Business context and reporting period
First Merchants Corporation, an Indiana-based community banking holding company, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2014. It operates primarily through First Merchants Bank and had 97 banking locations across Indiana, Illinois and Ohio. The prior-year comparisons are affected by the November 2013 acquisition of CFS Bancorp, which added 20 banking centers and materially expanded the company.
Key financial metrics
Amounts below are in millions, except per-share data and ratios.
| Metric | Q2 2014 / June 30, 2014 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $46.1 (quarter); $92.0 (six months) | $36.7 (quarter); $76.1 (six months) |
| Net income | $15.2 (quarter); $28.8 (six months) | $10.8 (quarter); $22.7 (six months) |
| Diluted earnings per common share | $0.41 (quarter); $0.79 (six months) | $0.34 (quarter); $0.72 (six months) |
| Net interest margin, FTE | 3.89% (quarter); 3.93% (six months) | 3.88% (quarter); 4.06% (six months) |
| Total assets | $5,615 | $5,437 at Dec. 31, 2013 |
| Total loans, before allowance | $3,723 | $3,632 at Dec. 31, 2013 |
| Total deposits | $4,330 | $4,231 at Dec. 31, 2013 |
| Total borrowings | $581 | $523 at Dec. 31, 2013 |
| Stockholders’ equity | $671 | $635 at Dec. 31, 2013 |
For the six months, operating cash flow was $28.6 million, investing cash outflow was $173.0 million, and financing cash inflow was $150.8 million. Cash and cash equivalents ended the period at $115.9 million, up from $109.4 million at year-end. The filing reports no loan-loss provision for the 2014 quarter or first half, versus $2.0 million and $4.1 million, respectively, in 2013.
Material changes versus prior periods
- Quarterly net income rose about 40% year over year; six-month net income rose about 27%. Growth reflects the CFS acquisition as well as higher net interest income and fee income, so reported comparisons are not like-for-like.
- Quarterly FTE net interest margin edged up to 3.89% from 3.88%; the six-month margin declined to 3.93% from 4.06%, as asset yields fell 13 basis points while funding costs were broadly unchanged.
- Six-month noninterest income increased 11.4% to $31.1 million, supported by acquisition-related customer fees and securities gains; mortgage-loan sale gains declined.
- Six-month noninterest expense increased 23.2% to $84.3 million. Drivers included CFS-related staffing and locations, $1.6 million of CFS integration costs, health-related costs, and unusually high snow removal expense.
- Nonaccrual loans declined to $51.3 million from $56.4 million at year-end; nonperforming assets plus loans at least 90 days delinquent fell to $72.4 million from $83.0 million. The allowance was $68.4 million, or 1.83% of loans, and covered 133.3% of nonaccrual loans.
- Available-for-sale and held-to-maturity securities totaled $1.214 billion at carrying value, up from $1.096 billion at year-end. Accumulated other comprehensive income improved to $4.2 million from a $6.4 million loss, largely reflecting securities valuation changes.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management notes that first-half results are not necessarily indicative of full-year results.
- Management identifies interest-rate and pricing changes, economic and credit deterioration, securities portfolio risks, competition, regulatory changes, and acquisition integration as factors that could affect results. A modeled immediate rate increase of 200 basis points would raise 12-month net interest income 4.88% versus base; a 100-basis-point decline would reduce it 3.02%. These are model scenarios, not forecasts.
- Liquidity sources include deposits, available-for-sale securities, and borrowing capacity. The Bank had $220.8 million in FHLB advances and $147.3 million of remaining FHLB capacity. A $20 million holding-company credit line was undrawn at June 30, 2014. The company reported compliance with its debt covenants.
- Consolidated and Bank regulatory capital ratios exceeded well-capitalized thresholds. Consolidated total risk-based capital was 15.11%; tangible common equity to tangible assets was 8.74%.
- On July 21, 2014, First Merchants agreed to acquire Community Bancshares, with combined assets expected to exceed $5.9 billion, subject to the merger agreement’s terms and conditions.
- In Q2, the company sold four of six remaining trust preferred securities for a $641,000 net gain; the two remaining securities had $1.5 million amortized cost and $764,000 fair value. Management considered the remaining unrealized losses temporary. A checking-account overdraft-fee class action was stayed pending possible arbitration; no arbitration had been initiated as of the filing.
Important facts for investors to verify
- Separate underlying growth from the CFS acquisition effect, including its contribution to interest income, fees, expenses and loan balances.
- Monitor whether the decline in nonperforming assets and absence of loan-loss provision continue, and review criticized loans, charge-offs and allowance assumptions.
- Assess deposit mix and funding costs, particularly brokered deposit growth and increased FHLB advances and other borrowings.
- Track interest-rate sensitivity, securities valuation and credit exposure, including the remaining trust preferred securities.
- Review Community Bancshares merger approvals, integration costs, expected synergies and eventual impact on capital and earnings.