First Merchants Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016. First Merchants is an Indiana-based financial holding company operating community banking through First Merchants Bank, with 105 banking locations across Indiana, Illinois and Ohio. Unless otherwise stated, amounts below are in millions of dollars.
Key financial results
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Net interest income | $61.0 | $54.5 |
| Net interest margin (FTE) | 3.98% | 3.83% |
| Net income available to common shareholders | $23.2 | $17.7 |
| Diluted EPS | $0.56 | $0.43 |
| Provision for loan losses | $2.4 | $0.6 |
| Cash dividends per share | $0.15 | $0.11 |
| Total assets | $7,326 at March 31 | $7,212 at December 31 |
| Loans, before allowance | $5,275 at March 31 | $5,140 at December 31 |
| Deposits | $5,635 at March 31 | $5,556 at December 31 |
| Total borrowings | $709 at March 31 | $694 at December 31 |
| Stockholders’ equity | $929 at March 31 | $902 at December 31 |
- Net income rose 31.1% year over year; diluted EPS increased 30.2%. Net interest income increased 12.0%, supported by organic loan growth and higher rates. FTE net interest income was $64.9 million, up from $57.6 million.
- Total interest income was $68.2 million versus $61.2 million; interest expense was $7.2 million versus $6.8 million. Net interest margin improved 15 basis points, as asset yields increased and funding costs were nearly unchanged.
- Total other income declined 6.3% to $14.8 million. Total other expense declined 7.3% to $43.1 million. Pre-tax income was $30.4 million versus $23.3 million.
- Effective tax rate was 23.6%, versus 24.0%. Adoption of share-based compensation guidance generated an approximately $0.8 million tax benefit in Q1 2017.
- Operating cash flow was $35.3 million, compared with $24.8 million. Investing activities used $146.2 million, primarily reflecting net loan growth and securities purchases; financing activities provided $87.2 million. Cash and cash equivalents fell $23.7 million during the quarter to $104.2 million.
Asset quality, liquidity and capital
- Loans increased $133.6 million during the quarter, particularly commercial and farmland and commercial and industrial lending. Deposits rose $78.8 million; brokered deposits and larger certificates/time deposits were the largest contributors. Borrowings rose $14.6 million, including a $40.0 million increase in FHLB advances, partly offset by lower federal funds purchased.
- The allowance for loan losses was $68.2 million, or 1.29% of loans, versus 1.28% at year-end. It covered 244.4% of non-accrual loans. Provision expense was $2.4 million, while net charge-offs were $0.2 million, compared with $0.9 million in Q1 2016. Management attributed the higher provision mainly to loan growth.
- Non-performing loans were $28.8 million, down from $34.7 million at year-end. Non-performing assets plus loans 90 days delinquent were $37.2 million, down from $43.8 million. Other real estate owned was $8.3 million.
- Available-for-sale securities totaled $730.8 million; held-to-maturity securities totaled $596.4 million. Management considered identified unrealized losses temporary, attributing them primarily to interest-rate changes, and reported no other-than-temporary impairment at quarter-end.
- Available-for-sale securities, cash and short-term assets support liquidity. Remaining FHLB borrowing capacity was $570.1 million. The company also reported $2.29 billion of loan commitments and $41.0 million of standby and commercial letters of credit; commitments may expire unused or be partially drawn.
- The Bank exceeded regulatory “well-capitalized” thresholds. At March 31, its total risk-based capital ratio was 13.34%, CET1 ratio 12.23%, and tier 1 leverage ratio 10.78%. The Corporation’s tangible common equity to tangible assets ratio, a non-GAAP measure, was 9.50%.
Material changes, outlook and risks
- Lower acquisition and integration costs were a major contributor to reduced expenses: such costs fell from $1.9 million in Q1 2016 to $0.4 million in Q1 2017. Salaries and benefits also declined, while outside data processing and occupancy costs increased.
- Q1 2016 included a $0.5 million life-insurance death benefit, contributing to lower year-over-year life-insurance earnings in Q1 2017. Securities gains also declined. Purchased-loan fair-value accretion increased to $4.3 million from $2.5 million, supporting interest income.
- No specific earnings or financial guidance is provided. Management said recent federal funds rate increases contributed positively to net interest income and margin. Its rate model estimated 12-month net interest income would rise 8.49% under an immediate 200-basis-point rate increase and fall 9.09% under a 100-basis-point decline; these are scenarios, not forecasts, and depend on modeling assumptions.
- Two pending stock-exchange mergers were announced: The Arlington Bank, with $292 million of assets, had an estimated transaction value of $75.8 million and was anticipated to close in Q2 2017, subject to approvals and customary conditions. Independent Alliance Banks, with $1.1 billion of assets, was anticipated to close in Q3 2017; First Merchants already owned 12.1%, and the estimated value of the remaining shares was $251.3 million. Neither merger was complete at quarter-end.
- Management cited risks including interest-rate and funding-price movements, economic weakness and credit losses, loan and securities portfolio deterioration, competition, regulatory changes, acquisition integration, and availability of earnings and capital for dividends. The filing says risk factors were not materially changed from the 2016 Form 10-K.
- The company is evaluating CECL, effective for it in 2020. Management said implementation could materially affect the allowance and earnings; the amount of any adjustment could not yet be determined. Routine litigation and regulatory examinations were not expected to have a material adverse effect.
- Derivative agreements include provisions that could require termination or collateralization if capital status or debt obligations trigger specified events. At March 31, the termination value of relevant derivatives in a net liability position was $3.3 million, and $8.7 million of collateral had been posted.
Important facts for investors to verify
- Whether loan growth can continue without a sustained increase in provision expense or deterioration in delinquencies, non-accruals and commercial real-estate credit quality.
- How much earnings growth is repeatable, given higher purchased-loan accretion, lower integration costs, and the one-time share-based compensation tax benefit.
- Merger approvals, closing timing, share issuance and dilution, integration costs, and the realized financial contribution of Arlington Bank and Independent Alliance Banks.
- Deposit mix and pricing, reliance on brokered and time deposits, borrowing needs, and liquidity under changing rate conditions.
- The eventual CECL allowance transition impact and any effect of interest-rate changes on net interest income and securities values.