Business Context and Reporting Period
Company: First Merchants Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: A diversified financial holding company headquartered in Muncie, Indiana, operating 80 banking centers across Indiana and Ohio. The primary business segment is community banking. During the quarter, the company completed the merger of three subsidiary banks into First Merchants Bank, National Association.
Key Financial Metrics
| Metric | Q3 2009 | Q3 2008 | YTD 2009 | YTD 2008 |
|---|---|---|---|---|
| Net Income (Loss) | $(4.93) million | $5.75 million | $(30.54) million | $20.42 million |
| Net Income (Loss) Available to Common | $(6.38) million | $5.75 million | $(34.07) million | $20.42 million |
| Diluted EPS (Common) | $(0.30) | $0.32 | $(1.62) | $1.13 |
| Net Interest Income | $38.85 million | $33.25 million | $115.78 million | $96.24 million |
| Net Interest Margin (FTE) | 3.83% | 3.91% | 3.71% | 3.83% |
| Provision for Loan Losses | $24.24 million | $7.09 million | $96.16 million | $17.99 million |
| Total Assets | $4.48 billion | N/A | N/A | N/A |
| Total Loans (Net) | $3.31 billion | N/A | N/A | N/A |
| Allowance for Loan Losses | $86.92 million | N/A | N/A | N/A |
| Stockholders' Equity | $475.90 million | N/A | N/A | N/A |
Material Changes vs. Prior Period
- Profitability Reversal: The company reported a net loss of $4.93 million for Q3 2009, a significant decline from the $5.75 million net income in Q3 2008. Year-to-date losses totaled $30.54 million compared to $20.42 million in income for the same period in 2008.
- Provision for Loan Losses: The primary driver of the loss was a $24.24 million provision for loan losses in Q3 2009, compared to $7.09 million in Q3 2008. YTD provision reached $96.16 million.
- Asset Quality Deterioration: Non-performing assets (NPA) plus loans 90+ days delinquent increased to $156.09 million (3.49% of total assets) from $112.12 million at year-end 2008. Impaired loans rose to $326.61 million.
- Allowance Build-up: The allowance for loan losses increased by $37.38 million to $86.92 million, representing 2.54% of total loans, up from 1.33% at December 31, 2008.
- Non-Interest Income: Increased by $6.46 million in Q3 2009 compared to Q3 2008, driven by net gains on sales of investment securities and mortgage loans, partially offset by other-than-temporary impairment (OTTI) charges of $1.23 million on pooled trust preferred investments.
- Non-Interest Expense: Increased by $11.9 million in Q3 2009, largely due to FDIC assessment increases, expenses related to Other Real Estate Owned (OREO), and costs associated with the Lincoln Bancorp acquisition.
Guidance, Outlook, Risks, and Contingencies
- Covenant Default: The company disclosed a breach of a financial covenant in its Loan Agreement with Bank of America, N.A. The covenant requires a minimum annualized return on average total assets of 0.35%. As of September 30, 2009, the company's return was -0.75%. The lender has notified the company of this default and intends to impose a default interest rate of 3% on the Term Loan. The company is in discussions regarding a potential waiver.
- Capital Position: Despite the losses, the company maintains regulatory capital ratios exceeding the "well capitalized" standards (Total Risk-based Capital: 13.08%; Tier 1 Risk-based Capital: 10.44%).
- Asset Quality Risks: Management highlighted that the decline in commercial and residential real estate values continues to negatively impact collateral values. They anticipate loan delinquencies and credit losses may increase if current market trends persist.
- Investment Portfolio: The company recognized OTTI losses of $3.75 million YTD on pooled trust preferred securities. Management does not intend to sell these securities and believes the remaining impairment is temporary, though credit losses have been recognized.
- Interest Rate Sensitivity: Net interest income simulation modeling indicates that a 200 basis point rise in rates would increase net interest income by 7.49%, while a 100 basis point fall would decrease it by 1.42%.
Key Facts for Investor Verification
- Covenant Breach Status: Verify the outcome of discussions with Bank of America regarding the waiver of the return on assets covenant and the potential acceleration of debt.
- Loan Loss Trends: Monitor the trajectory of non-performing assets and the adequacy of the allowance for loan losses given the 2.54% coverage ratio and rising charge-offs.
- Real Estate Exposure: Assess the concentration of commercial real estate and land development loans, which showed high non-performing ratios (5.28% and 21.54% respectively).
- OTTI Exposure: Review the remaining unrealized losses on pooled trust preferred securities and the assumptions used to determine if further credit losses are likely.
- Liquidity Position: Confirm the stability of core deposits and the availability of remaining borrowing capacity ($109.2 million) from the Federal Home Loan Bank.