First Merchants Corporation — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. First Merchants is an Indiana-based community bank holding company operating 118 locations across Indiana, Ohio, Michigan and Illinois.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net interest income | $133.4 million | $140.3 million | $415.3 million | $371.2 million |
| Net income | $56.4 million | $63.8 million | $181.3 million | $151.3 million |
| Net income available to common shareholders | $55.9 million | $63.3 million | $179.9 million | $150.4 million |
| Diluted EPS | $0.94 | $1.08 | $3.03 | $2.62 |
| Noninterest income | $27.8 million | $29.6 million | $79.2 million | $83.8 million |
| Noninterest expense | $93.9 million | $96.4 million | $280.2 million | $266.0 million |
- Third-quarter net interest margin was 3.29% on a fully taxable equivalent basis, down 26 basis points year over year. For the first nine months, it was 3.42%, up 12 basis points.
- Deposit and borrowing costs rose sharply. Q3 total cost of funds was 2.92%, versus 0.76% a year earlier; interest-bearing deposit cost was 2.83%, versus 0.60%.
- Operating cash flow was $172.7 million for the first nine months. Investing activities used $86.8 million and financing activities used $83.3 million; cash and due from banks ended at $125.2 million.
Balance sheet, capital and liquidity
- At September 30, total assets were $18.0 billion; loans were $12.27 billion and deposits $14.65 billion. Loans grew $267.5 million from year-end; management said growth was $406.0 million, or 4.6% annualized, excluding a $116.6 million commercial loan sale.
- Noninterest-bearing deposits were 17.4% of deposits, down from a 23.6% peak in Q2 2022. Core deposits were 90.7% of deposits; 28.5% of deposits were uninsured. Management described liquidity as ample.
- Total borrowings were $1.02 billion, down $289.4 million from year-end, primarily as excess liquidity was used to repay federal funds and FHLB advances. Remaining FHLB borrowing capacity was $702.7 million; there was no outstanding BTFP borrowing.
- Common Equity Tier 1 ratio was 11.26% for the Corporation and 11.76% for the Bank. The Bank met the regulatory well-capitalized requirements. Tangible common equity to tangible assets was 7.69%, versus 7.34% at year-end.
- Available-for-sale securities had $382.8 million of gross unrealized losses; accumulated other comprehensive loss was $307.3 million. Held-to-maturity securities had a $2.21 billion carrying value and $1.74 billion fair value. Management attributed securities losses to interest rates, not credit quality, and said it did not expect to sell before recovery.
Material changes and notable items
- Q3 net income available to common shareholders fell 11.7% year over year, while nine-month net income rose 19.8%. Nine-month results benefited from the Level One acquisition being included for a longer period in 2023 and from the prior-year acquisition-related provision and costs. Adjusted diluted EPS, a non-GAAP measure, was $0.94 for Q3 and $3.03 for nine months; the comparable 2022 figures were $1.12 and $3.01.
- Q3 net charge-offs were $20.4 million, including two large commercial and industrial charge-offs of $13.7 million and $5.4 million. The largest related to a syndicated specialty finance borrower affected by alleged fraud. Management called the exposures idiosyncratic and not indicative of a broader portfolio issue.
- Nonaccrual loans were $53.1 million, up $10.8 million from year-end; total past-due loans were $76.3 million, up $25.3 million. The loan allowance was $205.8 million, or 1.67% of loans, down from $223.3 million, or 1.86%, at year-end.
- Net interest income growth for the first nine months was more than offset in Q3 by rising funding costs. Management cited deposit pricing pressure and customers shifting to higher-yielding products. Q3 noninterest income also reflected $1.7 million of securities-sale losses and lower life-insurance benefit gains than in the prior-year quarter.
- The company sold $347.3 million of available-for-sale securities during the first nine months, recording $4.6 million in net losses. Proceeds and other liquidity were held in cash, used to support loan growth and repay borrowings rather than reinvested in securities.
- No specific earnings or financial guidance was provided. The filing identifies rate and deposit competition, economic and credit deterioration, bank-industry liquidity concerns, possible regulatory changes and higher FDIC premiums as risks. Management’s interest-rate model estimated 12-month net interest income would rise 1.5% under an immediate 200-basis-point increase and fall 1.1% under a 100-basis-point decrease; these are scenarios, not forecasts.
Investor verification points
- Review the two large Q3 charge-offs, the alleged-fraud exposure, and subsequent trends in criticized, past-due and nonaccrual loans and allowance coverage.
- Assess deposit retention, migration from noninterest-bearing accounts, uninsured deposit levels, and the cost and availability of contingent funding.
- Evaluate the size and duration of unrealized securities losses, including the held-to-maturity fair-value shortfall, and the implications if liquidity needs require asset sales.
- Reconcile GAAP and non-GAAP earnings and compare net interest margin and funding-cost trends in later periods; the filing provides no forward earnings guidance.
- Confirm capital and liquidity remain adequate as CECL capital transition effects phase out; management reported effective disclosure controls and no material changes to internal control over financial reporting.