FIRST MERCHANTS CORP quarterly report, Q1 FY2024

First Merchants Corporation — Q1 2024 Form 10-Q

Business context and reporting period. First Merchants Corporation is an Indiana-based financial holding company operating through First Merchants Bank, with 116 locations across Indiana, Ohio, Michigan and Illinois. Its business is community banking. This unaudited report covers the three months ended March 31, 2024; balance-sheet comparisons are to December 31, 2023.

Key financial results

Amounts below are in millions, except per-share data and ratios.

• Management reported adjusted diluted EPS, excluding PPP loan income and specified non-core expenses, of $0.85, versus $1.07 in Q1 2023. This is a non-GAAP measure; Q1 2024 adjustments included $1.1 million for an FDIC special assessment and $2.4 million of digital-platform conversion costs.
• Return on average assets was 1.04%, versus 1.42%; return on average equity was 8.47%, versus 12.21%. The effective tax rate fell to 12.5% from 15.0%, primarily because tax-exempt interest was a larger share of pretax income.

Balance sheet, funding and capital

• Total assets were $18.3 billion, down from $18.4 billion at year-end. Loans were $12.47 billion; deposits were $14.88 billion, up $63.1 million from year-end.
• Noninterest-bearing deposits were 15.7% of deposits at quarter-end, down from 16.9% at year-end, reflecting customer movement to higher-yielding accounts. Core deposits were 90.1% of deposits; 29.4% of deposits were uninsured.
• Total borrowings declined $167.1 million to $861.7 million, as the company used liquidity to repay funding and redeemed $40 million of subordinated debt. It gave notice of a further $25 million redemption in Q1; that redemption occurred in Q2 2024.
• Available borrowing capacity was $721.2 million at the FHLB and $1.1 billion at the Federal Reserve. No Federal Reserve Discount Window or Bank Term Funding Program borrowings were outstanding at quarter-end. Management described liquidity as ample.
• The Corporation’s CET1 ratio was 11.25%; the Bank’s was 11.62%. The Bank met regulatory well-capitalized requirements. Tangible common equity to tangible assets was 8.32%, versus 8.40% at year-end.
• Cash and cash equivalents decreased $12.1 million during the quarter. Investing activities provided $82.9 million, while financing activities used $153.9 million.

Material changes and credit quality

• Interest expense rose to $108.8 million from $62.3 million, principally as customers shifted to interest-bearing products and deposit pricing increased. Total cost of funds rose to 3.23% from 1.98%; asset yields increased less, contributing to the 48-basis-point year-over-year decline in FTE net interest margin.
• Noninterest income increased 6.6% year over year, partly because securities-sale losses were only $2,000, compared with $1.6 million in Q1 2023. Noninterest expense increased 3.4%, including the stated non-core charges.
• The allowance for loan losses was $204.7 million, or 1.64% of loans, broadly unchanged from year-end. Net charge-offs were $2.3 million, compared with $0.2 million in Q1 2023. Nonaccrual loans increased $8.9 million to $62.5 million; nonperforming assets plus loans 90 days past due and still accruing totaled $70.2 million, up from $58.6 million.
• Total past-due loans decreased to $68.9 million from $79.2 million at year-end, although loans 90 days or more past due increased. Management cited a rise in commercial real estate, non-owner-occupied nonaccrual loans.
• Available-for-sale securities had $248.0 million of gross unrealized losses at March 31, up from $220.6 million at year-end. Management attributed the losses to interest rates rather than credit quality, stated it did not intend to sell the securities, and said it was not more likely than not that it would be required to sell them before recovery. The held-to-maturity portfolio’s fair value was $1.82 billion versus a $2.16 billion carrying amount.

Outlook, risks and unusual items

• The filing provides no specific earnings or growth guidance. Management said it is reinvesting securities cash flows on a limited basis, prioritizing liquidity to repay borrowings and support loan growth, and continues to monitor economic forecasts, loan growth and credit quality.
• A significant subsequent event: in April, a borrower advised it planned to stop principal and interest payments for the foreseeable future after renegotiation and cessation of key government contracts. The loan was $38.6 million at March 31, was current and risk-graded Substandard at that date. The company is assessing a restructuring plan and collateral position and said the potential loss cannot yet be determined.
• Interest-rate sensitivity modeling estimated 12-month net interest income would be 2.6% higher under an immediate parallel 200-basis-point rate increase and 4.2% lower under a 100-basis-point decrease. These are modeled scenarios, not management forecasts.
• Risks identified include interest-rate and deposit-pricing changes, economic deterioration and credit losses, liquidity or confidence pressures affecting banks, adverse portfolio developments, regulation and competition. Management said there were no material changes to previously disclosed risk factors. Routine litigation and regulatory examinations were not expected to have a material adverse effect.
• The company repurchased 888,442 shares under its program for approximately $30.0 million and had about 1.8 million shares remaining available under the program at quarter-end. A $297,000 excise tax related to repurchases was recorded in equity.

Most important facts for investors to verify

• Track the $38.6 million borrower’s restructuring, collateral recovery and any resulting credit provision or charge-off.
• Monitor whether higher deposit costs continue to outpace asset-yield increases and pressure net interest margin.
• Review trends in nonaccrual and 90-day-past-due loans, especially commercial real estate, alongside charge-offs and allowance adequacy.
• Assess liquidity and deposit mix, including uninsured deposits, borrowing capacity and the effect of further subordinated-debt redemptions.
• Follow the size and duration of unrealized securities losses and their potential implications for capital or liquidity if securities must be sold.