First Merchants Corporation — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Figures are unaudited; dollars are in millions unless stated otherwise. First Merchants is an Indiana-based community banking holding company operating primarily in Indiana and Ohio.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $35.9 | $35.7 | $107.2 | $108.1 |
| Provision for loan losses | $5.6 | $10.5 | $16.8 | $39.4 |
| Other income | $13.2 | $11.0 | $36.1 | $35.0 |
| Other expenses | $34.2 | $35.1 | $102.5 | $104.1 |
| Net income | $6.7 | $1.6 | $17.7 | $2.9 |
| Income (loss) available to common shareholders | $(6.4) | $0.8 | $2.6 | $9.2 |
| Common diluted EPS | $(0.25) | $0.02 | $0.10 | $0.38 |
- Q3 net interest margin was 4.02% on a fully taxable-equivalent basis, up from 3.93%; nine-month margin was 3.98%, up from 3.88%. Average earning assets declined year over year.
- Operating cash flow was $67.1 versus $60.4 for the first nine months. Investing cash flow was $26.4 versus $137.6; financing cash flow was $(91.7) versus $(316.0). Cash and cash equivalents ended the period at $60.2.
- At September 30, total assets were $4,118.5; net loans $2,639.9; deposits $3,064.3; total borrowings $508.8; and stockholders’ equity $512.5. At year-end 2010, these were $4,170.8, $2,752.7, $3,268.9, $419.0, and $454.4, respectively.
- Consolidated total risk-based, Tier 1 risk-based, and Tier 1 leverage capital ratios were 16.21%, 13.60%, and 10.20%, respectively. The Bank was categorized as well capitalized.
Material changes and notable items
- Common shareholders’ Q3 loss principally reflects a $10.9 million pretax accounting loss on extinguishing trust preferred securities and a $1.4 million loss on retiring CPP preferred stock. The nine-month comparison also reflects a $10.1 million after-tax gain in 2010 from an earlier preferred-stock exchange. These items make reported common earnings less comparable to operating results.
- Loans, including loans held for sale, fell $132.0 million (4.6%) from year-end, which management attributed to normal runoff and weaker consumer and commercial borrowing demand. Deposits decreased $204.6 million (6.3%), including reductions in time and savings deposits. Securities grew by approximately $111.0 million as liquidity was redeployed; selected municipal securities were transferred from available-for-sale to held-to-maturity in August.
- Common equity issuance raised $21.2 million from 2.822 million shares sold privately at $7.50 per share. The Corporation issued $90.8 million of SBLF Series B preferred stock and used it, together with cash, to redeem $69.6 million of CPP preferred stock and $46.4 million of Treasury-held trust preferred securities. The Treasury retained a warrant for 991,453 common shares at $17.55.
- Credit indicators improved against year-end: nonperforming assets plus loans 90 days delinquent were $106.7 million, or 2.6% of assets, versus $120.0 million, or 2.9%; nonaccrual loans declined to $78.9 million. The allowance fell to $73.1 million, or 2.68% of loans, from $83.0 million, or 2.90%. Nine-month net charge-offs were $26.7 million versus $47.9 million in 2010; Q3 net charge-offs of $9.6 million exceeded the $5.6 million provision.
Outlook, risks, and contingencies
- The filing gives no quantified earnings or revenue guidance. Management cautions that nine-month results are not necessarily indicative of full-year results.
- Management identifies interest-rate and deposit-pricing changes, economic weakness, loan and investment deterioration, competition, regulatory changes, and availability of earnings and capital for dividends as risks. Commercial and real-estate credit remains sensitive to borrower cash flows, local economic conditions, and collateral values. Management considers the loan-loss allowance adequate, but its calculation relies on estimates and judgment.
- Interest-rate modeling estimated 12-month net interest income would fall 3.94% under a 100-basis-point rate decline, exceeding the stated negative 2.00% policy limit; a 200-basis-point increase was estimated to raise it 0.85%. The filing notes that modeled results depend on assumptions and may differ from actual outcomes.
- The Corporation failed its Bank of America credit-facility covenant requiring return on average total assets of at least 0.75%. The lender had applied a 3% default-rate increase but had not accelerated the $5 million term loan. The facility also includes $50 million of subordinated debt; the covenant breach creates potential lender remedies for the term loan.
- Liquidity sources included $496.6 million of available-for-sale securities and $76.6 million of remaining FHLB borrowing capacity. The Bank had $79 million of FDIC-guaranteed senior notes maturing March 30, 2012. Off-balance-sheet loan commitments and standby letters of credit totaled $677.1 million; actual funding needs may be lower because some commitments expire unused.
- Pooled trust preferred securities had $5.6 million amortized cost and only $165,000 fair value, with ratings ranging from Ca to C. The Corporation recorded $0.4 million of investment impairment in the first nine months; management reported no additional Q3 impairment. Five troubled debt restructurings made in 2011, totaling $2.7 million, remained on nonaccrual status.
Important facts for investors to verify
- Separate recurring banking performance from the Q3 trust-preferred extinguishment charge and the prior-year preferred-stock exchange gain.
- Monitor deposit outflows, loan demand, funding costs, and refinancing or repayment of the $79 million notes due in March 2012.
- Track compliance with the Bank of America covenant, lender actions, and the potential consequences of the term-loan default provisions.
- Assess whether improving nonperforming-asset trends and lower provisions are sustainable, particularly given Q3 charge-offs, real-estate exposure, restructurings, and the reduced allowance ratio.
- Review actual performance against the disclosed interest-rate simulations and the negative-rate policy limit, and confirm progress in qualified small-business lending under the SBLF preferred-stock terms.