First Merchants Corporation — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; the filing also reports fourth-quarter results. First Merchants is an Indiana-based community banking financial holding company operating across Indiana, Illinois, and Ohio.
Business context and material developments
- On November 12, 2013, First Merchants acquired CFS Bancorp in an all-stock transaction, issuing approximately 7.1 million shares valued at $135.6 million. CFS added approximately $1.106 billion of assets and $955 million of deposits; the acquired loan portfolio was approximately $639.6 million before purchase accounting discounts.
- The acquisition added $47.6 million of goodwill and a $7.3 million core deposit intangible. CFS results were consolidated from the acquisition date.
- The Corporation redeemed all $90.8 million of its Small Business Lending Fund preferred stock during 2013. It also issued $70 million of senior and subordinated notes, using proceeds in part to repay its $55 million Bank of America credit facility.
Financial performance and condition
| Metric | 2013 | 2012 | Change / context |
|---|---|---|---|
| Net interest income | $154.3 million | $152.3 million | Up 1.3% |
| Net interest income, fully taxable equivalent | $160.3 million | $158.1 million | Up $2.2 million |
| Net interest margin, FTE | 3.99% | 4.12% | Down 13 basis points |
| Other income | $54.8 million | $64.3 million | Down 14.8%, principally because 2012 included a $9.1 million FDIC acquisition gain |
| Other expenses | $143.2 million | $137.1 million | Up 4.5%; included acquisition and integration costs |
| Income before tax | $59.2 million | $61.0 million | Down |
| Net income | $44.5 million | $45.1 million | Down |
| Net income available to common shareholders | $42.2 million | $40.6 million | Up; lower preferred-stock dividends helped |
| Diluted earnings per share | $1.41 | $1.41 | Unchanged |
| Return on average assets | 0.95% | 0.96% | Slightly lower |
| Return on average equity | 7.80% | 7.58% | Higher |
- Fourth quarter: Net income available to common shareholders was $11.2 million, or $0.34 diluted per share, compared with $9.2 million, or $0.32 per share, in fourth-quarter 2012. Fourth-quarter 2013 included $1.0 million of loan-loss provision and $40.6 million of non-interest expense.
- Assets and lending: Year-end assets were $5.44 billion, up $1.13 billion year over year. Loans were $3.63 billion, up $730 million, and investment securities were $1.10 billion. Management attributed much of the growth to CFS.
- Credit quality: Provision for loan losses fell to $6.6 million from $18.5 million; net charge-offs declined to $8.1 million from $20.1 million. Non-performing assets plus loans 90 days past due were $83.0 million versus $81.4 million. Non-performing loans fell to $59.5 million from $66.1 million, while impaired loans increased to $119.8 million from $79.2 million, including acquired CFS loans.
- The allowance for loan losses was $67.9 million, or 1.87% of loans, compared with 2.37% a year earlier. Allowance coverage of non-accrual loans was 120.3%, down from 129.9%. The company reported an additional $132.4 million of criticized, but not impaired, loans.
- Cash flows: Operating cash flow was $183.1 million, investing cash flow was negative $138.2 million, and financing cash flow was negative $37.0 million. Cash and cash equivalents ended the year at $109.4 million, up $8.0 million. These cash-flow measures should be considered alongside acquisition activity and changes in balance-sheet accounts.
- Deposits, debt, and liquidity: Deposits were $4.23 billion, up $885 million, substantially reflecting CFS deposits. Total borrowings were $523.3 million, compared with $367.1 million. Available-for-sale securities had a year-end fair value of $536.2 million; remaining FHLB borrowing capacity was $228.1 million.
- Capital: Corporation Tier 1 risk-based and total risk-based capital ratios were 11.71% and 14.54%, respectively, versus 14.15% and 16.34% in 2012. The Bank was categorized as well capitalized. Common book value per share was $17.67; tangible book value per share was $12.17.
Management commentary, outlook, and risks
- Management said the CFS acquisition was expected to be accretive and bring operating synergies. The filing reports $5.4 million of 2013 non-recurring acquisition-related expenses; CFS contributed $8.9 million of non-interest expense during the period after closing. Pro forma results are explicitly not a projection of future performance.
- Management attributed net interest income growth to higher earning-asset volume, partially offset by lower asset yields and a lower margin in the low-rate environment. The filing provides no numerical earnings guidance or formal forecast.
- Management considered the loan-loss allowance adequate, while noting that estimates depend on economic conditions, collateral values, credit performance, and other judgmental assumptions. Commercial real estate represented a significant share of loans; construction and land-development loans rose to $177.1 million from $98.6 million.
- Interest-rate simulation estimated that a parallel 200-basis-point rise would increase twelve-month net interest income by 6.17% from the modeled base, while a 100-basis-point decline would reduce it by 2.45%. These are model scenarios, not management forecasts, and depend on assumptions about rates, deposits, and asset behavior.
- Other risks include competition, economic and interest-rate changes, regulatory and compliance costs, acquisition integration, operational and cybersecurity incidents, and potential loan and securities losses. Basel III implementation beginning in 2015 was not expected by management to have a material impact.
- The Corporation disclosed $1.258 billion of loan commitments and standby letters of credit; many are expected to expire unused or be only partly drawn. An overdraft-fee class action was stayed pending arbitration; the filing reported no effort to initiate arbitration as of the report date and management believed it had meritorious defenses.
- Auditors issued an unqualified opinion on the financial statements and internal controls. Management also concluded disclosure controls and internal control over financial reporting were effective as of year-end.
Important facts for investors to verify
- Whether CFS integration delivers the expected synergies and accretion, and how acquisition-related costs, deposit retention, and purchase-accounting loan discounts develop.
- Credit trends in acquired and originated portfolios, especially commercial real estate, criticized loans, impaired loans, non-performing assets, and the allowance relative to losses.
- Whether net interest margin stabilizes or remains pressured by interest rates, competition for deposits, and repricing dynamics; compare actual results with the filing’s rate-sensitivity scenarios.
- The composition and cost of funding, maturity and terms of borrowings, liquidity capacity, and the effect of the preferred-stock redemption and new debt issuance on capital and earnings.
- Unrealized securities losses and valuation assumptions, including trust preferred securities with $6.4 million amortized cost and $2.7 million fair value at year-end.
- Developments in the overdraft-fee litigation and the utilization or drawdown of off-balance-sheet credit commitments.