FIRST MERCHANTS CORP quarterly report, Q2 FY2022

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First Merchants Corporation — Q2 2022 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2022. Figures are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.

Business context

First Merchants is a Midwest community banking company operating through First Merchants Bank, with 124 banking locations in Indiana, Ohio, Michigan and Illinois. On April 1, 2022, it completed its acquisition of Level One Bancorp, adding 17 Michigan banking centers. Level One’s results are included from the acquisition date, so year-over-year comparisons reflect different consolidation periods.

Financial results and key metrics

  • Q2 revenue: Net interest income plus other income was $156.9 million, versus $135.1 million in Q2 2021. Net interest income was $128.7 million, up $24.4 million year over year; other income was $28.3 million, down $2.6 million.
  • Q2 earnings: Net income was $39.0 million and net income available to common stockholders was $38.5 million, compared with $55.6 million a year earlier. Diluted EPS was $0.63 versus $1.03. Management’s non-GAAP adjusted diluted EPS, excluding PPP income and Level One acquisition-related expenses and provision, was $1.01 versus $0.89; this measure is not GAAP.
  • Six-month results: Net interest income was $230.9 million versus $204.7 million; net income was $87.6 million versus $105.0 million; diluted EPS was $1.54 versus $1.94. FTE net interest margin was 3.16%, down from 3.23%.
  • Margins and funding costs: Q2 FTE net interest margin rose to 3.28% from 3.22% a year earlier. Q2 total cost of funds increased to 0.41% from 0.35%; management cited rate increases and deposit pricing pressure, particularly for municipal deposits.
  • Expenses and taxes: Q2 non-interest expense increased 40.4% to $97.3 million, including $12.5 million of Level One acquisition-related costs and $6.5 million of post-acquisition Level One expenses. Q2 effective tax rate was 9.0%, versus 15.6%, primarily reflecting higher tax-exempt interest income.
  • Balance sheet at June 30: Assets were $17.8 billion, loans $11.4 billion, deposits $14.6 billion, borrowings $1.04 billion and stockholders’ equity $2.0 billion. Loans grew $2.2 billion from year-end, including $1.6 billion acquired; deposits rose $1.8 billion, including $1.9 billion acquired. Excluding acquired loans and PPP runoff, management reported $633.3 million of organic loan growth from year-end.
  • Credit quality: Allowance for loan losses was $226.3 million, or 1.98% of loans, versus $195.4 million, or 2.11%, at year-end. The $16.8 million reported provision was attributed to Level One acquisition-related CECL adjustments. Non-accrual loans were $46.0 million; non-performing assets were $52.7 million, including $6.5 million of OREO.
  • Cash flow and liquidity: For the first six months, operating cash flow was $95.1 million, investing cash outflow $131.9 million and financing cash inflow $82.2 million. Cash and cash equivalents increased $45.4 million to $212.6 million. The Bank reported $420.1 million of remaining FHLB borrowing capacity.
  • Capital: At June 30, the Corporation’s CET1 ratio was 10.27%; the Bank’s was 11.03%. The Bank met regulatory well-capitalized requirements. Tangible common equity to tangible assets, a non-GAAP measure, was 7.04%, down from 9.01% at year-end.

Material changes and unusual items

  • The Level One acquisition added approximately $2.5 billion of assets, $1.6 billion of loans, $1.9 billion of deposits, $167.8 million of goodwill and $25.0 million of Series A preferred stock. First Merchants issued about 5.6 million common shares and paid $79.3 million in cash for the common equity; purchase accounting remains preliminary.
  • Available-for-sale securities had a $246.1 million net unrealized loss at June 30, compared with a $75.9 million net unrealized gain at year-end, primarily due to interest-rate changes. The company recorded no credit-loss allowance on these securities, stating the losses reflected rates rather than credit quality. Held-to-maturity securities had a fair value of $2.03 billion versus a carrying amount of $2.33 billion.
  • Accumulated other comprehensive loss was $198.6 million at June 30, compared with $55.1 million of accumulated other comprehensive income at year-end. The company excludes AOCI from regulatory capital under its election.
  • Loans past due totaled $46.9 million, up from $34.7 million at year-end; the filing attributes much of the increase in 60–89-day delinquencies to two real estate loans totaling $20.0 million. Management reported no outstanding COVID-related loan modifications at June 30.
  • Q2 cash dividends were $0.32 per common share; the company also paid $469,000 of preferred dividends. It did not repurchase shares under its public repurchase program during the quarter.

Outlook, risks and contingencies

No quantified earnings or revenue guidance is provided. Management said the Level One transaction was expected to be accretive and to bring synergies and economies of scale, but cautioned that anticipated benefits depend on successful integration and execution. It expects most remaining PPP loans to be forgiven under program terms.

Key stated risks include interest-rate and deposit-pricing changes, economic deterioration and credit losses, investment and loan portfolio performance, acquisition integration and realization of synergies, liquidity and capital needs, COVID-19 effects, regulatory changes, competition, and compliance with the Department of Justice settlement agreement and agreed order concerning fair lending. A rising 200-basis-point rate scenario indicated a 1.2% increase in modeled 12-month net interest income; a falling 100-basis-point scenario indicated a 4.9% decrease. Management stressed that these simulations depend on assumptions and are not forecasts. The filing reports routine litigation and regulatory examinations, which management did not expect to have a material adverse effect.

Important facts for investors to verify

  • Whether Level One integration delivers the expected cost savings and accretion, and how acquisition-related and ongoing expenses develop.
  • Organic loan and deposit trends after separating acquisition effects and PPP runoff, including deposit pricing and funding mix.
  • Credit performance, especially delinquencies, non-accruals, commercial real estate exposures, and the adequacy of the allowance as economic conditions change.
  • The effect of interest-rate movements on net interest margin, deposit costs, securities values and tangible capital; also distinguish AOCI effects from credit impairment.
  • Purchase-price allocation, acquired-loan marks and remaining measurement-period adjustments for Level One.
  • Regulatory capital, liquidity capacity, and compliance developments related to the DOJ fair-lending settlement and agreed order.