First Merchants Corporation — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. First Merchants is an Indiana-based community banking company operating through First Merchants Bank. Results include MBT Financial, acquired September 1, 2019, so year-over-year comparisons also reflect the larger acquired franchise.
Financial performance
- Second-quarter earnings: Net income available to common shareholders was $33.0 million, down from $41.1 million a year earlier; diluted EPS was $0.62 versus $0.83. For the first half, net income was $67.3 million versus $79.9 million and diluted EPS was $1.24 versus $1.61.
- Net interest income and margin: Q2 net interest income increased to $93.0 million from $85.3 million, but the fully taxable-equivalent net interest margin fell to 3.19% from 3.71%. For the first half, net interest income was $186.9 million versus $170.1 million and FTE margin was 3.32% versus 3.78%. Lower rates reduced asset yields; lower deposit and borrowing costs partly offset the effect.
- Credit costs: Q2 provision for loan losses rose to $21.9 million from $0.5 million; first-half provision was $41.6 million versus $1.7 million. Management attributed the increase primarily to COVID-19-related uncertainty and higher assessed credit risk.
- Other income and expenses: Q2 other income was $26.5 million versus $21.6 million, supported by wealth and card fees, mortgage-sale gains, and securities gains. Other expense was $60.0 million versus $57.6 million, reflecting MBT-related costs, higher FDIC assessments, and pandemic response spending, partly offset by lower data-processing and professional fees. First-half other income was $56.3 million versus $40.3 million; other expense was $126.2 million versus $114.2 million.
- Taxes and distributions: The effective tax rate was 12.3% in Q2 versus 15.9%; the first-half rate was 10.8% versus 15.5%, including a $1.2 million first-quarter tax benefit related to CARES Act NOL carrybacks. Q2 dividends were $0.26 per share. The company completed its $75 million repurchase authorization in Q1, buying 1.63 million shares at an average $34.21 per share.
Balance sheet, liquidity, and capital
- At June 30, total assets were $13.82 billion, up 10.9% from year-end 2019. Loans were $9.30 billion, up $831 million; total deposits were $10.97 billion, up $1.13 billion. Growth included PPP lending and deposits, stimulus-related deposits, and the effects of MBT.
- Cash and cash equivalents were $229.8 million. Total borrowings were $867.2 million, including $400.8 million of FHLB advances and $285.2 million of subordinated debentures and other borrowings. The company reported $671.6 million of remaining FHLB borrowing capacity. It repaid all $166.9 million of PPPL Facility borrowings during July 2020.
- For the first half, operating cash flow was $114.7 million; investing activities used $1.24 billion and financing activities provided $1.18 billion. Cash and cash equivalents increased $52.6 million.
- Regulatory capital remained above applicable well-capitalized thresholds. At June 30, the Corporation’s total risk-based capital ratio was 14.18%, CET1 ratio 11.84%, and tier 1 leverage ratio 9.45%. Tangible common equity to tangible assets, a non-GAAP measure, was 9.31%, down from 10.16% at year-end.
Asset quality, COVID-19, and outlook
- The allowance for loan losses was $121.1 million, or 1.30% of loans (1.44% excluding PPP loans), versus $80.3 million and 0.95% at year-end. Non-accrual loans rose to $50.1 million from $15.9 million; nonperforming assets were $58.6 million versus $24.3 million. Three relationships moved to non-accrual in Q2, including two senior-living exposures and one university-logo apparel exposure.
- The Bank modified approximately $1.12 billion of loans, or 12.1% of the portfolio, for 2,568 borrowers during the first half. These short-term COVID-19 modifications were not classified as TDRs under applicable relief. Commercial borrowers accounted for about 95% of modified balances; hotel, restaurant/food service, dental, and real-estate lessor industries were significant concentrations.
- The Bank had funded more than 5,000 PPP loans totaling $882.9 million net of deferred fees and costs. PPP loans carry a 1% rate and are fully SBA-guaranteed, subject to program compliance. The company recognized $2.7 million of net PPP processing fees as loan interest income in Q2.
- Management said economic activity had not returned to pre-pandemic levels and expected customer financial distress to continue through the remainder of 2020, particularly if infections rose or shutdowns resumed. It identified uncertain pandemic duration, borrower repayment capacity, collateral values, interest rates, and market conditions as key uncertainties. No specific earnings or financial guidance was provided.
- The company deferred CECL adoption under COVID-19 relief and continued using the incurred-loss model. It estimated that a January 1, 2020 CECL adoption would have increased the allowance by 55%–65% versus year-end 2019 and required an estimated $18 million reserve for unfunded commitments; these are estimates, not recorded Q2 amounts.
- Other risks include PPP-related litigation or SBA guarantee disputes, interest-rate and liquidity exposure, and heightened regulatory oversight: the Bank became subject to CFPB supervision on April 1 and interchange-fee limits on July 1, 2020. The filing also refers to a DOJ fair-lending settlement agreement and order. Management said ordinary-course claims and examinations were not expected to have a material adverse effect; it reported effective disclosure controls.
Key facts for investors to verify
- Whether pandemic-driven credit deterioration, loan delinquencies, and deferred payments result in further provisions or charge-offs; monitor non-accrual and criticized loans and the allowance.
- How quickly PPP loans are forgiven or repaid, the timing of remaining fee recognition, and whether SBA compliance issues or litigation arise.
- Actual CECL adoption timing and allowance impact, including the estimated unfunded-commitment reserve.
- Whether lower rates, deposit repricing, and loan growth stabilize net interest margin, and how deposit balances evolve as stimulus funds are spent.
- Capital and liquidity after the July PPPL repayment, and developments under the DOJ fair-lending agreement and new CFPB/interchange requirements.