Business context and reporting period
First Merchants Corporation is an Indiana-based financial holding company operating through First Merchants Bank, with community banking as its sole significant business segment. This Form 10-K covers the fiscal year ended December 31, 2019; fourth-quarter figures are unaudited. On September 1, 2019, the company acquired MBT Financial Corp. (Monroe Bank & Trust), adding 20 banking centers in Michigan.
Financial performance and position
| Metric | 2019 | 2018 |
|---|---|---|
| Net interest income | $356.7 million | $338.9 million |
| Net interest income, FTE | $369.7 million | $349.6 million |
| Net interest margin, FTE | 3.69% | 4.00% |
| Provision for loan losses | $2.8 million | $7.2 million |
| Other income | $86.7 million | $76.5 million |
| Other expenses | $246.8 million | $220.0 million |
| Net income available to common shareholders | $164.5 million | $159.1 million |
| Diluted EPS | $3.19 | $3.22 |
| Operating cash flow | $178.4 million | $180.2 million |
Fourth-quarter 2019 net income was $47.8 million and diluted EPS was $0.87, compared with $41.7 million and $0.85 in fourth-quarter 2018. Fourth-quarter net interest income was $97.6 million.
At year-end, total assets were $12.46 billion, loans $8.46 billion, deposits $9.84 billion, total borrowings $732.7 million and stockholders’ equity $1.79 billion. The allowance for loan losses was $80.3 million, or 0.95% of loans. Net charge-offs were $3.1 million (0.04% of average loans). Non-accrual loans fell to $15.9 million from $26.1 million; nonperforming assets were $24.3 million. Year-end cash and cash equivalents were $177.2 million. Available-for-sale securities totaled $1.79 billion; management reported no other-than-temporary impairment in 2019.
Regulatory capital remained substantial: Corporation CET1 was 12.13%, total risk-based capital 14.29%, and leverage ratio 10.54%. The Bank met the regulatory “well-capitalized” category. The company reported tangible common equity to tangible assets of 10.16% (non-GAAP).
Material changes versus the prior comparable period
- Net income rose 3.3%, while diluted EPS declined from $3.22 to $3.19. The 2019 result included $13.7 million of MBT acquisition-related expenses.
- Year-end assets increased 26.0%; loans rose 17.1% and deposits 26.9%. MBT contributed approximately $1.5 billion of assets, $732.6 million of loans and $1.1 billion of deposits. Excluding acquired loans, organic loan growth was $506.5 million, or 7%; organic deposit growth was $979.4 million, or 12.6%.
- Net interest margin contracted 31 basis points to 3.69%. Management attributed the pressure to higher funding costs and lower asset yields following Federal Reserve rate cuts; interest-bearing liability costs rose 34 basis points.
- Other income increased 13.4%, supported by acquired business and customer fee growth. Other expenses increased 12.2%, reflecting acquisition costs and MBT operating expenses, among other items.
- Provision expense decreased, but net charge-offs increased to $3.1 million from $1.7 million. Non-accrual loans improved; other real estate owned rose to $7.5 million, primarily due to one commercial property valued at $5.9 million.
- Cash from operations was $178.4 million; investing activities used $1.01 billion, chiefly reflecting securities purchases and loan growth. Financing activities provided $865.9 million, and cash increased $38.0 million.
Outlook, risks, contingencies and unusual items
- The filing gives no specific earnings or revenue guidance. Management expected the MBT transaction to be accretive and cited expected synergies and economies of scale; realization and timing are uncertain.
- First Merchants expected to adopt CECL on January 1, 2020. Management estimated a 55–65% increase in the allowance for credit losses and an approximately $18 million reserve for unfunded commitments, with a one-time after-tax adjustment to opening retained earnings. These were estimates subject to further review and changing assumptions.
- As assets exceeded $10 billion for four consecutive quarters, the Bank and affiliates were scheduled to come under CFPB supervisory and enforcement authority in second-quarter 2020. Management also expected Durbin Amendment debit interchange limits and the changed FDIC assessment method to reduce income or increase costs.
- The Bank entered a DOJ Settlement Agreement and Agreed Order in 2019 concerning fair-lending matters in the Indianapolis-Marion County market. The Bank made no admission, and there was no adjudication of the allegations; compliance and resolution remain subject to DOJ oversight.
- Other key risks include interest-rate and funding sensitivity, credit deterioration, integration and acquisition execution, cybersecurity and operational disruption, regulation, and the transition from LIBOR, then expected to be discontinued after 2021. The company disclosed a cumulative negative one-year rate-sensitivity gap of $2.5 billion; its model estimated net interest income would increase 5.8% under an immediate +200-basis-point scenario and decrease 3.5% under a −100-basis-point scenario.
- The board authorized repurchases of up to 3 million shares, capped at $75 million; 516,016 shares were repurchased for $19.0 million in 2019. The common dividend paid was $1.00 per share, up from $0.84.
Important facts for investors to verify
- Whether MBT integration delivers anticipated cost savings and earnings benefits, and how much of future growth is organic.
- Whether margin pressure continues as asset yields and deposit costs reprice, and whether actual rate sensitivity matches modeled outcomes.
- The realized CECL opening adjustment and subsequent credit-loss allowance, especially given criticized commercial loans of $330.4 million versus $259.6 million in 2018.
- Progress and costs under the DOJ agreement, and the financial impact of CFPB oversight and the $10 billion asset-threshold requirements.
- Liquidity and funding capacity, including the $638.7 million of remaining FHLB borrowing capacity, uninsured deposits, and $3.04 billion of loan commitments and standby letters of credit.
- Acquisition purchase accounting and goodwill: MBT added approximately $98.6 million of goodwill; total goodwill was $543.9 million. Auditors identified the allowance estimate and MBT acquisition valuation as critical audit matters, while issuing an unqualified opinion on the financial statements.