First Merchants Corporation — Q2 2012 Form 10-Q
Business context and reporting period. First Merchants is an Indiana-based community banking holding company. This unaudited filing covers the quarter and six months ended June 30, 2012; balance-sheet comparisons are to December 31, 2011. On February 10, 2012, its bank acquired certain assets and assumed deposits and other liabilities of SCB Bank from the FDIC.
Financial highlights
Amounts are in millions of dollars except per-share data, ratios, and where noted.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Interest income | $44.2 | $45.7 | $87.6 | $92.1 |
| Net interest income | $38.1 | $35.8 | $74.2 | $71.3 |
| Net interest margin, FTE | 4.11% | 3.99% | 4.04% | 3.96% |
| Provision for loan losses | $4.5 | $5.6 | $9.4 | $11.2 |
| Other income | $13.2 | $11.1 | $35.8 | $22.9 |
| Other expenses | $34.2 | $34.4 | $68.2 | $68.3 |
| Net income | $9.2 | $5.5 | $23.6 | $10.9 |
| Net income available to common shareholders | $8.1 | $4.5 | $21.3 | $9.0 |
| Diluted earnings per common share | $0.28 | $0.18 | $0.74 | $0.35 |
Balance sheet, liquidity, and capital
- Total assets were $4.232 billion, up $59.3 million from year-end 2011. Gross loans were $2.798 billion, up $84.2 million; deposits were $3.289 billion, up $154.2 million.
- Total borrowings fell to $373.6 million from $489.4 million, including repayment of $79 million of maturing FDIC-guaranteed Senior Notes and $41.2 million of FHLB advances. Shareholders’ equity was $535.7 million.
- Cash and cash equivalents were $68.5 million. Available-for-sale securities were $547.6 million. FHLB advances were $96.8 million, with reported remaining FHLB borrowing capacity of $227.3 million.
- Six-month operating cash flow was $37.6 million, versus $57.5 million in the prior-year period. Investing activities provided $58.7 million; financing activities used $101.1 million. Cash declined $4.8 million during the period.
- Consolidated total risk-based capital was 16.75%, Tier 1 risk-based capital 14.49%, and Tier 1 leverage 10.73%. Tangible common equity to tangible assets was 7.27%, compared with 6.84% at year-end.
Material changes and management commentary
- Q2 net income available to common shareholders increased $3.6 million year over year. Management attributed higher net interest income to increased earning assets, including SCB-acquired loans, and improved margin to lower funding and deposit costs and growth in noninterest-bearing and non-maturity deposits.
- Q2 noninterest income rose 19.0%, helped by mortgage loan sale gains, insurance commissions, and card interchange income. First-half noninterest income increased 56.3%, substantially reflecting the SCB acquisition gain.
- The SCB transaction generated a $9.1 million pretax gain ($0.21 per common share after tax). The acquired portfolio included $113.0 million of loans at book value, recorded at a $19.2 million fair-value discount; there was no FDIC loss-sharing agreement.
- Credit measures improved against year-end: nonperforming assets were $81.2 million versus $100.2 million; nonaccrual loans were $63.1 million versus $69.6 million; and other real estate owned was $14.2 million versus $16.3 million. Q2 net charge-offs were $4.8 million, down from $9.4 million a year earlier. The allowance was $70.1 million, 2.49% of loans and 111.1% of nonaccrual loans.
- Management said salaries and benefits rose, offset by lower core deposit intangible amortization, FDIC assessments, and credit-related expenses. It considered the allowance adequate, while noting estimation involves judgment and that declines in real estate values had adversely affected collateral values.
Outlook, risks, and contingencies
- The filing provides no specific earnings or financial guidance. Management cautioned that first-half results are not necessarily indicative of full-year results.
- Disclosed risks include interest-rate and pricing changes, adverse economic conditions and credit performance, competition and consolidation, regulatory changes, acquisition integration, and availability of earnings and capital for dividends. Risk factors were unchanged from the 2011 Form 10-K.
- Management’s 12-month interest-rate simulation estimated net interest income of $147.9 million in its base case, $153.8 million under an immediate +200 basis-point scenario (+4.03%), and $145.8 million under a -100 basis-point scenario (-1.40%). The filing stresses that outcomes depend on assumptions and are not forecasts.
- Off-balance-sheet loan commitments and standby/commercial letters of credit totaled $896.0 million; management noted commitments may expire unused or be only partly drawn. The company reported compliance with its Bank of America credit facility covenants at June 30, 2012. A minimum-return covenant breach at December 31, 2011 had been cured by March 31, 2012; the lender had applied a 3% default rate through that date but did not accelerate the term loan.
- The filing reports no legal proceedings and no material changes to previously disclosed risk factors. Management concluded disclosure controls were effective and reported no material recent change in internal control over financial reporting.
Important facts for investors to verify
- Separate recurring earnings from the $9.1 million SCB acquisition gain when assessing first-half performance and future earnings capacity.
- Track credit quality, especially commercial real estate exposure, impaired and acquired loans, charge-offs, troubled debt restructurings, and collateral values.
- Assess whether deposit growth and lower funding costs can sustain net interest margin, and review the interest-rate simulation’s assumptions and sensitivity.
- Monitor liquidity and refinancing needs, including the $896.0 million of commitments, FHLB capacity, repurchase funding, and the $55 million Bank of America facility maturing in 2015.
- Confirm ongoing regulatory capital and covenant compliance and the capacity to support dividends; the filing gives no forward earnings guidance.