First Merchants Corporation - 10-Q Summary
Business Context and Reporting Period
Company: First Merchants Corporation (Indiana-based financial holding company)
Reporting Period: Quarter and nine months ended September 30, 2010
Filing Date: November 9, 2010
Business Overview: The Corporation operates 80 banking centers in Indiana and Ohio, focusing on community banking, commercial and retail banking services, trust asset management, and insurance agency services.
Key Financial Metrics
| Metric | Q3 2010 | Q3 2009 | YTD 9M 2010 | YTD 9M 2009 |
|---|---|---|---|---|
| Net Income (Loss) | $1.6 million | ($4.9 million) | $2.9 million | ($30.5 million) |
| Net Income Available to Common | $0.8 million | ($6.4 million) | $9.2 million | ($34.1 million) |
| Diluted EPS (Common) | $0.02 | ($0.30) | $0.38 | ($1.62) |
| Net Interest Income | $35.7 million | $38.8 million | $108.1 million | $115.8 million |
| Provision for Loan Losses | $10.5 million | $24.2 million | $39.4 million | $96.2 million |
| Total Assets | $4.18 billion | N/A | N/A | N/A |
| Total Loans (Net) | $2.83 billion | N/A | N/A | N/A |
| Allowance for Loan Losses | $83.7 million | N/A | N/A | N/A |
| Net Charge-offs (Q3) | $13.8 million | $14.4 million | $47.9 million (YTD) | N/A |
| Cash and Cash Equivalents | $61.1 million | N/A | N/A | N/A |
Material Changes vs. Prior Period
- Profitability Turnaround: The Company returned to profitability in Q3 2010 ($1.6M net income) compared to a loss in Q3 2009. Year-to-date results include a significant non-recurring gain of $10.1 million from the exchange of preferred stock for trust preferred securities.
- Asset Quality Improvement: Non-performing assets (NPA) plus 90+ days delinquent loans decreased to $130.8 million (3.1% of total assets) from $146.5 million (3.5%) in the prior quarter. Non-accrual loans declined by $21.6 million from the previous quarter.
- Loan Portfolio Contraction: Total loans decreased by $349.1 million (10.6%) year-to-date due to normal run-off and reduced demand. Commercial and industrial, construction, and residential real estate were the largest segments to decline.
- Deposit Decline: Total deposits decreased by $282.2 million (8.0%) year-to-date, primarily driven by the maturity of brokered deposits and CDs over $100,000.
- Investment Portfolio Growth: Investment securities available for sale increased by $103.9 million to $517.5 million, utilizing excess liquidity generated from loan and deposit declines.
- Expense Reduction: Non-interest expenses decreased by $3.9 million (9.9%) in Q3 2010 compared to Q3 2009, aided by the absence of $1.9 million in pre-payment penalties incurred in the prior year.
Guidance, Outlook, Risks, and Unusual Items
- Unusual Items: The year-to-date earnings were significantly boosted by a $10.1 million after-tax gain resulting from the exchange of 46,400 shares of TARP preferred stock for trust preferred securities. This transaction also resulted in a $5.4 million deferred tax liability.
- Capital Position: The Corporation maintains regulatory capital ratios exceeding the "well capitalized" standard. Tier 1 risk-based capital ratio was 12.63% and total risk-based capital ratio was 15.52% as of September 30, 2010.
- Regulatory Risks: The Dodd-Frank Act is expected to increase operational costs, limit the ability to raise capital via trust preferred securities, and impose stricter consumer protection laws. The full impact remains unclear pending regulatory implementation.
- Covenant Breach: As of September 30, 2010, the Corporation failed to meet the minimum return on average total assets covenant (0.75%) on a $55 million credit facility with Bank of America. The lender has applied a default interest rate but has not accelerated the loan.
- Asset Impairment: The Company recognized other-than-temporary impairment (OTTI) losses of $1.5 million on pooled trust preferred securities for the nine months ended September 30, 2010.
Investor Verification Checklist
- Non-Recurring Gains: Verify the sustainability of earnings by excluding the $10.1 million gain from the preferred stock exchange when analyzing core operational performance.
- Covenant Compliance: Monitor the status of the Bank of America credit facility covenant breach and any potential acceleration of the $5 million term loan.
- Asset Quality Trends: Track the trajectory of non-accrual loans and net charge-offs, particularly in the commercial real estate and construction sectors, to assess the adequacy of the $83.7 million allowance for loan losses.
- Liquidity Management: Review the continued decline in deposits and the reliance on investment securities and borrowings to fund operations and maintain liquidity.
- Regulatory Capital: Assess the impact of Dodd-Frank regulations on the Company's ability to utilize trust preferred securities as Tier 1 capital in the future.