First Merchants Corporation — 2011 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2011; it is not a standalone fourth-quarter filing. First Merchants is an Indiana-based financial holding company focused on community banking, operating 78 banking locations across Indiana and Ohio, with insurance and trust services. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance and condition
| Metric | 2011 | 2010 |
|---|---|---|
| Total assets, year-end | $4,173.1 | $4,170.8 |
| Net interest income | $143.4 | $143.6 |
| Net interest margin, FTE | 3.98% | 3.87% |
| Provision for loan losses | $22.6 | $46.5 |
| Net income | $25.3 | $6.9 |
| Net income available to common stockholders | $9.0 | $11.7 |
| Diluted common EPS | $0.34 | $0.48 |
| Operating cash flow | $85.5 | $81.1 |
- Fourth-quarter 2011 net income available to common stockholders was $6.4 million, or $0.24 per diluted share. Quarterly results included a $10.9 million loss on extinguishment of trust preferred securities and a $1.4 million CPP discount-related loss, principally recorded in the third quarter.
- Pre-tax income rose to $33.9 million from $3.3 million, mainly because loan-loss provision expense fell by $23.9 million. Net income rose, but common earnings declined because of preferred-stock-related costs and transactions. Non-interest income increased 1.2% to $49.1 million; non-interest expense fell 4.5% to $135.9 million.
- Average earning-asset yield declined 33 basis points, while funding cost declined 44 basis points, lifting the FTE margin 11 basis points. Net interest income itself was nearly flat, reflecting lower average earning assets.
- Year-end loans were $2,713.4 million, down $122.3 million; investment securities were $946.4 million, up about $119.6 million. Total deposits declined $134.2 million to $3,134.7 million. Management said excess liquidity from loan contraction was invested in securities.
- Net charge-offs fell to $34.7 million from $55.6 million; non-performing assets including 90-day delinquencies declined to $100.8 million from $120.0 million. The $70.9 million allowance equaled 2.6% of loans and 101.9% of non-accrual loans. Separately, criticized but unimpaired loans totaled $206.1 million.
- Cash and cash equivalents ended at $73.3 million, up $15.0 million. Cash flows were $85.5 million from operations, $(28.2) million from investing, and $(42.3) million from financing. Available-for-sale securities had a $518.5 million fair value; remaining FHLB borrowing capacity was $94.8 million.
- Total borrowings were $489.4 million, up from $419.0 million. Year-end stockholders’ equity was $514.5 million. Corporation Tier 1 and total risk-based capital ratios were 13.92% and 16.54%; the Bank was reported well-capitalized.
Material changes, outlook, and risks
- Capital actions: The company issued $21.2 million of common stock in September and $90.8 million of SBLF Series B preferred stock. It used these proceeds and additional cash to redeem the remaining Treasury Series A preferred stock and Treasury-held trust preferred securities for an aggregate $116.6 million, and repurchased the Treasury warrant for $367,500. Series B dividends initially were set at 5%, with future rates tied to qualified small-business lending; the stated rate rises to 9% after four and a half years.
- Liquidity and covenant concern: The Bank’s $79 million FDIC-guaranteed notes matured March 30, 2012. The parent also disclosed noncompliance at year-end with a Bank of America covenant requiring a minimum 0.75% annualized return on average assets. The lender had applied a 3% default rate to the $5 million term loan but had not accelerated it; the term loan is secured by Bank shares. The related $50 million subordinated debt is not subject to acceleration for this covenant breach.
- Subsequent event: On February 10, 2012, the Bank agreed to acquire approximately $117 million of loans and assume $136 million of deposits from the FDIC in Shelby County, Indiana. The assets were purchased at a $29 million discount, with no deposit premium; specified troubled and real-estate-related assets were excluded. Balances remained subject to adjustment.
- Credit and valuation risks: Commercial real estate—especially commercial/farm land—is a major loan concentration. Management cited continuing sensitivity to local economic and property-value conditions. Trust-preferred securities had $5.7 million amortized cost but only $163,000 fair value; $0.4 million of 2011 credit impairment was charged to earnings, with other impairment-related amounts reflected in other comprehensive income. Management’s goodwill test found no impairment, but its valuation relied substantially on forecasts and other unobservable assumptions.
- Other notable items: The pension plan was underfunded by $6.7 million at year-end, versus a reported surplus of $1.9 million in 2010. The company dissolved its small life-reinsurance subsidiary during 2011 and reported no remaining exposure. No material pending litigation was identified. Management gave no quantitative earnings guidance; it warned that economic conditions, interest rates, credit losses, regulation, funding access, and operational or cyber risks could affect results.
Most important facts for investors to verify
- Whether the covenant breach was cured, waived, or otherwise resolved, and the status or refinancing of the $79 million notes due in March 2012.
- Subsequent credit performance of the $206.1 million criticized-loan pool, commercial real-estate exposures, renegotiated loans, and the adequacy of the allowance as losses and charge-offs evolve.
- Actual small-business lending and the resulting Series B preferred dividend rate and any potential lending incentive fee.
- Final purchase accounting, asset quality, and realized economics of the Shelby County FDIC transaction.
- Whether earnings improvement persists without relying primarily on lower provision expense, and how common-stock earnings compare after preferred dividends and related capital costs.
- Auditor issued an unqualified opinion on the financial statements and internal controls; management also reported effective disclosure controls and internal control over financial reporting.