First Merchants Corporation — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; balance-sheet comparisons are with December 31, 2018. First Merchants is an Indiana-based community banking holding company operating through First Merchants Bank, with banking locations in Indiana, Illinois and Ohio.
Financial performance and position
Amounts are in millions, except per-share data and ratios. Results are unaudited.
| Metric | Q2 / June 30, 2019 | Comparable period / prior date |
|---|---|---|
| Net income available to common shareholders | $41.1; diluted EPS $0.83 | Q2 2018: $39.6; $0.80 |
| Six-month net income / diluted EPS | $79.9 / $1.61 | First half 2018: $76.3 / $1.54 |
| Net interest income | Q2 $85.3; first half $170.1 | Q2 2018 $84.6; first half 2018 $164.5 |
| Fully taxable equivalent net interest margin | Q2 3.71%; first half 3.78% | Q2 2018 3.99%; first half 2018 3.96% |
| Total assets | $10,737.9 | $9,884.7 at December 31, 2018 |
| Loans, net of allowance | $7,430.1 | $7,143.9 at December 31, 2018 |
| Deposits | $8,319.3 | $7,754.6 at December 31, 2018 |
| Total borrowings | $793.3 | $671.0 at December 31, 2018 |
| Stockholders’ equity | $1,501.6 | $1,408.3 at December 31, 2018 |
| Cash and cash equivalents | $128.2 | $139.2 at December 31, 2018 |
| Cash dividends per share | Q2 $0.26; first half $0.48 | Q2 2018 $0.22; first half 2018 $0.40 |
Q2 net income increased about 3.6% year over year, while first-half net income increased about 4.7%. First-half operating cash flow was $83.0 million; investing activities used $756.8 million and financing activities provided $662.7 million. Cash and cash equivalents declined $11.1 million during the half.
First-half GAAP net interest income rose about 3.4%, but higher funding costs weighed on spread and margin. The company reported an FTE net interest margin decline of 28 basis points for Q2 and 18 basis points for the first half versus 2018. Q2 interest costs rose 46 basis points year over year, compared with a 12-basis-point increase in asset yields. The effective tax rate was 15.9% for Q2 and 15.5% for the first half, lower than the comparable 2018 periods, primarily due to higher tax-exempt interest income.
At June 30, the allowance for loan losses was $81.3 million, or 1.08% of loans. Nonperforming loans were $26.3 million, down from $27.3 million at year-end; nonperforming assets were $27.4 million, down from $29.4 million. First-half provision expense was $1.7 million versus $4.2 million in 2018, and net charge-offs were $1.0 million versus $1.7 million.
The Corporation’s June 30 regulatory capital ratios included a 12.05% CET1 ratio and 14.56% total risk-based capital ratio; the Bank met the regulatory definition of well capitalized. Tangible common equity to tangible assets was 10.07%, compared with 9.97% at year-end.
Material changes and management commentary
- Assets increased 8.6% from year-end. Total loans rose $288.0 million, while investment securities increased $460.3 million and interest-bearing time deposits rose $92.7 million. Management attributed growth in earning assets principally to organic loan growth and deposit-funded investment purchases.
- Deposits grew $564.7 million, with growth in interest-bearing checking, money market, certificates of deposit and savings; noninterest-bearing deposits declined. Borrowings rose $122.3 million, primarily reflecting higher Federal Home Loan Bank advances.
- Other income increased 18.8% in Q2, including growth in derivative hedge fees and realized securities gains. Noninterest expense increased 7.6%; marketing costs included expenses associated with the fair-lending settlement.
- Available-for-sale securities moved from a net unrealized loss position at year-end to a net unrealized gain position by June 30, primarily as longer-term market interest rates declined. Management said it did not consider the securities with unrealized losses other-than-temporarily impaired.
Outlook, risks and unusual items
- The filing provides no specific earnings, revenue or margin guidance. Management said results for the first half are not necessarily indicative of full-year results.
- The proposed MBT Financial Corp. merger, estimated at approximately $290.9 million based on the stated reference share price, remained subject to customary closing conditions and Federal Reserve approval. The companies expected to close in Q3 2019. MBT reported $1.3 billion of assets at June 30.
- On June 13, 2019, the Bank entered a DOJ settlement and agreed order concerning fair-lending practices; the order was pending court approval. The Bank agreed to invest $1.12 million over four years in a loan subsidy fund, establish specified Indianapolis-area banking and lending locations, and spend at least $125,000 annually for four years on outreach and related initiatives. It also recognized $1.2 million of DOJ/Fair Housing Center-related expenses in Q2. The Bank did not admit the allegations or liability. Failure to comply could materially adversely affect the business.
- The Corporation first exceeded $10 billion in assets as of March 31, 2019. Management discussed potential added regulatory requirements after the applicable qualifying period, including consumer-protection oversight and a change to FDIC assessment methodology; it also noted the Durbin Amendment’s potential to materially reduce debit-card interchange income.
- Interest-rate sensitivity modeling estimated a 6.08% increase in 12-month net interest income under an immediate parallel +200-basis-point scenario and a 3.44% decrease under a −100-basis-point scenario, relative to the modeled base case. These are analytical scenarios, not management forecasts, and depend on assumptions about rates and balance-sheet behavior.
- The Corporation planned to adopt CECL in the first quarter of 2020. Management expected a one-time opening retained-earnings adjustment but said the amount and overall impact could not yet be determined. The filing also identifies economic, credit, interest-rate, liquidity, regulatory, merger-integration and dividend-capacity risks.
- Lease accounting adoption on January 1, 2019 recognized an initial right-of-use asset of $23.3 million and lease liability of $23.8 million; June 30 balances were $22.0 million and $22.6 million, respectively.
Important facts for investors to verify
- Progress and conditions for the MBT merger, including final regulatory approval, closing timing, consideration and integration plans.
- Compliance costs, milestones and outcomes under the DOJ agreement, including court approval and the duration of related expenses.
- Whether deposit pricing and funding costs continue to pressure net interest margin, and how asset growth and any rate changes affect earnings.
- Loan-quality trends, charge-offs, criticized credits, allowance adequacy and the eventual impact of CECL adoption.
- Liquidity and funding composition, including reliance on wholesale borrowings, available FHLB capacity and the company’s exposure to commitments to extend credit.
- Potential consequences of remaining above the $10 billion asset threshold, including regulatory costs and any effect on interchange-fee income.