First Merchants Corporation — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023. First Merchants is an Indiana-based community banking holding company operating through First Merchants Bank across Indiana, Ohio, Michigan and Illinois. The results include Level One Bancorp, acquired April 1, 2022, so Q1 2022 is a pre-acquisition comparison.
Financial results and key metrics
| Metric | Q1 2023 | Q1 2022 / comparison |
|---|---|---|
| Net interest income | $144.1 million | $102.3 million |
| Net income | $64.1 million | $48.6 million |
| Net income available to common shareholders | $63.6 million | $48.6 million |
| Diluted EPS | $1.07 | $0.91 |
| FTE net interest margin | 3.58% | 3.03% |
| Total assets at period end | $18.18 billion | $17.94 billion at Dec. 31, 2022 |
| Total loans at period end | $12.24 billion | $12.00 billion at Dec. 31, 2022 |
| Total deposits at period end | $14.70 billion | $14.38 billion at Dec. 31, 2022 |
| Total borrowings at period end | $1.15 billion | $1.31 billion at Dec. 31, 2022 |
Non-interest income was $25.0 million, down 3.5% year over year; non-interest expense was $93.7 million, up 29.6%. The filing attributes much of the expense increase to the larger franchise following the Level One acquisition, including added staff, employee costs and technology investment. The effective tax rate was 15.0%, versus 13.0%.
Operating cash flow was $77.9 million; investing cash flow was negative $217.4 million and financing cash flow was positive $142.7 million. Cash and due from banks ended at $125.8 million; interest-bearing deposits were $352.7 million. Cash and cash equivalents increased $3.2 million during the quarter.
Material changes and balance-sheet developments
- Net interest income rose year over year as higher asset yields and Level One-related growth outweighed a sharp increase in funding costs. Interest-bearing deposit cost was 1.79%, versus 0.17% a year earlier; total cost of funds was 1.48%, versus 0.20%.
- Loans grew $237.9 million from year-end, or 7.9% annualized on a linked-quarter basis. Organic loan growth, excluding PPP paydowns, was reported as $239.0 million, or 8.0% annualized.
- Deposits increased $320.5 million from year-end, or 8.9% annualized. The mix shifted toward higher-cost time deposits; noninterest-bearing deposits were 20.2% of deposits, down from a 23.6% peak in Q2 2022.
- Borrowings declined $160.0 million, principally because federal funds purchased fell by $171.5 million. FHLB advances were $823.6 million; remaining FHLB borrowing capacity was $608.8 million.
- Available-for-sale securities were $1.79 billion. Their net unrealized loss improved to about $245.7 million from $296.7 million at year-end; held-to-maturity securities had fair value of $1.93 billion versus carrying value of $2.26 billion. Management said the unrealized losses reflected interest rates, not credit quality, and it did not intend or expect to be required to sell the securities before recovery.
Credit, capital, liquidity, outlook and risks
- The allowance for credit losses on loans was $223.1 million, or 1.82% of loans, compared with 1.86% at year-end. No provision was recorded in Q1; net charge-offs were $225,000. Non-accrual loans were $46.6 million, up $4.3 million from year-end. Total past-due loans increased to $82.9 million from $51.0 million; loans 90 days or more past due and still accruing were $7.0 million.
- Non-performing assets were $54.4 million. Non-performing assets plus loans 90 days or more past due and accruing totaled $61.4 million, compared with $50.7 million at year-end. The loan-loss allowance to non-accrual loans coverage ratio was 478.9%.
- Common Equity Tier 1 capital ratio was 10.82% at the Corporation and 11.52% at the Bank. Management said the Bank met the requirements to be considered well-capitalized and that regulatory capital ratios remained above applicable thresholds. Tangible common equity to tangible assets, a non-GAAP measure, was 7.75%, versus 7.34% at year-end.
- Management characterized liquidity as strong. It reported that 28.1% of deposits were uninsured, with 57.2% FDIC-insured and a further 14.8% covered by Indiana’s Public Deposit Insurance Fund. The Bank had not used the Federal Reserve’s Bank Term Funding Program as of March 31, 2023; management cited available liquidity from balance-sheet resources and borrowing facilities.
- The filing provides no specific earnings or financial guidance. Interest-rate simulation showed estimated 12-month net interest income 3.6% higher in a +200-basis-point scenario and 2.4% lower in a −100-basis-point scenario; management cautioned that model assumptions and actual outcomes may differ.
- Risks highlighted include deposit competition and outflows, liquidity and market concerns following bank failures, higher funding costs, interest-rate and asset-valuation changes, credit deterioration, regulatory changes and potentially higher FDIC assessments. The company said it expected possible new regulations and higher future FDIC insurance premiums.
- Unusual items included $1.6 million of realized losses on available-for-sale securities sold during the quarter and a one-time $2 million FDIC assessment credit that reduced expenses. Routine litigation and regulatory matters were not expected by management to have a material adverse effect. Disclosure controls were reported effective.
Most important facts for investors to verify
- Whether deposit mix, deposit pricing and deposit retention stabilize, especially given the decline in noninterest-bearing balances and the reported uninsured-deposit share.
- Whether loan delinquencies and non-accrual loans continue to rise, and whether the allowance remains adequate as loan growth and economic conditions evolve.
- How net interest margin responds to further rate changes and funding-cost competition, compared with management’s modeled scenarios.
- Whether liquidity capacity, including FHLB and Federal Reserve facilities, remains available and sufficient without forced securities sales.
- The effect of Level One integration, higher operating costs and any future FDIC or regulatory expense increases on earnings and capital.
- Changes in the sizable unrealized securities losses, and the assumptions underlying fair values and management’s ability to hold securities until recovery.