First Merchants Corporation — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual report, not a standalone fourth-quarter filing. First Merchants is an Indiana-based financial holding company operating primarily through its community bank, with 106 banking locations across Indiana, Illinois and Ohio.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Net income available to common shareholders | $81.1 million | $65.4 million |
| Diluted earnings per share | $1.98 | $1.72 |
| Net interest income | $226.5 million | $196.4 million |
| Net interest margin, fully taxable equivalent | 3.89% | 3.80% |
| Provision for loan losses | $5.7 million | $0.4 million |
| Total assets at year-end | $7.21 billion | $6.76 billion |
| Total loans at year-end | $5.14 billion | $4.69 billion |
| Total deposits at year-end | $5.56 billion | $5.29 billion |
| Total borrowings at year-end | $694.2 million | $568.5 million |
| Stockholders’ equity at year-end | $901.7 million | $850.5 million |
Revenue from net interest income and other income was approximately $291.7 million, versus $266.3 million in 2015. Return on average assets was 1.17% and return on average equity was 9.16%. Common dividends paid were $0.54 per share, up from $0.41.
Net cash provided by operating activities was $106.9 million; investing activities used $451.8 million, principally reflecting loan growth and securities purchases; financing activities provided $370.7 million. Cash and cash equivalents ended the year at $127.9 million, up from $102.2 million.
Changes versus the prior period
- Net income rose 24.0% and diluted EPS rose 15.1%. Net interest income increased $30.1 million, while the fully taxable equivalent margin expanded 9 basis points. Management attributed growth mainly to organic loan growth and the expanded earning-asset base.
- Loans grew $438.9 million from year-end 2015; management described $445.8 million as organic loan growth. Deposits increased $266.9 million. Federal funds purchased and FHLB advances also increased to help fund loan growth.
- Non-interest income declined $4.7 million, partly because 2015 included the $8.3 million gain on the FMIG insurance subsidiary sale. 2015 also included a $1.3 million gain on cancellation of subordinated debentures and $9.8 million of non-recurring acquisition, merger and system-conversion expenses.
- Non-interest expense increased 1.5% to $177.4 million. The 2016 amount included a $2.2 million gain from terminating a post-retirement benefit plan, which reduced salaries and benefits expense.
- The allowance for loan losses increased to $66.0 million, but declined as a share of loans to 1.28% from 1.33%. Non-performing assets plus loans 90 days delinquent fell to $43.8 million from $51.5 million, while non-performing loans increased to $34.7 million from $33.3 million.
Capital, liquidity and risks
- The Corporation reported regulatory ratios of 14.21% total risk-based capital, 12.02% Tier 1 capital, 11.10% common equity Tier 1 and 10.54% Tier 1 leverage. The Bank met the regulatory definition of well-capitalized. Tangible common equity to tangible assets was 9.24%.
- Available-for-sale securities had a year-end fair value of $696.9 million. Management reported no other-than-temporary impairment in 2016, though gross unrealized losses across available-for-sale and held-to-maturity securities totaled $13.5 million.
- Year-end FHLB advances were $298.9 million, with $291.4 million of remaining FHLB borrowing capacity. The Corporation reported a cumulative negative interest-rate-sensitivity gap of $874.0 million over one year. Its model estimated 12-month net interest income would rise 7.29% under an immediate 200-basis-point increase and fall 7.26% under a 100-basis-point decrease; these are scenario estimates, not forecasts.
- Loan commitments were $2.06 billion and standby letters of credit were $46.0 million. The filing notes that many commitments may expire unused or be only partly drawn. Deposits exceeding the FDIC insurance limit totaled $2.2 billion.
- Key exposures include credit deterioration, commercial real estate and borrower concentrations, interest-rate and funding risk, competition, regulatory and compliance costs, cybersecurity and operational disruptions, acquisition integration, and valuation of goodwill and other estimates. Goodwill was $244.0 million; the 2016 impairment test found no impairment. Management said the ultimate effect of the new expected-credit-loss standard (CECL) could not yet be determined.
- Management reported no material pending litigation and stated that ordinary-course claims were not expected to materially adversely affect the company. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Outlook and notable subsequent events
The filing provides no specific earnings or growth guidance. Management described continued acquisition-led geographic expansion as a strategy and cautioned that actual results may differ from forward-looking statements. The Bank converted from a national to an Indiana state-chartered bank effective April 15, 2016; management expected no effect on operations or customers.
After year-end, the company announced two pending stock-exchange mergers: The Arlington Bank, valued at approximately $75.8 million based on the cited share price, with completion anticipated in the second quarter of 2017; and Independent Alliance Banks, Inc. (IALB), with approximately $251.3 million estimated value for shares not already owned, anticipated to close in the third quarter of 2017. Both were subject to shareholder, regulatory and other customary approvals. First Merchants had purchased 12.1% of IALB for $19.8 million in November 2016.
Investor verification points
- Verify the reported earnings drivers and the sustainability of margin improvement, including $12.4 million of acquired-loan fair-value accretion income in 2016.
- Review commercial real estate exposure, criticized loans ($233.5 million), non-performing loan trends, reserve assumptions and the remaining acquired-loan fair-value discount ($34.9 million).
- Assess funding mix and liquidity, including increased borrowings, brokered deposits, uninsured deposits, commitment draw risk and available FHLB capacity.
- Check completion, final consideration, integration costs and expected benefits of the Arlington and IALB transactions; both remained pending when the filing was signed.
- Monitor CECL implementation and the potential effect on the allowance, earnings and capital; management had not quantified the impact.