First Merchants Corporation (Nasdaq: FRME) — 2021 Form 10-K
Reporting period: Fiscal year ended December 31, 2021. First Merchants is an Indiana-based financial holding company operating primarily as a community bank through 109 locations in Indiana, Ohio, Michigan and Illinois.
Financial performance and position
Unless noted otherwise, dollar amounts are in millions.
| Metric | 2021 | 2020 | Change or context |
|---|---|---|---|
| Net income available to common stockholders | $205.5 | $148.6 | Up 38.3% |
| Diluted earnings per share | $3.81 | $2.74 | Up 39.1% |
| Net interest income | $410.7 | $382.1 | Up $28.6 |
| Net interest margin, FTE | 3.18% | 3.29% | Down 11 basis points |
| Other income | $109.3 | $109.9 | Down 0.5% |
| Other expenses | $279.2 | $263.4 | Up 6.0% |
| Net cash provided by operating activities | $207.4 | $203.8 |
- Balance sheet: Total assets were $15.45 billion, up 9.9%; deposits were $12.73 billion, up 12.1%; and stockholders’ equity was $1.91 billion, versus $1.88 billion at year-end 2020.
- Lending: Loans totaled $9.24 billion, essentially unchanged year over year. Organic loan growth of $566.4 million was largely offset by a $560.5 million decline in PPP loans following forgiveness. PPP balances were $106.6 million at year-end.
- Credit quality: The allowance for loan losses was $195.4 million, or 2.11% of loans, compared with $130.6 million, or 1.41%, in 2020. Nonperforming loans declined to $43.4 million from $64.7 million; criticized commercial loans declined to $369.5 million from $518.0 million. Net charge-offs were $9.3 million, or 0.10% of average loans.
- Funding and liquidity: Total borrowings were $634.3 million, down from $684.9 million. Cash and due from banks plus interest-bearing deposits totaled $641.3 million. Available-for-sale securities had a fair value of $2.34 billion; remaining FHLB borrowing capacity was $728.5 million. The filing reports $3.95 billion of loan commitments and standby letters of credit, much of which may not be drawn.
- Capital: Corporation ratios were 13.92% total risk-based capital, 12.09% Tier 1 risk-based capital, 11.68% CET1 and 9.30% Tier 1 leverage. The Bank was classified as well capitalized. Tangible common equity to tangible assets, a non-GAAP measure, was 9.01%, down from 9.65%.
- Cash flow: Investing activities used $1.47 billion, primarily reflecting securities purchases; financing activities provided $1.24 billion, largely from deposit growth. Cash and cash equivalents decreased $25.8 million to $167.1 million.
Material changes and notable items
- Net income rose as net interest income increased and provision expense fell to zero from $58.7 million in 2020. The 2020 provision reflected elevated pandemic-related credit concerns; 2021 net charge-offs nevertheless increased to $9.3 million from $8.3 million.
- First Merchants adopted CECL on January 1, 2021. Adoption increased the loan allowance by $74.1 million and reduced retained earnings by $68.0 million after tax. The 2021 and 2020 credit-loss figures therefore reflect different accounting models.
- Interest rates pressured asset yields and margin: FTE asset yield fell 40 basis points, partly offset by a 35-basis-point decline in funding costs. PPP fee income included in interest income was $26.5 million, compared with $16.2 million in 2020.
- Deposits grew substantially, particularly demand and savings accounts; management attributed part of the growth to PPP proceeds and government stimulus payments. Excess liquidity funded securities purchases and repayment of maturing FHLB advances.
- Unrealized losses on available-for-sale securities were $13.6 million at year-end, versus $0.3 million in 2020. Management attributed the losses to interest-rate changes rather than credit deterioration; accumulated other comprehensive income declined by $19.7 million during 2021.
- The Bank acquired Hoosier Trust Company on April 1, 2021 for $3.2 million in cash. The proposed Level One Bancorp acquisition, valued at approximately $323.5 million, was pending at the filing date and subject to shareholder, Indiana DFI and other closing conditions; management expected closing in early Q2 2022.
- The Corporation repurchased 646,102 shares for $25.4 million and paid $61.2 million in common dividends. It also completed the consolidation of 17 banking centers during 2021.
Outlook, risks and contingencies
- The filing gives no numerical earnings or revenue guidance. Management described the loan allowance as appropriate but emphasized uncertainty around the pandemic, economic conditions and future credit performance.
- Key risks include interest-rate and margin sensitivity, borrower credit deterioration, deposit retention and wholesale funding access, competition, cybersecurity and third-party systems, regulatory and consumer-protection requirements, and acquisition integration. The Corporation reported a negative cumulative interest-rate gap of $3.7 billion within one year; its modeled 12-month net interest income increased 1.4% under a +200-basis-point scenario and decreased 0.9% under a -100-basis-point scenario.
- The Bank remained subject to a four-year DOJ Settlement Agreement and Agreed Order effective August 2019. The filing warns that failure to comply could adversely affect operations and future acquisitions.
- COVID-related borrower modifications outstanding were zero at December 31, 2021, versus $120.3 million across 87 loans a year earlier. PPP-related litigation and potential SBA guarantee disputes are identified as risks.
- Management reported no material pending litigation beyond ordinary-course matters. The independent auditor issued an unqualified opinion on the financial statements and internal controls; the allowance for credit losses was identified as a critical audit matter.
Most important facts for investors to verify
- Whether the proposed Level One merger closed on its announced terms, and its subsequent effects on capital, tangible book value, funding and integration costs.
- Whether credit trends and the $195.4 million CECL allowance remain adequate as forecasts and borrower conditions change, particularly in commercial real estate and criticized commercial exposures.
- How deposit balances and funding costs evolve, and whether securities-related unrealized losses or reinvestment yields affect capital, earnings and margin.
- How much earnings depended on PPP fee income, securities-sale gains, life-insurance benefits and other items that may not recur at similar levels.
- Progress under the DOJ settlement, as well as any material developments in PPP claims, regulatory matters or other contingencies.