First Merchants Corporation — Q1 2014 Form 10-Q
Business context and reporting period. This unaudited filing covers the three months ended March 31, 2014. First Merchants is an Indiana-based community banking holding company. Results include CFS Bancorp, acquired in November 2013; therefore, year-over-year comparisons reflect the expanded business.
Financial performance and position
| Metric | Q1 2014 / March 31, 2014 | Comparison |
|---|---|---|
| Net interest income | $45.9 million | $39.5 million in Q1 2013 |
| Net interest margin, FTE | 3.97% | 4.25% in Q1 2013 |
| Noninterest income | $15.2 million | $13.9 million in Q1 2013 |
| Noninterest expense | $43.1 million | $34.7 million in Q1 2013 |
| Net income | $13.6 million | $11.9 million in Q1 2013 |
| Net income available to common shareholders; diluted EPS | $13.6 million; $0.38 | $11.0 million; $0.38 in Q1 2013 |
| Cash and cash equivalents | $112.9 million | $109.4 million at December 31, 2013 |
| Total assets | $5.45 billion | $5.44 billion at December 31, 2013 |
| Total loans, before allowance | $3.62 billion | $3.63 billion at December 31, 2013 |
| Total deposits | $4.28 billion | $4.23 billion at December 31, 2013 |
| Total borrowings | $483.8 million | $523.3 million at December 31, 2013 |
| Operating cash flow | $6.6 million | $11.8 million in Q1 2013 |
Net interest income increased substantially year over year, primarily because of the CFS acquisition and higher average earning assets. FTE net interest margin contracted 28 basis points: asset yields fell 30 basis points while interest costs declined 2 basis points. Net income rose, but diluted EPS remained $0.38 as the average diluted share count increased to 36.3 million from 29.0 million.
Noninterest expense rose 24.2% year over year. The company reported $1.4 million of CFS acquisition and core-system integration costs in Q1, along with higher personnel, occupancy, equipment, and FDIC expenses. Noninterest income grew 9.4%, aided by the acquired customer base and securities-sale gains, partly offset by lower mortgage-loan sale gains.
The allowance for loan losses was $69.6 million, or 1.92% of loans, versus $67.9 million and 1.87% at year-end. Management reported no loan-loss provision in Q1 2014, compared with $2.1 million in Q1 2013. Net charge-offs were net recoveries of $1.7 million, compared with net charge-offs of $2.9 million a year earlier. Nonaccrual loans declined to $55.7 million from $56.4 million; nonperforming assets plus loans 90 days past due and still accruing were $78.9 million, down from $83.0 million at year-end.
Available-for-sale securities totaled $605.5 million, up $69.3 million since year-end. Total investment securities had $5.8 million of gross unrealized losses at quarter-end, versus $13.4 million at year-end. Management considered the losses temporary and reported no other-than-temporary impairment for the quarter. Tangible common equity to tangible assets was 8.65%, up from 8.34%. The company and its bank exceeded regulatory well-capitalized thresholds; the consolidated total risk-based capital ratio was 15.04%.
Changes, outlook, risks, and unusual items
- CFS acquisition: The November 2013 all-stock acquisition added 20 banking centers and approximately $639.6 million of loans at acquisition. It generated $47.6 million of goodwill and a $7.3 million core deposit intangible. Q1 2014 included $1.4 million of related integration and acquisition expenses.
- Funding and liquidity: Deposits increased $51.7 million from year-end, while borrowings declined $39.5 million. The Bank reported $199.0 million of remaining FHLB borrowing capacity. On April 11, 2014, the Corporation entered into a $20 million credit line maturing April 10, 2015, priced at one-month LIBOR plus 2.00%, with customary covenants.
- Interest-rate exposure: The company’s 12-month simulation at March 31 estimated net interest income of $189.1 million in a rising 200-basis-point scenario (+5.33% versus base) and $174.0 million in a falling 100-basis-point scenario (-3.09%). These are model scenarios, not management forecasts; actual results may differ.
- Risks and contingencies: Management cites sensitivity to interest rates, economic conditions, credit quality, competition, regulation, acquisition integration, and the availability of earnings and capital for dividends. A class action concerning overdraft fees was stayed pending arbitration; the filing reported no effort to initiate arbitration as of the report date. Management said there were no material changes to previously disclosed risk factors.
- Guidance: The filing provides no specific earnings or operating guidance. Management cautions that quarterly results are not necessarily indicative of full-year results.
Important facts for investors to verify
- How much of the reported earnings and expense growth reflects CFS, and whether integration savings or continuing costs emerge after system conversion.
- Whether net interest margin stabilizes or continues to decline as asset yields, deposit pricing, and interest rates change.
- Whether loan balances, credit classifications, nonperforming assets, and the allowance remain consistent with management’s estimates, particularly given the absence of a Q1 provision and net recoveries.
- The quality and liquidity of the securities portfolio, including the valuation and potential credit performance of pooled trust preferred securities.
- Deposit retention, use of FHLB advances and the new credit line, and compliance with debt and derivative-related covenants.
- Whether the overdraft-fee dispute proceeds to arbitration and whether any material developments affect potential exposure.