First Merchants Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012; unaudited. Dollar amounts below are in millions unless stated otherwise. First Merchants is an Indiana-based community banking company operating in Indiana and Ohio.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest income | $39.9 | $35.9 | $114.1 | $107.2 |
| Provision for loan losses | $4.6 | $5.6 | $14.0 | $16.8 |
| Other income | $14.3 | $13.2 | $50.1 | $36.1 |
| Other expenses | $34.4 | $34.2 | $102.6 | $102.5 |
| Net income | $11.2 | $6.7 | $34.8 | $17.7 |
| Net income (loss) available to common shareholders | $10.1 | $(6.4) | $31.4 | $2.6 |
| Diluted earnings (loss) per share | $0.35 | $(0.25) | $1.09 | $0.10 |
Fully taxable-equivalent net interest margin was 4.32% for Q3, up from 4.02%; the nine-month margin was 4.13%, versus 3.98%. Management attributed the improvement to lower funding costs, including deposit costs, and higher earning assets, including SCB-acquired loans and related discount accretion. Q3 noninterest income rose 7.9%, largely on higher mortgage loan sale gains. Nine-month other income included the $9.1 million SCB acquisition gain.
Operating cash flow was $47.2 million for the first nine months, investing cash flow was $39.3 million, and financing cash flow was $(102.8) million. Cash and cash equivalents fell $16.3 million to $57.0 million from year-end 2011.
Balance sheet, capital and liquidity
- Total assets were $4.25 billion, up $77.1 million from December 31, 2011. Loans were $2.84 billion, compared with $2.71 billion; total deposits were $3.19 billion, up $60.1 million.
- Total borrowings were $468.1 million, versus $489.4 million at year-end. The company repaid $79 million of matured FDIC-guaranteed senior notes and redeemed a $4.1 million subordinated debenture carrying a 10.2% rate.
- Available-for-sale securities were $551.6 million; held-to-maturity securities were $377.1 million. The Bank reported $145.5 million of FHLB advances and $168.2 million of remaining FHLB borrowing capacity.
- Consolidated total risk-based capital was 16.62%, Tier 1 risk-based capital 14.39%, and Tier 1 leverage 10.98%. Management said the Corporation and Bank exceeded well-capitalized thresholds. Tangible common equity to tangible assets was 7.51%, up from 6.84% at year-end.
- The company paid common dividends of $0.03 per share in Q3 and $0.07 per share for the nine months.
Credit quality, changes and unusual items
- Nonperforming assets declined to $77.7 million from $100.2 million at year-end; nonaccrual loans fell to $57.0 million from $69.6 million. However, accruing loans at least 90 days delinquent increased to $2.0 million from $0.6 million.
- The allowance for loan losses was $69.5 million, 2.43% of loans and 121.9% of nonaccrual loans. Q3 net charge-offs were $5.3 million, down from $9.6 million a year earlier; nine-month net charge-offs were $15.4 million, versus $26.7 million.
- The SCB Bank purchase and assumption closed February 10, 2012. First Merchants acquired assets with reported fair value of $146.1 million, including $93.8 million of loans and $18.9 million of securities, and assumed $137.0 million of liabilities, including $125.9 million of deposits. It recognized a $9.1 million gain; the transaction had no FDIC loss-sharing agreement.
- Q3 2011 common results included $12.3 million of after-tax losses associated with extinguishing trust preferred securities and retiring CPP preferred stock, contributing to the prior-year quarterly common-shareholder loss. The 2012 nine-month comparison also benefits from the SCB gain.
- Trust preferred securities had $6.0 million amortized cost and only $171,000 fair value; management recorded no additional impairment in 2012. This is a small portion of the investment portfolio but remains a significant valuation and credit-risk item.
- New troubled debt restructurings totaled $7.0 million post-modification for the first nine months; 11 of those loans were on nonaccrual at period-end. Management cited real estate collateral values and economic conditions as credit risks.
Outlook, risks and contingencies
The filing provides no formal earnings or revenue guidance. Management’s 12-month interest-rate model estimated net interest income of $144.7 million in its base case, $149.8 million under an immediate 200-basis-point rise (+3.48%), and $143.2 million under a 100-basis-point decline (-1.05%). Management cautioned that the simulations depend on assumptions and are not forecasts.
Disclosed risks include interest-rate and deposit-pricing changes, economic deterioration and credit losses, loan and investment portfolio performance, competition, regulation, acquisition integration, and availability of earnings and excess capital to support dividends. The company had $883.8 million of loan commitments and $22.0 million of standby and commercial letters of credit; actual funding needs may be lower because commitments may expire unused or be drawn only in part. Derivative agreements could require settlement or collateralization following specified capital or debt defaults; net-liability termination value was $10.6 million, with $9.3 million of collateral posted.
The Corporation had failed a Bank of America return-on-assets covenant at December 31, 2011, but was no longer in default as of March 31, 2012 and reported compliance at September 30, 2012. Management stated disclosure controls were effective. The filing reported no legal proceedings and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How much of earnings growth reflects recurring banking performance versus the $9.1 million acquisition gain and acquired-loan accretion.
- Whether the improvement in nonperforming assets and charge-offs persists, particularly given higher 90-day accruing delinquencies and restructured-loan defaults.
- The adequacy of the loan-loss allowance and the valuation/recovery assumptions for impaired loans, real estate collateral, and trust preferred securities.
- Deposit stability, borrowing needs, and the Bank’s capacity to fund loan commitments while maintaining capital and dividend flexibility.
- Whether actual net interest income tracks the filing’s rate-sensitivity scenarios as rates and deposit pricing change.