First Merchants Corporation — Q3 2013 Form 10-Q
Business context and period: Indiana-based community banking holding company reporting for the quarter and nine months ended September 30, 2013. The filing is unaudited. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless otherwise stated.
Key financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net interest income | $37.0m | $39.9m | $113.1m | $114.1m |
| Provision for loan losses | $1.5m | $4.6m | $5.6m | $14.0m |
| Other income | $11.8m | $14.3m | $39.7m | $50.1m |
| Other expenses | $34.2m | $34.4m | $102.7m | $102.6m |
| Net income | $10.4m | $11.2m | $33.1m | $34.8m |
| Net income available to common shareholders | $10.0m | $10.1m | $30.9m | $31.4m |
| Diluted EPS | $0.35 | $0.35 | $1.07 | $1.09 |
| Net interest margin | 3.97% | 4.32% | 4.03% | 4.13% |
- Profitability: Q3 common earnings decreased $0.1m year over year; nine-month common earnings fell $0.5m. Nine-month results in 2012 included a $9.1m pretax FDIC acquisition gain, so reported other income is not directly comparable.
- Margin and income: Management attributed weaker net interest margin to earning-asset yields falling faster than funding costs. Q3 FTE earning-asset yield was 4.35% and funding cost was 0.38%; for the nine months, those measures were 4.44% and 0.41%.
- Cash flow: Nine-month operating cash flow was $66.3m, compared with $47.2m in 2012. Investing activities used $79.6m versus providing $39.3m; financing provided $4.3m versus using $102.8m. Cash and equivalents declined $9.1m from year-end to $92.3m.
Balance sheet, credit, and capital
- At September 30, 2013, total assets were $4.326bn, up $21.1m from December 31, 2012. Gross loans were $2.925bn, up $23.2m; investment securities totaled $914.1m at carrying value, up $39.8m.
- Deposits were $3.256bn, down $90.5m. Time deposits decreased $160.0m while demand and savings deposits increased $69.5m. Total borrowings rose $156.9m to $524.0m, including increased federal funds purchased and FHLB advances.
- Allowance for loan losses was $66.2m, or 2.26% of loans, and management considered it adequate. Nine-month provision was $5.6m; net charge-offs were $8.8m, down from $15.4m in the comparable 2012 period.
- Credit indicators improved: non-accrual loans declined to $35.0m from $53.4m at year-end; nonperforming assets were $50.3m versus $79.3m; and nonperforming assets plus loans at least 90 days delinquent were $51.2m versus $81.4m.
- Capital ratios remained above regulatory “well-capitalized” thresholds. Consolidated total risk-based capital was 14.96%, Tier 1 risk-based capital 13.10%, and Tier 1 leverage 10.54%. Tangible common equity to tangible assets was 7.97%, versus 7.55% at year-end.
Material changes, outlook, risks, and unusual items
- Noninterest income declined 17.3% in Q3. Management cited lower mortgage-sale gains, securities gains, loan-level hedge income, and tax-credit fund income. Nine-month noninterest income was also lower, principally because 2012 included the $9.1m FDIC gain.
- Q3 noninterest expense fell 0.5%; nine-month expense was essentially flat. Higher salaries and benefits were partly offset by lower credit-related, FDIC assessment, and occupancy expenses.
- The company had agreed to acquire CFS Bancorp for an estimated $134m transaction value based on First Merchants’ October 31 share price. The all-stock exchange ratio was 0.65 First Merchants shares per CFS share; closing was anticipated in mid-November 2013, subject to customary conditions.
- After quarter-end, on November 1, the company issued $65m of 6.75% fixed-to-floating subordinated notes and $5m of 5% fixed-to-floating senior unsecured notes due 2028. Proceeds refinanced a $55m Bank of America facility; remaining funds were intended to redeem the remaining $34.0m Series B preferred stock, plus accrued dividends.
- Available-for-sale securities had $15.0m of gross unrealized losses at quarter-end, including a sharply impaired pooled trust-preferred position with $6.3m amortized cost and $0.5m fair value. Management concluded losses were temporary and reported no Q3 or nine-month OTTI charge; further impairment could reduce earnings.
- Interest-rate modeling estimated a 3.18% increase in 12-month net interest income under an immediate +200-basis-point scenario and a 2.14% decrease under a -100-basis-point scenario. Management cautioned that model assumptions may not match actual outcomes.
- Off-balance-sheet loan commitments and standby/commercial letters of credit totaled $1.085bn; the filing notes that commitments may expire unused or be only partly drawn. Remaining FHLB borrowing capacity was $188.9m.
- An overdraft-fee class action was stayed pending arbitration; the company said it believed it had meritorious defenses. A shareholder lawsuit relating to the CFS merger was dismissed as to First Merchants without prejudice on October 15; the filing said potential impact could not previously be estimated. No material changes to previously disclosed risk factors were reported.
- No specific earnings or operating guidance was provided. Management highlighted interest-rate, economic, credit, competition, regulatory, acquisition-integration, liquidity, and dividend-capacity risks.
Important facts for investors to verify
- Whether the CFS Bancorp merger closed as anticipated, and its final terms, integration costs, and effect on capital and earnings.
- Whether the planned Series B preferred redemption was completed and the resulting funding costs and capital ratios after the November debt issuance.
- Whether margin pressure continues and actual results track the filing’s interest-rate sensitivity estimates.
- Whether improving nonperforming loans and charge-offs persist, and whether the allowance remains adequate as loan balances and credit conditions change.
- Whether securities unrealized losses—especially pooled trust-preferred securities—remain temporary, and whether any additional impairment is recognized.
- Actual draws on the $1.085bn in commitments, deposit trends, and borrowing needs, including compliance with debt covenants.