First Merchants Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. First Merchants is an Indiana-based community banking company. Amounts below are in millions of dollars unless otherwise noted.
Financial performance
- Q3 earnings: Net income available to common shareholders was $16.1 million, or $0.45 diluted EPS, versus $10.0 million, or $0.35, in Q3 2013. Nine-month earnings were $44.9 million, or $1.24 diluted EPS, versus $30.9 million, or $1.07.
- Net interest income and margin: GAAP net interest income was $47.9 million in Q3, up from $37.0 million; nine-month income was $139.9 million, up from $113.1 million. On a fully taxable-equivalent basis, Q3 net interest margin was 4.0%, unchanged year over year; nine-month margin was also 4.0%. Management attributed much of the growth in income and earning assets to the November 2013 CFS Bancorp acquisition.
- Other income and expenses: Q3 other income rose 55.0% to $18.3 million, while other expenses increased 24.4% to $42.6 million. For nine months, other income increased 24.4% to $49.4 million and expenses increased 23.6% to $126.9 million. Growth reflected CFS, alongside items including securities and OREO gains, insurance death benefits, and acquisition/integration costs.
- Assets and funding: Total assets were $5.59 billion, up $154.1 million from December 31, 2013. Loans were $3.77 billion, up $140.1 million; investment securities were $1.19 billion, up $94.2 million. Deposits totaled $4.31 billion, up $78.7 million. Total borrowings were $561.6 million, up $38.4 million; FHLB advances increased $133.3 million, partly offset by lower federal funds purchased and repurchase agreements.
- Cash flow and liquidity: Nine-month operating cash flow was $52.4 million, investing cash flow was negative $197.1 million, and financing cash flow was positive $109.5 million. Cash and cash equivalents declined $35.2 million to $74.2 million. Available-for-sale securities totaled $568.0 million; remaining FHLB borrowing capacity was $283.8 million. The company also had an unused $20 million credit line maturing April 10, 2015.
- Capital: Stockholders’ equity was $684.6 million, versus $634.9 million at year-end. Consolidated total risk-based capital was 15.21% and Tier 1 leverage was 9.93%; the Bank and Corporation exceeded applicable well-capitalized thresholds. Tangible common equity to tangible assets was 9.05%, compared with 8.34% at year-end.
Credit quality and material changes
- Nonperforming assets were $64.8 million, down from $81.7 million at year-end; nonperforming assets plus loans at least 90 days delinquent were $65.6 million, down from $83.0 million. Nonaccrual loans were $49.1 million, including $10.6 million tied to one agricultural relationship that management described as unusual for the overall portfolio.
- The allowance for loan losses was $65.6 million, or 1.74% of loans, versus $67.9 million and 1.87% at year-end. It covered 133.6% of nonaccrual loans. Nine-month provision expense declined to $1.6 million from $5.6 million, while nine-month net charge-offs fell to $3.9 million from $8.8 million. Q3 net charge-offs, however, increased to $4.4 million from $3.5 million a year earlier; specific reserves on impaired loans also increased.
- Q3 and nine-month results include the acquired CFS business, so comparisons with 2013 are affected by the acquisition and are not wholly like-for-like. The filing reports $1.6 million of CFS acquisition/core-system integration expense for the first nine months of 2014 and $256,000 of Community Bancshares transaction expense.
- Accumulated other comprehensive income improved to $4.2 million from a $6.4 million loss at year-end, mainly reflecting gains on available-for-sale securities.
Outlook, risks and unusual items
- No specific earnings or revenue guidance is provided. Management’s interest-rate simulation estimated 12-month net interest income of $180.1 million in the base case, $190.9 million under an immediate 200-basis-point rate rise (+5.96%), and $174.5 million under a 100-basis-point decline (−3.14%). These scenarios are analytical estimates, not forecasts.
- Community Bancshares, with approximately $259 million of assets, was expected to merge into First Merchants on November 7, 2014; required regulatory and shareholder approvals had been obtained by the filing date.
- Management cited risks from interest-rate and pricing changes, economic weakness, credit or investment portfolio deterioration, regulation, competition, acquisition integration, liquidity and capital needs, and the ability to maintain dividends. It reported no material changes to previously disclosed risk factors and no legal proceedings.
- The company reported $2.3 million of nine-month realized securities gains. It sold four of six trust preferred securities in Q2, recording a $641,000 gain; the two remaining securities had $1.5 million amortized cost and $821,000 fair value. Management considered the remaining unrealized losses temporary and reported no Q3 2014 OTTI.
Investor verification points
- Assess how much reported earnings growth reflects CFS acquisition effects, loan fair-value accretion ($7.4 million for nine months), and nonrecurring gains or benefits.
- Review credit trends behind the higher Q3 charge-offs and specific impaired-loan reserves, including the agricultural relationship and collateral assumptions.
- Check deposit mix and funding costs, including the reported $249.9 million increase in brokered deposits and higher FHLB advances.
- Confirm the Community Bancshares merger’s completion, integration costs, and subsequent impact on capital, liquidity and earnings.
- Evaluate sensitivity to interest rates and the valuation assumptions for Level 3 securities, impaired loans and other real estate owned.