points) after June 15, 2011. The net proceeds to the Company were used for general corporate purposes, including the Company's acquisition of Mansfield. The trust preferred securities issued by Trust I and Trust II are included as Tier 1 capital of the Company for regulatory capital purposes. On March 1, 2005, the Federal Reserve Board adopted a final rule that allows the continued limited inclusion of trust preferred securities in the calculation of Tier 1 capital for regulatory purposes. The final rule provides a five-year transition period, ending June 30, 2009, for application of the quantitative limits. The Company does not expect the application of the quantitative limits to have a significant impact on its calculation of Tier 1 capital for regulatory purposes or its classification as well-capitalized. Interest Rate Sensitivity The Company seeks to maximize its net interest margin while maintaining an acceptable level of interest rate risk. Interest rate risk can be defined as the amount of forecasted net interest income that may be gained or lost due to changes in the interest rate environment, a variable over which management has no control. Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of interest-bearing assets differ significantly from the maturity or repricing characteristics of interest-bearing liabilities. The Company monitors its interest rate sensitivity position to maintain a balance between rate sensitive assets and rate sensitive liabilities. This balance serves to limit the adverse effects of changes in interest rates. The Company's asset liability management committee (ALCO) oversees the interest rate sensitivity position and directs the overall allocation of funds. In the banking industry, a traditional way to measure potential net interest income exposure to changes in interest rates is through a technique known as "static GAP" analysis which measures the cumulative differences between the amounts of assets and liabilities maturing or repricing at various intervals. By comparing the volumes of interest-bearing assets and liabilities that have contractual maturities and repricing points at various times in the future, management can gain insight into the amount of interest rate risk embedded in the balance sheet. The following table sets forth the Company's interest rate repricing GAP for selected maturity periods at June 30, 2006 (dollars in thousands): <TABLE> <CAPTION> Rate Sensitive Within ------------------------------------------------------------------------------------- Fair 1 year 1-2 years 2-3 years 3-4 years 4-5 years Thereafter Total Value ----------- ------------ ------------ ----------- ----------- ------------ ---------- ----------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Interest-earning assets: Federal funds sold and other interest-bearing deposits $ 2,408 $ - $ - $ - $ - $ - $ 2,408 $ 2,408 Taxable investment securities 25,456 35,184 23,704 15,489 18,087 54,716 172,636 172,636 Nontaxable investment securities 2,139 2,067 1,983 2,284 1,646 10,462 20,581 20,603 Loans 322,271 115,620 139,777 70,303 45,977 24,238 718,186 699,270 ----------- ------------ ------------ ----------- ----------- ------------ ---------- ----------- Total $352,274 $152,871 $165,464 $88,076 $65,710 $89,416 $913,811 $894,917 =========== ============ ============ =========== =========== ============ ========== =========== Interest-bearing liabilities: Savings and N.O.W. accounts $ 35,370 $ 11,988 $ 12,515 $ 18,311 $ 18,935 $113,565 $210,684 $214,691 Money market accounts 72,109 2,503 2,573 3,338 3,407 18,010 101,940 103,167 Other time deposits 211,711 119,416 8,161 7,432 7,606 329 354,655 353,128 Short-term borrowings/debt 79,578 - - - - - 79,578 75,357 Long-term borrowings/debt - - 15,000 5,000 23,620 - 43,620 43,701 ----------- ------------ ------------ ----------- ----------- ------------ ---------- ----------- Total $398,768 $133,907 $38,249 $34,081 $ 53,568 $ 131,904 $790,477 $790,044 =========== ============ ============ =========== =========== ============ ========== =========== Rate sensitive assets - rate sensitive liabilities $(46,494) $ 18,964 $ 127,215 $53,995 $ 12,142 $(42,488) $123,334 Cumulative GAP $(46,494) $(27,530) $ 99,685 $153,680 $165,822 $123,334 Cumulative amounts as % of total rate sensitive assets -5.1% 2.1% 13.9% 5.9% 1.3% -4.6% Cumulative Ratio -5.1% -3.0% 10.9% 16.8% 18.1% 13.5% </TABLE> The static GAP analysis shows that at June 30, 2006, the Company was liability sensitive, on a cumulative basis, through the twelve-month time horizon. This indicates that future increases in interest rates, if any, could have an adverse effect on net interest income. Conversely, future decreases in interest rates could have a positive effect on net interest income. There are several ways the Company measures and manages the exposure to interest rate sensitivity, including static GAP analysis. The Company's ALCO also uses other financial models to project interest income under various rate scenarios and prepayment/extension assumptions consistent with First Mid Bank's historical experience and with known industry trends. ALCO meets at least monthly to review the Company's exposure to interest rate changes as indicated by the various techniques and to make necessary changes in the composition terms and/or rates of the assets and liabilities. Based on all information available, management does not believe that changes in interest rates, which might reasonably be expected to occur in the next twelve months, will have a material adverse effect on the Company's net interest income. Capital Resources At June 30, 2006, the Company's stockholders' equity had increased $166,000 or ..2% to $72,492,000 from $72,326,000 as of December 31, 2005. During the first six months of 2006, net income contributed $4,926,000 to equity before the payment of dividends to common stockholders. The change in market value of available-for-sale investment securities decreased stockholders' equity by $864,000, net of tax. Additional purchases of treasury stock (103,019 shares at an average cost of $41.14 per share) decreased stockholders' equity by approximately $4,238,000. The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Bank holding companies follow minimum regulatory requirements established by the Board of Governors of the Federal Reserve System ("Federal Reserve System"), and First Mid Bank follows similar minimum regulatory requirements established for national banks by the Office of the Comptroller of the Currency ("OCC"). Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Quantitative measures established by each regulatory agency to ensure capital adequacy require the reporting institutions to maintain a minimum total risk-based capital ratio of 8% and a minimum leverage ratio of 3% for the most highly rated banks that do not expect significant growth. All other institutions are required to maintain a minimum leverage ratio of 4%. Management believes that, as of June 30, 2006 and December 31, 2005, the Company and First Mid Bank met all capital adequacy requirements. The trust preferred securities issued by Trust I and Trust II are included as Tier 1 capital of the Company for regulatory capital purposes. On March 1, 2005, the Federal Reserve Board adopted a final rule that allows the continued limited inclusion of trust preferred securities in the calculation of Tier 1 capital for regulatory purposes. The final rule provides a five-year transition period, ending June 30, 2009, for application of the quantitative limits. The Company does not expect the application of the quantitative limits to have a significant impact on its calculation of Tier 1 capital for regulatory purposes or its classification as well-capitalized. As of June 30, 2006, First Mid Bank had capital ratios that qualified it for treatment as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios must be maintained as set forth in the following table (dollars in thousands). <TABLE> <CAPTION> To Be Well- Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions -------------------------- ------------------------- ------------------------- Amount Ratio Amount Ratio Amount Ratio ------------- ------------ ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> <C> <C> June 30, 2006 Total Capital (to risk-weighted assets) Company $76,840 10.49% $58,583 > 8.00% N/A N/A - First Mid Bank 71,745 10.94% 52,475 > 8.00% $65,593 >10.00% - - Tier 1 Capital (to risk-weighted assets) Company 71,149 9.72% 29,292 > 4.00% N/A N/A - First Mid Bank 66,947 10.21% 26,237 > 4.00% 39,356 > 6.00% - - Tier 1 Capital (to average assets) Company 71,149 7.72% 36,880 > 4.00% N/A N/A - First Mid Bank 66,947 8.03% 33,331 > 4.00% 41,664 > 5.00% - - December 31, 2005 Total Capital (to risk-weighted assets) Company $75,901 11.87% $ 51,163 > 8.00% N/A N/A - First Mid Bank 73,913 11.66 50,726 > 8.00% $63,407 >10.00% - - Tier 1 Capital (to risk-weighted assets) Company 71,253 11.14 25,581 > 4.00% N/A N/A - First Mid Bank 69,265 10.92 25,363 > 4.00% 38,044 > 6.00% - - Tier 1 Capital (to average assets) Company 71,253 8.55 33,330 > 4.00% N/A N/A - First Mid Bank 69,265 8.36 33,152 > 4.00% 41,440 > 5.00% - - </TABLE> Banks and financial holding companies are expected to operate at or above the minimum capital requirements. These ratios are in excess of regulatory minimums and allow the Company to operate without capital adequacy concerns. The Company expects to continue to have capital ratios meeting regulatory requirements for treatment as well-capitalized following the acquisition of Mansfield Bancorp, Inc. Stock Plans Participants may purchase Company stock under the following four plans of the Company: the Deferred Compensation Plan, the First Retirement and Savings Plan, the Dividend Reinvestment Plan, and the Stock Incentive Plan. For more detailed information on these plans, refer to the Company's 2005 Annual Report on Form 10-K. On August 5, 1998, the Company announced a stock repurchase program for up to 3% of its common stock. In March 2000, the Board of directors approved the repurchase of an additional 5% of the Company's common stock. In September 2001, the Board of directors approved the repurchase of $3 million of additional shares of the Company's common stock and in August 2002, the Board of directors approved the repurchase of $5 million of additional shares of the Company's common stock. In September 2003, the Board of directors approved the repurchase of $10 million of additional shares of the Company's common stock. On April 27, 2004, the Board of directors approved the repurchase of an additional $5 million shares of the Company's common stock. On August 23, 2005 the Board of directors approved the repurchase of an additional $5 million shares of the Company's common stock, bringing the aggregate total on June 30, 2006 to 8% of the Company's common stock plus $28 million of additional shares. During the six-month period ending June 30, 2006, the Company repurchased 103,019 shares at a total cost of approximately $4,238,000. Since 1998, the Company has repurchased a total of 1,339,878 shares at a total price of approximately $33,989,000. As of June 30, 2006, the Company was authorized per all repurchase programs to purchase $218,000 in additional shares. Liquidity Liquidity represents the ability of the Company and its subsidiaries to meet all present and future financial obligations arising in the daily operations of the business. Financial obligations consist of the need for funds to meet extensions of credit, deposit withdrawals and debt servicing. The Company's liquidity management focuses on the ability to obtain funds economically through assets that may be converted into cash at minimal costs or through other sources. The Company's other sources of cash include overnight federal fund lines, Federal Home Loan Bank advances, deposits of the State of Illinois, the ability to borrow at the Federal Reserve Bank of Chicago, and the Company's operating line of credit with The Northern Trust Company. Details for the sources include: o First Mid Bank has $22.5 million available in overnight federal fund lines, including $10 million from Harris Trust and Savings Bank of Chicago and $12.5 million from The Northern Trust Company. Availability of the funds is subject to First Mid Bank meeting minimum regulatory capital requirements for total capital to risk-weighted assets and Tier 1 capital to total average assets. As of June 30, 2006, First Mid Bank's ratios of total capital to risk-weighted assets of 10.94% and Tier 1 capital to total average assets of 8.03% met regulatory requirements. Peoples State Bank also has $1 million available in overnight federal funds from Illinois Bankers' Bank. o First Mid Bank and Peoples can also borrow from the Federal Home Loan Bank as a source of liquidity. Availability of the funds is subject to the pledging of collateral to the Federal Home Loan Bank. Collateral that can be pledged includes one-to-four family residential real estate loans and securities. At June 30, 2006, the excess collateral at the Federal Home Loan Bank will support approximately $73.5 million and $11 million, for First Mid Bank and Peoples respectively, of additional advances. o First Mid Bank also receives deposits from the State of Illinois. The receipt of these funds is subject to competitive bid and requires collateral to be pledged at the time of placement. o First Mid Bank and Peoples State Bank are also members of the Federal Reserve System and can borrow funds provided that sufficient collateral is pledged. o In addition, as of June 30, 2006, the Company had a revolving credit agreement in the amount of $22.5 million with The Northern Trust Company with an outstanding balance of $15,000,000 and $7,500,000 in available funds. Management monitors its expected liquidity requirements carefully, focusing primarily on cash flows from: o lending activities, including loan commitments, letters of credit and mortgage prepayment assumptions; o deposit activities, including seasonal demand of private and public funds; o investing activities, including prepayments of mortgage-backed securities and call provisions on U.S. treasury and government agency securities; and o operating activities, including scheduled debt repayments and dividends to stockholders. The following table summarizes significant contractual obligations and other commitments at June 30, 2006 (in thousands): Less than More than Total 1 year 1-3 years 3-5 years 5 years ---------- ----------- ----------- ----------- ---------- Time deposits $354,655 $211,657 $127,631 $15,038 $ 329 Debt 35,620 - 15,000 - 20,620 Other borrowings 83,578 60,578 - 18,000 5,000 Operating leases 3,951 432 844 783 1,892 Supplemental retirement 782 50 100 100 532 ---------- ----------- ----------- ----------- ---------- $478,586 $272,717 $ 143,575 $33,921 $28,373 ========== =========== =========== =========== ========== For the six-month period ended June 30, 2006, net cash of $6.0 million and $18.9 million was provided from operating activities and financing activities, respectively, while investing activities used net cash of $20.6 million. In total, cash and cash equivalents increased by $4.3 million since year-end 2005. The Company has also issued $10 million of floating rate trust preferred securities through each of Trust I and Trust II. See heading "Repurchase Agreements and Other Borrowings" for a more detailed description. Off-Balance Sheet Arrangements First Mid Bank enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include lines of credit, letters of credit and other commitments to extend credit. Each of these instruments involves, to varying degrees, elements of credit, interest rate and liquidity risk in excess of the amounts recognized in the consolidated balance sheets. The Company uses the same credit policies and requires similar collateral in approving lines of credit and commitments and issuing letters of credit as it does in making loans. The exposure to credit losses on financial instruments is represented by the contractual amount of these instruments. However, the Company does not anticipate any losses from these instruments. The off-balance sheet financial instruments whose contract amounts represent credit risk at June 30, 2006 and December 31, 2005 were as follows (in thousands): June 30, December 31, 2006 2005 -------------- -------------- Unused commitments, including lines of credit: Commercial real estate $ 27,682 $ 28,745 Commercial operating 43,510 46,012 Home equity 17,592 16,160 Other 25,690 23,178 -------------- -------------- Total $114,474 $114,095 ============== ============== Standby letters of credit $ 4,281 $ 3,694 ============== ============== Commitments to originate credit represent approved commercial, residential real estate and home equity loans that generally are expected to be funded within ninety days. Lines of credit are agreements by which the Company agrees to provide a borrowing accommodation up to a stated amount as long as there is no violation of any condition established in the loan agreement. Both commitments to originate credit and lines of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the lines and some commitments are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Company to guarantee the financial performance of customers to third parties. Standby letters of credit are primarily issued to facilitate trade or support borrowing arrangements and generally expire in one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending credit facilities to customers. The maximum amount of credit that would be extended under letters of credit is equal to the total off-balance sheet contract amount of such instrument. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There has been no material change in the market risk faced by the Company since December 31, 2005. For information regarding the Company's market risk, refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2005. ITEM 4. CONTROLS AND PROCEDURES The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's "disclosure controls and procedures" (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), as of the end of the period covered by this report. Based on such evaluation, such officers have concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures are effective in bringing to their attention on a timely basis material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic filings under the Exchange Act. Further, there have been no changes in the Company's internal control over financial reporting during the last fiscal quarter that have materially affected or that are reasonably likely to affect materially the Company's internal control over financial reporting.
PART II ITEM 1. LEGAL PROCEEDINGS Since First Mid Bank acts as a depository of funds, it is named from time to time as a defendant in lawsuits (such as garnishment proceedings) involving claims as to the ownership of funds in particular accounts. Management believes that all such litigation as well as other pending legal proceedings in which the Company is involved constitute ordinary, routine litigation incidental to the business of the Company and that such litigation will not materially adversely affect the Company's consolidated financial condition. ITEM 1A. RISK FACTORS Various risks and uncertainties, some of which are difficult to predict and beyond the Company's control, could negatively impact the Company. As a financial institution, the Company is exposed to interest rate risk, liquidity risk, credit risk, operational risk, risks from economic or market conditions, and general business risks among others. Adverse experience with these or other risks could have a material impact on the Company's financial condition and results of operations, as well as the value of its common stock. There has been no material change to the risk factors described in the Company's Annual Report on Form 10-K for the year ended December 31, 2005. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS <TABLE> <CAPTION> ISSUER PURCHASES OF EQUITY SECURITIES - --------------------------------------------------------------------------------------------------------------------------- (d) Approximate Dollar (c) Total Number of Shares Value of Shares that Purchased as Part of May Yet Be Purchased (a) Total Number of (b) Average Price Publicly Announced Plans Under the Plans or Period Shares Purchased Paid per Share or Programs Programs - ---------------------- --------------------- ----------------------- ---------------------------- ------------------------- <S> <C> <C> <C> <C> April 1, 2006 - April 30, 2006 - - - $1,149,000 May 1, 2006 - May 31, 2006 1,580 $40.93 1,580 $1,084,000 June 1, 2006 - June 30, 2006 21,408 $40.48 21,408 $ 217,000 --------------------- ----------------------- ---------------------------- ------------------------- Total 22,988 $40.51 22,988 $217,000 ===================== ======================= ============================ ========================= </TABLE> See heading "Stock Plans" for more information regarding stock purchases. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Stockholders was held May 24, 2006. At the meeting, Joseph R. Dively, Sara J. Preston, and William S. Rowland were elected to serve as Class II directors with terms expiring in 2009. Continuing Class I directors (terms expiring 2008) are Kenneth R. Diepholz, Steven L. Grissom, and Gary W. Melvin and continuing Class III directors (terms expiring 2007) are Charles A. Adams, Daniel E. Marvin, Jr. and Ray Anthony Sparks. There were 4,340,725 issued and outstanding shares of common stock at the time of the Annual Meeting. The voting at the meeting, on the matter listed above, was as follows: Election of Directors: For Withheld Joseph R. Dively 3,790,817 19,327 Sara J. Preston 3,794,747 15,937 William S. Rowland 3,796,041 14,103 ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS The exhibits required by Item 601 of Regulation S-K and filed herewith are listed in the Exhibit Index that follows the Signature Page and that immediately precedes the exhibits filed.
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. FIRST MID-ILLINOIS BANCSHARES, INC. (Registrant) Date: August 8, 2006 /s/ William S. Rowland William S. Rowland President and Chief Executive Officer /s/ Michael L. Taylor Michael L. Taylor Chief Financial Officer
Exhibit Index to Quarterly Report on Form 10-Q Exhibit Number Description and Filing or Incorporation Reference - -------------------------------------------------------------------------------- 4.1 The Registrant agrees to furnish to the Commission, upon request, a copy of each instrument with respect to issues of long-term debt involving a total amount which does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis 11.1 Statement re: Computation of Earnings Per Share (Filed herewith on page 7) 31.1 Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 31.1 Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002 I, William S. Rowland, certify that: 1. I have reviewed this quarterly report on Form 10-Q of First Mid-Illinois Bancshares, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 8, 2006 By: /s/ William S. Rowland William S. Rowland, President and Chief Executive Officer
Exhibit 31.2 Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002 I, Michael L. Taylor, certify that: 1. I have reviewed this report on Form 10-Q of First Mid-Illinois Bancshares, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 8, 2006 By: /s/ Michael L. Taylor Michael L. Taylor, Chief Financial Officer
Exhibit 32.1 Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of First Mid-Illinois Bancshares, Inc. (the "Company") on Form 10-Q for the period ended June 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William S. Rowland, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: August 8, 2006 /s/ William S. Rowland William S. Rowland President and Chief Executive Officer
Exhibit 32.2 Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of First Mid-Illinois Bancshares, Inc. (the "Company") on Form 10-Q for the period ended June 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Michael L. Taylor, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: August 8, 2006 /s/ Michael L. Taylor Michael L. Taylor Chief Financial Officer