10-Q 1 form10q_sep04.txt 2004--3RD QTR UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 Commission file number: 0-13368 FIRST MID-ILLINOIS BANCSHARES, INC. (Exact name of Registrant as specified in its charter) Delaware 37-1103704 (State of incorporation)(I.R.S. employer identification no.) 1515 Charleston Avenue, Mattoon, Illinois 61938 (Address and zip code of principal executive offices) (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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) YES [X] NO [ ] As of November 8, 2004, 4,465,531 common shares, $4.00 par value, were outstanding. PART I ITEM 1. FINANCIAL STATEMENTS

See accompanying notes to unaudited consolidated financial statements. Consolidated Statements of Income (unaudited) (In thousands, except per share data)

See accompanying notes to unaudited consolidated financial statements. Consolidated Statements of Cash Flows (unaudited) Nine months ended (In thousands) September 30, 2004 2003 ---------- ---------- Cash flows from operating activities: Net income $ 7,181 $ 6,877 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 437 750 Depreciation, amortization and accretion, net 1,924 2,362 Gain on sale of securities, net (92) (370) Loss on sale of other real property owned, net 29 30 Gain on sale of mortgage loans held for sale, net (342) (1,680) Origination of mortgage loans held for sale (26,360) (119,338) Proceeds from sale of mortgage loans held for sale 25,787 126,742 (Increase) decrease in other assets (140) 698 Decrease in other liabilities (286) (791) ---------- ---------- Net cash provided by operating activities 8,138 15,208 ---------- ---------- Cash flows from investing activities: Capitalization of mortgage servicing rights - (1) Purchases of premises and equipment (744) (830) Net increase in loans (43,970) (45,807) Proceeds from sales of other real property owned 155 648 Proceeds from sales of securities available-for-sale 5,137 13,815 Proceeds from maturities of securities available-for-sale 60,076 112,989 Proceeds from maturities of securities held-to-maturity 110 210 Purchases of securities available-for-sale (57,903) (128,364) Purchases of securities held-to-maturity - (199) ---------- ---------- Net cash used in investing activities (37,139) (47,539) ---------- ---------- Cash flows from financing activities: Net increase in deposits 33,358 1,327 Increase (decrease) in repurchase agreements (6,722) 9,149 Proceeds from short-term FHLB advances 2,500 - Repayment of short-term FHLB advances (5,000) (5,000) Issuance of junior subordinated debentures 10,000 - Proceeds from short-term debt 6,675 500 Repayment of short-term debt (9,200) (200) Proceeds from issuance of common stock 524 707 Purchase of treasury stock (9,479) (3,466) Dividends paid on common stock (954) (778) ---------- ---------- Net cash provided by financing activities 21,702 2,239 ---------- ---------- Decrease in cash and cash equivalents (7,299) (30,020) Cash and cash equivalents at beginning of period 24,949 69,657 ---------- ---------- Cash and cash equivalents at end of period $17,650 $39,637 ========== ========== Additional disclosures of cash flow information: Cash paid during the period for: Interest $ 8,187 $ 9,655 Income taxes 3,365 3,408 Loans transferred to real estate owned 982 445 Dividends reinvested in common stock 1,252 873 Notes to Consolidated Financial Statements (unaudited) 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. 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") 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 September 30, 2004 and 2003, 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 September 30, 2004 presentation and there was no impact on net income or stockholders' equity. The results of the interim period ended September 30, 2004 are not necessarily indicative of the results expected for the year ending December 31, 2004. The Company operates as a one-segment entity for financial reporting purposes. 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 accounting principles generally accepted in the United States of America for complete financial statements and related footnote disclosures. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2003 Annual Report on Form 10-K. Stock Split On July 16, 2004, the Company effected a three-for-two stock split in the form of a 50% stock dividend for all shareholders of record as of July 6, 2004. Par value remained at $4 per share. All current and prior period share and per share amounts have been restated giving retroactive recognition to the stock split. Recent Accounting Pronouncements In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidated Variable Interest Entities" ("FIN 46"). The objective of FIN 46 is to provide guidance on how to identify a variable interest entity and determine when the assets, liabilities, non-controlling interests, and results of operations of a variable interest in an entity need to be included in a company's consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company's interest in the variable interest entity is such that the company will absorb a majority of the variable interest entity's losses and/or receive a majority of the entity's expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. The provisions of FIN 46 must be applied to an interest held in a variable interest entity or potential variable interest entity at the end of the first interim period after December 31, 2003. The adoption of the provisions of FIN 46 did not have a material impact on the Company's financial position or results of operations. In December 2003, the FASB issued Interpretation No. 46 (Revised), "Consolidation of Variable Interest Entities" ("FIN 46R"), which provides further guidance on the accounting for variable interest entities. The provisions of FIN 46R must be applied to an interest held in a variable interest entity or potential variable interest entity at the end of the first interim period after December 31, 2003. Upon adoption of FIN 46R, the Company was required to de-consolidate its investment in First Mid-Illinois Statutory Trust I ("Trust"), a statutory business trust and wholly-owned subsidiary of the Company. On February 27, 2004, the Company completed the issuance and sale of $10 million of floating rate capital securities ("Trust Preferred") through the Trust as part of a pooled offering. The $10 million in proceeds from the Trust Preferred issuance and an additional $310,000 for the Company's investment in common equity of the Trust, a total of $10,310 000, was invested in junior subordinated debentures of the Company. The Trust Preferred held by the Trust presently qualify as Tier I Capital for regulatory capital purposes. The adoption of FIN 46R and the de-consolidation of the Trust did not have a material impact on the Company's financial position or results of operations. Currently, the Company does not have any other investments affected by FIN 46R. On December 16, 2003, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 provides guidance on the accounting for differences between contractual and expected cash flows from the purchaser's initial investment in loans or debt securities acquired in a transfer, if those differences are attributable, at least in part, to credit quality. Among other things, SOP 03-3: (1) prohibits the recognition of the excess of contractual cash flows over expected cash flows as an adjustment of yield, loss accrual, or valuation allowance at the time of purchase; (2) requires that subsequent increases in expected cash flows be recognized prospectively through an adjustment of yield; and (3) requires the subsequent decreases in expected cash flows be recognized as an impairment. In addition, SOP 03-3 prohibits the creation or carrying over of a valuation allowance in the initial accounting of all loans within its scope that are acquired in a transfer. SOP 03-3 becomes effective for loans or debt securities acquired in fiscal years beginning after December 15, 2004. The Company does not expect the requirements of SOP 03-3 to have a material impact on its financial position or results of operations. In March 2004, the FASB reached a consensus on Emerging Issues Task Force Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF 03-1"). EITF 03-1 provides guidance for determining when an investment is impaired and whether the impairment is other than temporary. EITF 03-01 also incorporates into its consensus the required disclosures about unrealized losses on investments announced by the EITF in late 2003 and adds new disclosure requirements relating to cost-method investments. The new disclosure requirements are effective for annual reporting periods ending June 15, 2004 and the new impairment accounting guidance was to become effective for reporting periods beginning June 15, 2004. In September 2004, the FASB delayed the effective date of EITF 03-1 for measurement and recognition of impairment losses until implementation guidance is issued. The Company does not expect the adoption of impairment guidance contained in EITF 03-1 to have a material impact on its financial position or results of operations. Comprehensive Income The Company's comprehensive income for the three and nine-month periods ended September 30, 2004 and 2003 was as follows (in thousands): Three months ended Nine months ended September 30, September 30, ------------------ ------------------ 2004 2003 2004 2003 -------- --------- --------- -------- Net income $2,429 $2,393 $7,181 $6,877 Other comprehensive income: Unrealized gain (loss) during the period 1,691 1,475) (709) (788) Less realized gain during the period - - (92) (370) Tax effect (659) 575 312 451 -------- --------- --------- -------- Comprehensive income $3,461 $1,493 $6,692 $6,170 ======== ========= ========= ======== Earnings Per Share A three-for-two common stock split was effected on July 16, 2004, in the form of a 50% stock dividend for the stockholders of record at the close of business on July 6, 2004. Accordingly, information with respect to shares of common stock and earnings per share has been restated for current and prior periods presented to fully reflect the stock split. 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 nine-month periods ended September 30, 2004 and 2003 were as follows:

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 the insurance agency acquired, 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 September 30, 2004 and December 31, 2003 (in thousands):

Total amortization expense for the nine-month periods ended September 30, 2004 and 2003 was as follows (in thousands): September 30, ---------------------------- 2004 2003 -------------- ------------- Intangibles from branch acquisition $151 $151 Core deposit intangibles 150 213 Mortgage servicing rights 28 70 Customer list intangibles 143 143 -------------- ------------- $472 $577 ============== ============= 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 9/30/04 $472 Estimated amortization expense: For period 10/1/04-12/31/04 $151 For year ended 12/31/05 $578 For year ended 12/31/06 $579 For year ended 12/31/07 $515 For year ended 12/31/08 $454 For year ended 12/31/09 $417 In accordance with the provisions of SFAS 142, the Company performed testing of goodwill for impairment as of September 30, 2004, 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 The Company accounts for its Stock Incentive Plan in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting For Stock Issued to Employees," and related interpretations. Accordingly, compensation cost based on fair value at grant date has not been recognized for its stock options in the consolidated financial statements. As required by SFAS 123, "Accounting for Stock-Based Compensation" as amended by SFAS 148, "Accounting for Stock-Based Compensation--Transition and Disclosure," the Company provides pro forma net income and pro forma earnings per share disclosures for employee stock option grants. The following table illustrates the effect on net income if the fair value based method had been applied (in thousands, except per share data).

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, September 30, 2004 and 2003. 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 filings with the Securities and Exchange Commission. 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 $7,181,000 and $6,877,000 and diluted earnings per share was $1.56 and $1.42 for the nine months ended September 30, 2004 and 2003, respectively. The increase in net income was primarily the result of higher net interest income. The increase in earnings per share was the result of improved net income and a decrease in the number of shares outstanding due to share repurchases made through our stock buy-back program. During the first nine months of 2004, the Company acquired 296,748 shares at a total investment of $9,479,000. The following table shows the Company's annualized performance ratios for the nine months ended September 30, 2004 and 2003, compared to the performance ratios for the year ended December 31, 2003: Nine months ended Year ended September 30, September 30, December 31, 2004 2003 2003 --------------- -------------- ------------- Return on average assets 1.20% 1.19% 1.17% Return on average equity 14.17% 13.33% 13.11% Average equity to average assets 8.44% 8.93% 8.94% Total assets at September 30, 2004 and December 31, 2003 were $822.1 million and $793.6 million, respectively. This increase was the result of an increase in loan portfolio balances. Net loan balances were $592.9 million at September 30, 2004, an increase of $44.5 million, or 8.1%, from $548.4 million at December 31, 2003, primarily due to an increase in commercial real estate and agricultural loans. Total deposit balances increased to $648.4 million at September 30, 2004 from $615.0 million at December 31, 2003. Net interest margin, defined as net interest income divided by average interest-earning assets, was 3.78% for the nine months ended September 30, 2004, up from 3.72% for the same period in 2003. The increase in the net interest margin is attributable to the increase in the loan portfolio balances since September 30, 2003, which offset declines in yields of loans and securities, combined with decreases in the cost of deposits. Net interest income before the provision for loan losses was $21.2 million for the nine months ended September 30, 2004 compared to $20 million for the same period in 2003. In 2004, the growth in earning assets primarily composed of the loan growth and net interest margin expansion from the decline in the cost of interest-bearing liabilities increased net interest income. During the first quarter of 2004, the Company recovered $85,000 in interest on an agricultural real estate loan that had been charged-off in a prior period. Noninterest income decreased $770,000, or 8.1%, to $8.7 million for the nine months ended September 30, 2004 compared to $9.5 million in 2003. The primary cause of this decrease was a decline in mortgage banking revenue from $1,581,000 in 2003 to $384,000 in 2004 due to the slowing of refinancings in early 2004. Also, the Company received $370,000 in gains on the sale of securities during the first nine months of 2003, compared to $92,000 in gains on the sale of securities during the same period in 2004. These declines were partially offset by an increase in trust and brokerage revenues due to improvement in equity prices and growth in new business and an increase in service charges due to greater overdraft charges. Noninterest expense increased 2.2% or $408,000, to $18.6 million for the nine months ended September 30, 2004 compared to $18.2 million in 2003. The primary factor in the expense increase was increased salaries and benefits expense, increases in marketing and promotion expense due to new products rolled out in the second quarter and increases in accounting and legal professional fees incurred in implementing the requirements of the Sarbanes-Oxley Act of 2002. Following is a summary of the factors that contributed to the changes in net income (in thousands): 2004 versus 2003 ------------------------------------------ Three months ended Nine months ended September 30 September 30 -------------------- --------------------- Net interest income $ 253 $1,222 Provision for loan losses 188 313 Other income, including securities transactions (341) (770) Other expenses (75) (408) Income taxes 11 (53) -------------------- --------------------- Increase in net income $36 $304 ==================== ===================== Credit quality is an area of importance to the Company and the first nine months of 2004 reflected favorable results in this area. Total nonperforming loans were $3.6 million at September 30, 2004, compared to $4.8 million at September 30, 2003. As a result, the Company's provision for loan loss for the nine months ended September 30, 2004 was $437,000 compared to $750,000 for the nine months ended September 30, 2003. At September 30, 2004, the composition of the loan portfolio remained similar to the same period last year. Net charge-offs were 0.07% of average loans compared to .05% in 2003. During the third quarter of 2004, the Company received a recovery of $68,500 on two commercial real estate loans of a single borrower. During the second quarter of 2003, the Company received a recovery of $382,000 on two commercial loans of a single borrower. Loans secured by both commercial and residential real estate comprised 72% and 70% of the loan portfolio as of September 30, 2004 and 2003, respectively. 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 September 30, 2004 and 2003 was 10.78% and 9.94%, respectively. The Company's total capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at September 30, 2004 and 2003 was 11.54% and 10.70%, respectively. The increase in 2004 was the result of the issuance of trust preferred securities by First Mid-Illinois Statutory Trust I ("Trust"), which qualify as Tier I capital for the Company under Federal Reserve Board guidelines. The Trust invested the proceeds of the issuance in junior subordinated debentures of the Company. This was partially offset by a decline in equity as a result of the increase in the number of shares repurchased under the Company's stock repurchase program. 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 September 30, 2004 and 2003 were $92.6 million and $83.2 million, respectively. Critical Accounting Policies The Company has established various accounting policies that govern the application of accounting principles generally accepted in the United States 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 2003 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):

(1) Nonaccrual loans are not material and have been included in the average balances. 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 nine months ended September 30, 2004, compared to the same period in 2003 (in thousands): For the nine months ended September 30, 2004 compared to 2003 Increase / (Decrease) Total Change Volume (1) Rate (1) ----------------------------------------- Earning Assets: Interest-bearing deposits $ (90) $ (76) $(14) Federal funds sold (60) (48) (12) Investment securities: Taxable (20) 94 (114) Tax-exempt (55) (54) (1) Loans (2) 696 1,788 (1,092) ------------------------------------------ Total interest income 471 1,704 (1,233) ----------------------------------------- Interest-Bearing Liabilities: Interest-bearing deposits Demand deposits (352) 54 (406) Savings deposits (68) 10 (78) Time deposits (495) 242 (737) Securities sold under agreements to repurchase 52 42 10 FHLB advances (105) (149) 44 Federal funds purchased 3 1 2 Junior subordinated debt 255 255 - Other debt (41) (39) (2) ----------------------------------------- Total interest expense (751) 416 (1,167) ----------------------------------------- Net interest income $1,222 $1,288 $ (66) ========================================= (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) Nonaccrual loans are not material and have been included in the average balances. Net interest income increased $1,222,000, or 6.1% to $21,187,000 for the nine months ended September 30, 2004, from $19,965,000 for the same period in 2003. The increase in net interest income was primarily due to growth in earning assets primarily composed of loan growth and net interest margin expansion from the decline in the cost of interest-bearing liabilities. The Company also recovered $85,000 in interest on an agricultural loan. For the nine months ended September 30, 2004, average-earning assets increased by $30.9 million, or 4.3%, and average interest-bearing liabilities increased $32.4 million, or 5.3%, compared with average balances for the same period in 2003. Changes in average balances are shown below: < Average loans increased by $46.5 million or 9.0% in 2004 compared to 2003. < Average securities increased by $2.0 million or 1.2% in 2004 compared to 2003. < Average interest-bearing deposits increased by $20.0 million or 3.8% in 2004 compared to 2003. < Average securities sold under agreements to repurchase increased by $9.6 million or 21.7% in 2004 compared to 2003. < Average borrowings and other debt decreased by $5.4 million or 13.3% in 2004 compared to 2003. < Net interest margin increased to 3.78% in 2004 from 3.72% in 2003. 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 3.87% in 2004 and 3.81% in 2003. The TE adjustments to net interest income for September 30, 2004 and 2003 were $458,000 and $488,000, respectively. Provision for Loan Losses The provision for loan losses for the nine months ended September 30, 2004 was $437,000 compared to $750,000 for the same period in 2003. The decrease in the provision was primarily due to a decrease in non-performing loans. Nonperforming loans decreased from $4,766,000 as of September 30, 2003 to $3,606,000 as of September 30, 2004. Net charge-offs were $303,000 for the nine months ended September 30, 2004 compared to $204,000 during the same period in 2003. 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 and nine-month periods ended September 30, 2004 and 2003 (in thousands):

Following are explanations for the three months ended September 30, 2004 compared to the same period in 2003: < Trust revenues increased $15,000 or 3.0% to $514,000 from $499,000. Trust assets, at market value, were $354 million at September 30, 2004 compared to $339 million at September 30, 2003. The increase in trust revenues was the result of new business and an increase in equity prices. < Revenues from brokerage decreased $14,000 or 16.5% to $71,000 from $85,000 as a result of a decrease in the number of stock transactions. < Insurance commissions decreased $27,000 or 7.4% to $336,000 from $363,000 due to a decrease in commissions received on sales of business property and casualty insurance. < Fees from service charges increased $90,000 or 7.7% to $1,255,000 from $1,165,000. This was primarily the result of continued increases in overdraft fees through the Company's Payment Privilege program. Under Payment Privilege, overdrafts up to a limit of $500 are paid for qualifying customers in exchange for a fee. A greater number of overdrafts paid has resulted in an increase in fee income. < Mortgage banking income decreased $504,000 or 78.5% to $138,000 from $642,000. This decrease was due to the declining volume of fixed rate loans originated and sold by First Mid Bank. The decrease in volume is largely attributed to the slowdown in mortgage refinancing activity. Loans sold balances are as follows: < $10.3 million (representing 105 loans) for the 3rd quarter of 2004. < $49.7 million (representing 522 loans) for the 3rd quarter of 2003. First Mid Bank generally releases the servicing rights on loans sold into the secondary market. < Other income increased $99,000 or 21.4% to $562,000 from $463,000. This increase was primarily due to increased ATM service fees and increased loan closing fees in our Maryville branch. Following are explanations for the nine months ended September 30, 2004 compared to the same period in 2003: < Trust revenues increased $232,000 or 16.1% to $1,676,000 from $1,444,000. Trust assets, at market value, were $354 million at September 30, 2004 compared to $339 million at September 30, 2003. The increase in trust revenues was the result of new business and an increase in equity prices. < Revenues from brokerage increased $89,000 or 42.6% to $298,000 from $209,000 as a result of an increase in the number of stock transactions. < Insurance commissions decreased $29,000 or 2.5% to $1,112,000 from $1,141,000 due to a decrease in commission on sales of business property and casualty insurance. < Fees from service charges increased $269,000 or 8.1% to $3,572,000 from $3,303,000. This was primarily the result of continued increases in overdraft fees through the Company's Payment Privilege program. Under Payment Privilege, overdrafts up to a limit of $500 are paid for qualifying customers in exchange for a fee. A greater number of overdrafts paid has resulted in an increase in fee income. < The sale of a security during the nine months ended September 30, 2004 resulted in net security gains of $92,000 compared to $370,000 during the same period of 2003. < Mortgage banking income decreased $1,197,000 or 75.7% to $384,000 from $1,581,000. This decrease was due to the declining volume of fixed rate loans originated and sold by First Mid Bank. The decrease in volume is largely attributed to the slowdown in mortgage refinancing activity. Loans sold balances are as follows: < $32.9 million (representing 348 loans) for the nine-month period ended September 30, 2004. < $125.1 million (representing 1,349 loans) for the nine-month period ended September 30, 2003. First Mid Bank generally releases the servicing rights on loans sold into the secondary market. < Other income increased $144,000 or 10.0% to $1,583,000 from $1,439,000. This increase was primarily due to prior years' income tax refunds received during the first quarter of 2004, increased ATM service fees and increased loan closing fees in our Maryville branch. 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 and nine-month periods ended September 30, 2004 and 2003 (in thousands):

Following are explanations for the three months ended September 30, 2004 compared to the same period in 2003: < Salaries and employee benefits, the largest component of other expense, increased $10,000 or 0.3% to $3,378,000 from $3,368,000. This increase is primarily due to merit increases for continuing employees. There were 312 full-time equivalent employees at September 30, 2004 compared to 320 at September 30, 2003. < Occupancy and equipment expense decreased $1,000 or 0.1% to $1,078,000 from $1,079,000. < Other operating expenses increased $69,000 or 6.8% to $1,080,000 in 2004 from $1,011,000 in 2003. This increase was a result of increased franchise taxes for the Company. < All other categories of operating expenses decreased a net of $3,000 or 0.4% to $716,000 from $719,000. Following are explanations for the nine months ended September 30, 2004 compared to the same period in 2003: < Salaries and employee benefits, the largest component of other expense, increased $159,000 or 1.6% to $10,087,000 from $9,928,000. This increase is primarily due to merit increases for continuing employees and related benefit expenses. There were 312 full-time equivalent employees at September 30, 2004 compared to 320 at September 30, 2003. < Occupancy and equipment expense increased $35,000 or 1.1% to $3,237,000 from $3,202,000, primarily due to increased property taxes. < Other operating expenses increased $150,000 or 5.1% to $3,089,000 in 2004 from $2,939,000 in 2003. This increase was a result of increases in franchise taxes for the Company, loan collection expense and ATM expenses. < All other categories of operating expenses increased a net of $64,000 or 2.9% to $2,243,000 from $2,179,000. The increase was primarily due to increased legal and professional fees resulting from the provisions of the Sarbanes-Oxley Act of 2002, increased marketing and promotion expense due to new deposit products rolled out in the second quarter of 2004 and from fees associated with the issuance of trust preferred securities, the proceeds of which were invested in junior subordinated debentures of the Company, during the first quarter of 2004. Income Taxes Total income tax expense amounted to $3,630,000 (33.6% effective tax rate) for the nine months ended September 30, 2004, compared to $3,577,000 (34.2% effective tax rate) for the same period in 2003. The decrease in effective tax rate is due to a reduction in the current year tax expense accrual to more accurately reflect the estimated tax liability and deferred tax position for 2004. 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 as of September 30, 2004 and December 31, 2003 (in thousands): September 30, December 31, 2004 2003 ------------------------------------ Real estate - residential $121,201 $113,905 Real estate - agricultural 49,192 52,509 Real estate - commercial 259,030 224,427 ------------------------------------ Total real estate - mortgage $429,423 $390,841 Commercial and agricultural 134,741 131,609 Installment 31,120 28,932 Other 2,122 1,442 ------------------------------------ Total loans $597,406 $552,824 ==================================== Overall loans increased $44.6 million, or 8.1% as a result of an increase in commercial real estate and agricultural loans. Total real estate mortgage loans have averaged approximately 70% 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 $1,665,000 and $751,000 as of September 30, 2004 and December 31, 2003, respectively. At September 30, 2004, the Company had loan concentrations in agricultural industries of $90.9 million, or 15.2%, of outstanding loans and $93.3 million, or 18.1%, at December 31, 2003. In addition, the Company had loan concentrations in the following industries as of September 30, 2004 compared to December 31, 2003 (dollars in thousands):

The Company had no further loan concentrations in excess of 25% of Tier 1 risk-based capital. The following table presents the balance of loans outstanding as of September 30, 2004, by maturities (in thousands): Maturity (1) ------------------------------------------------- Over 1 One year through Over or less (2) 5 years 5 years Total ------------------------------------------------- Real estate - residential $ 59,357 $ 58,697 $3,147 $121,201 Real estate - agricultural 11,111 32,654 5,427 49,192 Real estate - commercial 64,253 159,408 35,369 259,030 ------------------------------------------------- Total real estate - mortgage $134,721 $250,759 $ 43,943 $429,423 Commercial and agricultural 98,941 34,346 1,454 134,741 Installment 15,929 15,148 43 31,120 Other 690 842 590 2,122 ------------------------------------------------- Total loans $250,281 $301,095 $ 46,030 $597,406 ================================================= (1) Based on scheduled principal repayments. (2) Includes demand loans, past due loans and overdrafts. As of September 30, 2004, loans with maturities over one year consisted of approximately $239,392,000 in fixed rate loans and $107,733,000 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 September 30, 2004 and December 31, 2003 (in thousands): September 30, December 31, 2004 2003 ---------------------------------- Nonaccrual loans $3,606 $3,296 Renegotiated loans which are performing in accordance with revised terms - 35 ---------------------------------- Total nonperforming loans $3,606 $3,331 ================================== The $310,000 increase in nonaccrual loans during the nine months ended September 30, 2004 resulted from the net of $2,148,000 of loans put on nonaccrual status, $1,770,000 of loans brought current or paid-off, $50,000 of loans charged-off and $18,000 of loans transferred to other real estate owned. Interest income that would have been reported if nonaccrual and renegotiated loans had been performing totaled $148,000 for the nine months ended September 30, 2004 and $211,000 for the year ended December 31, 2003. Loan Quality and Allowance for Loan Losses The allowance for loan losses represents management's best estimate of the reserve necessary to adequately cover probable losses in the loan portfolio. The provision for loan losses is the charge against current earnings that is determined by management as the amount needed to maintain an allowance for loan losses that is adequate but not excessive. 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 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 in the determination of such specific allocations. Additional factors considered by management in evaluating the overall adequacy of the allowance for loan losses include historical net loan losses, the level and composition of nonaccrual, past due and renegotiated loans 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 that 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 September 30, 2004, the Company's loan portfolio included $90.9 million of loans to borrowers whose businesses are directly related to agriculture. The balance decreased by $2.4 million from $93.3 million at December 31, 2003. 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. The Company has $27.5 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 nonperforming loans to this business segment and potentially in loan losses. The Company also has $20.2 million of loans to operators of non-residential buildings and $17.8 million of loans to apartment building owners. Analysis of the allowance for loan losses as of September 30, 2004 and 2003, and of changes in the allowance for the three and nine-month periods ended September 30, 2004 and 2003, was as follows (dollars in thousands):

During the first nine months of 2004, the Company had charge-offs of $118,000 on two commercial loans of a single borrower and charge-offs of $124,000 on two commercial real estate loans of a single borrower. The Company also recovered $85,000 in interest on an agricultural real estate loan that had been charged-off in a prior period and $68,500 on two commercial real estate loans that were previously charged-off. During 2003, the Company had charge-offs of $170,000 on a commercial building loan and $80,000 on an agricultural operating loan secured by crops and real estate. The Company also received a recovery of $382,000 on two commercial loans 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 the adequacy 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 September 30, 2004 and December 31, 2003 (dollars in thousands):

At September 30, 2004, the Company's investment portfolio showed a slight increase in other securities and mortgage-backed securities and a decrease in U.S. Treasury securities and obligations of U.S. government corporations and agencies and obligations of states and political subdivisions securities. 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 September 30, 2004 and December 31, 2003 were as follows (in thousands):

At September 30, 2004, there were no securities in a continuous unrealized loss position for twelve months or more. The following table indicates the expected maturities of investment securities classified as available-for-sale and held-to-maturity, presented at amortized cost, at September 30, 2004 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).

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 September 30, 2004. Investment securities carried at approximately $144,133,000 and $147,603,000 at September 30, 2004 and December 31, 2003, 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 nine months ended September 30, 2004 and for the year ended December 31, 2003 (dollars in thousands): September 30, 2004 December 31, 2003 --------------------------------------------- Weighted Weighted Average Average Amount Rate Amount Rate --------------------------------------------- Demand deposits: Non-interest-bearing $ 84,857 - $ 85,368 - Interest-bearing 226,753 .63% 219,809 .81% Savings 59,822 .39% 56,402 .54% Time deposits 259,154 2.77% 250,403 3.06% --------------------------------------------- Total average deposits $630,586 1.40% $611,982 1.59% ============================================= The following table sets forth the maturity of time deposits of $100,000 or more at September 30, 2004 and December 31, 2003 (in thousands): September 30, December 31, 2004 2003 -------------------------------------- 3 months or less $30,923 $ 20,510 Over 3 through 6 months 18,590 10,906 Over 6 through 12 months 16,614 24,654 Over 12 months 49,745 28,446 -------------------------------------- Total $115,872 $ 84,516 ====================================== During the first nine months of 2004, the balance of time deposits of $100,000 or more increased by $31.4 million. The increase in balances was primarily attributable to an increase in brokered CDs of $25.9 million. 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 $48.8 million and $22.9 million as of September 30, 2004 and December 31, 2003, respectively. The Company also maintained time deposits for the State of Illinois with balances of $4.4 million and $6.3 million as of September 30, 2004 and December 31, 2003, 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, 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 September 30, 2004 and December 31, 2003 is presented below (dollars in thousands): September 30, December 31, 2004 2003 --------------- -------------- Securities sold under agreements to repurchase $53,153 $ 59 875 Federal Home Loan Bank advances: Overnight 2,500 - Fixed term - due in one year or less 12,300 5,000 Fixed term - due after one year 13,000 25,300 Debt: Loans due in one year or less 6,700 9,025 Loans due after one year 400 600 Junior subordinated debentures 10,310 - --------------- -------------- Total $98,363 $99,800 =============== ============== Average interest rate at end of period 2.35% 2.13% Maximum outstanding at any month-end Securities sold under agreements to repurchase $58,326 $59,875 Federal Home Loan Bank advances: Overnight 7,000 - Fixed term - due in one year or less 12,300 5,000 Fixed term - due after one year 25,300 30,300 Debt: Loans due in one year or less 9,025 9,025 Loans due after one year 400 600 Junior subordinated debentures 10,310 - Averages for the period (YTD) Securities sold under agreements to repurchase $53,786 $47,795 Federal Home Loan Bank advances: Overnight 1,332 - Fixed term - due in one year or less 6,278 5,000 Fixed term - due after one year 20,117 26,094 Federal funds purchased 290 14 Debt: Loans due in one year or less 6,907 8,796 Loans due after one year 420 615 Junior subordinated debentures 8,165 - --------------- -------------- Total $97,295 $88,314 =============== ============== Average interest rate during the period 2.38% 2.41% FHLB advances represent borrowings by First Mid Bank to economically fund loan demand. The fixed term advances consist of $25.3 million as follows: < $5 million advance at 6.16% with a 5-year maturity, due March 20, 2005 < $2.3 million advance at 6.10% with a 5-year maturity, due April 7, 2005 < $5 million advance at 6.12% with a 5-year maturity, due September 6, 2005 < $5 million advance at 5.34% with a 5-year maturity, due December 14, 2005 < $3 million advance at 5.98% with a 10-year maturity, due March 1, 2011 < $5 million advance at 4.33% with a 10-year maturity, due November 23, 2011 Other debt, both short-term and long-term, represents the outstanding loan balances for the Company. At September 30, 2004, outstanding loan balances include $6,500,000 on a revolving credit agreement with The Northern Trust Company with a floating interest rate of 1.25% over the federal funds rate (3.03% as of September 30, 2004) and that matured on October 23, 2004. On October 23, 2004, the Company entered into an agreement with The Northern Trust Company to renew this loan for one year with a maturity date of October 22, 2005, under the same terms and conditions stated above. The loan has a maximum available balance of $15 million. The loan is secured by all of the common stock of First Mid Bank. The credit agreement contains requirements for the Company and First Mid Bank to maintain various operating and capital ratios and also contains requirements for prior lending approval for certain sales of assets, merger activity, the acquisition or issuance of debt, and the acquisition of treasury stock. The Company and First Mid Bank were in compliance with the existing covenants at September 30, 2004 and at December 31, 2003. The balance also includes a $600,000 balance remaining on a promissory note resulting from the acquisition of Checkley with an annual interest rate equal to the prime rate listed in the money rate section of the Wall Street Journal (4.25% as of September 30, 2004) and principal payable annually over five years, with a final maturity of January 2007. 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 (the "Trust"), a statutory business trust and wholly-owned subsidiary of the Company, as part of a pooled offering. The Company established the Trust for the purpose of issuing the trust preferred securities. Upon adoption of FIN 46R, the Company was required to de-consolidate its investment in the Trust. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company's investment in common equity of the Trust, 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 the Trust 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. The Company intends to use the proceeds of the offering for general corporate purposes. The trust preferred securities issued by the Trust are included as Tier 1 capital of the Company for regulatory capital purposes. On July 2, 2003, the Federal Reserve Board issued a supervisory letter instructing bank holding companies to continue to include trust preferred securities in the calculation of Tier 1 capital for regulatory purposes until further notice. As a result of the issuance of FIN 46R, the Federal Reserve Board is currently evaluating whether de-consolidation of the Trust will affect the qualification of the trust preferred securities as Tier 1 capital. If it is determined that the trust preferred securities no longer qualify as Tier 1 capital, the Company would still be classified 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 September 30, 2004 (dollars in thousands):

The static GAP analysis shows that at September 30, 2004, the Company was asset sensitive, on a cumulative basis, through the twelve-month time horizon. This indicates that future increases in interest rates, if any, could have a positive effect on net interest income. Conversely, future decreases in interest rates could have an adverse 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 September 30, 2004, the Company's stockholders' equity had decreased $1,869,000 or 2.7% to $68,726,000 from $70,595,000 as of December 31, 2003. During the first nine months of 2004, net income contributed $7,181,000 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 $489,000, net of tax. Additional purchases of treasury stock (296,468 shares at an average cost of $31.94 per share) decreased stockholders' equity by $9,479,000. 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 September 30, 2004 and December 31, 2003, the Company and First Mid Bank met all capital adequacy requirements. The trust preferred securities issued by First Mid-Illinois Statutory Trust I are included as Tier 1 capital of the Company for regulatory capital purposes. On July 2, 2003, the Federal Reserve Board issued a supervisory letter instructing bank holding companies to continue to include trust preferred securities in the calculation of Tier 1 capital for regulatory purposes until further notice. As a result of the issuance of FIN 46R, the Federal Reserve Board is currently evaluating whether de-consolidation of the Trust will affect the qualification of the trust preferred securities as Tier 1 capital. If it is determined that the trust preferred securities no longer qualify as Tier 1 capital, the Company would still be classified as well-capitalized. As of September 30, 2004, the most recent notification from the OCC categorized First Mid Bank 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). There are no conditions or events since that notification that management believes have changed this categorization.

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. 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 2003 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 approved the repurchase of an additional 5% of the Company's common stock. In September 2001, the Board approved the repurchase of $3 million of additional shares of the Company's common stock and in August 2002, the Board approved the repurchase of $5 million of additional shares of the Company's common stock. In September 2003, the Board approved the repurchase of $10 million of additional shares of the Company's common stock. On April 27, 2004, the Board approved the repurchase of an additional $5 million shares of the Company's common stock, bringing the aggregate total on September 30, 2004 to 8% of the Company's common stock plus $23 million of additional shares. During the nine-month period ending September 30, 2004, the Company repurchased 296,748 shares at a total price of $9,479,000. On February 9, 2004, the Company acquired as treasury stock, a total of 150,000 shares of outstanding common stock from three shareholders pursuant to privately negotiated transactions. Total consideration for these shares amounted to $4,750,000. Since 1998, the Company has repurchased a total of 1,094,176 shares at a total price of $24,015,000. As of September 30, 2004, the Company was authorized per all repurchase programs to purchase $5,192,000 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: < First Mid Bank has $17 million available in overnight federal fund lines, including $10 million from Harris Trust and Savings Bank of Chicago and $7 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 September 30, 2004, First Mid Bank's ratios of total capital to risk-weighted assets of 11.80% and Tier 1 capital to total average assets of 8.27% exceeded minimum regulatory requirements. < First Mid Bank 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 September 30, 2004, the excess collateral at the Federal Home Loan Bank will support approximately $46 million of additional advances. < 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. < First Mid Bank is also a member of the Federal Reserve System and can borrow funds provided that sufficient collateral is pledged. < In addition, the Company has a revolving credit agreement in the amount of $15 million with The Northern Trust Company. The Company has an outstanding balance of $6,500,000 as of September 30, 2004, and $8,500,000 in available funds. The credit agreement matured on October 23, 2004. On October 23, 2004, the Company entered into an agreement with The Northern Trust Company to renew this loan for one year with a maturity date of October 22, 2005, under the same terms and conditions. The agreement contains requirements for the Company and First Mid Bank to maintain various operating and capital ratios and for prior lender approval for certain sales of assets, merger activity, the acquisition or issuance of debt, and the acquisition of treasury stock. The Company and First Mid Bank were in compliance with the existing covenants at September 30, 2004. Management monitors its expected liquidity requirements carefully, focusing primarily on cash flows from: < lending activities, including loan commitments, letters of credit and mortgage prepayment assumptions; < deposit activities, including seasonal demand of private and public funds; < investing activities, including prepayments of mortgage-backed securities and call provisions on U.S. government treasuries and agency securities; and < operating activities, including scheduled debt repayments and dividends to stockholders. The following table summarizes significant contractual obligations and other commitments at September 30, 2004 (in thousands):

For the nine-month period ended September 30, 2004, net cash of $8.1 million and $21.7 million was provided from operating activities and financing activities, respectively, while investing activities used net cash of $37.1 million. In total, cash and cash equivalents decreased by $7.3 million since year-end 2003. Generally, during 2004, the funding of loans and purchases of available-for-sale securities decreased cash balances. 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 (the "Trust"), a statutory business trust and wholly-owned subsidiary of the Company, as part of a pooled offering. The Company established the Trust for the purpose of issuing the trust preferred securities. Upon adoption of FIN 46R, the Company was required to de-consolidate its investment in the Trust. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company's investment in common equity of the Trust, 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 the Trust mature in 2034, bear interest at three-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. The Company intends to use the proceeds of the offering for general corporate purposes. The trust preferred securities issued by the Trust are included as Tier 1 capital of the Company for regulatory capital purposes. Management believes that it has adequate sources of liquidity to meet its contractual obligations as well as to provide for contingencies that might reasonably be expected to occur. 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 September 30, 2004 and December 31, 2003 were as follows (in thousands): September 30, December 31, 2004 2003 --------------- -------------- Unused commitments, including lines of credit: Commercial real estate $ 22,326 $ 24,283 Commercial operating 36,746 32,928 Home equity 15,526 13,207 Other 15,092 14,991 --------------- -------------- Total $ 89,690 $ 85,409 =============== ============== Standby letters of credit $ 2,949 $ 2,440 =============== ============== 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. Subsequent Event On October 23, 2004, the Company entered into an agreement with The Northern Trust Company to renew its revolving credit agreement in the amount of $15 million for one year with a maturity date of October 22, 2005, as more particularly described in the "Repurchase Agreements and Other Borrowings" section above. 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, 2003. 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, 2003. 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 and all of its wholly-owned subsidiaries' "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 and all of its wholly-owned subsidiaries' 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 controls over financial reporting during the last fiscal quarter that have materially affected or that are reasonably likely to affect materially the Company's internal controls 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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS ISSUER PURCHASES OF EQUITY SECURITIES

On August 5, 1998, the Company announced a stock repurchase program for up to 3% of its common stock. In March 2000, the Board approved the repurchase of an additional 5% of the Company's common stock. In September 2001, the Board approved the repurchase of $3 million of additional shares of the Company's common stock and in August 2002, the Board approved the repurchase of $5 million of additional shares of the Company's common stock. In September 2003, the Board approved the repurchase of $10 million of additional shares of the Company's common stock. On April 27, 2004, the Board approved the repurchase of an additional $5 million shares of the Company's common stock, bringing the aggregate total on September 30, 2004 to 8% of the Company's common stock plus $23 million of additional shares. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS (a) 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: November 8, 2004 /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 -------------------------------------------------------------------------------- 11.1 Statement re: Computation of Earnings Per Share (Filed herewith on page 6) 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)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and 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 c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth 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 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: November 8, 2004 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)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and 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 c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth 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 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: November 8, 2004 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 September 30, 2004 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: November 8, 2004 /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 September 30, 2004 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: November 8, 2004 /s/ Michael L. Taylor Michael L. Taylor Chief Financial Officer