First Merchants Corporation — 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020; quarterly figures below refer to the fourth quarter. First Merchants is an Indiana-based community banking holding company operating through one bank across Indiana, Ohio, Michigan and Illinois, with 124 banking locations.
Financial performance and condition
| Metric | 2020 | 2019 |
|---|---|---|
| Net interest income | $382.1 million | $356.7 million |
| Net interest income, FTE basis | $399.1 million | $369.7 million |
| Net interest margin, FTE | 3.29% | 3.69% |
| Other income | $109.9 million | $86.7 million |
| Provision for loan losses | $58.7 million | $2.8 million |
| Other expenses | $263.4 million | $246.8 million |
| Net income | $148.6 million | $164.5 million |
| Diluted earnings per share | $2.74 | $3.19 |
| Return on average assets / equity | 1.10% / 8.14% | 1.48% / 10.48% |
- Scale and growth: Year-end assets were $14.1 billion, up 12.9%; loans were $9.24 billion, up 9.2%; deposits were $11.36 billion, up 15.5%. The filing attributes deposit growth partly to PPP proceeds and federal stimulus payments retained by customers.
- Profit and margins: Net income fell about 9.6%, despite higher net interest income and other income. Lower market rates reduced earning-asset yields; the FTE asset yield fell 94 basis points, while funding costs declined. FTE margin compressed 40 basis points to 3.29%.
- Credit costs: The allowance for loan losses rose to $130.6 million, or 1.41% of loans, from $80.3 million, or 0.95%. Net charge-offs increased to $8.3 million from $3.1 million. Nonperforming loans rose to $64.7 million from $16.8 million; nonaccrual loans were $61.5 million, including $40.0 million tied to senior and assisted-living real estate relationships.
- Cash flow: Operating cash flow was $204.8 million. Investing activities used $1.55 billion, largely reflecting loan growth and securities purchases; financing activities provided $1.36 billion, including deposit growth. Cash and cash equivalents increased $15.7 million to $192.9 million. These cash-flow measures should be interpreted in the context of a bank’s balance-sheet funding activity.
- Debt and liquidity: Total borrowings were $684.9 million, down from $732.7 million. Available-for-sale securities were $1.92 billion; the Bank reported $723.3 million of remaining FHLB borrowing capacity. Management said it increased liquidity and managed assets and liabilities to preserve capital.
- Capital: Corporation regulatory ratios were 14.36% total risk-based capital, 12.48% Tier 1 risk-based capital, 12.02% CET1 and 9.57% Tier 1 leverage. Tangible common equity to tangible assets, a non-GAAP measure, was 9.65%, down from 10.16%.
- Fourth quarter: Net income was $45.1 million and diluted EPS was $0.83; provision expense was $4.5 million.
Material changes and notable items
- Revenue growth included higher mortgage-related loan-sale gains, fiduciary and wealth-management fees, derivative fees and securities gains. Net realized gains on available-for-sale securities were $11.9 million, versus $4.4 million in 2019.
- Expense growth reflected a full year of MBT operations (acquired September 2019), higher salaries, occupancy, equipment and FDIC assessments. The Corporation also recorded $4.5 million related to the announced consolidation of 17 banking centers, plus $2.5 million of pandemic-related costs and community donations.
- Durbin Amendment interchange-fee limits applied from July 1, 2020 after the Bank exceeded $10 billion in assets; management reported a material reduction in interchange income. The Bank also became subject to CFPB supervision and enforcement authority in the second quarter.
- The Corporation repurchased 1.63 million shares for $55.9 million in the first quarter, completing its prior $75 million repurchase authorization. In January 2021, the board authorized a new program of up to $100 million.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management cautioned that COVID-19’s duration and economic effects remained uncertain, with potential impacts on borrower repayment, collateral values, loan demand, credit quality and net interest income. Senior living, hotels and accommodations, and restaurants/food service represented about 7% of total loans.
- At year-end, $120.3 million across 87 loans remained in COVID-related payment deferral; $66.1 million, or 55%, was in the hotel industry. These qualifying modifications were temporarily exempt from troubled-debt-restructuring classification under applicable relief provisions.
- CECL was adopted January 1, 2021, after the 2020 reporting period. The filing says the allowance increased 57% at adoption and a separate reserve of approximately $21 million was recorded for potential losses on unfunded commitments. The CECL transition and future credit conditions could affect earnings and reserves.
- The Bank is subject to a four-year DOJ Settlement Agreement and Agreed Order effective August 8, 2019; management said compliance and resolution remain subject to DOJ determination. The filing identifies failure to comply as a potentially material risk.
- Other risks include PPP processing litigation or SBA-guarantee disputes, funding access, interest-rate and LIBOR transition risk, cyber and operational incidents, regulatory costs, and acquisition integration. The company announced a $3.225 million Hoosier Trust acquisition, subject to regulatory approval and expected to close in second-quarter 2021.
- Management reported no material pending legal proceedings beyond ordinary-course matters. The auditor issued an unqualified opinion on the financial statements and internal controls; the allowance for loan losses was identified as a critical audit matter.
Investor verification priorities
- Track performance of the $40.0 million senior-living-related nonaccrual exposures, the $120.3 million of deferred loans and the $518.0 million of criticized commercial loans.
- Review CECL’s actual opening adjustment and subsequent reserve effects against the disclosed 57% allowance increase and approximately $21 million unfunded-commitment reserve.
- Assess whether deposit growth persists as PPP funds and stimulus balances normalize, and how low rates and Durbin limits affect margin and fee income.
- Monitor DOJ Settlement Agreement compliance, PPP forgiveness and guarantee outcomes, and the execution and costs of the 17-branch consolidation.
- Confirm the status and terms of the Hoosier Trust acquisition and the extent of repurchases under the new authorization.