First Merchants Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; balance-sheet comparisons are to December 31, 2015. First Merchants is an Indiana-based bank holding company focused on community banking, operating 106 banking locations across Indiana, Illinois and Ohio. Amounts below are in U.S. dollars; financial statement amounts are reported in thousands unless noted.
Financial results and key metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $57.7 million | $50.3 million | $168.1 million | $146.3 million |
| Provision for loan losses | $1.9 million | $0 | $3.2 million | $0.4 million |
| Other income | $16.9 million | $16.3 million | $49.1 million | $55.8 million |
| Other expenses | $44.1 million | $43.0 million | $135.4 million | $129.3 million |
| Net income available to common stockholders | $21.1 million | $17.1 million | $58.8 million | $51.2 million |
| Diluted earnings per share | $0.51 | $0.45 | $1.43 | $1.35 |
| FTE net interest margin | 3.94% | 3.85% | 3.88% | 3.82% |
Q3 net income rose 23.4% year over year; nine-month net income increased 14.7%. Management attributed higher net interest income mainly to organic loan growth and the C Financial and Ameriana acquisitions. Purchased-loan fair-value accretion contributed $3.8 million in Q3 and $9.5 million year to date. The nine-month comparison is affected by the prior-year $8.3 million gain on sale of the insurance subsidiary, which was absent in 2016.
At September 30, total assets were $7.02 billion, up 3.9% from year-end; loans were $4.97 billion, up $280.0 million, and deposits were $5.44 billion, up $154.6 million. Total borrowings were $622.3 million, up $53.8 million. Stockholders’ equity was $900.9 million. Cash and cash equivalents were $99.6 million, compared with $102.2 million at year-end.
For the first nine months, operating cash flow was $82.9 million, investing cash flow was negative $276.9 million and financing cash flow was positive $191.4 million; cash declined $2.6 million. The Bank reported $295.8 million of remaining FHLB borrowing capacity. Regulatory capital remained above applicable well-capitalized thresholds; the Bank’s total risk-based capital ratio was 13.23% and common equity tier 1 ratio was 12.15%. Tangible common equity to tangible assets, a non-GAAP measure, was 9.48%.
Credit quality, changes and notable items
- Allowance for loan losses was $63.5 million, or 1.28% of loans, versus $62.5 million, or 1.33%, at year-end. Nine-month net charge-offs were $2.2 million, compared with $1.5 million in 2015; provision expense increased to $3.2 million from $0.4 million.
- Non-accrual loans were $34.1 million, up from $31.4 million at year-end; the allowance covered 186.1% of non-accrual loans. Non-performing assets plus loans 90 days or more delinquent totaled $49.9 million, down from $51.5 million. Commercial impaired loans fell to $84.2 million from $97.5 million.
- Other income for the first nine months fell 12.1%, mainly because 2015 included the insurance-sale gain and insurance commissions. Expenses increased 4.7%, reflecting the larger franchise and acquisition-related staffing and operating costs, partly offset by lower professional services costs.
- Ameriana, acquired December 31, 2015, expanded the company’s central and east-central Indiana footprint. The Bank converted from a national to an Indiana state charter effective April 15, 2016; management said it was not expected to affect operations or customers.
- After quarter-end, the company agreed to acquire approximately 12.11% of Independent Alliance Banks for $19.8 million, with closing expected in November 2016. The Federal Reserve may view IAB as subject to First Merchants’ “source of strength” obligation; management did not anticipate a need for capital support based on IAB’s current regulatory capital position.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management’s 12-month interest-rate simulation estimated net interest income would increase 8.41% under an immediate 200-basis-point rise and decrease 5.08% under a 100-basis-point fall; these are modeled scenarios, not forecasts, and depend on assumptions about rates and balance-sheet behavior. Key stated risks include interest-rate and pricing changes, adverse economic or credit developments, real-estate values, competition, regulation, acquisition integration, liquidity and the capacity to pay dividends. The company reported routine litigation and regulatory examinations, which management did not expect to have a material adverse effect. Loan commitments and letters of credit totaled $2.12 billion; usage may be partial or zero. Derivative agreements include collateral and termination provisions tied to certain capital or default events.
Important facts for investors to verify
- How much future earnings growth depends on acquisition-related loan accretion, and how that income may run off.
- Whether loan-quality trends, including rising non-accrual loans and net charge-offs, warrant further provisioning.
- The sustainability of margin improvement amid changing rates, deposit pricing and wholesale funding costs.
- The final terms, closing and potential source-of-strength implications of the IAB investment.
- How the insurance divestiture and other prior-year items affect comparisons of recurring noninterest income and expenses.