First Merchants Corporation (FRME) — Q3 2019 Form 10-Q
Business context and reporting period
Community banking company headquartered in Indiana; results cover the three and nine months ended September 30, 2019. On September 1, the company acquired MBT Financial Corp. (MBT), adding 20 banking centers in Michigan. MBT’s results are included from the acquisition date. Unless noted otherwise, amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $88.9 million | $86.5 million | $259.1 million | $251.0 million |
| Net income available to common shareholders | $36.8 million | $41.1 million | $116.6 million | $117.4 million |
| Diluted EPS | $0.71 | $0.83 | $2.32 | $2.37 |
| Net interest margin, FTE | 3.62% | 4.05% | 3.72% | 3.99% |
| Provision for loan losses | $0.6 million | $1.4 million | $2.3 million | $5.6 million |
At September 30, total assets were $12.33 billion, loans net of allowance were $8.22 billion, deposits were $9.77 billion, total borrowings were $684.8 million, and stockholders’ equity was $1.75 billion. The allowance for loan losses was $80.6 million, or 0.97% of loans. Nonperforming loans were $23.3 million; nonperforming assets were $30.5 million. Management considered the allowance adequate.
Nine-month cash from operating activities was $136.5 million; investing activities used $830.8 million and financing activities provided $757.4 million. Cash and cash equivalents ended the period at $202.4 million. Available-for-sale securities were $1.65 billion. The Bank reported $524.7 million of remaining FHLB borrowing capacity. At September 30, the Bank’s CET1 ratio was 12.21% and total risk-based capital ratio was 13.05%; it met the regulatory well-capitalized requirements.
Material changes versus prior periods
- Third-quarter net income fell to $36.8 million from $41.1 million, and diluted EPS declined to $0.71 from $0.83. Nine-month net income and EPS were also slightly lower year over year.
- Net interest income rose, but FTE net interest margin declined. Management attributed margin pressure to higher deposit and wholesale funding costs, alongside lower asset yields in Q3 following Federal Reserve rate cuts.
- Q3 noninterest expense rose 22.4% year over year. The company recorded $11.2 million of MBT acquisition-related expense in the quarter and $11.9 million for the first nine months. The company issued approximately 6.4 million shares valued at $229.9 million for the acquisition.
- Assets increased $2.4 billion from year-end 2018; MBT contributed $1.5 billion. Excluding MBT, management reported annualized organic asset growth of 13.3%, loan growth of 6.4%, and deposit growth of 15.6%.
- Credit indicators improved overall: nonperforming loans declined from $27.3 million at year-end, and provision expense was lower. However, Q3 net charge-offs were $1.3 million versus $0.5 million a year earlier, including a $1.3 million individual charge-off.
- The company repurchased 516,016 shares for $19.0 million under a new authorization of up to 3 million shares and $75 million in aggregate.
Outlook, commentary, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management said liquidity and interest-rate sensitivity remained adequate; its model estimated 12-month net interest income would rise 7.25% under an immediate +200-basis-point scenario and decline 3.20% under a −100-basis-point scenario versus base. These are modeled scenarios, not forecasts.
- MBT’s purchase price allocation remains preliminary and subject to adjustment during the one-year measurement period. The acquisition generated $97.8 million of goodwill and a $16.5 million core deposit intangible. Pro forma results are informational and not a projection of future performance.
- The Bank is subject to a DOJ fair-lending Settlement Agreement and Agreed Order. Commitments include $1.12 million for a loan subsidy fund over four years, specified branch and loan-office actions, and at least $125,000 annually for four years for outreach and related initiatives. The company also reported $1.2 million of second-quarter expense related to DOJ and community agreements. Failure to comply could adversely affect the business.
- The company expects to adopt CECL in Q1 2020 and anticipates a one-time cumulative adjustment to retained earnings; the impact was still being finalized, with an estimate expected in Q4 2019. Management cautioned that the new expected-credit-loss model could materially affect the allowance and earnings.
- Other stated risks include changes in interest rates, economic and credit conditions, acquisition integration, regulatory requirements, liquidity and capital needs, and the ability to sustain dividends. The company had exceeded $10 billion in assets, bringing additional regulatory requirements; management also cited potential reduction in debit interchange income from the Durbin Amendment.
- Ordinary-course litigation was not expected by management to have a material adverse effect. Disclosure controls were reported effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether MBT integration, cost savings and expected accretion offset acquisition expenses and the added goodwill and intangible amortization.
- Whether deposit and funding costs continue to pressure net interest margin, particularly after 2019 rate cuts.
- Credit quality trends, including charge-offs, nonperforming assets, the allowance’s adequacy, and the effect of acquired loans and CECL adoption.
- Progress and costs under the DOJ settlement, and any regulatory consequences of the company’s expanded asset size.
- Capital, liquidity and dividend capacity after the acquisition and planned share repurchases.