First Merchants Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with the three months ended March 31, 2017 unless otherwise noted. First Merchants is an Indiana-based community banking holding company. The 2017 acquisitions of Arlington Bank and Independent Alliance Banks (IAB) expanded the business and affect year-over-year comparability.
Financial performance
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Net interest income | $79.9 million | $61.0 million |
| Net interest income, fully taxable equivalent | $82.5 million | $64.9 million |
| Net interest margin, fully taxable equivalent | 3.92% | 3.98% |
| Noninterest income | $19.6 million | $14.8 million |
| Noninterest expense | $53.7 million | $43.1 million |
| Provision for loan losses | $2.5 million | $2.4 million |
| Net income available to common shareholders | $36.7 million | $23.2 million |
| Diluted earnings per share | $0.74 | $0.56 |
| Effective tax rate | 15.3% | 23.6% |
| Operating cash flow | $31.0 million | $35.3 million |
Management reported diluted EPS growth of 32.1%. Higher earnings reflected loan growth, the full-quarter contribution of the 2017 acquisitions, and tax reform. Net interest income increased substantially, but funding costs rose faster than asset yields: the FTE spread contracted 12 basis points and margin fell 6 basis points. Net income also included $1.6 million of realized gains on available-for-sale securities; other income included increased derivative hedge income.
Balance sheet, liquidity and capital
- At March 31, 2018, total assets were $9.47 billion, up $105.3 million from year-end 2017. Total loans were $6.90 billion, up $147.8 million (8.7% annualized); net loans were $6.83 billion.
- Deposits totaled $7.33 billion, up $155.1 million from year-end. Total borrowings were $776.6 million, down $57.8 million; federal funds purchased declined $94.0 million while FHLB advances rose $35.0 million. Cash and cash equivalents were $128.8 million, down $26.1 million from year-end.
- Cash from operations was $31.0 million; investing activities used $145.8 million, principally reflecting loan growth and securities activity; financing activities provided $88.7 million. The filing reports no separate free-cash-flow measure.
- Available-for-sale securities were $1.00 billion and held-to-maturity securities were $540.0 million. The company reported $22.7 million of gross unrealized losses across investment securities, which management attributed primarily to interest-rate changes and considered temporary.
- The allowance for loan losses was $76.4 million, or 1.11% of loans. Non-accrual loans were $27.5 million; nonperforming loans were $28.1 million and nonperforming assets were $37.8 million. Net charge-offs rose to $1.1 million from $0.2 million a year earlier.
- The Bank remained “well capitalized.” At March 31, the Bank’s total risk-based capital ratio was 13.19%, CET1 ratio 12.22%, and tier 1 leverage ratio 10.84%. The Corporation’s tangible common equity to tangible assets ratio was 9.32%.
- Available FHLB borrowing capacity was $468.8 million. Outstanding loan commitments and standby/commercial letters of credit totaled $2.65 billion; management cautioned that commitments may expire unused or be only partially drawn.
Changes, outlook and risks
Compared with Q1 2017, net income increased 58%, while noninterest income rose 31.8% and noninterest expense rose 24.6%. Acquisitions contributed to both revenue and costs, so the reported growth is not solely organic. The federal corporate tax rate reduction from 35% to 21% helped lower the effective tax rate. Comprehensive income was $18.5 million versus $33.1 million, primarily reflecting a $17.7 million after-tax unrealized loss on available-for-sale securities in Q1 2018; accumulated other comprehensive loss reached $21.7 million at quarter-end.
The filing provides no specific earnings or revenue guidance. Management described liquidity and interest-rate positioning as adequate and reported that modeled 12-month net interest income would increase 8.68% under an immediate 200-basis-point rate rise and decline 6.70% under a 100-basis-point fall, relative to the modeled base case. These are scenario estimates, not forecasts, and depend on assumptions about rates, balances, and deposit behavior.
Key risks include interest-rate and deposit-pricing movements, economic deterioration and credit losses, real-estate values, competition, regulation, and integrating acquired businesses. Management said the allowance was adequate, but loss estimates depend on judgment and economic conditions. Adoption of the CECL credit-loss standard was planned for Q1 2020; the potential adjustment and overall financial impact could not yet be determined and could be material. Routine litigation and regulatory examinations were not expected by management to have a material adverse effect; no material change to previously disclosed risk factors was reported.
Investor facts to verify
- How much of earnings and loan growth reflects acquired businesses versus organic performance, and how acquisition-related expenses and intangible amortization evolve.
- Whether deposit-cost increases continue to outpace asset-yield gains and pressure net interest margin.
- Credit trends behind the sharp increase in net charge-offs, including commercial real estate, residential, and consumer exposures, and the adequacy of the allowance.
- The duration and sensitivity of securities-related unrealized losses, and any effects of rates or liquidity needs on potential sales.
- CECL implementation progress and the eventual opening-equity/allowance impact, which the filing says cannot yet be quantified.
- Capital and liquidity resilience if loan commitments are drawn or modeled rate and funding assumptions differ from actual conditions.