First Merchants Corporation — Q2 2023 Form 10-Q
Business and period. First Merchants is an Indiana-based community banking holding company operating through First Merchants Bank, with 119 banking locations across Indiana, Ohio, Michigan and Illinois. This unaudited filing covers the quarter and six months ended June 30, 2023; balance-sheet comparisons are with December 31, 2022. Dollar figures below are in millions unless noted.
Financial performance and condition
| Metric | Q2 2023 | Comparable period / change |
|---|---|---|
| Net interest income | $137.8 | $128.7 in Q2 2022, up 7.1% |
| Non-interest income | $26.3 | $28.3 in Q2 2022 |
| Net income / common earnings | $60.9 / $60.4 | $39.0 / $38.5 in Q2 2022 |
| Diluted EPS | $1.02 | $0.63 in Q2 2022; $1.07 in Q1 2023 |
| FTE net interest margin | 3.39% | 3.28% in Q2 2022 |
For the first six months, net interest income was $282.0 million, net income available to common stockholders was $124.0 million, and diluted EPS was $2.09, versus $230.9 million, $87.1 million and $1.54, respectively, in 2022. Management’s non-GAAP adjusted diluted EPS, excluding PPP income and Level One acquisition-related expenses, was $1.02 for Q2 versus $1.01 a year earlier, and $2.09 for the first half versus $1.89.
Q2 pretax income was $71.6 million; income tax expense was $10.7 million and the effective tax rate was 15.0%. The efficiency ratio was 52.21%. For the first half, operating cash flow was $113.7 million; investing activities used $1.330 billion and financing activities used $126.0 million. Cash and due from banks declined $13.6 million to $109.0 million.
At June 30, total assets were $18.0 billion and stockholders’ equity was $2.15 billion. Loans were $12.27 billion, up $266.3 million from year-end; the allowance for loan losses was $221.1 million, or 1.80% of loans, compared with 1.86% at year-end. Deposits totaled $14.58 billion, up $198.4 million from year-end, while borrowings fell $286.7 million to $1.03 billion. The CET1 ratio was 11.07% at the holding company and 11.65% at the Bank; management reported regulatory capital ratios above applicable well-capitalized requirements.
Material changes and management commentary
- Net interest income and earnings increased year over year, reflecting higher asset yields, loan growth and the inclusion of Level One for a full first half in 2023. Higher deposit and borrowing costs partly offset asset-yield gains: Q2 total cost of funds was 1.97%, versus 0.30% a year earlier. Management reported that interest costs rose faster than asset yields, narrowing net interest spread.
- Non-interest income declined year over year, principally due to a $1.4 million Q2 realized loss on available-for-sale securities; first-half realized securities losses were $3.0 million. Non-interest expense fell 4.9% in Q2, partly because Q2 2022 included Level One acquisition charges. First-half non-interest expense rose 9.8%, including higher personnel, technology and operating costs associated with the larger franchise.
- Management is not reinvesting securities cash flows into the investment portfolio, instead retaining liquidity to support loan growth. Total securities declined $372.3 million from year-end. Available-for-sale securities had $269.8 million of gross unrealized losses at June 30; management attributed these losses to interest rates, not credit quality, and said it did not intend or expect to be required to sell before recovery.
- Non-accrual loans rose to $69.2 million from $42.3 million at year-end; total nonperforming assets were $76.9 million. Past-due loans increased to $70.6 million from $51.0 million. The allowance declined through net charge-offs; no net provision expense was reported for the first half, although segment-level allowance movements occurred.
- Noninterest-bearing deposits represented 18.1% of deposits, down from 23.6% at the Q2 2022 peak, as customers moved into higher-yielding products. Management reported 74.5% of deposits insured and stated that available liquidity, including unused borrowing capacity, was ample. The Bank had $721.1 million of remaining FHLB capacity and no outstanding Bank Term Funding Program balance. Interest-rate simulations estimated a 2.1% increase in twelve-month net interest income under a +200-basis-point scenario and a 1.4% decline under a -100-basis-point scenario; these are model scenarios, not guidance.
Outlook, risks and contingencies
The filing provides no quantified earnings or margin guidance. Management said it would continue monitoring loan growth, economic forecasts and credit quality to determine future provision needs. Key stated risks include interest-rate movements and deposit pricing, economic deterioration and credit losses, liquidity and deposit competition following bank failures, possible regulatory changes and higher FDIC assessments, and acquisition integration.
A potential fraud involving a borrower was identified at quarter-end. The related $15.9 million commercial and industrial loan was on non-accrual status at June 30; the company was evaluating collateral and could not determine the potential principal or interest loss. Separately, the company disclosed $5.04 billion of loan commitments and $41.5 million of standby letters of credit; these off-balance-sheet amounts are not necessarily expected cash requirements because commitments may expire unused. The reserve for unfunded commitments was $23.3 million. Management said routine litigation and regulatory matters were not expected to have a material adverse effect.
Important facts for investors to verify
- Developments in the $15.9 million borrower fraud case, collateral recovery and any resulting charge-off or allowance impact.
- Whether rising past-due and non-accrual loans, particularly commercial and industrial and commercial real estate exposures, lead to higher credit costs.
- Deposit retention, migration into higher-cost products, uninsured deposit levels and actual access to stated contingent liquidity sources.
- How securities sales, interest-rate changes and any need to sell securities affect accumulated unrealized losses, tangible capital and liquidity.
- How sustainable reported earnings and margins are as funding costs reset, and how non-GAAP adjusted EPS compares with GAAP results and prior-period acquisition effects.