First Merchants Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are with December 31, 2012. Dollar amounts below are in millions unless stated otherwise. First Merchants is an Indiana-based community bank holding company operating primarily in Indiana and Ohio.
Financial performance and position
- Earnings: Net income was $11.9 million, versus $14.4 million a year earlier. Net income available to common shareholders was $11.0 million, or $0.38 per diluted share, compared with $13.2 million, or $0.46 per share.
- Interest income and margin: Net interest income was $39.5 million, up from $36.1 million. Fully taxable equivalent net interest margin rose to 4.25% from 3.96%; the filing attributes the improvement to lower funding costs, acquired-loan accretion and a $2.5 million recovery on a previously charged-off loan. Average earning assets increased $54.3 million year over year.
- Other income and expenses: Other income fell to $13.9 million from $22.7 million, primarily because Q1 2012 included a $9.1 million gain on the SCB Bank transaction. Noninterest expense rose 2.0% to $34.7 million, including higher salaries, benefits, commissions and incentives.
- Credit costs: Provision for loan losses declined to $2.1 million from $4.9 million. Net charge-offs were $2.9 million, down from $5.4 million. Nonaccrual loans fell to $46.8 million from $53.4 million; nonperforming assets were $65.3 million, down from $79.3 million. The $68.5 million allowance equaled 2.36% of loans and 146.6% of nonaccrual loans.
- Balance sheet: Total assets were $4.253 billion, down $52.0 million from year-end. Loans were $2.880 billion, down from $2.902 billion. Deposits were $3.311 billion, down $35.6 million, or 1.1%. Total borrowings were $366.8 million, approximately unchanged from year-end.
- Liquidity and cash flow: Cash and cash equivalents declined to $51.6 million from $101.5 million. Q1 operating cash flow was $11.8 million, investing cash flow was negative $1.5 million, and financing cash flow was negative $60.2 million. The Bank reported $206.3 million of remaining FHLB borrowing capacity and $532.9 million of available-for-sale securities.
- Capital and shareholder returns: Consolidated total risk-based capital was 15.91%, Tier 1 risk-based capital 14.03%, and Tier 1 leverage 11.00%; the Bank exceeded well-capitalized thresholds. Tangible common equity to tangible assets was 7.88%. The common dividend was $0.03 per share. The Corporation redeemed $22.7 million of Treasury-held Series B preferred stock in January.
Material changes versus comparable periods
- Common earnings and diluted EPS declined year over year, but the comparison is affected by the $9.1 million SCB Bank acquisition gain recorded in Q1 2012. Excluding that unusual prior-year gain, other income was less sharply lower.
- Net interest income and margin improved, while interest expense fell to $4.3 million from $7.4 million, reflecting lower funding costs.
- Credit quality indicators generally improved: provision and net charge-offs declined, and nonaccrual loans and nonperforming assets were lower than at year-end 2012.
- Cash decreased substantially from year-end, while time deposits, available-for-sale securities and repurchase-agreement borrowings increased. Total assets and loans contracted modestly.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management notes that Q1 results are not necessarily indicative of full-year results.
- Interest-rate simulations estimate 12-month net interest income of $144.5 million in the base case, $152.5 million with an immediate 200-basis-point rise (+5.51%), and $142.7 million with a 100-basis-point decline (−1.25%). Management cautions that assumptions and actual results may differ.
- Key stated risks include changes in interest rates and loan or deposit pricing, economic deterioration and credit losses, investment portfolio developments, competition, regulatory changes, acquisition integration, and availability of earnings and capital to support dividends.
- On April 16, 2013, the Corporation was named in a class action alleging improper checking-account overdraft fee practices. No class had been certified; management said it could not assess the probability of a material adverse outcome or estimate a loss. The company stated that it believes it has meritorious defenses.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. The filing reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How much of the improvement in net interest income is recurring, given the acquired-loan accretion and $2.5 million loan recovery cited by management?
- Whether lower nonperforming loans and charge-offs continue, and whether the allowance remains adequate as loan mix and economic conditions change.
- The cause and sustainability of the decline in cash, deposit trends, and the company’s capacity to meet funding needs and debt maturities.
- Potential financial and operational consequences of the overdraft-fee litigation, which the filing says cannot yet be reasonably estimated.
- Whether investment-security valuations and unrealized losses—particularly pooled trust preferred securities—change materially; management reported no other-than-temporary impairment at quarter-end.