FIRST MERCHANTS CORP annual report, FY2012

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First Merchants Corporation — 2012 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2012. First Merchants is an Indiana-based financial holding company operating primarily through its community bank, with 76 banking locations in Indiana and Ohio.

Financial performance and position

  • Earnings: Net income was $45.1 million and net income available to common shareholders was $40.6 million, or $1.41 per diluted share, versus $25.3 million and $9.0 million, or $0.34 per diluted share, respectively, in 2011. Return on average assets was 0.96%; return on average equity was 7.58%.
  • Interest income and margins: Net interest income was $152.3 million, up from $143.4 million. Fully taxable-equivalent net interest margin increased to 4.12% from 3.98%. Average earning-asset yield fell 25 basis points, while funding cost fell 39 basis points.
  • Other income and expenses: Other income was $64.3 million, up 30.9%, including a $9.1 million pre-tax gain from the SCB Bank transaction. Other expenses rose 0.9% to $137.1 million. The effective tax rate was 26.0%.
  • Credit costs: Provision for loan losses declined to $18.5 million from $22.6 million. Net charge-offs fell to $20.1 million from $34.7 million, or 0.71% of average loans versus 1.26%.
  • Cash flow: Operating activities provided $70.3 million; investing activities provided $11.9 million; financing activities used $54.0 million. Cash and cash equivalents increased $28.1 million to $101.5 million.
  • Balance sheet and liquidity: Assets were $4.305 billion, up $131.7 million. Loans were $2.902 billion, deposits $3.346 billion, and stockholders’ equity $552.2 million. The Bank had $94.2 million of FHLB advances and $217.3 million of remaining FHLB borrowing capacity. Available-for-sale securities had a market value of $513.3 million.
  • Debt and capital: Total borrowings declined to $367.1 million from $489.4 million. Corporation Tier 1 risk-based and total risk-based capital ratios were 14.15% and 16.34%; the Bank was classified as well capitalized. Common dividends were $0.10 per share for the year.

Material changes versus 2011

  • The Bank acquired selected assets and assumed deposits and certain liabilities of SCB Bank from the FDIC effective February 10, 2012. The transaction added $93.8 million of loans and $125.9 million of deposits and generated a $9.1 million pre-tax gain. Acquired assets were discounted by $29.0 million from book value; acquired loans included a $19.2 million fair-value discount.
  • Loans and loans held for sale increased $193.2 million; investment securities decreased approximately $72.0 million. Deposits increased $211.7 million.
  • Non-performing assets plus loans at least 90 days delinquent declined to $81.4 million from $100.8 million. The allowance for loan losses was $69.4 million, or 2.37% of loans, compared with $70.9 million, or 2.60%, a year earlier.
  • 2011 common earnings included a $12.3 million after-tax loss tied to extinguishing trust-preferred securities and related preferred-stock transactions, reducing comparability with 2012.
  • The Bank repaid $79.0 million of FDIC-guaranteed senior notes at maturity in March 2012 and the Corporation redeemed a $4.1 million high-cost subordinated debenture in August.

Outlook, risks and unusual items

  • The filing gives no specific earnings or revenue guidance. Management says it expects to continue geographic expansion through acquisitions and routinely evaluates acquisition opportunities.
  • Management reported improving credit indicators and considered the allowance adequate, while noting that economic conditions, real-estate collateral values, borrower performance and loan growth could lead to higher credit losses. Commercial and farm-land loans represented 43.6% of loans; construction and land-development lending remained under close review.
  • Interest-rate sensitivity modeling estimated that a parallel 200-basis-point increase would raise modeled 12-month net interest income 5.33% from the base case; a 100-basis-point decline would reduce it 1.18%. These are model scenarios, not forecasts, and depend on assumptions about rates, prepayments and deposit behavior.
  • The Corporation held trust-preferred securities with $6.1 million amortized cost and just $194,000 fair value, a $5.9 million unrealized loss. Management attributed the decline to illiquidity and credit-related cash-flow risk and did not consider the remaining investment portfolio other-than-temporarily impaired.
  • Goodwill was $141.4 million. The 2012 impairment test found fair value above carrying value, but depended substantially on management forecasts and other unobservable valuation assumptions.
  • Liquidity depends in part on dividends from subsidiaries, which are legally restricted. The Corporation had $70.7 million available for 2013 subsidiary dividends without prior regulatory approval. It also reported $873.5 million in loan commitments and $21.7 million in standby letters of credit; many commitments may expire unused.
  • The Corporation was in compliance with Bank of America credit-facility covenants at year-end; it had been in covenant default during 2011, and the lender applied a higher rate through March 31, 2012. The $55 million facility matures in February 2015.
  • On January 3, 2013, the Corporation redeemed $22.7 million of Series B preferred stock; approximately $68 million remained outstanding afterward. Management identified regulatory change, competition, operational and cybersecurity risks, economic conditions, and reliance on estimates for loan-loss reserves, securities, goodwill and pension obligations.
  • Management and the independent auditor reported effective internal control over financial reporting; the auditor issued an unqualified opinion. The filing reports no material pending litigation.

Important facts for investors to verify

  • How much of 2012 earnings growth reflects recurring banking results versus the $9.1 million SCB acquisition gain and the unusual 2011 preferred-security charges.
  • Whether credit-quality improvement continues, particularly in commercial real estate, and whether the allowance remains adequate against non-accrual, impaired and criticized loans.
  • The performance and expected accretion of acquired SCB loans, including acquired-credit-impaired assets and their fair-value discounts.
  • Funding and capital implications of remaining Series B preferred stock, debt maturities, dividend restrictions and the subsequent preferred-stock redemption.
  • The sensitivity of actual earnings and liquidity to interest-rate changes, deposit behavior, collateral valuations and unused lending commitments.

Note: The filing’s MD&A gives non-accrual loans as $53.999 million in one passage, while its detailed tables and other disclosures report $53.399 million. The detailed tables report $53.399 million; investors may wish to confirm the discrepancy.