First Merchants Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018. First Merchants is an Indiana-based community banking holding company operating through First Merchants Bank, with 115 banking locations across Indiana, Illinois and Ohio.
Financial performance and position
| Metric | Q1 2019 / March 31, 2019 | Comparable period / prior year-end |
|---|---|---|
| Net income available to common shareholders | $38.8 million | $36.7 million in Q1 2018 |
| Diluted earnings per share | $0.78 | $0.74 in Q1 2018 |
| Net interest income | $84.9 million | $79.9 million in Q1 2018 |
| Net interest margin, FTE | 3.84% | 3.92% in Q1 2018 |
| Net interest spread, FTE | 3.56% | 3.71% in Q1 2018 |
| Total assets | $10.21 billion | $9.88 billion at Dec. 31, 2018 |
| Total loans | $7.30 billion | $7.22 billion at Dec. 31, 2018 |
| Total deposits | $8.05 billion | $7.75 billion at Dec. 31, 2018 |
| Total borrowings | $615.3 million | $671.0 million at Dec. 31, 2018 |
| Cash and cash equivalents | $115.9 million | $139.2 million at Dec. 31, 2018 |
| Stockholders’ equity | $1.46 billion | $1.41 billion at Dec. 31, 2018 |
Net income increased approximately 5.8% year over year and diluted EPS increased 5.4%. Net interest income rose as earning assets grew, but funding costs increased faster than asset yields: management reported a 32-basis-point increase in asset yields versus a 47-basis-point increase in interest costs. FTE net interest margin declined 8 basis points. The effective tax rate was 15.2%, compared with 15.3% in Q1 2018.
Noninterest income declined 4.3% to $18.7 million, including lower loan-sale gains and securities gains; service charges and card fees increased. Noninterest expense rose 5.5% to $56.6 million, with increases in salaries, data processing, occupancy, foreclosure costs and outside services.
Operating cash flow was $51.9 million, investing cash use was $300.8 million, and financing cash provided was $225.5 million. Cash and cash equivalents decreased $23.4 million during the quarter. The filing reports $80.9 million in loan-loss allowance, or 1.11% of loans; Q1 provision was $1.2 million and net charge-offs were $0.85 million. Nonperforming assets plus loans 90 days past due and still accruing totaled $30.7 million.
Regulatory capital remained above applicable well-capitalized thresholds for the Bank: total risk-based capital was 13.39%, CET1 was 12.40%, and Tier 1 leverage was 10.62%. The Corporation’s tangible common equity to tangible assets ratio was 10.14%.
Material changes and developments
- Assets increased $326.2 million from year-end, including a $230.1 million increase in investment securities and $73.4 million in loan growth. Management attributed securities growth partly to investing excess liquidity from deposit growth.
- Deposits rose $293.2 million, with growth in certificates of deposit and demand and savings deposits; noninterest-bearing deposits declined as interest-bearing deposits increased. Borrowings fell $55.6 million, primarily because federal funds purchased declined $84.0 million.
- Accumulated other comprehensive loss improved to $1.6 million from $21.4 million at year-end, primarily reflecting higher securities fair values as longer-term interest rates declined.
- The company adopted lease accounting guidance on January 1, 2019 and recorded an initial right-of-use asset of $23.3 million and lease liability of $23.8 million. At quarter-end, operating lease assets were $22.6 million and liabilities were $23.2 million.
- First Merchants exceeded $10 billion in assets for the first time as of March 31, 2019. After four consecutive quarters at or above that threshold and any applicable phase-in, additional requirements include revised FDIC assessment calculations and CFPB examination of consumer-protection compliance. Management also cited a material reduction in debit-card interchange income from Durbin Amendment compliance.
Outlook, commentary, risks and contingencies
The filing provides no specific earnings or financial guidance. Management said results benefited from organic loan growth and described liquidity and interest-rate sensitivity as adequate to support its objective of stable net interest income. The twelve-month simulation estimated net interest income of $334.7 million in the base case, $366.5 million under an immediate 200-basis-point increase, and $321.8 million under an immediate 100-basis-point decrease; management cautioned that model assumptions and actual outcomes may differ.
The pending MBT Financial Corp. merger was estimated at approximately $290.9 million based on the October 9, 2018 share price. MBT shareholders approved the agreement, and FDIC and Indiana approvals had been received, but a Federal Reserve waiver and customary closing conditions remained outstanding. The merger was expected to close in the first half of 2019; the filing does not report a completed transaction.
Key risks discussed include interest-rate and deposit-pricing changes, economic deterioration and credit losses, loan and investment portfolio performance, competition, regulatory changes and acquisition integration. The company’s allowance estimate depends on management judgments about borrower conditions, collateral values and the economy. The company planned to adopt CECL in Q1 2020; implementation was underway, but the size of the expected opening allowance adjustment and overall financial impact could not yet be determined. Loan commitments and standby and commercial letters of credit totaled $2.74 billion, though the company noted many are expected to expire unused or be only partially drawn. Management stated ordinary-course litigation and regulatory examinations were not expected to have a material adverse effect; no material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether the MBT merger closed, and its final consideration, integration costs and impact on capital and earnings.
- Deposit mix, deposit pricing and the effect of the $10 billion asset threshold and Durbin Amendment on interchange income and regulatory costs.
- Trends in net interest margin, funding costs and the company’s sensitivity to changing interest rates.
- Credit quality, including nonaccrual loans, net charge-offs, criticized loans and whether the $80.9 million allowance remains adequate.
- The timing, assumptions and eventual financial effect of CECL adoption in 2020.
- Liquidity and funding availability, including draws on commitments, FHLB borrowing capacity and the decline in cash during the quarter.