First Merchants Corporation — Q3 2021 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2021. First Merchants is an Indiana-based community banking holding company operating through First Merchants Bank, with 109 banking locations across Indiana, Illinois, Ohio and Michigan. Financial amounts below are in millions unless noted.
Financial results and position
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net interest income | $104.7 | $92.9 | $309.4 | $279.8 |
| Provision for credit losses on loans | $0 | $12.5 | $0 | $54.2 |
| Net income available to common shareholders | $52.8 | $36.2 | $157.8 | $103.5 |
| Diluted earnings per share | $0.98 | $0.67 | $2.92 | $1.91 |
| Fully taxable-equivalent net interest margin | 3.20% | 3.15% | 3.22% | 3.26% |
| Return on average assets | 1.41% | 1.06% | 1.43% | 1.04% |
- Q3 net income rose about 46% year over year; nine-month net income rose about 53%. Higher net interest income and no current-period loan-loss provision were major contributors.
- At September 30, total assets were $15.06 billion, up 7.1% from December 31, 2020. Loans were $9.04 billion, down $201.6 million; deposits were $12.35 billion, up $987.1 million.
- Cash and cash equivalents were $169.3 million and interest-bearing deposits were $369.4 million. Available-for-sale securities were $2.37 billion and held-to-maturity securities, net, were $2.07 billion.
- Total borrowings were $636.3 million, down $48.6 million from year-end. The company reported $334.1 million of FHLB advances and $183.6 million of repurchase agreements. Remaining FHLB borrowing capacity was $719.3 million.
- Nine-month operating cash flow was $161.5 million; investing cash outflow was $1.06 billion, reflecting substantial securities purchases; financing cash inflow was $874.1 million. Cash and cash equivalents declined $23.6 million from year-end.
- Regulatory capital remained above applicable minimums. At September 30, the Corporation’s total risk-based capital ratio was 14.02%, CET1 ratio 11.75%, and tier 1 leverage ratio 9.28%. Tangible common equity to tangible assets was 8.94%, versus 9.65% at year-end.
Material changes and notable items
- Net interest margin increased 5 basis points year over year in Q3, but declined 4 basis points for the nine-month period. Lower funding costs partly offset lower asset yields. Q3 interest-bearing deposit cost was 0.23%, compared with 0.45% a year earlier.
- Noninterest income increased 8.9% in Q3 to $28.5 million; nine-month income increased 1.3% to $83.5 million. Wealth-management fees and deposit service charges improved; nine-month results also included gains from a $76.1 million mortgage portfolio sale. Card fees and securities gains were lower year over year.
- Noninterest expense increased 10.3% in Q3 to $71.4 million and 8.3% for nine months to $206.8 million. Higher compensation, data-processing costs and other expenses contributed.
- Total investment securities increased about $1.3 billion from year-end, funded in part by deposit growth and liquidity from PPP loan forgiveness. Loans declined partly because PPP balances fell to $198.1 million from $667.1 million; organic commercial and industrial growth partly offset that reduction.
- Net loan recoveries were $0.2 million in Q3; nine-month net charge-offs were $4.7 million, versus $7.7 million in 2020. Nonaccrual loans declined to $51.5 million from $61.5 million at year-end. Total past-due loans declined to $38.9 million from $72.8 million.
- The allowance for credit losses on loans was $200.0 million, or 2.21% of loans. The comparison is affected by adoption of CECL on January 1, 2021, which increased the allowance by $74.1 million and reduced retained earnings by $68.0 million after tax. The filing reports no loan-loss provision for the first nine months of 2021.
- Accumulated other comprehensive income fell to $39.9 million from $74.8 million at year-end, principally reflecting unrealized securities losses. Available-for-sale securities had $16.2 million of gross unrealized losses; management attributed these to interest-rate changes, not credit quality, and said it did not intend to sell and was not more likely than not to be required to sell before recovery.
- The company acquired Hoosier Trust Company on April 1 for $3.2 million cash; Hoosier had approximately $290 million in assets under management. The acquisition added $1.5 million of goodwill and a $2.2 million customer-relationship intangible.
- The Corporation repurchased 529,498 shares for $20.8 million during the first nine months under a program authorizing up to $100 million of repurchases. Common dividends were $0.29 per share in Q3.
Outlook, risks and contingencies
- The filing provides no specific earnings or financial guidance. Management noted continuing uncertainty about COVID-19, including variant strains, economic recovery, borrower repayment capacity, collateral values and loan quality. The majority of remaining PPP loans were expected to be forgiven by the SBA.
- Interest-rate sensitivity modeling estimated that a parallel 200-basis-point rise would increase net interest income 1.9% over 12 months, while a 100-basis-point decline would reduce it 0.3%. These are model scenarios, not management forecasts; actual results may differ.
- COVID-related loan deferrals totaled $15.4 million across 14 loans at quarter-end; $13.8 million was in the entertainment industry. The filing notes the potential for economic and real-estate deterioration to increase delinquencies and credit losses.
- Loan commitments and standby letters of credit totaled approximately $3.97 billion. These are contractual off-balance-sheet exposures and are not necessarily expected to be drawn in full. CECL-related reserves for unfunded commitments were $20.5 million.
- Derivative agreements could require settlement or collateralization upon specified capital or default events. The net-liability termination value under agreements with such features was $41.7 million; $58.8 million of collateral had been posted. No breach was reported.
- Management cited compliance with a DOJ fair-lending Settlement Agreement and Agreed Order as a risk factor. The filing reports no material change in previously disclosed risk factors and says routine litigation or regulatory examinations are not expected to have a material adverse effect.
Important facts for investors to verify
- How credit quality and the $200.0 million CECL allowance evolve, including the remaining entertainment-sector deferrals, criticized loans and subsequent charge-offs.
- How much of the remaining $198.1 million PPP balance is forgiven and how quickly related deferred fees are recognized.
- Whether deposit growth and investment purchases continue to support funding and margins, and how portfolio unrealized losses respond to interest-rate movements.
- Capital levels and the pace of share repurchases and dividends, considering the CECL regulatory-capital transition through 2024.
- Progress on the DOJ fair-lending agreement and any material developments in regulatory examinations, litigation or off-balance-sheet commitments.