UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
______________________________
DATE OF REPORT (Date of earliest event reported): March 4, 2005
______________________________
FIRST MERCHANTS CORPORATION
(Exact Name of Registrant as Specified in its Charter)
_______________________________
INDIANA 0-17071 35-1544218
(State or other jurisdiction (Commission File Number) (IRS Employer
of incorporation) Identification No.)
200 East Jackson Street
P.O. Box 792
Muncie, IN 47305-2814
(Address of Principal Executive Offices, including Zip Code)
(765) 747-1500
(Registrant's Telephone Number, including Area Code)
Check the appropriate box below if the Form 8-K filing is intended to
simultaneously satisfy the filing obligation of the registrant under any of the
following provisions:
[ ] Written communications pursuant to Rule 425 under the Securities Act (17 CFR
230.425)
[ ] Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR
240.14a-12)
[ ] Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange
Act (17 CFR 240.14d-2(b))
[ ] Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange
Act (17 CFR 240.13e-4(c))
ITEM 2.02 RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
On March 3, 2005, First Merchants Corporation mailed its Annual Report
2004 ("Report") to its stockholders of record on February 11, 2005. The Report
is attached hereto as Exhibit 99.1 and is incorporated herein by reference. The
Report 2004 is being furnished by the Registrant pursuant to Regulation FD and
is not being filed.
ITEM 9.01 FINANCIAL STATEMENTS AND EXHIBITS.
(a) None
(b) None
(c) Exhibits.
Exhibit 99.1 First Merchants Corporation Annual Report 2004
(Furnished pursuant to Regulation FD)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
FIRST MERCHANTS CORPORATION
(Registrant)
By: /s/ Mark K. Hardwick
--------------------------------------------
Mark K. Hardwick
Senior Vice President and
Chief Financial Officer
(Principal Financial and Chief
Accounting Officer)
Dated: March 4, 2005
EXHIBIT INDEX
-------------
Exhibit No. Description
- ----------- -----------
99.1 First Merchants Corporation Annual Report 2004
First Merchants Corporation
Exhibit No. 99.1
your partners in success
- --------------------------------------------------------------------------------
[GRAPHIC]
- --------------------------------------------------------------------------------
First Merchants Corporation
Annual Report 2004
FINANCIAL HIGHLIGHTS 1
TO OUR SHAREHOLDERS 2
YEAR IN REVIEW 4
INVESTOR SUMMARY 6
DIRECTORS 7
OFFICERS 8
FINANCIAL REVIEW 9
Annual Meeting
The Annual Meeting of Stockholders
of First Merchants Corporation
will be held...
Thursday, April 14, 2005 . 3:30 pm
Horizon Convention Center
401 South High Street
Muncie, Indiana 47305
Corporate Profile
First Merchants Corporation, a financial holding company headquartered in
Muncie, Indiana, was organized in September 1982 as the bank holding company for
Merchants National Bank of Muncie, now First Merchants Bank, N.A. Since its
organization, First Merchants Corporation has grown to include ten affiliate
banks with over seventy locations in seventeen Indiana and three Ohio counties,
a trust company, a multi-line insurance company, and a title company.
Subsidiaries of the Corporation include First Merchants Bank, N.A. in Delaware
and Hamilton Counties; The Madison Community Bank, N.A. in Madison County; First
United Bank, N.A. in Henry County; The Union County National Bank of Liberty
with locations in Union, Fayette, Wayne and Butler (OH) counties; The Randolph
County Bank, N.A.; The First National Bank of Portland in Jay County; Decatur
Bank & Trust Company, N.A. in Adams County; Frances Slocum Bank & Trust Company,
NA. in Wabash, Howard, and Miami counties; Lafayette Bank and Trust Company,
N.A. in Tippecanoe, Carroll, Jasper, and White counties; and Commerce National
Bank in Franklin and Hamilton counties in Ohio.
The Corporation also operates First Merchants Insurance Services, a full-service
property, casualty, personal lines, and health care insurance agency
headquartered in Muncie, Indiana, and is the majority owner of the Indiana Title
Insurance Company LLC, a title insurance agency.
Merchants Trust Company unites the trust and asset management services of all
affiliate banks of the Corporation and represents one of the largest trust
companies in the State of Indiana, with assets in excess of $1.5 billion.
Merchants Trust Company provides a full range of trust and investment services
for individuals, families, businesses, and not-for-profit organizations. In
addition, Merchants Trust Company specializes in turn-key retirement plans,
including pension plans, profit sharing, 401(k) and 403(b) plans, cross-tested
plans, and cash balance plans.
First Merchants Corporation
MARKET AREA
[GRAPHIC]
[GRAPHIC]
Financial Highlights
(table dollar amounts in thousands, except per share data)
DILUTED NET INCOME PER SHARE
00 01 02 03 04
- -------- -------- -------- -------- --------
$ 1.50 $ 1.61 $ 1.69 $ 1.50 $ 1.58
DIVIDENDS PER SHARE
00 01 02 03 04
- -------- -------- -------- -------- --------
$ .78 $ .84 $ .86 $ .90 $ .92
AVERAGE ASSETS
(in millions)
00 01 02 03 04
- -------- -------- -------- -------- --------
$1,532.7 $1,689.7 $2,406.3 $2,960.2 $3,109.1
at year end 2004 2003
Total Assets $ 3,191,668 $ 3,076,812
Stockholders' Equity 314,603 303,965
Total Loans 2,431,418 2,356,546
Total Investments 421,535 356,797
Total Deposits 2,408,150 2,362,101
Trust Accounts at Market Value
(not included in banking assets) 1,552,923 1,518,269
for the year
Interest Income $ 156,974 $ 155,530
Interest Expense 51,585 52,388
Net Interest Income 105,389 103,142
Provision for Loan Losses 5,705 9,477
Total Other Income 34,554 35,902
Total Other Expenses 91,642 91,279
Income Tax Expense 13,185 10,717
Net Income 29,411 27,571
per share
Basic Net Income $ 1.59 $ 1.51
Diluted Net Income 1.58 1.50
Cash Dividends .92 .90
Book Value 16.93 16.42
Market Value (Dec. 31 Bid Price) 28.30 25.51
averages during the year
Total Assets $ 3,109,104 $ 2,960,195
Total Loans 2,369,017 2,281,614
Total Investments 393,903 338,835
Total Deposits 2,365,306 2,257,075
1
[GRAPHIC]
[GRAPHIC]
[GRAPHIC]
2004
marked a return to
growth in earnings
that has distinguished
First Merchants Corporation
over the last three decades.
Dear Fellow Shareholders:
The cover of our Annual Report this year shows an image of a puzzle piece with
the logo used by our Corporation and our affiliates. This image is symbolic of
the role our companies play to provide just the right piece that helps complete
the financial picture for our clients - regardless of the shape or size.
2004 was a year filled with many exciting accomplishments for our company both
at the corporate and affiliate level, and this past year marks a return to
growth in earnings that has distinguished First Merchants Corporation over the
last three decades.
At year end, the Corporation recorded net income of $29.4 million compared to
$27.6 million in 2003. Diluted earnings per share were $1.58 for the year, a
5.3 percent increase over the prior year.
The Corporation's assets equaled $3.2 billion at the close of 2004, an increase
of $115 million, or 3.7 percent, from 2003 results. Of the total assets, the
Corporation's three primary earning assets: loans, investments, and bank-owned
life insurance, comprised $2.9 billion, an increase of $143 million over the
prior year.
Net interest income, after provision for loan losses, increased 6.4 percent, a
total of $6 million, as compared to 2003. Mitigating this increase was a $1.3
million decline in total other income, primarily the result of a $2.8 million
decline from lower gains on the sale of mortgage loans. Throughout the industry,
mortgage volume peaked in 2003 and has been declining with the rise in interest
rates.
In all, our 2004 results are encouraging and reflect an improving environment
for our banking services. We expect 2005 to be even better.
corporate developments In my letter to you in our 2000 Annual Report, I stated
that "the key to successful operation of a multi-chartered community banking
organization is standardization." Standardization and centralization were
specific areas of focus for our Corporate staff the past two years as we made
tremendous strides to improve the consistency and efficiency of our operations,
technology and products.
During 2004, a great deal of work from many of our dedicated employees went in
to centralizing many functions that were previously handled by our affiliate
companies. These included operational functions like statement and item
processing, and loan and deposit operations; as well as administrative and
finance functions like purchasing, asset-liability structure and general ledger
balancing. While it is easy to list these successful projects, each required
months of detailed planning and coordination to complete.
Additionally, our finance and audit divisions completed a review of our internal
controls and certified them in accordance with Section 404 of the Sarbanes-Oxley
Act. First Merchants Corporation was an accelerated filer, making the task even
more impressive. Our external auditing firm, BKD, also reviewed and signed off
on our internal controls - something that not every public company can proclaim.
Our technology group continued to improve the reliability and stability of our
data communications network and brought standardization to the network
architecture to ensure that our affiliate companies continue to have first-class
technology.
Perhaps the project that had the biggest benefit to our affiliate banks' clients
was our product standardization that occurred this year. Across the Corporation,
our banks sold, and the Operations group supported, 103 types of consumer
checking and savings accounts.
Through many months of planning, coordination and hard work, a group of
corporate and affiliate bank staff led the way to refine our product offering to
seven consumer checking and savings products each with the features that will
keep our banks competitive in their markets.
2
affiliated accomplishments During early 2004, the Boards of Randolph County Bank
and Union County National Bank made the strategic decision to merge their banks
upon the retirement of UCNB's president, Norm Locke, after forty-five years of
distinguished service to First Merchants Corporation and its affiliates.
The consolidation of these two affiliates of our Corporation combined the
boards, staff, and markets of these two historic banks. UCNB recently celebrated
its 132nd anniversary and Randolph County Bank has been serving that county
since 1865...140 years. The name of the resulting bank, United Communities
National Bank - or simply UCNB - reflects our spirit and passion for community
banking.
While many of our affiliate banks achieved increases in deposit market share
during 2004, Lafayette Bank & Trust Company continues to outpace several
super-regional banks with the largest and growing market share in this key
market.
During 2004, our newest family member, Commerce National Bank, expanded into the
Cincinnati metro area, opening an office in Hamilton County. We expect this move
to introduce the unique "business banking" services upon which CNB was founded.
Our logo has been well known around East Central Indiana for many years, but
this year, it started becoming more recognizable in the western portion of the
state. Lafayette Bank & Trust successfully completed a total rebranding project
that included the adoption of the corporate logo and color scheme on all their
banking centers, sales and marketing collateral, and advertising.
First Merchants Bank also began the process of replacing its banking center
signage in Delaware County this year. This project has received a very positive
reaction from both our employees and our clients.
As we grow and establish our brand of community banking in new markets, we know
that others will come to understand that our brand represents a financial
institution that believes in local decisions for local businesses and
individuals.
director changes Early in 2005, we will have several changes in the make up of
our Board. Stefan Anderson, the Chairman of our Board of Directors, will be
retiring from our Board after eighteen years as chairman and thirty-one years
with the company. In fact, Steve remarked to me the other day that his banking
career has spanned forty-five years. Also, long-time Board members, Frank
Bracken and Norm Johnson, will be retiring and another, Blaine Brownell, has
moved to Virginia to pursue a new career opportunity. We thank all of these
directors for their valuable contributions, wise counsel, and service to our
Corporation.
looking forward to 2005 I want to thank all of the dedicated employees of our
Corporation - they are the true engine of our company. We hope that this past
year is the first in another long string of growth years and look forward
optimistically to 2005.
Sincerely,
/s/ Michael L. Cox
Michael L. Cox
President and Chief Executive Officer
A Special Note of Thanks to Stefan Anderson...
Steve's stewardship of this Corporation and our founding bank, as well as his
service to Muncie and the State of Indiana, are deserving of our sincere and
heartfelt thanks.
When people in this community and around the state talk about First Merchants,
they inevitably mention with fondness the name steve anderson and recall a story
or two about his impact on their business or project.
Steve, we thank you for all you've done to make First Merchants the successful
company that it is today.
[PHOTO]
3
2004 [GRAPHIC] Year in
Combining Forces
In April, the Boards of Directors of The Union County National Bank of Liberty
and The Randolph County Bank made a strategic decision to consolidate their
banks upon President Norm Locke's retirement at the end of 2004.
The continuing institution, United Communities National Bank or simply UCNB, is
headquartered in Winchester, Indiana, and will serve the combined markets of the
former banks, including locations in Randolph, Wayne, Fayette, Union, and Butler
(Ohio) counties.
Setting a Standard
First Merchants Corporation is dedicated to providing our customers with
competitive personal checking and savings account products. Throughout FMC, our
affiliate banks sold, and our operations group supported, 103 different personal
products. In 2004, a personal checking and savings account standardization
project was undertaken.
First Merchants Corporation's affiliate banks now offer seven standard personal
checking and savings products to their customers. By listening to our customers
and placing their needs as our first priority, over 130,000 customers are now
enjoying unlimited check writing, free online banking and bill payment, free
telephone banking, free check cards and access to our large network of ATMs.
Showing Their Colors
[GRAPHIC][GRAPHIC]
Lafayette Bank & Trust undertook a rebranding project that included replacing
signage and marketing materials. It was punctuated by the introduction of a new
advertising program that both introduced customers and the community to the new
logo and colors as well as the 'your partners in success' slogan that is being
used by the other affiliate banks.
First Merchants Bank also got into the act by beginning to replace signs at its
Delaware County banking centers.
Going Digital
[GRAPHIC]
A new law that went into effect in late October, commonly referred to as "Check
21," is the first step in bringing the nation's check processing system into the
digital age. It requires all banks to be able to accept scanned, digital
versions of checks. These "substitute checks" are a replica and the legal
equivalent of the original checks. Because they are digital, banks are able to
securely send them electronically. The goal of this effort, to modernize the
system, is to improve the efficiency of the system, reduce costs, and enhance
fraud prevention. First Merchants Corporation and our affiliate banks led the
way in addressing these new requirements.
4
Review
december 29 PERCENT INCREASE IN FOURTH QUARTER EARNINGS PER SHARE
- --------------------------------------------------------------------------------
First Merchants Corporation (NASDAQ:FRME) reported
fourth quarter diluted earnings per share totaling $.40,
a 29 percent increase over $.31 recorded in the fourth
quarter of 2003. Net income during the period totaled
$7.5 million compared to $5.8 million in 2003. Michael
L. Cox, President and Chief Executive Officer, stated
that, "Our fourth quarter and full year results are
encouraging and reflect an improving environment for our
banking services. Our banking activity continued to
expand as evidenced by $164 million growth in our
commercial loan portfolio. Mortgage banking activity,
while near historic high levels, continues to be
volatile and impacting gain on sale income. Overall, we
are pleased with the year-end, and look forward to
continued growth in 2005."
october 5 PERCENT INCREASE IN THIRD QUARTER EARNINGS PER SHARE
- --------------------------------------------------------------------------------
The Corporation's reported third quarter diluted
earnings per share totaled $.41, a 5.1 percent increase
over $.39 recorded in 2003. Net income during the period
totaled $7.7 million compared to $7.3 million in 2003.
Increases in the Federal Open Market Committee's target
Fed Funds rate of an additional 50 basis points during
the quarter improved net interest income by $945,000
over the second quarter of 2004. Overall, economic
activity is showing increased stimulus accompanied by
slight upward pressure on deposit rates.
august CASH DIVIDEND REFLECTS CONTINUED STRENGTH
- --------------------------------------------------------------------------------
The Corporation Board of Directors declared a $.23 per
share cash dividend.
This dividend reflects the continued strength of First
Merchants and our affiliate companies. We are pleased to
continue a return of profits to our shareholders at a
payout level exceeding our financial peer group.
july MID-YEAR 2004 RESULTS REPRESENT CONTINUATION OF
POSITIVE TRENDS
- --------------------------------------------------------------------------------
The Corporation reported year-to-date, diluted earnings
per share of $.77, a 3.8 percent decline from $.80
recorded in 2003. Net income during the period totaled $
14.3 million compared to $14.4 million in 2003.
Total assets of the Corporation equaled $3.1 billion as
of June 30, 2004, an increase of $71 million from the
prior year. Loans, investments and bank owned life
insurance, the Corporation's three primary earning
assets, totaled $2.8 billion, an increase of $100
million over the June 30, 2003 amount of $2.7 million.
The improvement in earning assets was primarily funded
by increases in deposits and capital totaling $62
million and reductions in cash and cash equivalents.
First Merchants Corporation's second quarter 2004
results represent a continuation of positive trends.
Despite higher provisioning for loan losses than
planned, earnings per share improved by another $.03
over the prior quarter and non-performing loans declined
to the lowest level in two years.
april RANDOLPH COUNTY BANK & UCNB ANNOUNCE MERGER
- --------------------------------------------------------------------------------
The Board of Directors of the Corporation agreed to
merge two affiliates by the end of 2004 as the result of
a retiring president. The affiliates merged were The
Randolph County Bank of Winchester and Union City, led
by President James A. Meinerding, and The Union County
National Bank of Liberty, led by Norm Locke who retired
at the end of 2004.
The resulting bank has $290 million in assets and 90
employees. The bank's name is "United Communities
National Bank" in keeping with the spirit of our
corporate commitment to community banking. Meinerding
will be president of the resulting bank. All directors,
officers, and employees have remained. The United
Communities National Bank will have offices in
Winchester, Union City, Richmond, Liberty, and
Connersville, Indiana; as well as Oxford, Ohio.
february CASH DIVIDEND ANNOUNCED
- --------------------------------------------------------------------------------
First Merchants Corporation announced the following
action taken by its Board of Directors on February 10,
2004. The Board declared a first quarter cash dividend
of $0.23 per share.
5
[GRAPHIC]
Investor Summary
TRADING HISTORY
Listed on NASDAQ/NMS on June 20, 1989
Trading Symbol: FRME
2004 Stock Price Range:
High $ 29.19
Low $ 22.20
Current bid price as of 12/31/04: $28.30
2004 NASDAQ
Trading Volume:
6,610,460 shares
December 31,2004 Shares outstanding:
18,573,997
RETURN ON ASSETS
02 03 04
- ------ ------ ------
1.16% .93% .95%
EFFICIENCY RATIO
(indicates the cost to produce a dollar of revenue)
02 03 04
- ------ ------ ------
57.7 61.6 61.9
RETURN ON EQUITY
02 03 04
- ------ ------ ------
11.72% 9.39% 9.49%
LOAN LOSSES
(as a percent of average loans)
02 03 04
- ------ ------ ------
.37 .44 .37
STOCK PERFORMANCE
A purchase of 100 shares in September 1982, when the holding company was
organized, would have cost $4,200. Through three 2-for-1 stock splits, three
3-for-2 stock splits, and three five percent (5%) stock dividends, the number of
shares held as of December 31, 2004, would be approximately 3,126 with a market
value of $88,466. In addition, dividends in the amount of $32,310 would have
been paid on the initial investment of $4,200.
$ 4,200 $ 32,310 $ 88,466
EARNINGS GROWTH
[GRAPHIC]
1975 2004
- ----------- ------------
$ 1,537,000 $ 29,411,000
FIRST MERCHANTS CORPORATION
STEFAN S. ANDERSON
Chairman of the Board
ROBERT M. SMITSON
Vice Chairman of the Board
Maxon Corporation
Chairman of the Board
Retired
MICHAEL L. COX
First Merchants Corporation
President
Chief Executive Officer
ROGER M. ARWOOD
First Merchants Corporation
Executive Vice President
Chief Operating Officer
JAMES F. AULT
Madison Community Bank
Chairman of the Board
General Motors Corporation
Retired
RICHARD A. BOEHNING
Bennett, Boehning & Clary
Of Counsel
FRANK A. BRACKEN, ESQ.
Ball Associates
Attorney
Retired
DR. BLAINEA. BROWNELL
U21 pedagogica
Chief Executive Officer
THOMAS B. CLARK
Jarden Corporation
Chairman of the Board
President
Chief Executive Officer
Retired
DR. JO ANN M. GORA
Ball State University
President
BARRY J. HUDSON
First National Bank
Chairman of the Board
ROBERT T. JEFFARES
Great Lakes Chemical Corporation
Executive Vice President
Chief Financial Officer
Retired
NORMAN M. JOHNSON
Union County National Bank
Chairman of the Board
Stein Roe & Farnham
Executive Vice President
Retired
THOMAS D. MCAULIFFE
Commerce National Bank
Chairman of the Board
Chief Executive Officer
CHARLES E. SCHALLIOL
State OF Indiana
Office of Management & Budget
Director
JEAN L. WOJTOWICZ
Cambridge Capital
Management Corp.
President
Chief Executive Officer
SECRETARY TO THE BOARD
LARRY R. HELMS
First Merchants Corporation
Senior Vice President
ASSISTANT SECRETARY
TO THE BOARD
C. RONALD HALL
First Merchants Corporation
Vice President
[GRAPHIC]
BOARDS OF DIRECTORS
FIRST MERCHANTS BANK
STEFAN S. ANDERSON
Chairman of the Board
ROBERT M. SMITSON
Vice Chairman of the Board
Maxon Corporation
Chairman of the Board
Retired
MICHAEL L. COX
First Merchants Corporation
President
Chief Executive Officer
ROGER M. ARWOOD
First Merchants Corporation
Executive Vice President
Chief Operating Officer
JACK L. DEMAREE
First Merchants Bank
President
Chief Executive Officer
RONALD K. FAUQUHER
Ontario Systems, LLC
Senior Vice President
MICHAEL B.GALLIHER
Boyce Forms / Systems
Keystone & Komputrol Software
Presdent
Chief Execiutive Officer
THOMAS K. GARDINER, MD, FACP
Cardinal Health System, Inc.
Executive Vice President
SUZANNE L. GRESHAM, PhD
Comprehensive Mental Health
Services, Inc.
President
Chief Executive Officer
Retired
JOHN W. HARTMEYER
Al Pete Meats, Inc.
Chief Executive Officer
MARIA WILLIAMS-HAWKINS, PhD
Ball State University
NELSON W.HEINRICHS
Centennial Packaging, Inc.
Chairman of the Board
Retired
JON H. MOLL
DeFur Voran, LLP
Partner
JOSEPH E. WILSON
Muncie Power Products, Inc.
Chairman of the Board
Chief Executive Officer
SECRETARY TO THE BOARD
CYNTHIA G. HOLADAY
First Merchants Bank
Assistant Vice President
Executive Administrative Officer
CHAIRMAN EMERITUS
William P. Givens
DIRECTORS EMERITI
Clell W. Douglass
Hurley C. Goodall
Betty J. Kendall
Hamer D. Shafer
COMMERCE NATIONAL BANK
THOMAS D. MCAULIFFE
Chairman of the Board
Chief Executive Officer
JOHN A. ROMELFANGER
Commerce National Bank
Executive Vice President
Chief Operating Officer
ROGER M. ARWOOD*
First Merchants Corporation
Executive Vice President
Chief Operating Officer
LORETO V. CANINI
Canini & Pellecchia, Inc.
President
JAMESON CRANE, JR.
Crane Group, Co.
Vice President
RHONDA J. DEMUTH
TDCI, Inc.
Chief Executive Officer
GEORGE A. GUMMER
G.A. Gummer & Associates, Inc.
Owner
WILLIAM L. HOY
Columbus Sign Company
Chief Executive Officer
VICTOR D. IRELAN
Dublin Building Systems
Chairman of the Board
CLARK KELLOGG
CBS Sports
Basketball Analyst
SAMUEL E. MCDANIEL
Mc Daniel's Painting
& Construction, Inc.
Owner
RICHARD F. RUHL
Dick Ruhl Ford Sales, Inc.
Retired
JOHN A. TONTI
West Penn Foods, Inc.
President
ALAN R. WEILER
Archer-Meek-Weiler Agency, Inc.
Chairman
WILLIAM WICKHAM
SBC Advertising Co.
Chairman
Chief Executive Officer
DAVID L. WINKS
Capital Lighting, Inc.
Vice President
MICHAEL WREN
M-E Engineering
Retired
* advisory director
DECATUR BANK
& TRUST COMPANY
PHILIP H. BARGER
Chairman of the Board
Barger Farms, Inc.
DENNIS A. BIEBERICH
Decatur Bank & Trust Company
President
Chief Executive Officer
KEVAN B. BIGGS
Ideal Suburban Homes, Inc.
Vice President
GREGORY A. FLEMING
Fleming Excavating, Inc.
President
MARK KAEHR
R & K Incinerator, Inc.
President
WAYNE M. PORTER
Thunderbird Products
Vice President of Sales
JOHN L. SCHULTZ
Baker & Schultz, Inc.
President
FIRST NATIONAL BANK OF
PORTLAND
BARRY J. HUDSON
Chairman of the Board
ROBERT G. BELL
First National Bank of Portland
President
Chief Executive Officer
BRADLEY K. GLENTZER
Portland Motor Parts
Owner
BONNIE R. MAITLEN, PhD
Training & Development
Specialist-Consultant
REDA THEURER-MILLER
Youth Service Bureau of Jay County, Inc.
Chief Executive Officer
STEPHEN R. MYRON, MD
Preferred Medical Providers
President
SAMUEL P. SHOEMAKER
John Jay Center for Learning
Executive Director
Retired
GARY L. WHITENACK
Whitenack Farm & Supply Co.
Farmer
FIRST UNITED BANK
DANIEL R. EICHHORN, DVM
Chairman of the Board
Veterinarian
JOHN M. FINNERTY
First United Bank
President
Chief Executive Officer
DAVID L. KEESLING
Farmer
MARY WISEHART PHILLIPS
Wisehart & Wisehart
Attorney
RICHARD A. RUSSELL
Slick Engineering
FRANCES SLOCUM BANK
ROBERT R. HALDERMAN
Chairman of the Board
Halderman Real Estate Services
Chairman
Halderman Farm Management, Inc.
Chairman
PAMELA C. BECKOM
Harbaugh Enterprises, Inc.
President
Pizza Hut of Kokomo, Inc.
President
Pizza Hut of Chillicothe, Inc.
President
RICHARD T. DOERMER
Growth Capital Company
President
JOHN W. FORRESTER
Wabash Electric Supply, Inc.
President
GREGORY L. GARNER, OD
Midwest Eye Consultants, PC
President
Chief Executive Officer
ARTHUR W. JASEN
B. Walter & Company
President
Walter Dimension Co.
President
HAL D. JOB
Frances Slocum Bank
President
Chief Executive Officer
JAMES M. RIDENOUR
Indiana University
Professor
Retired
CHARLES R. TIEDE
Tiede, Metz & Downs PC
Attorney
LAFAYETTE BANK
& TRUST COMPANY
ROBERT J. WEEDER
Chairman of the Board
TONY S. ALBRECHT
President
Chief Executive Officer
RICHARD A. BOEHNING
Bennett, Boehning & Clary
Of Counsel
KELLY V. BUSCH
KVB Broadcasting
Managing General Partner
MICHAEL L. COX
First Merchants Corporation
President
Chief Executive Officer
VERNON N. FURRER
Self-Employed Farmer
W. L. HANCOCK
PSI Energy,
A CINERGY Company
General Manager
Retired
JOSEPH B. HORNETT
Purdue Research Foundation
Senior Vice President
Treasurer
ROBERT T. JEFFARES
Executive Vice President
Chief Financial Officer
Great Lakes
Chemical Corporation
Retired
JEFFREY L. KESSLER
Stall & Kessler Diamond Center
Co-owner
ROY D. MEEKS
Nelmeeks, Inc.
President
ERIC P. MEISTER
GTE North, Inc.
Central Division Manager
Retired
DIRECTORS EMERITI
Gordon G. Beemer
Joseph A. Bonner
Charles E. Maki
MADISON COMMUNITY BANK
JAMES F. AULT
Chairman of the Board
General Motors Corporation
Delco Remy Division
General Manager
Retired
GEORGE R. LIKENS
Vice Chairman of the Board
Farmer
MICHAEL L. BAKER
Madison Community Bank
President
Chief Executive Officer
EDWARD L. FOGGS
Church of God
Minister-at-Large
Interchurch Relations
JEFFREY A. JENNESS
Church of God
Executive Secretary & Treasurer
Board of Pension
JOSEPH R. KILMER
Attorney at Law
C. DAVID KLEINHENN
Kleinhenn Company
President
HERBERT G. LIKENS
Farmer
ROBERT J. PENSEC
Carbide Grinding Company
President
STEPHEN D. SKAGGS
Perfecto Tool & Engineering Co., Inc.
Vice President
CURT STEPHENSON
First Merchants Insurance Services
Vice President
RANDOLPH COUNTY BANK
MICHAEL D. WICKERSHAM
Chairman of the Board
Wick's Pies, Inc.
President
CLYDE T. BATEMAN
Farmer
THOMAS E. CHALFANT
Farmer
W. SCOTT HAWKINS
Registered Representative
Lincoln Financial Advisors
ERROL P. KLEM
Klem Golf, Inc.
President
MARTHA A. MATHIAS
Frank Miller Lumber Co., Inc.
President
Chief Executive Officer
JAMES A. MEINERDING
Randolph County Bank
President
Chief Executive Officer
UNION COUNTY
NATIONAL BANK
NORMAN M. JOHNSON
Chairman of the Board
Stein, Roe & Farnham
Executive Vice President
Retired
NORMAN LOCKE
Union County National Bank
President
Chief Executive Officer
RICHARD A. DANIELS
McCullough-Hyde
Memorial Hospital
President
Chief Executive Officer
GERALD S. PAUL
Medreco, Inc.
President
JAN S. WILLIAMS
Williams & Keckler, LLC
Certified Public Accountant
FIRST MERCHANTS
INSURANCE SERVICES
MICHAEL L. COX
Chairman
First Merchants Corporation
President
Chief Executive Officer
DAN M. VANTREESE
President
Chief Executive Officer
ROGER M. ARWOOD
First Merchants Corporation
Executive Vice President
Chief Operating Officer
LARRY R. HELMS
First Merchants Corporation
Senior Vice President
MARK K. HARDWICK
First Merchants Corporation
Senior Vice President
Chief Financial Officer
FIRST MERCHANTS
REINSURANCE CO., LTD.
MICHAEL L. COX
Chairman
First Merchants Corporation
President
Chief Executive Officer
LARRY R. HELMS
Secretary
First Merchants Corporation
Senior Vice President
MARK K. HARDWICK
Treasurer
First Merchants Corporation
Senior Vice President
Chief Financial Officer
INDIANA TITLE
INSURANCE COMPANY
MICHAEL L. COX
Chairman
First Merchants Corporation
President
Chief Executive Officer
JAMES W. SMITH
Co-President
JAMES W. TRULOCK
Co-President
DAVID W. HEETER
Mutual First Financial, Inc
Chief Executive Officer
HARRY J. BAILEY
Ameriana Bancorp
President
Chief Executive Officer
MERCHANTS
TRUST COMPANY
STEFAN S. ANDERSON
Chairman of the Board
MICHAEL L. COX
First Merchants Corporation
President
Chief Executive Officer
ROGER M. ARWOOD
First Merchants Corporation
Executive Vice President
Chief Operating Officer
JAMES L. THRASH
Merchants Trust Company
President
Chief Executive Officer
JON H. MOLL
DeFur Voran, LLP
Partner
7
EXECUTIVE OFFICERS
[GRAPHIC]
SENIOR OFFICERS
FIRST MERCHANTS CORPORATION
MICHAEL L. COX
President
Chief Executive Officer
ROGER M. ARWOOD
Executive Vice President
Chief Operating Officer
ROBERT R. CONNORS
Senior Vice President
Operations & Technology
MARK K. HARDWICK
Senior Vice President
Chief Financial Officer
LARRY R. HELMS
Senior Vice President
Administrative Services
& General Counsel
FIRST MERCHANTS CORPORATION
KIMBERLY J. ELLINGTON
Senior Vice President
JEFF S. DAVIS
First Vice President
STEPHAN H. FLUHLER
First Vice President
JEFFREY B. LORENTSON
First Vice President
ROBERT C. RHOADES
First Vice President
JAMI L. CORNISH
Vice President
BRIAN A. EDWARDS
Vice President
PAUL A. FISH
Vice President
PHILLIP W. FORTNER
Vice President
C. RONALD HALL
Vice President
CHRISTINA L. HOYT
Vice President
SONDRA A. KASELONIS
Vice President
GARY D. MARSHALL
Vice President
PAMELA S. MILLER
Vice President
LARRY J. MOORE
Vice President
BRENDA G. NIVENS
Vice President
DAVID L. ORTEGA
Vice President
MITZI K. THOMAS
Vice President
CAROL A. LAMBERT
Senior Staff Auditor
FIRST MERCHANTS BANK
JACK L. DEMAREE
President
Chief Executive Officer
THOMAS E. BUCZEK
Senior Vice President
CHRIS B. PARKER
Senior Vice President
WILLIAM R. REDMAN
Senior Vice President
JAMES S. CARR
Vice President
MERRILL V. CLEVENGER
Vice President
MICHAEL L. HAUK
Vice President
PATRICIA HUDSON
Vice President
JAMES A. KERSTIENS
Vice President
SUSAN R. LAVERTY
Vice President
STEPHEN B. MOORE
Vice President
JEFFREY M. PARSONS
Vice President
DENBY R. TURNER
Vice President
CYNTHIA S. WHITE
Vice President
THOMAS E. WILEY
Vice President
BRAD C. WISE
Vice President
JOHN A. WOOD
Vice President
FIRST MERCHANTS
INSURANCE SERVICES
DAN M. VAN TREESE
President
Chief Executive Officer
TERRY LOTHAMER
Vice President
JOHN PARKER
Vice President
LINDA PEVLER
Vice President
CURT STEPHENSON
Vice President
INDIANA TITLE
INSURANCE COMPANY
JAMES W. SMITH
Co-President
JAMES W. TRULOCK
Co-President
COMMERCE NATIONAL BANK
THOMAS D. MCAULIFFE
President
Chief Executive Officer
JOHN A. ROMELFANGER
Executive Vice President
Chief Operating Officer
MARK SBROCHI
Executive Vice President
Chief Credit Officer
CATHERINE A. DIECKMAN
Senior Vice President
JENNIFER M. GRIFFITH
Senior Vice President
JEFFREY A. NELSON
Senior Vice President
MELISSA K. SWARTZLANDER
Senior Vice President
ROBERT T. WHETZEL
Senior Vice President
HOWARD E. BOLES
Vice President
MARTIN F. BRADY
Vice President
W. ALEX COOK
Vice President
JOHN S. DIMAURO
Vice President
WILLIAM E. DUDLEY
Vice President
JAMES T. HEMPHILL
Vice President
JESSICA HOMAN
Vice President
F. ANDREW REARDON
Vice President
THOMAS J. SANSONE
Vice President
JOSEPH J. SAULINE
Vice President
DECATUR BANK
& TRUST COMPANY
DENNIS A. BIEBERICH
President
Chief Executive Officer
DAVID R. LENGERICH
Vice President
SHARON K. LINDER
Vice President
FIRST NATIONAL BANK
OF PORTLAND
ROBERT G. BELL
President
Chief Executive Officer
RICHARD L. HUFFMAN
Executive Vice President
Chief Trust & Investment Officer
DUANE D. SAUTBINE
Senior Vice President
THERESA T. BOLLENBACHER
Vice President
JANICE E. FERRELL
Vice President
CARL F. WALKER
Vice President
FIRST UNITED BANK
JOHN M. FINNERTY
President
Chief Executive Officer
JEAN E. REAL
Senior Executive Vice President
CHRISTOPHER J. ALLEN
Executive Vice President
REBECCA I. BLACK
Senior Vice President
JOYCE D. DICK
Senior Vice President
SUE E. GOODMAN
Vice President
BRIAN A. HUFF
Vice President
RICHARD W. WARNER
Vice President
FRANCES SLOCUM BANK
HAL D. JOB
President
Chief Executive Officer
RONALD D. KERBY
Executive Vice President
TONY A. MILLSPAUGH
Senior Vice President
DUANE A. DAVIS
Vice President
DENNIS L. FRIEDEN
Vice President
JOHN F. GOUVEIA III
Vice President
SONDRA A. KASELONIS
Vice President
RODNEY F. MORRISON
Vice President
MARC A. SHELLEY
Vice President
LAFAYETTE BANK
& TRUST COMPANY
TONY S. ALBRECHT
President
Chief Executive Officer
TODD A. BURKLOW
Executive Vice President
DANIEL J. GICK
Executive Vice President
DAVID T. FLINT
Senior Vice President
SHERRY L. KEITH
Senior Vice President
G. ATLEE OYLER
Senior Vice President
DAVID F. SCHRUM
Senior Vice President
CHARLES E. WISE
Senior Vice President
EDWARD R. BOES
Vice President
LORI L. BOLLOCK
Vice President
JOE D. COFFING
Vice President
CYNTHIA K. COX
Vice President
MONTY L. EDGING
Vice President
ARTHUR D. GRISEZ
Vice President
TAMARA L. HOPKINS
Vice President
JEFFREY W. LOVE
Vice President
MARK W. MOLTER
Vice President
RENEE D. REED
Vice President
CAROL S. ROSENTRETER
Vice President
S. JAMES SMYTH
Vice President
MALCOLM E. STAIR
Vice President
MICHELLE D. TURNPAUGH
Vice President
LARRY D. WILEY
Vice President
R. SCOTT WILLIAMS
Vice President
MADISON
COMMUNITY BANK
MICHAEL L. BAKER
President
Chief Executive Officer
KIRK A. KLABUNDE
Senior Vice President
MICHAEL E. STEPHENS
Senior Vice President
STEPHEN J. BILL
Vice President
RICHARD K. FULAYTAR
Vice President
MARY ANN GARDNER
Vice President
SHERRY HAZELBAKER
Vice President
JOHN L. MAY
Vice President
GRETCHEN D. PATTERSON
Vice President
RANDOLPH COUNTY BANK
JAMES A. MEINERDING
President
Chief Executive Officer
CHAD S. GUGGENBILLER
Executive Vice President
BRIAN A. EDWARDS
Executive Vice President
Cashier
RICK D. TUDOR
Senior Vice President
UNION COUNTY
NATIONAL BANK
NORMAN LOCKE
President
Chief Executive Officer
DIANE M. BOLSER
Executive Vice President
DALE A. CUMMINS
Executive Vice President
LEE M. ELZEMEYER
Senior Vice President
KYLE D. CLARK
Vice President
MERCHANTS
TRUST COMPANY
JAMES L. THRASH
President
Chief Executive Officer
LAWRENCE A. ANTHROP
Senior Vice President
WILLIAM J. BITTERMANN, JR.
Senior Vice President
TERRY L. BLAKER
Senior Vice President
DAVID L. FORBES
Senior Vice President
ELKE U. BALTIMORE
Vice President
J. NEAL BARNUM
Vice President
BRENT P. BRANDON
Vice President
PAMELA S. HAAGER
Vice President
RICHARD L. HUFFMAN
Vice President
JAMES E. KEENE
Vice President
KIMBERLYA. LOVELESS
Vice President
JEFF C. MANTOCK
Vice President
CAROL S. MERCHAND
Vice President
SHARON L. POWELL
Vice President
DENNIS D. PUPPEL
Vice President
JOHN A. ROMELFANGER
Vice President
JOHN L. SHOCKLEY
Vice President
N. JANE SMITH
Vice President
M. TERESA SWAIM
Vice President
STACY A. TERHUNE
Vice President
DOUGLAS M. WEHRMAN
Vice President
DOUGLAS L. WHITE
Vice President
8
FINANCIAL REVIEW
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 20
CONSOLIDATED FINANCIAL STATEMENTS 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 25
ANNUAL MEETING, STOCK PRICE AND DIVIDEND INFORMATION 54
COMMON STOCK LISTING 55
FORM 10-K, FINANCIAL INFORMATION AND CODE OF ETHICS 56
1
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
(in thousands, except share data) 2004 2003 2002 2001 2000
===================================================================================================================================
Operations (3)
Net Interest Income
Fully Taxable Equivalent (FTE) Basis .............. $ 108,986 $ 106,899 $ 96,599 $ 66,806 $ 58,619
Less Tax Equivalent Adjustment ......................... 3,597 3,757 3,676 2,445 2,637
---------- ---------- ---------- ---------- ----------
Net Interest Income .................................... 105,389 103,142 92,923 64,361 55,982
Provision for Loan Losses .............................. 5,705 9,477 7,174 3,576 2,625
---------- ---------- ---------- ---------- ----------
Net Interest Income
After Provision for Loan Losses ................... 99,684 93,665 85,749 60,785 53,357
Total Other Income ..................................... 34,554 35,902 27,077 18,543 16,634
Total Other Expenses ................................... 91,642 91,279 71,009 45,195 40,083
---------- ---------- ---------- ---------- ----------
Income Before Income Tax Expense .................. 42,596 38,288 41,817 34,133 29,908
Income Tax Expense ..................................... 13,185 10,717 13,981 11,924 9,968
---------- ---------- ---------- ---------- ----------
Net Income ............................................. $ 29,411 $ 27,571 $ 27,836 $ 22,209 $ 19,940
========== ========== ========== ========== ==========
Per share data (1)(3)
Basic Net Income ....................................... $ 1.59 $ 1.51 $ 1.70 $ 1.63 $ 1.51
Diluted Net Income ..................................... 1.58 1.50 1.69 1.61 1.50
Cash Dividends Paid .................................... .92 .90 .86 .84 .78
December 31 Book Value ................................. 16.93 16.42 15.24 12.82 11.61
December 31 Market Value (Bid Price) ................... 28.30 25.51 21.67 21.78 19.54
Average balances (3)
Total Assets ........................................... $3,109,104 $2,960,195 $2,406,251 $1,689,694 $1,532,691
Total Loans (4)......................................... 2,369,017 2,281,614 1,842,429 1,270,555 1,104,013
Total Deposits ......................................... 2,365,306 2,257,075 1,857,053 1,331,631 1,209,015
Securities Sold Under Repurchase Agreements
(long-term portion) ............................... 181 66,535 44,394 53,309
Total Federal Home Loan Bank Advances .................. 225,375 208,733 155,387 103,941 80,008
Total Subordinated Debentures, Revolving
Credit and Term Loans ............................ 96,230 94,203 52,756 2,571
Total Stockholders' Equity ............................. 310,004 293,603 237,575 166,232 141,446
Year-end balances (3)
Total Assets ........................................... $3,191,668 $3,076,812 $2,678,687 $1,787,035 $1,621,063
Total Loans (4)......................................... 2,431,418 2,356,546 2,025,922 1,359,893 1,175,586
Total Deposits ......................................... 2,408,150 2,362,101 2,036,688 1,421,251 1,288,299
Securities Sold Under Repurchase Agreements
(long-term portion) .............................. 320 23,632 32,500 32,500
Total Federal Home Loan Bank Advances .................. 223,663 212,779 184,677 103,499 93,182
Total Subordinated Debentures, Revolving
Credit and Term Loans ............................ 97,206 97,782 72,488 8,500
Total Stockholders' Equity ............................. 314,603 303,965 261,129 179,128 156,063
Financial ratios (3)
Return on Average Assets ............................... .95% .93% 1.16% 1.31% 1.30%
Return on Average Stockholders' Equity ................. 9.49 9.39 11.72 13.36 14.10
Average Earning Assets to Total Assets ................. 90.28 89.99 91.38 93.29 94.85
Allowance for Loan Losses as % of Total Loans .......... .93 1.08 1.11 1.11 1.06
Dividend Payout Ratio .................................. 58.23 60.00 50.89 52.17 52.00
Average Stockholders' Equity to Average Assets ......... 9.97 9.92 9.87 9.84 9.23
Tax Equivalent Yield on Earning Assets (2).............. 5.72 5.98 6.83 7.80 8.19
Cost of Supporting Liabilities ......................... 1.84 1.97 2.44 3.56 4.16
Net Interest Margin on Earning Assets .................. 3.88 4.01 4.39 4.24 4.03
(1) Restated for all stock dividends and stock splits.
(2) Average earning assets include the average balance of securities
classified as available for sale, computed based on the average of the
historical amortized cost balances without the effects of the fair value
adjustment.
(3) Business combinations that affect the comparability of the 2004, 2003 and
2002 information are discussed in Note 2 to the Consolidated Financial
Statements. Business combinations that affect the comparability of the
2001 and 2000 information are discussed in the Corporation's Forms 10-K
for years ended December 31, 2003 and 2002.
(4) Includes loans held for sale.
2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
First Merchants Corporation ("Corporation") from time to time includes
forward-looking statements in its oral and written communication. The
Corporation may include forward-looking statements in filings with the
Securities and Exchange Commission, such as Form 10-K and Form 10-Q, in other
written materials and in oral statements made by senior management to analysts,
investors, representatives of the media and others. The Corporation intends
these forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995, and the Corporation is including this statement for purposes of
these safe harbor provisions. Forward-looking statements can often be identified
by the use of words like "estimate," "project," "intend," "anticipate," "expect"
and similar expressions. These forward-looking statements include:
o statements of the Corporation's goals, intentions and expectations;
o statements regarding the Corporation's business plan and growth
strategies;
o statements regarding the asset quality of the Corporation's loan and
investment portfolios; and
o estimates of the Corporation's risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions
and uncertainties, including, among other things, the following important
factors which could affect the actual outcome of future events:
o fluctuations in market rates of interest and loan and deposit pricing,
which could negatively affect the Corporation's net interest margin,
asset valuations and expense expectations;
o adverse changes in the economy, which might affect the Corporation's
business prospects and could cause credit-related losses and expenses;
o adverse developments in the Corporation's loan and investment
portfolios;
o competitive factors in the banking industry, such as the trend towards
consolidation in the Corporation's market; and
o changes in the banking legislation or the regulatory requirements of
federal and state agencies applicable to bank holding companies and
banks like the Corporation's affiliate banks.
Because of these and other uncertainties, the Corporation's actual future
results may be materially different from the results indicated by these
forward-looking statements. In addition, the Corporation's past results of
operations do not necessarily indicate its future results.
CRITICAL ACCOUNTING POLICIES
Generally accepted accounting principles require management to apply significant
judgment to certain accounting, reporting and disclosure matters. Management
must use assumptions and estimates to apply those principles where actual
measurement is not possible or practical. For a complete discussion of the
Corporation's significant accounting policies, see the notes to the consolidated
financial statements and discussion throughout this Annual Report. Below is a
discussion of the Corporation's critical accounting policies. These policies are
critical because they are highly dependent upon subjective or complex judgments,
assumptions and estimates. Changes in such estimates may have a significant
impact on the
3
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES continued
Corporation's financial statements. Management has reviewed the application of
these policies with the Corporation's Audit Committee.
Allowance for Loan Losses. The allowance for loan losses represents management's
estimate of probable losses inherent in the Corporation's loan portfolio. In
determining the appropriate amount of the allowance for loan losses, management
makes numerous assumptions, estimates and assessments.
The Corporation's strategy for credit risk management includes conservative
credit policies and underwriting criteria for all loans, as well as an overall
credit limit for each customer significantly below legal lending limits. The
strategy also emphasizes diversification on a geographic, industry and customer
level, regular credit quality reviews and management reviews of large credit
exposures and loans experiencing deterioration of credit quality.
The Corporation's allowance consists of three components: probable losses
estimated from individual reviews of specific loans, probable losses estimated
from historical loss rates, and probable losses resulting from economic,
environmental, qualitative or other deterioration above and beyond what is
reflected in the first two components of the allowance.
Larger commercial loans that exhibit probable or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and legal options available to the Corporation. Included in the review of
individual loans are those that are impaired as provided in SFAS No. 114,
Accounting by Creditors for Impairment of a Loan. Any allowances for impaired
loans are measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate or fair value of the underlying
collateral. The Corporation evaluates the collectibility of both principal and
interest when assessing the need for a loss accrual.
Historical loss rates are applied to other commercial loans not subject to
specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans
are not individually risk graded. Rather, credit scoring systems are used to
assess credit risks. Reserves are established for each pool of loans using loss
rates based on a five year average net charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted for
significant factors that, in management's judgment, reflect the impact of any
current conditions on loss recognition. Factors which management considers in
the analysis include the effects of the national and local economies, trends in
the nature and volume of loans (delinquencies, charge-offs and nonaccrual
loans), changes in mix, asset quality trends, risk management and loan
administration, changes in the internal lending policies and credit standards,
collection practices and examination results from bank regulatory agencies and
the Corporation's internal loan review. An unallocated reserve, primarily based
on the factors noted above, is maintained to recognize the imprecision in
estimating and measuring loss when evaluating reserves
4
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES continued
for individual loans or pools of loans. Allowances on individual loans and
historical loss rates are reviewed quarterly and adjusted as necessary based on
changing borrower and/or collateral conditions and actual collection and
charge-off experience.
The Corporation's primary market areas for lending are north-central and
east-central Indiana and Columbus, Ohio. When evaluating the adequacy of
allowance, consideration is given to this regional geographic concentration and
the closely associated effect changing economic conditions have on the
Corporation's customers.
The Corporation has not substantively changed any aspect of its overall approach
in the determination of the allowance for loan losses. There have been no
material changes in assumptions or estimation techniques as compared to prior
periods that impacted the determination of the current period allowance.
Valuation of Securities. The Corporation's available-for-sale security portfolio
is reported at fair value. The fair value of a security is determined based on
quoted market prices. If quoted market prices are not available, fair value is
determined based on quoted prices of similar instruments. Available-for-sale and
held-to-maturity securities are reviewed quarterly for possible
other-than-temporary impairment. The review includes an analysis of the facts
and circumstances of each individual investment such as the length of time the
fair value has been below cost, the expectation for that security's performance,
the credit worthiness of the issuer and the Corporation's ability to hold the
security to maturity. A decline in value that is considered to be other-than
temporary is recorded as a loss within other operating income in the
consolidated statements of income.
Pension. The Corporation provides pension benefits to its employees. In
accordance with applicable accounting rules, the Corporation does not
consolidate the assets and liabilities associated with the pension plan.
Instead, the Corporation recognizes a prepaid asset for contributions the
Corporation has made to the pension plan in excess of pension expense. The
measurement of the prepaid asset and the annual pension expense involves
actuarial and economic assumptions.
The assumptions used in pension accounting relate to the expected rate of return
on plan assets, the rate of increase in salaries, the interest-crediting rate,
the discount rate, and other assumptions. See Note 16 "Employee Benefit Plans"
in the Annual Report for the specific assumptions used by the Corporation.
The annual pension expense for the Corporation is currently most sensitive to
the discount rate. Each 25 basis point reduction in the 2005 discount rate of
6.0 percent would increase the Corporation's 2005 pension expense by
approximately $206,000. In addition, each 25 basis point reduction in the 2005
expected rate of return of 8.0 percent would increase the Corporation's 2005
pension expense by approximately $96,000.
Goodwill and Intangibles. For purchase acquisitions, the Company is required to
record the assets acquired, including identified intangible assets, and the
liabilities assumed at their fair value, which in many instances involves
estimates based on third party valuations, such as appraisals, or internal
valuations based on
5
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL ACCOUNTING POLICIES continued
discounted cash flow analyses or other valuation techniques that may include
estimates of attrition, inflation, asset growth rates or other relevant factors.
In addition, the determination of the useful lives for which an intangible asset
will be amortized is subjective.
Goodwill and indefinite-lived assets recorded must be reviewed for impairment on
an annual basis, as well as on an interim basis if events or changes indicate
that the asset might be impaired. An impairment loss must be recognized for any
excess of carrying value over fair value of the goodwill or the indefinite-lived
intangible with subsequent reversal of the impairment loss being prohibited. The
tests for impairment fair values are based on internal valuations using
management's assumptions of future growth rates, future attrition, discount
rates, multiples of earnings or other relevant factors. The resulting estimated
fair values could have a significant impact on the carrying values of goodwill
or intangibles and could result in impairment losses being recorded in future
periods.
BUSINESS SUMMARY
The Corporation is a diversified financial holding company headquartered in
Muncie, Indiana. Since its organization in 1982, the Corporation has grown to
include 10 affiliate banks with over 70 locations in 17 Indiana and 3 Ohio
counties. In addition to its branch network, the Corporation's delivery channels
include ATMs, check cards, interactive voice response systems and internet
technology.
The Corporation's business activities are currently limited to one significant
business segment, which is community banking. The Corporation's financial
service affiliates include 10 nationally chartered banks: First Merchants Bank,
N.A., The Madison Community Bank, N.A., First United Bank, N.A., The Randolph
County Bank, N.A., Union County National Bank, First National Bank, Decatur Bank
and Trust Company, N.A., Frances Slocum Bank & Trust Company, N.A., Lafayette
Bank and Trust Company, N.A. and Commerce National Bank. Effective January 1,
2005, Union County National Bank was merged into The Randolph County Bank, N.A.,
and the name of the continuing institution is United Communities National Bank.
The banks provide commercial and retail banking services. In addition, the
Corporation's trust company, multi-line insurance company and title company
provide trust asset management services, retail and commercial insurance agency
services and title services, respectively.
Management believes that its mission, guiding principles and strategic
initiatives produce profitable growth for stockholders. Our vision is to satisfy
all the financial needs of our customers, help them succeed financially and be
recognized as the premier financial services company in our markets. Our primary
strategy to achieve this vision is to increase product usage and focus on
providing each customer with all of the financial products that fulfill their
needs. Our cross-sell strategy and diversified business model facilitate growth
in strong and weak economic cycles.
Management believes it is important to maintain a well controlled environment as
we continue to grow our businesses. Sound credit policies are maintained and
have resulted in declining nonperforming loans and net charge-offs as a
percentage of loans outstanding from the prior year. Interest rate and market
risks inherent in our asset and liability balances are managed within prudent
ranges, while ensuring
6
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSSINESS SUMMARY continued
adequate liquidity and funding. Our stockholder value has continued to increase
due to customer satisfaction and the balanced way we manage our business risk.
RESULTS OF OPERATIONS
As of December 31, 2004 total assets equaled $3,191,668,000, an increase of
$114,856,000 or 3.7 percent over 2003. Of this amount, loans increased
$74,548,000 and investments increased $64,738,000. Details of these changes are
discussed within the "EARNING ASSETS" section of Management's Discussion and
Analysis of Financial Condition and Results of Operations.
As of December 31, 2003 total assets equaled $3,076,812,000, an increase of
$398,125,000 from December 31, 2002. Of this amount, loans increased
$349,126,000, investments increased $14,735,000, intangibles, including
goodwill, increased $35,506,000 and cash value of life insurance increased by
$23,618,000. The addition of Commerce National Bank on March 1, 2003 accounted
for $298,702,000 in loan growth, $12,500,000 in investment growth and most of
the increase in intangibles.
Absent Commerce National Bank, total loans increased by $50,424,000 in 2003.
Positive growth of commercial and industrial and commercial real estate loans of
$73,436,000 was mitigated by declines in installment loans and residential real
estate loans of $12,166,000 and $9,776,000, respectively.
The Corporation also completed the purchase of $23 million in Bank Owned Life
Insurance (BOLI) during May, 2003. The BOLI yield is 8.34 percent on a fully tax
equivalent basis, adjustable annually. The tax-free investment was used to
offset the cost of current employee benefit programs.
Net income for 2004 totaled $29,411,000, an increase of $1,840,000 or 6.7
percent. The increase was primarily attributable to loan growth and improved
credit quality. Diluted earnings per share totaled $1.58, a 5.3 percent increase
from $1.50 reported for 2003.
Net income for 2003 totaled $27,571,000, down from $27,836,000 in 2002. The
$265,000 decrease was attributable to several factors, including compression of
the net interest margin, increased provision for loan losses and increased
noninterest expenses. These factors and others are discussed within the
respective sections of Management's Discussion and Analysis of Financial
Condition and Results of Operations. Diluted earnings per share totaled $1.50, a
11.2 percent decrease from $1.69 reported for 2002.
Return on equity totaled 9.49 percent in 2004, 9.39 percent in 2003 and 11.72
percent in 2002. Return on assets totaled .95 percent in 2004, .93 percent in
2003 and 1.16 percent in 2002. Multiple factors impacting the reported financial
results are discussed within the respective sections of Management's Discussion
and Analysis of Financial Condition and Results of Operations.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL
The Corporation's regulatory capital continues to exceed regulatory "well
capitalized" standards. Tier I regulatory capital consists primarily of total
stockholders' equity and subordinated debentures issued to business trusts
categorized as qualifying borrowings, less non-qualifying intangible assets and
unrealized net securities gains. The Corporation's Tier I capital to average
assets ratio was 7.50 percent and 7.38 percent at December 31, 2004 and 2003,
respectively. In addition, at December 31, 2004, the Corporation had a Tier I
risk-based capital ratio of 9.57 percent and total risk-based capital ratio of
11.57 percent. Regulatory capital guidelines require a Tier I risk-based capital
ratio of 4.0 percent and a total risk-based capital ratio of 8.0 percent.
The Corporation's GAAP capital ratio, defined as total stockholders' equity to
total assets, equaled 9.86 percent as of December 31, 2004, down from 9.88
percent in 2003. When the Corporation acquires other companies for stock, GAAP
capital increases by the entire amount of the purchase price.
The Corporation's tangible capital ratio, defined as total stockholders' equity
less intangibles net of tax to total assets less intangibles net of tax, equaled
5.92 percent as of December 31, 2004 up from 5.78 percent in 2003.
Management believes that all of the above capital ratios are meaningful
measurements for evaluating the safety and soundness of the Corporation.
Additionally, management believes the following table is also meaningful when
considering performance measures of the Corporation. The table details and
reconciles tangible earnings per share, return on tangible capital and tangible
assets to traditional GAAP measures.
December 31,
(Dollars in Thousands) 2004 2003
===============================================================================
Average Goodwill..................................... $ 112,281 $ 107,232
Average Core Deposit Intangible (CDI)................ 22,164 24,393
Average Deferred Tax on CDI.......................... (8,105) (8,951)
---------- ----------
Intangible Adjustment.............................. $ 126,340 $ 122,674
========== ==========
Average Stockholders' Equity (GAAP Capital).......... $ 310,004 $ 293,603
Intangible Adjustment................................ (126,340) (122,674)
---------- ----------
Average Tangible Capital........................... $ 183,664 $ 170,929
========== ==========
Average Assets....................................... $3,109,104 $2,960,195
Intangible Adjustment................................ (126,340) (122,674)
---------- ----------
Average Tangible Assets............................ $2,982,764 $2,837,521
========== ==========
Net Income........................................... $ 29,411 $ 27,571
CDI Amortization, net of tax......................... 2,133 2,341
---------- ----------
Tangible Net Income................................ $ 31,544 $ 29,912
========== ==========
Diluted Earnings per Share........................... $ 1.58 $ 1.50
Diluted Tangible Earnings per Share.................. $ 1.69 $ 1.63
Return on Average GAAP Capital....................... 9.49% 9.39%
Return on Average Tangible Capital................... 17.49% 17.50%
Return on Average Assets............................. 0.95% 0.93%
Return on Average Tangible Assets.................... 1.06% 1.05%
8
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ASSET QUALITY/PROVISION FOR LOAN LOSSES
The Corporation's primary business focus is middle market commercial and
residential real estate, auto and small consumer lending, which results in
portfolio diversification. Management ensures that appropriate methods to
understand and underwrite risk are utilized. Commercial loans are individually
underwritten and judgmentally risk rated. They are periodically monitored and
prompt corrective actions are taken on deteriorating loans. Retail loans are
typically underwritten with statistical decision-making tools and are managed
throughout their life cycle on a portfolio basis.
The allowance for loan losses is maintained through the provision for loan
losses, which is a charge against earnings. The amount provided for loan losses
and the determination of the adequacy of the allowance are based on a continuous
review of the loan portfolio, including an internally administered loan "watch"
list and an independent loan review primarily provided by an outside accounting
firm. The evaluation takes into consideration identified credit problems, as
well as the possibility of losses inherent in the loan portfolio that are not
specifically identified. (See Critical Accounting Policies)
At December 31, 2004, non-performing loans totaled $19,281,000, a decrease of
$7,343,000, as noted in the following table. Loans 90 days past due other than
non-accrual and restructured loans decreased by $4,623,000. The amount of
non-accrual loans, totaling $15,355,000 at December 31, 2004, will increase or
decrease going forward due to portfolio growth, routine problem loans
recognition and resolution through collections, sales or charge-offs. The
performance of any loan can be affected by external factors, such as economic
conditions, or factors particular to a borrower, such as actions of a borrower's
management.
At December 31, 2004, impaired loans totaled $49,411,000, an increase of
$4,639,000 from year end 2003. At December 31, 2004, a specific allowance for
losses was not deemed necessary for impaired loans totaling $41,683,000, but a
specific allowance of $1,673,000 was recorded for the remaining balance of
impaired loans of $7,728,000 and is included in the Corporation's allowance for
loan losses. The average balance of impaired loans for 2004 was $59,568,000. The
increase of total impaired loans of $4,639,000 is primarily due to the increase
of performing, substandard classified loans, which comprise a portion of the
Corporation's total impaired loans. A loan is deemed impaired when, based on
current information or events, it is probable that all amounts due of principal
and interest according to the contractual terms of the loan agreement will not
be collected. For the Corporation, all performing, substandard classified loans
are included in the impaired loan total.
At December 31, 2004, the allowance for loan losses was $22,548,000, a decrease
of $2,945,000 from year end 2003. As a percent of loans, the allowance was .93
percent at December 31, 2004 and 1.08 percent at December 31, 2003. Management
believes that the allowance for loan losses is adequate to cover losses inherent
in the loan portfolio at December 31, 2004. The process for determining the
adequacy of the allowance for loan losses is critical to our financial results.
It requires management to make difficult, subjective and complex judgments, as a
result of the need to make estimates about the effect of matters that are
uncertain. Therefore, the allowance for loan losses, considering current factors
at the time, including economic conditions and ongoing internal and external
examination processes, will
9
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ASSET QUALITY/PROVISION FOR LOAN LOSSES continued
increase or decrease as deemed necessary to ensure the allowance for loan losses
remains adequate. In addition, the allowance as a percentage of charge-offs and
nonperforming loans will change at different points in time based on credit
performance, loan mix and collateral values.
The provision for loan losses in 2004 was $5,705,000, a decrease of $3,772,000
from $9,477,000 in 2003. The Corporation's allowance for loan losses reflects
decreased non-performing loans as noted in the following table and decreased
specific reserves, resulting in decreased provision expense.
The following table summarizes the non-accrual, contractually past due 90 days
or more other than non-accruing and restructured loans for the Corporation.
(Dollars in Thousands) December 31,
2004 2003
=========================================================================
Non-accrual loans .............................. $ 15,355 $ 19,453
Loans contractually
past due 90 days or more
other than non-accruing ..................... 1,907 6,530
Restructured loans ............................. 2,019 641
-------- --------
Total ....................................... $ 19,281 $ 26,624
======== ========
The table below represents loan loss experience for the years indicated.
(Dollars in Thousands) 2004 2003 2002
======================================================================================
Allowance for loan losses:
Balance at January 1 ............................... $25,493 $22,417 $15,141
------- ------- -------
Chargeoffs ......................................... 10,901 12,139 8,113
Recoveries ......................................... 2,251 2,011 1,313
------- ------- -------
Net chargeoffs ..................................... 8,650 10,128 6,800
Provision for loan losses .......................... 5,705 9,477 7,174
Allowance acquired in acquisitions.................. 3,727 6,902
------- ------- -------
Balance at December 31 ............................. $22,548 $25,493 $22,417
======= ======= =======
Ratio of net chargeoffs during the period to
average loans outstanding during the period ....... .37% .44% .37%
LIQUIDITY
Liquidity management is the process by which the Corporation ensures that
adequate liquid funds are available for the Corporation and its subsidiaries.
These funds are necessary in order for the Corporation and its subsidiaries to
meet financial commitments on a timely basis. These commitments include
withdrawals by depositors, funding credit obligations to borrowers, paying
dividends to shareholders, paying operating expenses, funding capital
expenditures, and maintaining deposit reserve requirements. Liquidity is
monitored and closely managed by the asset/liability committees at each
subsidiary and by the Corporation's asset/liability committee.
The liquidity of the Corporation is dependent upon the receipt of dividends from
its bank subsidiaries, which are subject to certain regulatory limitations as
explained in Note 14 to the consolidated financial statements, and access to
other funding sources. Liquidity of the Corporation's bank subsidiaries is
derived primarily from core deposit growth, principal payments received on
loans, the sale and maturity of
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY continued
investment securities, net cash provided by operating activities, and access to
other funding sources.
The most stable source of liability-funded liquidity for both the long-term and
short-term is deposit growth and retention in the core deposit base. In
addition, the Corporation utilizes advances from the Federal Home Loan Bank
("FHLB") as a funding source. At December 31, 2004, total borrowings from the
FHLB were $223,663,000. The Corporation's bank subsidiaries have pledged certain
mortgage loans and certain investments to the FHLB. The total available
remaining borrowing capacity from the FHLB at December 31, 2004, was
$148,451,000.
The principal source of asset-funded liquidity is investment securities
classified as available-for-sale, the market values of which totaled
$416,177,000 at December 31, 2004. Securities classified as held-to-maturity
that are maturing within a short period of time can also be a source of
liquidity. Securities classified as held-to-maturity and that are maturing in
one year or less totaled $1,110,000 at December 31, 2004. In addition, other
types of assets-such as cash and due from banks, federal funds sold and
securities purchased under agreements to resell, and loans and interest-bearing
deposits with other banks maturing within one year-are sources of liquidity.
In the normal course of business, the Corporation is a party to a number of
other off-balance sheet activities that contain credit, market and operational
risk that are not reflected in whole or in part in the Corporation's
consolidated financial statements. Such activities include: traditional
off-balance sheet credit-related financial instruments and commitments under
operating leases.
The Corporation provides customers with off-balance sheet credit support through
loan commitments and standby letters of credit. Summarized credit-related
financial instruments at December 31, 2004 are as follows:
At December 31,
(Dollars in Thousands) 2004
================================================================================
Amounts of commitments:
Loan commitments to extend credit ............................... $ 540,087
Standby letters of credit ....................................... 22,024
----------
$ 562,111
==========
Since many of the commitments are expected to expire unused or be only partially
used, the total amount of unused commitments in the preceding table does not
necessarily represent future cash requirements.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY continued
In addition to owned banking facilities, the Corporation has entered into a
number of long-term leasing arrangements to support the ongoing activities of
the Corporation. The required payments under such commitments and other
borrowing arrangements at December 31, 2004 are as follows:
2005 2006 2007 2008 2009 2010 Total
(Dollars in Thousands) and after
=========================================================================================================
Operating leases $ 1,746 $ 1,515 $ 1,145 $ 880 $ 829 $ 2,287 $ 8,402
Federal funds purchased 32,550 32,550
Securities sold under
repurchase agreements 87,152 320 87,472
Federal Home Loan Bank Advances 33,477 29,859 24,995 19,306 9,428 106,598 223,663
Subordinated debentures,
revolving credit lines and
term loans 8,250 88,956 97,206
-------- ------- ------- ------- -------- --------- --------
Total $163,175 $31,694 $26,140 $20,186 $ 10,257 $ 197,841 $449,293
======== ======= ======= ======= ======== ========= ========
The Corporation's purchase obligations have no material impact in its cash flow
or liquidity and, accordingly, has not been included in the above table.
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK
Asset/Liability Management has been an important factor in the Corporation's
ability to record consistent earnings growth through periods of interest rate
volatility and product deregulation. Management and the Board of Directors
monitor the Corporation's liquidity and interest sensitivity positions at
regular meetings to review how changes in interest rates may affect earnings.
Decisions regarding investment and the pricing of loan and deposit products are
made after analysis of reports designed to measure liquidity, rate sensitivity,
the Corporation's exposure to changes in net interest income given various rate
scenarios and the economic and competitive environments.
It is the objective of the Corporation to monitor and manage risk exposure to
net interest income caused by changes in interest rates. It is the goal of the
Corporation's Asset/Liability function to provide optimum and stable net
interest income. To accomplish this, management uses two asset liability tools.
GAP/Interest Rate Sensitivity Reports and Net Interest Income Simulation
Modeling are both constructed, presented and monitored quarterly.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued
Management believes that the Corporation's liquidity and interest sensitivity
position at December 31, 2004, remained adequate to meet the Corporation's
primary goal of achieving optimum interest margins while avoiding undue interest
rate risk. The following table presents the Corporation's interest rate
sensitivity analysis as of December 31, 2004.
(Dollars in Thousands) At December 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
1-180 DAYS 181-365 DAYS 1-5 YEARS BEYOND 5 YEARS TOTAL
====================================================================================================================================
Rate-Sensitive Assets:
Federal funds sold and interest-bearing deposits ........ $ 9,343 $ 9,343
Investment securities ................................... 37,978 $ 47,068 $ 223,942 $ 112,547 421,535
Loans ................................................... 1,198,089 252,368 831,534 149,427 2,431,418
Federal Reserve and Federal Home Loan Bank stock ........ 21,323 1,535 22,858
---------- ---------- ---------- ---------- ----------
Total rate-sensitive assets ........................ 1,245,410 299,436 1,076,799 263,509 2,885,154
---------- ---------- ---------- ---------- ----------
Rate-Sensitive Liabilities:
Interest-bearing deposits ............................... 1,411,013 173,153 489,473 3,826 2,077,465
Securities sold under repurchase agreements ............. 87,472 87,472
Federal Home Loan Bank advances ......................... 9,750 21,174 87,664 105,075 223,663
Subordinated debentures, revolving credit
lines and term loans .................................. 13,250 83,956 97,206
---------- ---------- ---------- ---------- ----------
Total rate-sensitive liabilities ................... 1,521,485 194,327 577,137 192,857 2,485,806
---------- ---------- ---------- ---------- ----------
Interest rate sensitivity gap by period .................... $ (276,075) $ 105,109 $ 499,662 $ 70,652
Cumulative rate sensitivity gap ............................ (276,075) (170,966) 328,696 399,348
Cumulative rate sensitivity gap ratio
at December 31, 2004 .................................... 81.9% 90.0% 114.3% 116.1%
at December 31, 2003 .................................... 73.6% 83.6% 111.6% 115.1%
The Corporation had a cumulative negative gap of $170,966,000 in the one-year
horizon at December 31, 2004, just over 5.4 percent of total assets.
The Corporation places its greatest credence in net interest income simulation
modeling. The above GAP/Interest Rate Sensitivity Report is believed by the
Corporation's management to have two major shortfalls. The GAP/Interest Rate
Sensitivity Report fails to precisely gauge how often an interest rate sensitive
product reprices, nor is it able to measure the magnitude of potential future
rate movements.
Net interest income simulation modeling, or earnings-at-risk, measures the
sensitivity of net interest income to various interest rate movements. The
Corporation's asset liability process monitors simulated net interest income
under three separate interest rate scenarios; base, rising and falling.
Estimated net interest income for each scenario is calculated over a 12-month
horizon. The immediate and parallel changes to the base case scenario used in
the model are presented below. The interest rate scenarios are used for
analytical purposes and do not necessarily represent management's view of future
market movements. Rather, these are intended to provide a measure of the degree
of volatility interest rate movements may introduce into the earnings of the
Corporation.
The base scenario is highly dependent on numerous assumptions embedded in the
model, including assumptions related to future interest rates. While the base
sensitivity analysis incorporates management's best estimate of interest rate
and balance sheet dynamics under various market rate movements, the actual
behavior and resulting earnings impact will likely differ from that projected.
For mortgage-related assets, the base simulation model captures the expected
prepayment behavior under changing interest rate environments. Assumptions and
methodologies regarding the interest rate or balance behavior of indeterminate
maturity products, e.g., savings, money market,
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued
NOW and demand deposits reflect management's best estimate of expected future
behavior.
The comparative rising and falling scenarios for the period ended December 31,
2005 assume further interest rate changes in addition to the base simulation
discussed above. These changes are immediate and parallel changes to the base
case scenario. In addition, total rate movements (beginning point minus ending
point) to each of the various driver rates utilized by management in the base
simulation for the period ended December 31, 2005 are as follows:
Driver Rates RISING FALLING
=============================================================
Prime 200 Basis Points (200) Basis Points
Federal Funds 200 (200)
One-Year CMT 200 (200)
Two-Year CMT 200 (200)
CD's 200 (74)
FHLB Advances 200 (200)
Results for the base, rising and falling interest rate scenarios are listed
below. The net interest income shown represents cumulative net interest income
over a 12-month time horizon. Balance sheet assumptions used for the base
scenario are the same for the rising and falling simulations.
BASE RISING FALLING
=========================================================================
Net Interest Income (Dollars in Thousands) $109,311 $117,212 $ 97,757
Variance from base $ 7,901 $(11,554)
Percent of change from base 7.2% (10.6)%
The comparative rising and falling scenarios for the period ending December 31,
2004 assume further interest rate changes in addition to the base simulation
discussed above. These changes are immediate and parallel changes to the base
case scenario. In addition, total rate movements (beginning point minus ending
point) to each of the various driver rates utilized by management in the base
simulation for the period ended December 31, 2004 are as follows:
Driver Rates RISING FALLING
=============================================================
Prime 200 Basis Points (200) Basis Points
Federal Funds 200 (100)
One-Year T-Bill 200 (138)
Two-Year T-Bill 200 (194)
Interest Checking 100 (14)
MMIA Savings 100 (24)
First Flex 100 (24)
CD's 200 (59)
FHLB Advances 200 (117)
Results for the base, rising and falling interest rate scenarios are listed
below. The net interest income shown represents cumulative net interest income
over a 12-month time horizon. Balance sheet assumptions used for the base
scenario are the same for the rising and falling simulations.
BASE RISING FALLING
=========================================================================
Net Interest Income (Dollars in Thousands) $100,873 $102,792 $ 87,217
Variance from base $ 1,919 $(13,656)
Percent of change from base 1.90% (13.54)%
14
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
EARNING ASSETS
Earnings assets increased approximately $115.7 million during 2004 as compared
to 2003. Loans grew by $74.5 million. Positive growth of commercial and
industrial and commercial, construction and farmland real estate loans of
approximately $178.9 million was mitigated by a $105.3 million decline in
residential real estate loans.
Investment securities increased by $64.7 million. The Corporation purchased
agency mortgage-backed securities, including ten year amortizing pools and five
and seven year mortgage balloon pools. In addition, three to five year tax
exempt state and municipal securities and federal agency securities were
purchased during 2004.
The table below reflects the earning asset mix for the years 2004 and 2003 (at
December 31).
Earning Assets
(Dollars in Millions) December 31,
================================================================================
2004 2003
-------- --------
Federal funds sold and interest-bearing time deposits $ 9.3 $ 40.6
Securities available for sale ....................... 416.2 348.9
Securities held to maturity ......................... 5.4 7.9
Mortgage loans held for sale ........................ 3.4 3.0
Loans ............................................... 2,428.0 2,353.6
Federal Reserve and Federal Home Loan Bank stock .... 22.9 15.5
-------- --------
Total ........................................... $2,885.2 $2,769.5
======== ========
DEPOSITS AND BORROWINGS
The table below reflects the level of deposits and borrowed funds (repurchase
agreements; Federal Home Loan Bank advances; subordinated debentures, revolving
credit lines and term loans; and other borrowed funds) based on year-end levels
at December 31, 2004 and 2003.
(Dollars in Millions) December 31,
2004 2003
---------- ----------
Deposits ........................................ $ 2,408.2 $ 2,362.1
Federal funds purchased.......................... 32.6
Securities sold under repurchase agreements...... 87.5 71.1
Federal Home Loan Bank advances ................. 223.7 212.8
Subordinated debentures, revolving credit lines
and term loans................................ 97.2 97.8
Other borrowed funds ............................ 1.5
The Corporation has continued to leverage its capital position with Federal Home
Loan Bank advances, as well as repurchase agreements which are pledged against
acquired investment securities as collateral for the borrowings. The interest
rate risk is included as part of the Corporation's interest simulation discussed
in Management's Discussion and Analysis of Financial Condition and Results of
Operations under the headings "LIQUIDITY" and "INTEREST SENSITIVITY AND
DISCLOSURES ABOUT MARKET RISK".
NET INTEREST INCOME
Net interest income is the primary source of the Corporation's earnings. It is a
function of net interest margin and the level of average earning assets. The
following table reflects the Corporation's asset yields, interest expense, and
net interest income as a percent of average earning assets for the three-year
period ending in 2004.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
NET INTEREST INCOME continued
In 2004, asset yields decreased 26 basis points (FTE) and interest cost
decreased 13 basis points, resulting in a 13 basis point (FTE) decrease in net
interest income as compared to 2003. Margins remained compressed through the
first half of 2004 as the combined first and second quarters net interest margin
equaled 3.87 percent. In June 2004, the first of five 25 basis point overnight
federal funds rate increases by the Federal Open Market Committee occurred,
helping increase the combined third and fourth quarter net interest margin to
3.90 percent. However, the net interest margin for the 2004 fourth quarter
declined to 3.85 percent. This was primarily due to the reversal of
approximately $340,000 of interest income in the fourth quarter, related to
loans placed on non-accrual status and charged-off during the quarter. In
addition, the Corporation maintained an average federal funds sold position of
approximately $60 million, which generated lower yields.
In 2003, asset yields decreased 85 basis points (FTE) and interest cost
decreased 47 basis points, resulting in a 38 basis point (FTE) decrease in net
interest income as compared with 2002. The margin compression was primarily a
result of a stressed Indiana economy and an interest rate cycle that
approximated a 40-year low during 2003.
(Dollars in Thousands) December 31,
2004 2003 2002
---------- ----------- ----------
Net Interest Income.............................. $ 105,389 $ 103,142 $ 92,923
FTE Adjustment................................... $ 3,597 $ 3,757 $ 3,676
Net Interest Income
On a Fully Taxable Equivalent Basis............ $ 108,986 $ 106,899 $ 96,599
Average Earning Assets........................... $2,806,776 $ 2,663,853 $2,198,943
Interest Income (FTE) as a Percent
of Average Earning Assets...................... 5.72% 5.98% 6.83%
Interest Expense as a Percent
of Average Earning Assets...................... 1.84% 1.97% 2.44%
Net Interest Income (FTE) as a Percent
of Average Earning Assets...................... 3.88% 4.01% 4.39%
Average earning assets include the average balance of securities classified as
available for sale, computed based on the average of the historical amortized
cost balances without the effects of the fair value adjustment. In addition,
annualized amounts are computed utilizing a 30/360 day basis.
OTHER INCOME
The Corporation offers a wide range of fee-based services. Fee schedules are
regularly reviewed by a pricing committee to ensure that the products and
services offered by the Corporation are priced to be competitive and profitable.
Other income in 2004 amounted to $34,554,000, a 3.8 percent decline from 2003.
The decrease of $1,348,000 is primarily attributable to the following factors:
1. Net gains and fees on sales of mortgage loans included in other income
decreased by $2,759,000 due to decreased mortgage volume during 2004.
2. Life insurance proceeds included in other income was $0 for 2004
compared to $535,000 for 2003.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OTHER INCOME continued
3. Service charges on deposit accounts increased $533,000 or 4.8 percent
due to increased number of customer accounts and price adjustments.
4. Revenues from fiduciary activities increased $896,000 or 13.3 percent
due to expansion, market improvements and price adjustments.
Other income in 2003 amounted to $35,902,000 or 32.6 percent higher than in
2002. The increase of $8,825,000 is primarily attributable to the following
factors:
1. Net gains and fees on sales of mortgage loans included in other income
increased by $4,676,000 due to increased mortgage volume during most
of 2003.
In addition, decreasing mortgage loan rates during the first three
quarters of 2003 caused an increase in refinancing volume, which
facilitated an increase in loan sales activity.
2. Service charges on deposit accounts increased $1,775,000 or 19.0
percent due to increased number of accounts, price adjustments and
approximately $742,000 of additional service charge income related to
April 1, 2002 acquisition of Lafayette.
3. Life insurance proceeds included in other income was $535,000 for
2003, compared to $0 for the same period last year.
4. Insurance commissions increased by $465,000 or 21.1 percent primarily
as a result of the September 6, 2002 acquisition of Stephenson
Insurance Services, Inc.
5. Revenues from fiduciary activities increased $478,000 or 7.6 percent
due primarily to the additional fees related to the acquisition of
Lafayette.
OTHER EXPENSES
Other expenses represent non-interest operating expenses of the Corporation.
Other expenses amounted to $91,642,000 in 2004, an increase of 0.4 percent from
the prior year, or $363,000. The following factors account for most of the
increase:
1. Salaries and benefit expense grew $1,995,000 or 4.0 percent, due to
normal salary increases and additional salary cost related to the
March 1, 2003 acquisition of Commerce National.
2. Prepayment penalties for early prepayment of FHLB advances totaled
$340,000 for 2003 and no such penalties were incurred during 2004.
3. Investment securities write-downs totaling $615,000 were incurred in
2003, resulting from other-than-temporary losses being recognized on
two securities. No investment security write-downs resulting from
other-than temporary losses were incurred during 2004.
4. In 2003, the Corporation incurred $460,000 expense to fund the
anticipation of a settlement of a claim. No such expense was incurred
during 2004.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OTHER EXPENSES continued
Other expenses represent non-interest operating expenses of the Corporation.
Other expenses amounted to $91,279,000 in 2003, an increase of 28.5 percent from
the prior year, or $20,270,000. The following factors account for most of the
increase:
1. Salaries and benefit expense grew $11,334,000 or 29.0 percent, due to
normal salary increases, staff additions and additional salary cost
related to the April 1, 2002 acquisition of Lafayette and the March 1,
2003 acquisition of Commerce National.
2. Net occupancy expenses increased by $1,262,000 or 34.7 percent
primarily due to the acquisitions of Lafayette and Commerce National.
3. Equipment expense increased by $1,364,000 or 20.3 percent primarily
due to the acquisitions of Lafayette and Commerce National.
4. Core deposit intangible amortization increased by $1,111,000, due to
the acquisitions of Lafayette and Commerce National.
5. Prepayment penalties for early prepayment of FHLB advances totaled
$340,000 for 2003 and no such penalties were incurred during 2002.
6. Investment securities write-downs totaling $615,000 were incurred in
2003, resulting from other-than-temporary losses being recognized on
two securities.
INCOME TAXES
Income tax expense totaled $13,185,000 for 2004, which is an increase of
$2,468,000 from 2003. The 2004 increase in tax expense is primarily a result of
the increase of the 2004 income before income tax, as compared to 2003.
In addition, the effective tax rates for the periods ending December 31, 2004,
2003 and 2002 were 31.0 percent, 28.0 percent and 33.4 percent, respectively.
The effective tax rate has remained lower than the federal statutory income tax
rate of 34 percent, primarily due to the Corporation's tax-exempt investment
income on securities and loans, income tax credits generated from investments in
affordable housing projects, income generated by subsidiaries domiciled in a
state with no state or local income tax, increases in tax exempt earnings from
bank-owned life insurance contracts and reduced state taxes, resulting from the
effect of state income apportionment.
INFLATION
Changing prices of goods, services and capital affect the financial position of
every business enterprise. The level of market interest rates and the price of
funds loaned or borrowed fluctuate due to changes in the rate of inflation and
various other factors, including government monetary policy.
Fluctuating interest rates affect the Corporation's net interest income, loan
volume and other operating expenses, such as employee salaries and benefits,
reflecting the effects of escalating prices, as well as increased levels of
operations and other factors. As the inflation rate increases, the purchasing
power of the dollar
18
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INFLATION continued
decreases. Those holding fixed-rate monetary assets incur a loss, while those
holding fixed-rate monetary liabilities enjoy a gain. The nature of a financial
holding company's operations is such that there will generally be an excess of
monetary assets over monetary liabilities, and, thus, a financial holding
company will tend to suffer from an increase in the rate of inflation and
benefit from a decrease.
19
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee, Board of Directors and Stockholders
First Merchants Corporation
Muncie, Indiana
We have audited the accompanying consolidated balance sheets of First Merchants
Corporation as of December 31, 2004 and 2003, and the related consolidated
statements of income, comprehensive income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 2004. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Merchants
Corporation as of December 31, 2004 and 2003, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2004, in conformity with accounting principles generally accepted in the United
States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of First Merchants
Corporation's internal control over financial reporting as of December 31, 2004
based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and
our report dated January 28, 2005 expressed unqualified opinions on management's
assessment and on the effectiveness of the Corporation's internal control over
financial reporting.
Indianapolis, Indiana
January 28, 2005
20
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets
(in thousands, except share data) December 31,
==========================================================================================================
2004 2003
Assets
Cash and due from banks ................................................ $ 69,960 $ 77,112
Federal funds sold ..................................................... 32,415
----------- -----------
Cash and cash equivalents .............................................. 69,960 109,527
Interest-bearing time deposits ......................................... 9,343 8,141
Investment securities
Available for sale .................................................. 416,177 348,860
Held to maturity (fair value of $5,520 and $8,326) .................. 5,358 7,937
----------- -----------
Total investment securities ....................................... 421,535 356,797
Mortgage loans held for sale ........................................... 3,367 3,043
Loans, net of allowance for loan losses of $22,548 and $25,493.......... 2,405,503 2,328,010
Premises and equipment ................................................. 38,254 39,639
Federal Reserve and Federal Home Loan Bank stock ....................... 22,858 15,502
Interest receivable .................................................... 17,318 16,840
Core deposit intangibles ............................................... 20,669 24,044
Goodwill................................................................ 120,615 118,679
Cash value of life insurance............................................ 42,061 37,927
Other assets ........................................................... 20,185 18,663
----------- -----------
Total assets ...................................................... $ 3,191,668 $ 3,076,812
=========== ===========
Liabilities
Deposits
Noninterest-bearing .................................................. $ 330,685 $ 338,201
Interest-bearing ..................................................... 2,077,465 2,023,900
----------- -----------
Total deposits ..................................................... 2,408,150 2,362,101
Borrowings ............................................................. 440,891 383,170
Interest payable ....................................................... 4,411 4,680
Other liabilities ...................................................... 23,613 22,896
----------- -----------
Total liabilities .................................................. 2,877,065 2,772,847
Commitments and Contingent Liabilities
Stockholders' equity
Preferred stock, no-par value
Authorized and unissued -- 500,000 shares
Common stock, $.125 stated value
Authorized -- 50,000,000 shares
Issued and outstanding -- 18,573,997 and 18,512,834 shares .......... 2,322 2,314
Additional paid-in capital ............................................. 150,862 150,310
Retained earnings ...................................................... 161,459 149,096
Accumulated other comprehensive income (loss)........................... (40) 2,245
----------- -----------
Total stockholders' equity ........................................ 314,603 303,965
----------- -----------
Total liabilities and stockholders' equity ........................ $ 3,191,668 $ 3,076,812
=========== ===========
See notes to consolidated financial statements.
21
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Income
(in thousands, except share data) Year Ended December 31,
====================================================================================================
2004 2003 2002
Interest income
Loans receivable
Taxable ................................................ $139,953 $141,236 $129,279
Tax exempt ............................................. 581 707 638
Investment securities
Taxable ................................................ 8,371 6,105 9,086
Tax exempt ............................................. 6,098 6,270 6,190
Federal funds sold ....................................... 165 487 557
Deposits with financial institutions ..................... 555 76 197
Federal Reserve and Federal Home Loan Bank stock ......... 1,251 649 735
-------- -------- --------
Total interest income ................................ 156,974 155,530 146,682
-------- -------- --------
Interest expense
Deposits ................................................. 33,844 34,858 39,700
Securities sold under repurchase agreements .............. 517 1,521 2,060
Federal Home Loan Bank advances .......................... 9,777 9,439 8,166
Subordinated debentures, revolving
credit and term loans .................................. 6,784 6,161 3,756
Other borrowings ......................................... 663 409 77
-------- -------- --------
Total interest expense .............................. 51,585 52,388 53,759
-------- -------- --------
Net interest income ......................................... 105,389 103,142 92,923
Provision for loan losses ................................ 5,705 9,477 7,174
-------- -------- --------
Net interest income after provision for loan losses ......... 99,684 93,665 85,749
-------- -------- --------
Other income
Fiduciary activities ..................................... 7,632 6,736 6,258
Service charges on deposit accounts ...................... 11,638 11,105 9,330
Other customer fees ...................................... 4,083 4,124 3,918
Net realized gains on
sales of available-for-sale securities ................. 1,188 950 739
Commission income ........................................ 3,088 2,668 2,203
Earnings on cash surrender value
of life insurance ...................................... 1,798 1,347 689
Net gains and fees on sales of loans ..................... 3,629 6,388 1,712
Other income ............................................. 1,498 2,584 2,228
-------- -------- --------
Total other income .................................. 34,554 35,902 27,077
-------- -------- --------
Other expenses
Salaries and employee benefits ........................... 52,479 50,484 39,150
Net occupancy expenses ................................... 5,308 4,894 3,632
Equipment expenses ....................................... 7,665 8,073 6,709
Marketing expenses........................................ 1,709 1,797 1,495
Outside data processing fees ............................. 4,920 4,118 3,664
Printing and office supplies ............................. 1,580 1,706 1,597
Core deposit amortization................................. 3,375 3,704 2,589
Other expenses ........................................... 14,606 16,503 12,173
-------- -------- --------
Total other expenses ................................ 91,642 91,279 71,009
-------- -------- --------
Income before income tax .................................... 42,596 38,288 41,817
Income tax expense ....................................... 13,185 10,717 13,981
-------- -------- --------
Net income .................................................. $ 29,411 $ 27,571 $ 27,836
======== ======== ========
Net income per share:
Basic .................................................... $ 1.59 $ 1.51 $ 1.70
Diluted .................................................. 1.58 1.50 1.69
See notes to consolidated financial statements.
22
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Comprehensive Income
Year Ended December 31,
(in thousands) 2004 2003 2002
==================================================================================================================================
Net income ............................................................................ $ 29,411 $ 27,571 $ 27,836
--------- -------- ---------
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities available for sale:
Unrealized holding gains (losses) arising during the period,
net of income tax (expense) benefit of $1,199, $1,465, and $(2,426)............... (1,799) (2,197) 3,639
Less: Reclassification adjustment for gains included in net income,
net of income tax expenses of $(475), $(380), and $(296)........................ 713 570 443
Unrealized loss on pension minimum funding liability:
Unrealized loss arising during the period,
net of income tax benefit of $150, $357, and $879 ................................ (227) (536) (1,318)
--------- -------- ---------
(2,285) (2,231) 1,878
--------- -------- ---------
COMPREHENSIVE INCOME $ 27,126 $ 25,340 $ 29,714
========= ======== =========
Consolidated Statements of Stockholders' Equity
(in thousands, except share data)
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK
---------------------- ADDITIONAL RETAINED ACCUMULATED OTHER
SHARES AMOUNT PAID-IN CAPITAL EARNINGS COMPREHENSIVE TOTAL
INCOME (LOSS)
----------- -------- --------------- --------- ----------------- ---------
Balances, January 1, 2002 12,670,307 $ 1,584 $ 50,642 $ 124,304 $ 2,598 $ 179,128
Net income for 2002.......................... 27,836 27,836
Cash dividends ($.86 per share).............. (13,995) (13,995)
Other comprehensive income (loss),
net of tax ............................... 1,878 1,878
Stock issued under employee benefit plans ... 35,613 4 654 658
Stock issued under dividend reinvestment
and stock purchase plan .................. 28,487 5 946 951
Stock options exercised ..................... 49,689 6 488 494
Stock redeemed .............................. (148,405) (20) (4,313) (4,333)
Issuance of stock related to acquisitions.... 2,912,869 364 68,183 68,547
Five percent (5%) stock dividend............. 774,188 97 (97)
Cash paid in lieu of fractional shares....... (35) (35)
----------- -------- -------- --------- -------- ---------
Balances, December 31, 2002 16,322,748 2,040 116,503 138,110 4,476 261,129
Net income for 2003.......................... 27,571 27,571
Cash dividends ($.90 per share).............. (16,557) (16,557)
Other comprehensive income (loss),
net of tax ............................... (2,231) (2,231)
Stock issued under employee benefit plans ... 39,747 5 814 819
Stock issued under dividend reinvestment
and stock purchase plan .................. 48,168 6 1,218 1,224
Stock options exercised ..................... 66,513 8 1,183 1,191
Stock redeemed .............................. (17,915) (2) (486) (488)
Issuance of stock related to acquisition..... 1,173,996 147 31,188 31,335
Five percent (5%) stock dividend............. 879,577 110 (110)
Cash paid in lieu of fractional shares....... (28) (28)
----------- -------- -------- --------- -------- ---------
Balances, December 31, 2003 18,512,834 2,314 150,310 149,096 2,245 303,965
Net income for 2004.......................... 29,411 29,411
Cash dividends ($.92 per share).............. (17,048) (17,048)
Other comprehensive income (loss),
net of tax ............................... (2,285) (2,285)
Stock issued under employee benefit plans ... 45,267 6 897 903
Stock issued under dividend reinvestment
and stock purchase plan .................. 50,799 6 1,272 1,278
Stock options exercised ..................... 90,338 11 1,393 1,404
Stock redeemed .............................. (193,789) (24) (4,702) (4,726)
Issuance of stock related to acquisition..... 68,548 9 1,692 1,701
----------- -------- -------- --------- -------- ---------
Balances, December 31, 2004 18,573,997 $ 2,322 $150,862 $ 161,459 $ (40) $ 314,603
=========== ======== ======== ========= ======== =========
See notes to consolidated financial statements.
23
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Cash Flows
===============================================================================================================
Year Ended December 31,
(in thousands, except share data) 2004 2003 2002
===============================================================================================================
Operating activities:
Net income ......................................................... $ 29,411 $ 27,571 $ 27,836
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses ........................................ 5,705 9,477 7,174
Depreciation and amortization..................................... 5,064 4,769 4,273
Mortgage loans originated for sale ............................... (83,313) (212,243) (140,584)
Proceeds from sales of mortgage loans ............................ 82,989 230,745 126,905
Net change in
Interest receivable .......................................... (478) 1,368 763
Interest payable ............................................. (269) (1,695) (1,318)
Other adjustments ................................................ 842 5,677 (7,354)
--------- --------- ---------
Net cash provided by operating activities .................... 39,951 65,669 17,695
--------- --------- ---------
Investing activities:
Net change in interest-bearing deposits ............................ (1,202) (4,573) 10,729
Purchases of
Securities available for sale .................................... (214,393) (260,467) (182,511)
Proceeds from maturities of
Securities available for sale .................................... 116,294 174,003 164,273
Securities held to maturity ...................................... 4,307
Proceeds from sales of
Securities available for sale .................................... 32,336 58,245 21,363
Purchase of Federal Reserve and Federal Home Loan Bank stock (7,356) (4,093) (3,059)
Net change in loans ................................................ (83,198) (56,825) (100,650)
Net cash paid in acquisition ....................................... (201) (7,793) (12,532)
Other adjustments .................................................. (6,106) (2,262) (2,435)
--------- --------- ---------
Net cash used by investing activities......................... (163,826) (103,765) (100,515)
--------- --------- ---------
Cash flows from financing activities:
Net change in
Demand and savings deposits ...................................... 89,008 39,400 34,818
Certificates of deposit and other time deposits .................. (42,959) 14,476 (26,662)
Receipt of borrowings .............................................. 181,211 73,303 138,981
Repayment of borrowings ............................................ (124,763) (84,755) (32,047)
Cash dividends ..................................................... (17,048) (16,557) (13,995)
Stock issued under employee benefit plans .......................... 903 819 658
Stock issued under dividend reinvestment
and stock purchase plan .......................................... 1,278 1,224 951
Stock options exercised ............................................ 1,404 1,191 494
Stock redeemed ..................................................... (4,726) (488) (4,333)
Cash paid in lieu of issuing fractional shares ..................... (28) (35)
--------- --------- ---------
Net cash provided by activities .............................. 84,308 28,585 98,830
--------- --------- ---------
Net change in cash and cash equivalents ............................... (39,567) (9,511) 16,010
Cash and cash equivalents, beginning of year .......................... 109,527 119,038 103,028
--------- --------- ---------
Cash and cash equivalents, end of year ................................ $ 69,960 $ 109,527 $ 119,038
========= ========= =========
Additional cash flows information:
Interest paid ....................................................... $ 51,854 $ 53,727 $ 53,228
Income tax paid ..................................................... 10,501 13,952 14,313
See notes to consolidated financial statements.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of First Merchants Corporation
("Corporation"), and its wholly owned subsidiaries, First Merchants Bank, N.A.
("First Merchants"), The Madison Community Bank, N.A. ("Madison"), First United
Bank, N.A. ("First United"), The Randolph County Bank, N.A. ("Randolph County"),
The Union County National Bank ("Union National"), First National Bank ("First
National"), Decatur Bank and Trust Company, N.A. ("Decatur"), Frances Slocum
Bank & Trust Company, N.A. ("Frances Slocum"), Lafayette Bank and Trust Company,
N.A. ("Lafayette"), and Commerce National Bank ("Commerce National"),
(collectively the "Banks"), Merchants Trust Company, National Association
("MTC"), First Merchants Insurance Services, Inc. ("FMIS"), First Merchants
Reinsurance Company ("FMRC"), Indiana Title Insurance Company ("ITIC") and CNBC
Retirement Services, Inc. ("CRS, Inc."), conform to generally accepted
accounting principles and reporting practices followed by the banking industry.
The more significant of the policies are described below. Effective January 1,
2005, Union National was merged into Randolph County, and the name of the
continuing institution is United Communities National Bank.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The Corporation is a financial holding company whose principal activity is the
ownership and management of the Banks and operates in a single significant
business segment. The Banks operate under national bank charters and provide
full banking services, including trust services. As national banks, the Banks
are subject to the regulation of the Office of the Comptroller of the Currency
and the Federal Deposit Insurance Corporation.
The Banks generate commercial, mortgage, and consumer loans and receive deposits
from customers located primarily in north-central and east-central Indiana and
Butler, Franklin and Hamilton counties in Ohio. The Banks' loans are generally
secured by specific items of collateral, including real property, consumer
assets and business assets.
CONSOLIDATION
The consolidated financial statements include the accounts of the Corporation
and all its subsidiaries, after elimination of all material intercompany
transactions.
INVESTMENT SECURITIES-Debt securities are classified as held to maturity when
the Corporation has the positive intent and ability to hold the securities to
maturity. Securities held to maturity are carried at amortized cost. Debt
securities not classified as held to maturity are classified as available for
sale. Securities available for sale are carried at fair value with unrealized
gains and losses reported separately in accumulated other comprehensive income,
net of tax.
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES continued
Amortization of premiums and accretion of discounts are recorded as interest
income from securities. Realized gains and losses are recorded as net security
gains (losses). Gains and losses on sales of securities are determined on the
specific-identification method.
Available-for-sale and held-to-maturity securities are reviewed quarterly for
possible other-than-temporary impairment. The review includes an analysis of the
facts and circumstances of each individual investment such as the length of time
the fair value has been below cost, the expectation for that security's
performance, the credit worthiness of the issuer and the Corporation's ability
to hold the security to maturity. A decline in value that is considered to be
other-than temporary is recorded as a loss within other operating income in the
consolidated statements of income.
LOANS HELD FOR SALE are carried at the lower of aggregate cost or market. Market
is determined using the aggregate method. Net unrealized losses, if any, are
recognized through a valuation allowance by charges to income based on the
difference between estimated sales proceeds and aggregate cost.
LOANS held in the Corporation's portfolio are carried at the principal amount
outstanding. Certain nonaccrual and substantially delinquent loans may be
considered to be impaired. A loan is impaired when, based on current information
or events, it is probable that the Banks will be unable to collect all amounts
due (principal and interest) according to the contractual terms of the loan
agreement. In applying the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 114, the Corporation considers its investment in
one-to-four family residential loans and consumer installment loans to be
homogeneous and therefore excluded from separate identification for evaluation
of impairment. Interest income is accrued on the principal balances of loans,
except for installment loans with add-on interest, for which a method that
approximates the level yield method is used. The accrual of interest on impaired
loans is discontinued when, in management's opinion, the borrower may be unable
to meet payments as they become due. When interest accrual is discontinued, all
unpaid accrued interest is reversed when considered uncollectable. Interest
income is subsequently recognized only to the extent cash payments are received.
Certain loan fees and direct costs are being deferred and amortized as an
adjustment of yield on the loans.
ALLOWANCE FOR LOAN LOSSES is maintained to absorb losses inherent in the loan
portfolio and is based on ongoing, quarterly assessments of the probable losses
inherent in the loan portfolio. The allowance is increased by the provision for
loan losses, which is charged against current operating results. Loan losses are
charged against the allowance when management believes the uncollectibility of a
loan balance is confirmed. Subsequent recoveries, if any, are credited to the
allowance. The Corporation's methodology for assessing the appropriateness of
the allowance consists of three key elements - the determination of the
appropriate reserves for specifically identified loans, historical losses, and
economic, environmental or qualitative factors.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES continued
Larger commercial loans that exhibit probable or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and legal options available to the Corporation. Included in the review of
individual loans are those that are impaired as provided in SFAS No. 114. Any
allowances for impaired loans are measured based on the present value of
expected future cash flows discounted at the loan's effective interest rate or
fair value of the underlying collateral. The Corporation evaluates the
collectibility of both principal and interest when assessing the need for a loss
accrual. Historical loss rates are applied to other commercial loans not subject
to specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans
are not individually risk graded. Rather, credit scoring systems are used to
assess credit risks. Reserves are established for each pool of loans using loss
rates based on a five year average net charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted for
significant factors that, in management's judgment, reflect the impact of any
current conditions on loss recognition. Factors which management considers in
the analysis include the effects of the national and local economies, trends in
the nature and volume of loans (delinquencies, charge-offs and nonaccrual
loans), changes in mix, asset quality trends, risk management and loan
administration, changes in the internal lending policies and credit standards,
collection practices and examination results from bank regulatory agencies and
the Corporation's internal loan review.
An unallocated reserve, primarily based on the factors noted above, is
maintained to recognize the imprecision in estimating and measuring loss when
evaluating reserves for individual loans or pools of loans. Allowances on
individual loans and historical loss rates are reviewed quarterly and adjusted
as necessary based on changing borrower and/or collateral conditions and actual
collection and charge-off experience.
PREMISES AND EQUIPMENT are carried at cost net of accumulated depreciation.
Depreciation is computed using the straight-line and declining balance methods
based on the estimated useful lives of the assets. Maintenance and repairs are
expensed as incurred, while major additions and improvements are capitalized.
Gains and losses on dispositions are included in current operations.
FEDERAL RESERVE AND FEDERAL HOME LOAN BANK STOCK are required investments for
institutions that are members of the Federal Reserve Bank ("FRB") and Federal
Home Loan Bank ("FHLB") systems. The required investment in the common stock is
based on a predetermined formula.
INTANGIBLE ASSETS that are subject to amortization, including core deposit
intangibles, are being amortized on both the straight-line and accelerated basis
over 10 years. Intangible assets are periodically evaluated as to the
recoverability of their carrying value.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES continued
GOODWILL is maintained by applying the provisions of SFAS No. 142. Goodwill is
reviewed for impairment annually in accordance with this statement with any loss
recognized through the income statement, at that time.
INCOME TAX in the consolidated statements of income includes deferred income tax
provisions or benefits for all significant temporary differences in recognizing
income and expenses for financial reporting and income tax purposes. The
Corporation files consolidated income tax returns with its subsidiaries.
STOCK OPTIONS are granted for a fixed number of shares to employees. The
Corporation's stock-based employee compensation plans are described more fully
in Note 16. The Corporation's stock option plans are accounted for in accordance
with Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock
Issued to Employees, and related interpretations.
APB No. 25 requires compensation expense for stock options to be recognized only
if the market price of the underlying stock exceeds the exercise price on the
date of the grant. Accordingly, the Corporation recognized compensation expense
of $12,000 in 2003 and $23,000 in 2002, related to specific grants in which the
market price exceeded the exercise price. For all remaining grants, no
stock-based employee compensation cost is reflected in net income, as options
granted under those plans had an exercise price equal to the market value of the
underlying common stock on the grant date.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
Year Ended December 31
2004 2003 2002
----------------------------
Net income, as reported ...................... $29,411 $27,571 $27,836
Add: Total stock-based employee compensation
cost included in reported net income, net
of income taxes ........................... 12 23
Less: Total stock-based employee compensation
cost determined under the fair value based
method, net of income taxes ............... (1,083) (1,034) (1,029)
------- ------- -------
Pro forma net income $28,328 $26,549 $26,830
======= ======= =======
Earnings per share:
Basic - as reported ....................... $ 1.59 $ 1.51 $ 1.70
Basic - pro forma ......................... $ 1.53 $ 1.46 $ 1.64
Diluted - as reported ..................... $ 1.58 $ 1.50 $ 1.69
Diluted - pro forma ....................... $ 1.52 $ 1.45 $ 1.63
EARNINGS PER SHARE have been computed based upon the weighted average common and
common equivalent shares outstanding during each year.
NOTE 2
BUSINESS COMBINATIONS
Effective October 15, 2004, the Corporation acquired Mangas Agencies, Inc.,
which was merged into FMIS, a wholly-owned subsidiary of the Corporation. The
Corporation
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 2
BUSINESS COMBINATIONS continued
issued 68,548 shares of its common stock at a cost of $24.80 per share to
complete the transaction. The acquisition was deemed to be an immaterial
acquisition.
On March 1, 2003, the Corporation acquired 100 percent of the outstanding stock
of CNBC Bancorp, the holding company of Commerce National, CRS, Inc. and CNBC
Trust I. Commerce National is a national chartered bank located in Columbus,
Ohio. CNBC Bancorp was merged into the Corporation, and Commerce National
maintained its national charter as a wholly-owned subsidiary of the Corporation.
CRS, Inc. and the CNBC Trust I are also maintained as wholly-owned subsidiaries
of the Corporation. The Corporation issued approximately 1,225,242 shares of its
common stock and approximately $24,562,000 in cash to complete the transaction.
As a result of the acquisition, the Corporation will have an opportunity to
increase its customer base and continue to increase its market share. The
purchase had a recorded acquisition price of $55,729,000, including goodwill of
$30,291,000 none of which is deductible for tax purposes. Additionally, core
deposit intangibles totaling $8,171,000 were recognized and are being amortized
over 10 years using the 150 percent declining balance method.
The combination was accounted for under the purchase method of accounting. All
assets and liabilities were recorded at their fair values as of March 1, 2003.
The purchase accounting adjustments are being amortized over the life of the
respective asset or liability. Commerce National's results of operations are
included in the Corporation's consolidated income statement beginning March 1,
2003. The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition.
Investments....................... $ 12,500
Loans............................. 298,702
Premises and equipment............ 1,293
Core deposit intangibles.......... 8,171
Goodwill.......................... 30,291
Other............................. 20,789
--------
Total assets acquired.......... 371,746
--------
Deposits.......................... 271,537
Other............................. 44,480
--------
Total liabilities acquired..... 316,017
--------
Net assets acquired............ $ 55,729
========
The following proforma disclosures, including the effect of the purchase
accounting adjustments, depict the results of operations as though the CNBC
Bancorp merger had taken place at the beginning of each period.
Year Ended
December 31,
2003 2002
-------- --------
Net Interest Income........... $104,797 $102,641
Net Income.................... 23,601 29,454
Per Share - combined:
Basic Net Income........... 1.28 1.67
Diluted Net Income......... 1.27 1.66
Effective January 1, 2003, the Corporation formed MTC, a wholly-owned subsidiary
of the Corporation, through a capital contribution totaling approximately
$2,038,000.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 2
BUSINESS COMBINATIONS continued
On January 1, 2003, MTC purchased the trust operations of First Merchants, First
National and Lafayette for a fair value acquisition price of $20,687,000. MTC
united the trust and asset management services of all affiliate banks of the
Corporation. All intercompany transactions related to this purchase by MTC have
been eliminated in the consolidated financial statements of the Corporation.
Effective September 6, 2002, the Corporation acquired Stephenson Insurance
Service, Inc., which was merged into FMIS, a wholly-owned subsidiary of the
Corporation. The Corporation issued 38,090 shares of its common stock at a cost
of $26.16 per share to complete the transaction. This acquisition was deemed to
be an immaterial acquisition.
On April 1, 2002, the Corporation acquired 100 percent of the outstanding stock
of Lafayette Bancorporation, the holding company of Lafayette, which is located
in Lafayette, Indiana. Lafayette is a national chartered bank with branches
located in central Indiana. Lafayette Bancorporation was merged into the
Corporation, and Lafayette maintained its bank charter as a subsidiary of First
Merchants Corporation. The Corporation issued approximately 3,057,298 shares of
its common stock at a cost of $21.30 per share and approximately $50,867,000 in
cash to complete the transaction. As a result of the acquisition, the
Corporation has an opportunity to increase its customer base and continue to
increase its market share. The purchase had a recorded acquisition price of
$115,978,000, including goodwill of $57,893,000 none of which is deductible for
tax purposes. Additionally, core deposit intangibles totaling $16,052,000 were
recognized and are being amortized over 10 years using the 150 percent declining
balance method.
The combination was accounted for under the purchase method of accounting. All
assets and liabilities were recorded at their fair values as of April 1, 2002.
The purchase accounting adjustments are being amortized over the life of the
respective asset or liability. Lafayette's results of operations are included in
the Corporation's consolidated income statement beginning April 1, 2002. The
following table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition.
Investments....................... $104,717
Loans............................. 552,016
Premises and equipment............ 10,269
Core deposit intangibles.......... 16,052
Goodwill.......................... 57,893
Other............................. 64,074
--------
Total assets acquired.......... 805,021
--------
Deposits.......................... 607,281
Other............................. 81,762
--------
Total liabilities acquired..... 689,043
--------
Net assets acquired............ $115,978
========
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 2
BUSINESS COMBINATIONS continued
The following proforma disclosures, including the effect of the purchase
accounting adjustments, depict the results of operations as though the Lafayette
merger had taken place at the beginning of each period.
Year Ended
December 31,
2002
------------
Net Interest Income .................... $ 98,855
Net Income ............................. 28,016
Per share - combined:
Basic Net Income ..................... 1.16
Diluted Net Income ................... 1.60
Effective January 1, 2002, the Corporation acquired Delaware County Abstract
Company, Inc. and Beebe & Smith Title Insurance Company, Inc., which were merged
into ITIC, a wholly-owned subsidiary of the Corporation. The Corporation issued
approximately 114,365 shares of its common stock at a cost of $21.31 per share
to complete the transaction. ITIC's operations were subsequently contributed to
Indiana Title Insurance Company, LLC in which the Corporation has a 52.12
percent ownership interest. This acquisition was deemed to be an immaterial
acquisition.
NOTE 3
RESTRICTION ON CASH AND DUE FROM BANKS
The Banks are required to maintain reserve funds in cash and/or on deposit with
the Federal Reserve Bank. The reserve required at December 31, 2004, was
$4,397,000.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 4
INVESTMENT SECURITIES
- ---------------------------------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
=========================================================================================================
Available for sale at December 31, 2004
U.S. Treasury .................................... $ 1,745 $ 1 $ 1,744
Federal agencies ................................. 65,325 $ 73 332 65,066
State and municipal .............................. 150,284 5,243 82 155,445
Mortgage-backed securities ....................... 183,200 485 1,980 181,705
Other asset-backed securities .................... 18 18
Marketable equity securities ..................... 12,191 8 12,199
---------- ---------- ---------- ----------
Total available for sale ...................... 412,763 5,809 2,395 416,177
---------- ---------- ---------- ----------
Held to maturity at December 31, 2004
State and municipal .............................. 5,306 162 5,468
Mortgage-backed securities ....................... 52 52
---------- ---------- ---------- ----------
Total held to maturity ........................ 5,358 162 5,520
---------- ---------- ---------- ----------
Total investment securities ................... $ 418,121 $ 5,971 $ 2,395 $ 421,697
========== ========== ========== ==========
Available for sale at December 31, 2003
U.S. Treasury .................................... $ 1,498 $ 1,498
Federal agencies ................................. 38,290 $ 523 $ 52 38,761
State and municipal .............................. 118,794 6,932 86 125,640
Mortgage-backed securities ....................... 174,208 813 1,817 173,204
Corporate obligations ............................ 500 16 516
Marketable equity securities ..................... 9,237 4 9,241
---------- ---------- ---------- ----------
Total available for sale ...................... 342,527 8,288 1,955 348,860
---------- ---------- ---------- ----------
Held to maturity at December 31, 2003
State and municipal .............................. 7,860 389 8,249
Mortgage-backed securities ....................... 77 77
---------- ---------- ---------- ----------
Total held to maturity ........................ 7,937 389 8,326
---------- ---------- ---------- ----------
Total investment securities ................... $ 350,464 $ 8,677 $ 1,955 $ 357,186
========== ========== ========== ==========
Certain investments in debt securities are reported in the financial statements
at an amount less than their historical cost. The historical cost of these
investments totaled $192,366,000 and $102,973,000 at December 31, 2004 and 2003,
respectively. Total fair value of these investments was $189,971,000 and
$101,018,000, which is approximately 45.1 and 28.3 percent of the Corporation's
available-for-sale and held-to-maturity investment portfolio at December 31,
2004 and 2003, respectively. These declines primarily resulted from recent
increases in market interest rates.
Based on evaluation of available evidence, including recent changes in market
interest rates, credit rating information and information obtained from
regulatory filings, management believes the declines in fair value for these
securities are temporary. Should the impairment of any of these securities
become other than temporary, the cost basis of the investment will be reduced
and the resulting loss recognized in net income in the period the
other-than-temporary impairment is identified.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 4
INVESTMENT SECURITIES continued
The following tables show the Corporation's gross unrealized losses and fair
value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2004 and 2003:
Less than 12 12 Months or Total
Months Longer
---------------------------------------------------------------------------
GROSS GROSS GROSS
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
---------------------------------------------------------------------------
Temporarily impaired investment
securities at December 31, 2004:
U.S. Treasury ....................................... $ 1,496 $ (1) $ 1,496 $ (1)
Federal agencies .................................... 46,227 (303) $ 1,472 $ (29) 47,699 (332)
State and municipal ................................. 2,976 (20) 1,094 (62) 4,070 (82)
Mortgage-backed securities .......................... 109,213 (1,129) 27,493 (851) 136,706 (1,980)
---------- ---------- ---------- ---------- ---------- ----------
Total temporarily impaired investment securities . $ 159,912 $ (1,453) $ 30,059 $ (942) $189,971 $ (2,395)
========== ========== ========== ========== ========== ==========
Less than 12 12 Months or Total
Months Longer
---------------------------------------------------------------------------
GROSS GROSS GROSS
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
---------------------------------------------------------------------------
Temporarily impaired investment
securities at December 31, 2003:
Federal agencies .................................... $ 7,410 $ (50) $ 747 $ (2) $ 8,157 $ (52)
State and municipal ................................. 2,547 (82) 166 (4) 2,713 (86)
Mortgage-backed securities .......................... 90,148 (1,817) 90,148 (1,817)
---------- ---------- ---------- ---------- ---------- ----------
Total temporarily impaired investment securities . $ 100,105 $ (1,949) $ 913 $ (6) $ 101,018 $ (1,955)
========== ========== ========== ========== ========== ==========
The amortized cost and fair value of securities available for sale and held to
maturity at December 31, 2004, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because issuers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
- ----------------------------------------------------------------------------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY
AMORTIZED COST FAIR VALUE AMORTIZED COST FAIR VALUE
================================================================================================================
Maturity distribution at December 31, 2004:
Due in one year or less............................ $ 13,026 $ 13,128 $ 1,110 $ 1,125
Due after one through five years .................. 129,277 130,362 2,760 2,856
Due after five through ten years .................. 50,916 53,439 295 328
Due after ten years ............................... 24,132 25,323 1,141 1,159
--------- --------- -------- --------
217,351 222,252 5,306 5,468
Mortgage-backed securities ........................ 183,200 181,705 52 52
Other asset-backed securities ..................... 21 21
Marketable equity securities ...................... 12,191 12,199
--------- --------- -------- --------
Totals .......................................... $ 412,763 $ 416,177 $ 5,358 $ 5,520
========= ========= ======== ========
Securities with a carrying value of approximately $157,356,000 and $158,474,000
were pledged at December 31, 2004 and 2003 to secure certain deposits and
securities sold under repurchase agreements, and for other purposes as permitted
or required by law.
Proceeds from sales of securities available for sale during 2004, 2003 and 2002
were $32,336,000, $58,245,000 and $21,363,000. Gross gains of $1,502,000,
$950,000 and $739,000 in 2004, 2003 and 2002, and gross losses of $314,000 in
2004 were realized on those sales.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 5
LOANS AND ALLOWANCE
2004 2003
============================================================================================
Loans at December 31:
Commercial and industrial loans .................................. $ 462,538 $ 443,140
Agricultural production financing and other loans to farmers ..... 98,902 95,048
Real estate loans:
Construction ................................................ 164,738 149,865
Commercial and farmland ..................................... 709,163 564,578
Residential ................................................. 761,163 866,477
Individuals' loans for household and other personal expenditures . 198,532 196,093
Tax-exempt loans ................................................. 8,203 16,363
Other loans ...................................................... 24,812 21,939
---------- ----------
2,428,051 2,353,503
Allowance for loan losses........................................ (22,548) (25,493)
---------- ----------
Total loans ................................................. $2,405,503 $2,328,010
========== ==========
2004 2003 2002
===============================================================================
Allowance for loan losses:
Balance, January 1 ................... $ 25,493 $ 22,417 $ 15,141
Allowance acquired in acquisitions 3,727 6,902
Provision for losses ................. 5,705 9,477 7,174
Recoveries on loans .................. 2,251 2,011 1,313
Loans charged off .................... (10,901) (12,139) (8,113)
---------- ---------- ----------
Balance, December 31 ................. $ 22,548 $ 25,493 $ 22,417
========== ========== ==========
Information on nonaccruing, contractually past due 90 days or more other than
nonaccruing and restructured loans is summarized below:
2004 2003 2002
===============================================================================
At December 31:
Non-accrual loans ....................... $ 15,355 $ 19,453 $ 14,134
Loans contractually past due 90 days
or more other than nonaccruing ........ 1,907 6,530 6,676
Restructured loans ...................... 2,019 641 2,508
---------- ---------- ----------
Total non-performing loans.......... $ 19,281 $ 26,624 $ 23,318
========== ========== ==========
Nonaccruing loans are loans which are reclassified to a nonaccruing status when
in management's judgment the collateral value and financial condition of the
borrower do not justify accruing interest. Interest previously recorded, but not
deemed collectible, is reversed and charged against current income. Interest
income on these loans is then recognized when collected.
Restructured loans are loans for which the contractual interest rate has been
reduced or other concessions are granted to the borrower, because of a
deterioration in the financial condition of the borrower resulting in the
inability of the borrower to meet the original contractual terms of the loans.
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 5
LOANS AND ALLOWANCE continued
Information on impaired loans is summarized below: 2004 2003 2002
============================================================================================
As of, and for the year ending December 31:
Impaired loans with an allowance ................. $ 7,728 $ 12,725 $ 16,901
Impaired loans for which the discounted
cash flows or collateral value exceeds the
carrying value of the loan ................... 41,683 32,047 27,450
---------- ---------- ----------
Total impaired loans ...................... $ 49,411 $ 44,772 $ 44,351
========== ========== ==========
Total impaired loans as a percent
of total loans ............................... 2.03% 1.90% 2.19%
Allowance for impaired loans (included in the
Corporation's allowance for loan losses) ..... $ 1,673 $ 5,728 $ 7,299
Average balance of impaired loans ................ 59,568 50,245 49,663
Interest income recognized on impaired loans ..... 4,166 3,259 3,656
Cash basis interest included above ............... 3,029 2,714 2,344
NOTE 6
PREMISES AND EQUIPMENT
2004 2003
===============================================================================
Cost at December 31:
Land ............................................. $ 8,281 $ 7,463
Buildings and leasehold improvements ............. 40,520 40,308
Equipment ........................................ 38,852 38,777
---------- ----------
Total cost ................................... 87,653 86,548
Accumulated depreciation and amortization ........ (49,399) (46,909)
---------- ----------
Net .......................................... $ 38,254 $ 39,639
========== ==========
The Corporation is committed under various noncancelable lease contracts for
certain subsidiary office facilities. Total lease expense for 2004, 2003 and
2002 was $2,151,000, $1,629,000 and $1,027,000, respectively. The future minimum
rental commitments required under the operating leases in effect at December 31,
2004, expiring at various dates through the year 2013 are as follows for the
years ending December 31:
====================================================
2005 ..................................... $ 1,746
2006 ..................................... 1,515
2007 ..................................... 1,145
2008 ..................................... 880
2009 ..................................... 829
After 2009 ................................ 2,287
-------
Total future minimum obligations $ 8,402
=======
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 7
GOODWILL
The changes in the carrying amount of goodwill at December 31 are noted below.
No impairment loss was recorded in 2004 and 2003.
2004 2003
===============================================================================
Balance, January 1 .................................. $ 118,679 $ 87,640
Goodwill acquired ................................... 1,900 30,291
Adjustments to previously
acquired goodwill ................................. 36 748
---------- ----------
Balance, December 31 ................................ $ 120,615 $ 118,679
========== ==========
NOTE 8
CORE DEPOSIT INTANGIBLES
The carrying basis and accumulated amortization of recognized core deposit
intangibles at December 31 were:
2004 2003
===============================================================================
Gross carrying amount ............................... $ 31,073 $ 31,073
Accumulated amortization ............................ (10,404) (7,029)
---------- ----------
Core deposit intangibles ......................... $ 20,669 $ 24,044
========== ==========
Amortization expense for the years ended December 31, 2004, 2003 and 2002, was
$3,375,000, $3,704,000 and $2,571,000, respectively. Estimated amortization
expense for each of the following five years is:
2005 ..................................... $ 3,065
2006 ..................................... 3,013
2007 ..................................... 3,013
2008 ..................................... 3,013
2009 ..................................... 3,013
After 2009 ............................... 5,552
--------
$ 20,669
========
NOTE 9
DEPOSITS
2004 2003
===============================================================================
Deposits at December 31:
Demand deposits .................................. $ 703,989 $ 706,202
Savings deposits ................................. 634,132 643,328
Certificates and other time deposits
of $100,000 or more ............................ 258,362 279,810
Other certificates and time deposits ............. 811,667 732,761
---------- ----------
Total deposits ............................... $2,408,150 $2,362,101
========== ==========
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 9
DEPOSITS continued
=====================================================
Certificates and other time deposits maturing
in years ending December 31:
2005 .................................... $ 608,607
2006 .................................... 214,577
2007 .................................... 168,394
2008 .................................... 47,572
2009 .................................... 27,009
After 2009 .............................. 3,870
----------
$1,070,029
==========
NOTE 10
BORROWINGS
2004 2003
===============================================================================
Borrowings at December 31:
Federal funds purchased .......................... $ 32,550
Securities sold under repurchase agreements ...... 87,472 $ 71,095
Federal Home Loan Bank advances .................. 223,663 212,779
Subordinated debentures, revolving credit
lines and term loans ........................... 97,206 97,782
Other borrowed funds.............................. 1,514
---------- ----------
Total borrowings ............................. $ 440,891 $ 383,170
========== ==========
Securities sold under repurchase agreements consist of obligations of the Banks
to other parties. The obligations are secured by U.S. Treasury, Federal agency
obligations and corporate asset-backed securities. The maximum amount of
outstanding agreements at any month-end during 2004 and 2003 totaled $87,472,000
and $74,969,000, and the average of such agreements totaled $62,669,000 and
$70,354,000 during 2004 and 2003.
Maturities of securities sold under repurchase agreements; Federal Home Loan
Bank advances; and subordinated debentures, revolving credit lines and term
loans as of December 31, 2004, are as follows:
SUBORDENATED DEBENTURES
SECURITIES SOLD UNDER FEDERAL HOME LOAN REVOLOVING CREDIT LINES
REPURCHASE AGREEMENTS BANK ADVANCES AND TERM LOANS
- ----------------------------------------------------------------------------------------------------------------------
AMOUNT AMOUNT AMOUNT
======================================================================================================================
Maturities in years ending December 31:
2005 .............................. $ 87,152 $ 33,477 $ 8,250
2006 .............................. 320 29,859
2007 .............................. 24,995
2008 .............................. 19,306
2009 .............................. 9,428
After 2009 ........................ 106,598 88,956
-------- --------- --------
Total ...................... $ 87,472 $ 223,663 $ 97,206
======== ========= ========
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 10
BORROWINGS continued
The terms of a security agreement with the FHLB require the Corporation to
pledge, as collateral for advances, qualifying first mortgage loans and all
otherwise unpledged investment securities in an amount equal to at least 160
percent of these advances. Advances are subject to restrictions or penalties in
the event of prepayment. The total available remaining borrowing capacity from
the FHLB at December 31, 2004, was $148,451,000.
Subordinated Debentures, Revolving Credit Lines and Term Loans. Three borrowings
were outstanding on December 31, 2004, for $97,206,000.
o First Merchants Capital Trust I. The subordinated debenture, entered
into on April 12, 2002, for $54,832,000 will mature on June 20, 2032.
The Corporation may redeem the debenture no earlier than June 30,
2007, subject to the prior approval of the Federal Reserve, as
required by law or regulation. Interest is fixed at 8.75 percent and
payable on March 31, June 30, September 30 and December 31 of each
year.
o CNBC Statutory Trust I. As part of the March 1, 2003, acquisition of
CNBC Bancorp, the Corporation assumed $4,124,000 of a junior
subordinated debenture entered into on February 22, 2001. The
subordinated debenture of $4, 124,000 will mature on February 22,
2031. Interest is fixed at 10.20 percent and payable on February 22
and August 22 of each year. The Corporation may redeem the debenture,
in whole or in part, at its option commencing February 22, 2011, at a
redemption price of 105.10 percent of the outstanding principal amount
and, thereafter, at a premium which declines annually. On or after
February 22, 2021, the securities may be redeemed at face value with
prior approval of the Board of Governors of the Federal Reserve
System.
o Lasalle Bank, N.A. The outstanding balance of a Loan and Subordinated
Debenture Loan Agreement ("LaSalle Agreement") entered into with
LaSalle Bank, N.A. on March 25, 2003 for $38,250,000. The LaSalle
Agreement includes three credit facilities:
o The Term Loan of $5,000,000 matures on March 25, 2010.
Interest is calculated at a floating rate equal to the
lender's prime rate or LIBOR plus 1.50 percent. The Term Loan
is secured by 100 percent of the common stock of First
Merchants Bank, N.A. and 100 percent of the common stock of
Lafayette Bank and Trust Company, N.A. The Agreement contains
several restrictive covenants, including the maintenance of
various capital adequacy levels, asset quality and
profitability ratios, and certain restrictions on dividends
and other indebtedness.
o The Revolving Loan had a balance of $8,250,000 at December 31,
2004. Interest is payable quarterly based on LIBOR plus 1
percent. Principal and interest are due on or before March
23,2005. The total principal amount outstanding at any one
time may not exceed $20,000,000. The Revolving Loan is secured
by 100 percent of the common stock of First Merchants Bank,
N.A. and 100 percent of the common stock of Lafayette Bank and
Trust Company, N.A. The Agreement contains several restrictive
covenants, including the maintenance of various capital
adequacy levels,
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 10
BORROWINGS continued
asset quality and profitability ratios, and certain
restrictions on dividends and other indebtedness.
o The Subordinated Debenture of $25,000,000 matures on March 25,
2010. Interest is calculated at a floating rate equal to, at
the Corporation's option, either the lender's prime rate or
LIBOR plus 2.50 percent. The Subordinated Debenture is treated
as Tier 2 Capital for regulatory capital purposes.
NOTE 11
LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The loans are serviced primarily for the Federal
Home Loan Mortgage Corporation, and the unpaid balances totaled $113,344,000,
$105,865,000 and $90,346,000 at December 31, 2004, 2003 and 2002. The amount of
capitalized servicing assets is considered immaterial.
NOTE 12
INCOME TAX
2004 2003 2002
=========================================================================================================
Income tax expense for the year ended December 31:
Currently payable:
Federal ..................................................... $ 11,934 $ 9,475 $ 11,869
State ....................................................... 1,772 1,569 2,615
Deferred:
Federal ..................................................... (615) (597) (446)
State ....................................................... 94 270 (57)
---------- ---------- ----------
Total income tax expense ................................. $ 13,185 $ 10,717 $ 13,981
========== ========== ==========
Reconciliation of federal statutory to actual tax expense:
Federal statutory income tax at 34% ......................... $ 14,483 $ 13,030 $ 14,085
Tax-exempt interest ......................................... (2,098) (2,198) (2,006)
Graduated tax rates ......................................... 335 289 355
Effect of state income taxes ................................ 1,178 1,213 1,613
Earnings on life insurance .................................. (472) (512) (133)
Tax credits ................................................. (274) (317) (293)
Other ....................................................... 33 (788) 360
---------- ---------- ----------
Actual tax expense ....................................... $ 13,185 $ 10,717 $ 13,981
========== ========== ==========
Tax expense applicable to security gains and losses for the years ended December
31, 2004, 2003 and 2002, was $475,000, $380,000, and $296,000, respectively.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 12
INCOME TAX continued
A cumulative net deferred tax liability is included in the consolidated balance
sheets. The components of the net liability are as follows:
2004 2003
============================================================================================
Deferred tax liability at December 31:
Assets:
Differences in accounting for loan losses ..................... $ 9,438 $ 11,305
Deferred compensation ......................................... 2,707 2,514
State income tax .............................................. 524 18
Other ......................................................... 222 135
---------- ----------
Total assets .............................................. 12,891 13,972
---------- ----------
Liabilities:
Differences in depreciation methods ........................... 3,469 3,061
Differences in accounting for loans and securities ............ 8,181 9,905
Differences in accounting for loan fees ....................... 628 715
Differences in accounting for pensions
and other employee benefits ................................. 339 861
State income tax ..............................................
Net unrealized gain on securities available for sale........... 2,220 2,123
Other ......................................................... 1,317 1,102
---------- ----------
Total liabilities ......................................... 16,154 17,767
---------- ----------
Net deferred tax liability ................................ $ (3,263) $ (3,795)
========== ==========
NOTE 13
COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business there are outstanding commitments and
contingent liabilities, such as commitments to extend credit and standby letters
of credit, which are not included in the accompanying financial statements. The
Corporation's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments for commitments to extend credit and
standby letters of credit is represented by the contractual or notional amount
of those instruments. The Banks use the same credit policies in making such
commitments as they do for instruments that are included in the consolidated
balance sheets.
Financial instruments whose contract amount represents credit risk as of
December 31, were as follows:
2004 2003
--------- ---------
Commitments
to extend credit $ 540,087 $ 481,771
Standby letters
of credit 22,024 25,242
Commitments to extend credit are agreements to lend to a customer, as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Banks evaluate each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Banks upon extension of credit, is based on management's credit
evaluation. Collateral held varies, but may
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 13
COMMITMENTS AND CONTINGENT LIABILITIES continued
include accounts receivable, inventory, property and equipment, and
income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Banks to
guarantee the performance of a customer to a third party.
The Corporation and subsidiaries are also subject to claims and lawsuits, which
arise primarily in the ordinary course of business. It is the opinion of
management that the disposition or ultimate resolution of such claims and
lawsuits will not have a material adverse effect on the consolidated financial
position of the Corporation.
NOTE 14
STOCKHOLDERS' EQUITY
National banking laws restrict the maximum amount of dividends that a bank may
pay in any calendar year. National banks are limited to the bank's retained net
income (as defined) for the current year plus those for the previous two years.
At December 31, 2004, First Merchants, Union National, First National and
Frances Slocum had no retained net profits available for 2005 dividends to the
Corporation without prior regulatory approval. The amount at December 31, 2004,
available for 2005 dividends from Madison, First United, Randolph County,
Decatur, Lafayette and Commerce National to the Corporation totaled $3,937,000,
$238,000, $927,000, $17,000, $2,807,000 and $3,164,000, respectively.
Total stockholders' equity for all subsidiaries at December 31, 2004, was
$393,772,000, of which $370,668,000 was restricted from dividend distribution to
the Corporation.
The Corporation has a Dividend Reinvestment and Stock Purchase Plan, enabling
stockholders to elect to have their cash dividends on all shares held
automatically reinvested in additional shares of the Corporation's common stock.
In addition, stockholders may elect to make optional cash payments up to an
aggregate of $2,500 per quarter for the purchase of additional shares of common
stock. The stock is credited to participant accounts at fair market value.
Dividends are reinvested on a quarterly basis.
On August 15, 2003 and August 13 2002, the Board of Directors of the Corporation
declared a five percent (5%) stock dividend on its outstanding common shares.
The new shares were distributed on September 12, 2003 and September 13, 2002, to
holders of record on August 29, 2003 and August 30, 2002, respectively.
NOTE 15
REGULATORY CAPITAL
The Corporation and Banks are subject to various regulatory capital requirements
administered by the federal banking agencies and are assigned to a capital
category. The assigned capital category is largely determined by three ratios
that are calculated according to the regulations: total risk adjusted capital,
Tier 1 capital,
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 15
REGULATORY CAPITAL continued
and Tier 1 leverage ratios. The ratios are intended to measure capital relative
to assets and credit risk associated with those assets and off-balance sheet
exposures of the entity. The capital category assigned to an entity can also be
affected by qualitative judgments made by regulatory agencies about the risk
inherent in the entity's activities that are not part of the calculated ratios.
There are five capital categories defined in the regulations, ranging from well
capitalized to critically undercapitalized. Classification of a bank in any of
the undercapitalized categories can result in actions by regulators that could
have a material effect on a bank's operations.
At December 31, 2004, the management of the Corporation believes that it meets
all capital adequacy requirements to which it is subject. The most recent
notifications from the regulatory agencies categorized the Corporation and Banks
as well capitalized under the regulatory framework for prompt corrective action.
To be categorized as well capitalized, the Banks must maintain a minimum total
capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier
I capital to average assets of 10 percent, 6 percent and 5 percent,
respectively. There have been no conditions or events since that notification
that management believes have changed this categorization.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 15
REGULATORY CAPITAL continued
Actual and required capital amounts and ratios are listed below.
2004 2003
- -----------------------------------------------------------------------------------------------------------------------------------
REQUIRED FOR REQUIRED FOR
ACTUAL ADEQUATE CAPITAL (1) ACTUAL ADEQUATE CAPITAL (1)
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
===================================================================================================================================
December 31
Total Capital (1)(to risk-weighted assets)
Consolidated ...................... $275,786 11.57% $190,736 8.00% $266,488 11.60% $183,793 8.00%
First Merchants ................... 68,064 11.47 47,474 8.00 67,425 11.08 48,667 8.00
First United ...................... 7,703 11.86 5,196 8.00 21,682 10.71 16,198 8.00
First United ...................... 7,703 11.86 5,196 8.00 6,679 10.95 4,882 8.00
Randolph County ................... 8,847 11.58 6,111 8.00 8,023 11.20 5,731 8.00
Union County ...................... 16,293 12.00 10,858 8.00 15,679 11.37 11,032 8.00
First National .................... 10,198 11.42 7,146 8.00 10,643 12.25 6,951 8.00
Decatur ........................... 11,419 11.62 7,862 8.00 11,273 11.84 7,616 8.00
Frances Slocum .................... 17,491 12.93 10,825 8.00 18,173 15.19 9,571 8.00
Lafayette ......................... 71,962 11.35 50,701 8.00 70,401 11.32 49,765 8.00
Commerce National ................. 36,829 10.70 27,532 8.00 36,698 12.31 23,851 8.00
Tier I Capital (1)(to risk-weighted assets)
Consolidated ...................... $228,234 9.57% $ 95,368 4.00% $215,995 9.40% $ 91,896 4.00%
First Merchants ................... 62,310 10.50 23,737 4.00 59,858 9.84 24,334 4.00
Madison ........................... 23,671 10.54 8,981 4.00 19,473 9.62 8,099 4.00
First United ...................... 7,100 10.93 2,598 4.00 5,985 9.81 2,441 4.00
Randolph County ................... 7,998 10.47 3,055 4.00 7,160 10.00 2,865 4.00
Union County ...................... 14,596 10.75 5,429 4.00 14,067 10.20 5,516 4.00
First National .................... 9,322 10.44 3,573 4.00 9,750 11.22 3,476 4.00
Decatur ........................... 10,635 10.82 3,931 4.00 10,268 10.79 3,808 4.00
Frances Slocum..................... 15,793 11.67 5,412 4.00 16,669 13.93 4,785 4.00
Lafayette ......................... 67,028 10.58 25,350 4.00 64,982 10.45 24,883 4.00
Commerce National ................. 27,648 8.03 13,766 4.00 27,472 9.21 11,926 4.00
Tier I Capital (1) (to average assets)
Consolidated ...................... $228,234 7.50% $121,711 4.00% $215,995 7.38% $117,110 4.00%
First Merchants ................... 62,310 7.78 32,024 4.00 59,858 7.37 32,475 4.00
Madison ........................... 23,671 9.01 10,510 4.00 19,473 8.07 9,658 4.00
First United ...................... 7,100 7.68 3,700 4.00 5,985 6.99 3,426 4.00
Randolph County ................... 7,998 8.42 3,799 4.00 7,160 7.89 3,632 4.00
Union County ...................... 14,596 7.47 7,814 4.00 14,067 7.30 7,709 4.00
First National .................... 9,322 7.99 4,664 4.00 9,750 8.53 4,571 4.00
Decatur ........................... 10,635 7.96 5,342 4.00 10,268 7.61 5,400 4.00
Frances Slocum..................... 15,793 9.58 6,593 4.00 16,669 10.52 6,341 4.00
Lafayette ......................... 67,028 7.94 33,747 4.00 64,982 8.02 32,397 4.00
Commerce National ................. 27,648 7.01 15,785 4.00 27,472 7.78 14,133 4.00
(1) as defined by regulatory agencies
NOTE 16
EMPLOYEE BENEFIT PLANS
The Corporation's defined-benefit pension plans cover substantially all of the
Corporation's employees. The benefits are based primarily on years of service
and employees' pay near retirement. Contributions are intended to provide not
only for benefits attributed to service-to-date, but also for those expected to
be earned in the future.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
The table below sets forth the plans' funded status and amounts recognized in
the consolidated balance sheets at December 31, using measurement dates of
September 30, 2004 and 2003.
December 31
2004 2003
===============================================================================
Change in benefit obligation
Benefit obligation at beginning of year ............ $ 45,579 $ 44,718
Service cost ....................................... 1,920 1,564
Interest cost ...................................... 2,789 2,617
Actuarial (gain) loss .............................. 1,917 (1,667)
Benefits paid ...................................... (1,847) (1,653)
-------- --------
Benefit obligation at end of year .................. 50,358 45,579
-------- --------
Change in plan assets
Fair value of plan assets at beginning of year ..... 33,940 31,650
Actual return on plan assets ....................... 3,080 3,876
Benefits paid ...................................... (1,847) (1,653)
Employer contributions ............................. 3,854 67
-------- --------
Fair value of plan assets at end of year ........... 39,027 33,940
-------- --------
Unfunded status .................................... (11,331) (11,639)
Unrecognized net actuarial loss..................... 10,944 9,656
Unrecognized prior service cost .................... 1,697 1,834
Unrecognized transition asset ...................... (27) (178)
-------- --------
Prepaid benefit cost (liability) ................... 1,283 (327)
Additional pension liability ....................... (5,416) (4,924)
-------- --------
Net minimum liability............................... $ (4,133) $ (5,251)
======== ========
Amounts recognized in the balance sheets consist of:
Prepaid benefit cost (liability) ................... $ 1,283 $ (327)
Additional pension liability ....................... (5,416) (4,924)
Intangible asset ................................... 1,697 1,834
Deferred taxes ..................................... 1,487 1,236
Accumulated other comprehensive loss ............... 2,232 1,854
-------- --------
Net amount recognized ................................... $ 1,283 $ (327)
======== ========
In January 2005, the Board of Directors of the Corporation approved the
curtailment of the accumulation of defined benefits for future services provided
by certain participants in the First Merchants Corporation Retirement Pension
Plan (the "Plan"). Employees of the Corporation and certain of its subsidiaries
who are participants in the Plan were notified that, on and after March 1, 2005,
no additional pension benefits will be earned by employees who have not both
attained the age of fifty-five (55) and accrued at least ten (10) years of
"Vesting Service". As a result of this action, the Corporation has decided to
record a $1,630,000 pension curtailment loss to record previously unrecognized
prior service costs in accordance with SFAS No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Plans and for Termination
Benefits." This loss will be recognized and recorded by the Corporation in the
first quarter of 2005.
At December 31, 2004 and 2003, the plans' accumulated benefit obligation totaled
$43,161,000 and $39,192,000, respectively. Projected future benefit payments in
years ending December 31 are as follows:
2005 ................................ $ 1,821
2006 ................................ 1,985
2007 ................................ 2,136
2008 ................................ 2,210
2009 ................................ 2,380
2010 to 2014 ......................... 15,042
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
The Corporation's planned and required contributions to its defined-benefit
pension plans in 2005 total $564,000. The Corporation's contributions paid to
its defined-benefit pension plans in 2004 totaled $3,854,000, of which
$2,108,000 was required and $1,746,000 was discretionary.
At September 30, 2004 the plans' assets were allocated 68 percent to equity
securities, 28 percent to debt securities, and 4 percent to real estate and
other plan assets. The targeted allocation for those categories of plan assets
are 40 to 80 percent, 20 to 60 percent and 1 to 15 percent, respectively.
At September 30, 2003 the plans' assets were allocated 67 percent to equity
securities, 25 percent to debt securities, and 8 percent to real estate and
other plan assets. The targeted allocation for those categories of plan assets
are 40 to 80 percent, 20 to 60 percent, and 0 to 15 percent, respectively.
2004 2003 2002(1)
==============================================================================================
Pension cost includes the following components:
Service cost-benefits earned during the year ............ $ 1,920 $ 1,564 $ 1,770
Interest cost on projected benefit obligation ........... 2,789 2,617 2,202
Actual (return) loss on plan assets ..................... (3,080) (3,876) 2,654
Net amortization and deferral ........................... 614 1,617 (5,674)
------- ------- -------
Total pension cost ................................... $ 2,243 $ 1,922 $ 952
======= ======= =======
(1) Lafayette components are included beginning as of April 1, 2002.
2004 2003 2002
==============================================================================================
Assumptions used in the accounting as of December 31 were:
Discount rate ........................................ 6.00% 6.25% 6.75%
Rate of increase in compensation ..................... 4.00% 4.00% 4.00%
Expected long-term rate of return on assets .......... 8.00% 8.00% 8.14%
The above assumptions used to measure benefit obligations as of the plan's
measurement date were the same assumptions used to determine the net benefit
cost.
At September 30, 2004 and 2003, the Corporation based its estimate of the
expected long-term rate of return on analysis of the historical returns of the
plans and current market information available. The plans' investment strategies
are to provide for preservation of capital with an emphasis on long-term growth
without undue exposure to risk. The assets of the plans' are invested in
accordance with the plans' Investment Policy Statement, subject to strict
compliance with ERISA and any other applicable statutes.
The plans' risk management practices include quarterly evaluations of investment
managers, including reviews of compliance with investment manager guidelines and
restrictions; ability to exceed performance objectives; adherence to the
investment philosophy and style; and ability to exceed the performance of other
investment managers. The evaluations are reviewed by management with appropriate
follow-up and actions taken, as deemed necessary. The Investment Policy
Statement generally allows investments in cash and cash equivalents, real
estate, fixed income debt securities and equity securities, and specifically
prohibits investments in derivatives, options, futures, private placements,
short selling, non-marketable securities and purchases of non-investment grade
bonds.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
At December 31, 2004, the maturities of the plans' debt securities ranged from
14 days to 6.2 years, with a weighted average maturity of 2.9 years. At December
31, 2003, the maturities of the plans' debt securities ranged from 59 days to
5.6 years, with a weighted average maturity of 2.5 years.
The 1994 Stock Option Plan reserved 546,978 shares of Corporation common stock
for the granting of options to certain employees and non-employee directors. The
exercise price of the shares may not be less than the fair market value of the
shares upon the grant of the option. Options become 100 percent vested when
granted and are fully exercisable generally six months after the date of the
grant, for a period of ten years. No shares remain available for grant under the
1994 Plan.
The 1999 Long-term Equity Incentive Plan was approved by the Corporation's
shareholders at the 1999 annual meeting. The aggregate number of shares that are
available for grants under that Plan in any calendar year is equal to the sum
of: (a) 1 percent of the number of common shares of the Corporation outstanding
as of the last day of the preceding calendar year; plus (b) the number of shares
that were available for grants, but not granted, under the Plan in any previous
year; but in no event will the number of shares available for grants in any
calendar year exceed 1.5 percent of the number of common shares of the
Corporation outstanding as of the last day of the preceding calendar year.
Options, which have a ten year life, become 100 percent vested ranging from six
months to two years and are fully exercisable when vested. The 1999 Long-term
Equity Incentive Plan will expire in 2009.
The table below is a summary of the status of the Corporation's stock option
plans and changes in those plans as of and for the years ended December 31,
2004, 2003 and 2002.
Year Ended December 31, 2004 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
===================================================================================================================================
Outstanding, beginning of year ................ 951,509 $ 20.71 842,583 $ 19.89 770,817 $ 17.91
Granted ....................................... 185,170 25.60 190,714 23.46 166,760 26.85
Exercised ..................................... (95,899) 15.48 (69,672) 16.93 (71,538) 12.74
Cancelled ..................................... (21,137) 25.36 (12,116) 22.27 (23,456) 22.18
--------- ------- -------
Outstanding, end of year ...................... 1,019,643 $ 22.00 951,509 $ 20.71 842,583 $ 19.89
========= ======= =======
Options exercisable at year end ............... 693,560 653,040 569,758
Weighted-average fair value of
options granted during the year ............ $ 6.98 $ 5.99 $ 7.47
As of December 31, 2004, other information by exercise price range for options
outstanding and exercisable is as follows:
OUTSTANDING EXERCISABLE
- ---------------------------------------------------------------------------- -----------------------------
EXERCISE PRICE NUMBER WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
RANGE OF SHARES EXERCISE PRICE REMAINING CONTRACTUAL LIFE OF SHARES EXERCISE PRICE
===============================================================================================================
$ 12.43 - $19.73 417,854 $17.77 4.1 years 417,484 $17.77
20.46 - 25.60 449,631 24.28 7.8 years 123,963 23.29
26.29 - 26.93 152,158 26.87 7.2 years 152,113 26.87
--------- -------
1,019,643 $22.00 6.2 years 693,560 $20.75
========= =======
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
Although the Corporation has elected to follow APB No. 25, SFAS No. 123 requires
pro forma disclosures of net income and earnings per share as if the Corporation
had accounted for its employee stock options under that Statement.
The fair value of each option grant was estimated on the grant date using an
option-pricing model with the following assumptions:
2004 2003 2002
----- ----- -----
Risk-free interest rates........ 4.57% 3.55% 4.78%
Dividend yields................. 3.64% 3.65% 3.63%
Volatility factors of expected
market price common stock... 30.89% 31.29% 31.02%
Weighted-average expected
life of the options ........ 8.50 years 8.50 years 8.50 years
Under SFAS No. 123, compensation cost is recognized in the amount of the
estimated fair value of the options and amortized to expense over the options'
vesting period. The pro forma effect on net income and earnings per share of
this statement are shown in Note 1 to the consolidated financial statements.
The 1999 Employee Stock Purchase Plan enabled eligible employees to purchase the
Corporation's common stock. A total of 289,406 shares of the Corporation's
common stock were initially reserved for issuance pursuant to the plan. The
price of the stock to be paid by the employees was determined by the
Corporation's compensation committee, but was not less than 85 percent of the
lesser of the fair market value of the Corporation's common stock at the
beginning or at the end of the offering period. Common stock purchases were made
annually and paid through advance payroll deductions of up to 20 percent of
eligible compensation. Participants under the plan purchased 45,267 shares in
2004 at $19.94 per share. The fair value on the purchase date was $25.60. The
1999 Employee Stock Purchase Plan expired after the July 1, 2004 purchase of
shares.
The Corporation's Employee Stock Purchase Plan is accounted for in accordance
with APB No. 25. Although the Corporation has elected to follow APB No. 25, SFAS
No. 123 requires pro forma disclosures of net income and earnings per share as
if the Corporation had accounted for the purchased shares under that statement.
The pro forma disclosures are included in Note 1 to the consolidated financial
statements and were estimated using an option pricing model with the following
assumptions for 2004, 2003 and 2002, respectively: dividend yield of 3.64, 3.65,
and 3.63 percent; an expected life of one year for all years; expected
volatility of 30.89, 31.29, and 31.02 percent; and risk-free interest rates of
4.57, 3.55 and 4.78 percent. The fair value of those purchase rights granted in
2004, 2003 and 2002 was $6.38, $4.81 and $10.14 respectively.
The First Merchants Corporation 2004 Employee Stock Purchase Plan was approved
by the Corporation's stockholders at their annual meeting on April 22, 2004. The
effective date of the Plan was July 1, 2004. Its purpose is to provide eligible
employees of the Corporation and its subsidiaries an opportunity to purchase
shares of common stock of the Corporation through annual offerings financed by
payroll deductions. A total of 400,000 shares of the Corporation's common stock
are reserved for issuance
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
pursuant to the plan. The price of the stock to be paid by the employees is
determined by the Corporation's compensation committee, but may not be less than
85 percent of the lesser of the fair market value of the Corporation's common
stock at the beginning or at the end of the offering period. Common stock
purchases are made annually and are paid through advance payroll deductions of
up to 20 percent of eligible compensation. At December 31, 2004, $904,000 has
been withheld from compensation, plus interest, toward the purchase of shares
after June 30, 2005, the end of the annual offering period.
The Corporation maintains retirement savings 401(k) plans in which substantially
all employees may participate. The Corporation matches employees' contributions
at the rate of 25 to 50 percent for the first 5 to 6 percent of base salary
contributed by participants. The Corporations' expense for the plans was
$660,000 for 2004, $600,000 for 2003, and $315,000 for 2002.
The Corporation maintains supplemental executive retirement and other
nonqualified retirement plans for the benefit of certain directors and officers.
Under the plans, the Corporation agrees to pay retirement benefits that are
actuarially determined based upon plan participants' compensation amounts and
years of service. Accrued benefits payable totaled $ 3,004,000 and $2,511,000 at
December 31, 2004 and 2003. Benefit plan expense was $615,000, $485,000 and
$436,000 for 2004, 2003 and 2002.
The Corporation maintains post-retirement benefit plans that provide health
insurance benefits to retirees. The plans allow retirees to be carried under the
Corporation's health insurance plan, generally from ages 55 to 65. The retirees
pay most of the premiums due for their coverage, with amounts paid by retirees
ranging from 70 to 100 percent of the premiums payable. The accrued benefits
payable under the plans totaled $1,022,000 and $898,000 at December 31, 2004 and
2003. Post-retirement plan expense totaled $202,000, $240,000 and $19,000 for
the years ending December 31, 2004, 2003 and 2002.
NOTE 17
NET INCOME PER SHARE
=================================================================================================================================
Year Ended December 31, 2004 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------------
WEIGHTED-AVERAGE PER SHARE WEIGHTED-AVERAGE PER SHARE WEIGHTED-AVERAGE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT
=================================================================================================================================
Basic net income per share:
Net income available to
common stockholders .......... $29,411 18,540,451 $ 1.59 $27,571 18,233,855 $ 1.51 $27,836 16,364,788 $ 1.70
====== ====== ======
Effect of dilutive stock options.. 126,826 137,575 137,703
------- ---------- ------- ---------- ------- ----------
Diluted net income per share:
Net income available to
common stockholders
and assumed conversions ...... $29,411 18,667,277 $ 1.58 $27,571 18,371,430 $ 1.50 $27,836 16,502,491 $ 1.69
======= ========== ====== ======= ========== ====== ======= ========== ======
Options to purchase 320,661, 233,658 and 162,207 shares of common stock with
weighted average exercise prices of $24.66, $24.01 and $25.94 at December 31,
2004, 2003 and 2002 were excluded from the computation of diluted net income per
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 17
NET INCOME PER SHARE continued
share because the options exercise price was greater than the average market
price of the common stock.
NOTE 18
FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument:
CASH AND CASH EQUIVALENTS The fair value of cash and cash equivalents
approximates carrying value.
INTEREST-BEARING TIME DEPOSITS The fair value of interest-bearing time deposits
approximates carrying value.
INVESTMENT SECURITIES Fair values are based on quoted market prices.
MORTGAGE LOANS HELD FOR SALE The fair value of mortgages held for sale
approximates carrying values.
LOANS For both short-term loans and variable-rate loans that reprice frequently
and with no significant change in credit risk, fair values are based on carrying
values. The fair value for other loans is estimated using discounted cash flow
analyses, using interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality.
FEDERAL RESERVE AND FEDERAL HOME LOAN BANK STOCK The fair value of FRB and FHLB
stock is based on the price at which it may be resold to the FRB and FHLB.
INTEREST RECEIVABLE/PAYABLE The fair values of interest receivable/payable
approximate carrying values.
CASH VALUE OF LIFE INSURANCE The fair value of cash value of life insurance
approximates carrying value.
DEPOSITS The fair values of noninterest-bearing demand accounts,
interest-bearing demand accounts and savings deposits are equal to the amount
payable on demand at the balance sheet date. The carrying amounts for variable
rate, fixed-term certificates of deposit approximate their fair values at the
balance sheet date. Fair values for fixed-rate certificates of deposit and other
time deposits are estimated using a discounted cash flow calculation that
applies interest rates currently being offered on certificates to a schedule of
aggregated expected monthly maturities on such time deposits.
BORROWINGS The fair value of borrowings is estimated using a discounted cash
flow calculation, based on current rates for similar debt, except for short-term
and adjustable rate borrowing arrangements. At December 31, the fair value for
these instruments approximates carrying value.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 18
FAIR VALUES OF FINANCIAL INSTRUMENTS continued
OFF-BALANCE SHEET COMMITMENTS
Loan commitments and letters-of-credit generally have short-term, variable-rate
features and contain clauses which limit the Banks' exposure to changes in
customer credit quality. Accordingly, their carrying values, which are
immaterial at the respective balance sheet dates, are reasonable estimates of
fair value.
The estimated fair values of the Corporation's financial instruments are as
follows:
2004 2003
- -----------------------------------------------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
=======================================================================================================================
Assets at December 31:
Cash and cash equivalents .................................. $ 69,960 $ 69,960 $ 109,527 $ 109,527
Interest-bearing time deposits ............................. 9,343 9,343 8,141 8,141
Investment securities available for sale ................... 416,177 416,177 348,860 348,860
Investment securities held to maturity ..................... 5,358 5,520 7,937 8,326
Mortgage loans held for sale ............................... 3,367 3,367 3,043 3,043
Loans ...................................................... 2,405,503 2,415,924 2,328,010 2,383,666
FRB and FHLB stock ......................................... 22,858 22,858 15,502 15,502
Interest receivable ........................................ 17,318 17,318 16,840 16,840
Cash value of life insurance ............................... 42,061 42,061 37,927 37,927
Liabilities at December 31:
Deposits ................................................... 2,408,150 2,404,595 2,362,101 2,378,669
Borrowings:
Federal funds purchased ................................ 32,550 32,550
Securities sold under repurchase agreements ............ 87,472 85,136 71,095 71,139
FHLB advances .......................................... 223,663 234,247 212,779 239,251
Subordinated debentures, revolving credit
lines and term loans ................................. 97,206 105,139 97,782 103,313
Other borrowed funds.................................... 1,514 1,514
Interest payable ........................................... 4,411 4,411 4,680 4,680
NOTE 19
CONDENSED FINANCIAL INFORMATION (parent company only)
Presented below is condensed financial information as to financial position,
results of operations, and cash flows of the Corporation:
CONDENSED BALANCE SHEETS
December 31,
2004 2003
==============================================================================
Assets
Cash .............................................. $ 987 $ 3,235
Investment securities available for sale........... 3,500 3,500
Investment in subsidiaries ........................ 401,721 391,241
Goodwill .......................................... 448 448
Other assets ...................................... 10,039 10,500
-------- --------
Total assets ................................... $416,695 $408,924
======== ========
Liabilities
Borrowings ........................................ $ 97,206 $ 99,550
Other liabilities ................................. 4,886 5,409
-------- --------
Total liabilities .............................. 102,092 104,959
Stockholders' equity ................................. 314,603 303,965
-------- --------
Total liabilities and stockholders' equity ..... $416,695 $408,924
======== ========
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 19
CONDENSED FINANCIAL INFORMATION (parent company only) continued
CONDENSED STATEMENTS OF INCOME
December 31,
2004 2003 2002
===============================================================================================================
Income
Dividends from subsidiaries ................................................ $ 28,983 $ 45,445 $ 22,720
Administrative services fees from subsidiaries.............................. 13,767 10,849 6,580
Other income ............................................................... 375 472 535
-------- -------- ---------
Total income ............................................................ 43,125 56,766 29,835
-------- -------- ---------
Expenses
Amortization of core deposit intangibles
and fair value adjustments ................................................ 11 26 28
Interest expense............................................................ 6,785 6,463 3,858
Salaries and employee benefits.............................................. 11,240 9,531 7,641
Net occupancy expenses...................................................... 1,481 1,869 1,527
Equipment expenses.......................................................... 2,918 1,955 1,447
Telephone expenses.......................................................... 1,383 1,571 1,543
Other expenses.............................................................. 3,228 3,730 2,767
-------- -------- ---------
Total expenses .......................................................... 27,046 25,145 18,811
-------- -------- ---------
Income before income tax benefit and equity in
undistributed income of subsidiaries ......................................... 16,079 31,621 11,024
Income tax benefit ...................................................... 4,557 5,577 4,336
-------- -------- ---------
Income before equity in undistributed income of subsidiaries ................. 20,636 37,198 15,360
Equity in undistributed (distributions in excess of)
income of subsidiaries ................................................... 8,775 (9,627) 12,476
-------- -------- ---------
Net Income ................................................................... $ 29,411 $ 27,571 $ 27,836
======== ======== =========
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
================================================================================================================
2004 2003 2002
================================================================================================================
Operating activities:
Net income ........................................................ $ 29,411 $ 27,571 $ 27,836
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization .................................................... 11 26 28
Distributions in excess of (equity in undistributed)
income of subsidiaries ............... ........................ (8,775) (9,627) (12,476)
Net change in:
Other assets ................................................. (535) 2,406 (6,892)
Other liabilities ............................................ 461 (6) 4,430
-------- -------- ---------
Net cash provided by operating activities ................. 20,573 20,370 12,926
-------- -------- ---------
Investing activities - Investment in subsidiaries .................... (2,289) (25,858) (51,135)
-------- -------- ---------
Net cash used by investing activities ..................... (2,289) (25,858) (51,135)
-------- -------- ---------
Financing activities:
Cash dividends .................................................... (17,048) (16,557) (13,995)
Borrowings......................................................... 7,251 47,594 55,832
Repayment of borrowings ........................................... (9,594) (29,550)
Stock issued under employee benefit plans ......................... 903 819 658
Stock issued under dividend reinvestment
and stock purchase plan ......................................... 1,278 1,339 951
Stock options exercised ........................................... 1,404 1,191 494
Stock redeemed .................................................... (4,726) (489) (4,333)
Cash paid in lieu of issuing fractional shares .................... (28) (35)
-------- -------- ---------
Net cash provided (used) by financing activities .......... (20,532) 4,319 39,572
-------- -------- ---------
Net change in cash ................................................... (2,248) (1,169) 1,363
Cash, beginning of year .............................................. 3,235 4,404 3,041
-------- -------- ---------
Cash, end of year .................................................... $ 987 $ 3,235 $ 4,404
======== ======== =========
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 20
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth certain quarterly results for the years ended
December 31, 2004 and 2003:
- ----------------------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OUTSTANDING NET INCOME PER SHARE
QUARTER INTEREST INTEREST NET INTEREST PROVISION FOR NET -----------------------------------------------
ENDED INCOME EXPENSE INCOME LOAN LOSSES INCOME BASIC DILUTED BASIC DILUTED
2004:
March ............ $ 38,224 $ 12,592 $ 25,632 $ 1,372 $ 6,935 18,518,282 18,645,571 $ .37 $ .37
June ............. 38,099 12,252 25,847 1,720 7,355 18,511,190 18,633,301 .40 .40
September......... 39,801 13,009 26,792 1,380 7,653 18,548,041 18,658,459 .41 .41
December.......... 40,850 13,732 27,118 1,233 7,468 18,583,492 18,720,802 .41 .40
---------- -------- ------------ ------------- -------- ------ ------
$ 156,974 $ 51,585 $ 105,389 $ 5,705 $ 29,411 18,540,451 18,667,277 $ 1.59 $ 1.58
========== ======== ============ ============= ======== ====== ======
2003:
March ............ $ 38,981 $ 12,971 $ 26,010 $ 4,601 $ 5,658 17,565,405 17,675,633 $ .32 $ .32
June ............. 39,554 13,599 25,955 2,123 8,745 18,392,925 18,519,155 .48 .48
September......... 38,959 13,085 25,874 1,706 7,349 18,466,678 18,622,306 .40 .39
December.......... 38,036 12,733 25,303 1,047 5,819 18,497,612 18,666,079 .31 .31
---------- -------- ------------ ------------- -------- ------ ------
$ 155,530 $ 52,388 $ 103,142 $ 9,477 $ 27,571 18,233,855 18,371,400 $ 1.51 $ 1.50
========== ======== ============ ============= ======== ====== ======
NOTE 21
ACCOUNTING MATTERS
On December 12, 2003, the American Institute of Certified Public Accountants
issued Statement of Position No. 03-3, Accounting for Certain Loans or Debt
Securities Acquired in a Transfer (SOP 03-3). SOP 03-3 requires acquired loans
with poor credit quality to be recorded at fair value and prohibits carrying
over or creation of valuation allowances in the initial accounting for the
loans. SOP 03-3 also limits the yield that may be accreted to income. SOP 03-3
applies to the purchase of an individual loan, a pool of loans, a group of
loans, and loans acquired in a business combination. SOP 03-3 is effective for
loans acquired in fiscal years beginning after December 31, 2004. SOP 03-3 is
not expected to have a material impact on the Corporation's results of
operations or financial condition.
In March 2004, the Emerging Issues Task Force (EITF) finalized and issued EITF
03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments (EITF 03-1). EITF 03-1 provides recognition and measurement
guidance regarding when impairments of equity and debt securities are considered
other-than-temporary, requiring a charge to earnings, and also requires
additional annual disclosures for investments in unrealized loss positions. The
additional annual disclosure requirements were previously issued by the EITF in
November 2003 and were effective for the Corporation for the year ended December
31, 2003. In September 2004, the Financial Accounting Standards Board (FASB)
issued FASB Staff Position (FSP) EITF 03-1-1, which delays the recognition and
measurement provisions of EITF 03-1, pending the issuance of further
implementation guidance. We are currently evaluating the effect of the
recognition and measurement provisions of EITF 03-1. While our analysis is
pending the FASB's revisions to EITF 03-1, we currently believe the adoption of
EITF 03-1 will not result in a material impact on the Corporation's results of
operations or financial condition.
In December, 2004, FASB issued an amendment to SFAS 123 (SFAS 123R), which
eliminates the ability to account for share-based compensation transactions
using Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees,
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
ACCOUNTING MATTERS continued
and generally requires that such transactions be accounted for using a fair
value-based method. SFAS 123R will be effective for the Corporation beginning
July 1, 2005. SFAS123R applies to all awards granted after the required
effective date and to awards modified, repurchased, or cancelled after that
date. The cumulative effect of initially applying this Statement, if any, is
recognized as of the required effective date.
As of the required effective date, the Corporation may elect to apply SFAS 123R
using a modified version of prospective application. Under that transition
method, compensation cost is recognized on or after the required effective date
for the portion of outstanding awards for which the requisite service has not
yet been rendered, based on the grant-date fair value of those awards calculated
under SFAS 123 for either recognition or pro forma disclosures. For periods
before the required effective date, the Corporation may elect to apply a
modified version of retrospective application under which financial statements
for prior periods are adjusted on a basis consistent with the pro forma
disclosures required for those periods by SFAS 123.
The Corporation will first report compensation cost under SFAS 123R in the third
quarter of 2005. For liability-classified awards, the Corporation will initially
measure the cost of employee services received in exchange for an award based on
its current fair value; the fair value will be remeasured subsequently at each
reporting date through the settlement date, and changes in fair value will be
recognized as compensation cost. For equity-classified awards, the grant date
fair value will be recognized in earnings over the requisite service period. We
are currently evaluating the effect of the recognition and measurement
provisions of SFAS 123R, but we currently believe the adoption of SFAS 123R will
not result in a material impact on the Corporation's results of operations or
financial condition.
53
ANNUAL MEETING, STOCK PRICE AND DIVIDEND INFORMATION
The 2005 Annual Meeting of Stockholders
of First Merchants Corporation
will be held...
Thursday, April 14, 2005 at 3:30 p.m.
Horizon Convention Center
401 South High Street
Muncie, Indiana
STOCK INFORMATION
PRICE PER SHARE
QUARTER HIGH LOW DIVIDENDS DECLARED(1)
=================================================================================================
2004 2003 2004 2003 2004 2003
------------------- ----------------- ----------------------
First Quarter ............. $ 26.33 $ 23.15 $ 23.50 $ 21.29 $ .23 $ .22
Second Quarter ............. 25.88 24.56 22.20 21.72 .23 .22
Third Quarter .............. 25.77 27.25 22.96 23.47 .23 .23
Fourth Quarter ............. 29.19 27.22 24.15 25.00 .23 .23
(1) The Liquidity section of Management's Discussion & Analysis of Financial
Condition and Results of Operations and Note 14 to Consolidated Financial
Statements include discussions regarding dividend restrictions from the
bank subsidiaries to the Corporation.
The table above lists per share prices and dividend payments during 2004 and
2003. Prices are as reported by the National Association of Securities Dealers.
Automated Quotation - National Market System.
Numbers rounded to nearest cent when applicable.
54
COMMON STOCK LISTING
COMMON STOCK LISTING
First Merchants Corporation common stock is traded over-the-counter on the
NASDAQ National Market System. Quotations are carried in many daily papers. The
NASDAQ symbol is FRME (Cusip #320817-10-9). At the close of business on January
31, 2005, the number of shares outstanding was 18,578,882. There were 2,975
stockholders of record on that date.
General Stockholder Inquiries
Stockholders and interested investors may obtain information about the
Corporation upon written request or by calling:
Mr. Brian Edwards
Shareholder Relations Officer
First Merchants Corporation
P. O. Box 792
Muncie, Indiana 47308-0792
765-741-7278
800-262-4261 Ext. 7278
Stock Transfer Agent and Registrar
American Stock Transfer & Trust Company
59 Maiden Lane, 1st Floor
New York, NY 10038
55
FORM 10-K, FINANCIAL INFORMATION AND CODE OF ETHICS
FORM 10-K, FINANCIAL INFORMATION AND CODE OF ETHICS
The Corporation, upon request and without charge, will furnish stockholders,
security analysts and investors a copy of Form 10-K filed with the Securities
and Exchange Commission.
The Securities and Exchange Commission maintains a web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the commission, including the
Corporation; that address is http://www.sec.gov
The Corporation has adopted a Code of Ethics that applies to its Chief Executive
Officer, Chief Operating Officer, Chief Financial Officer, Controller and
Treasurer. It is part of the Corporation's Code of Business Conduct, which
applies to all employees and directors of the Corporation and its affiliates. A
copy of the Code of Ethics may be obtained, free of charge, by writing to the
General Counsel of First Merchants Corporation at 200 East Jackson Street,
Muncie, IN 47305. In addition, the Code of Ethics is maintained on the
Corporation's web site, which can be accessed at http://www.firstmerchants.com.
Please contact:
Mr. Mark Hardwick
Senior Vice President
and Chief Financial Officer
First Merchants Corporation
P. O. Box 792
Muncie, Indiana 47308-0792
765-751-1857
1-800-262-4261 Ext. 1857
56
[GRAPHIC] No Matter What the Shape...
In today's crowded and sometimes confusing financial marketplace, businesses and
consumers are looking for solutions that are just the right fit.
First Merchants Corporation and our family of companies strive to provide a
complete array of financial solutions to meet the needs of the residents in our
markets -- no matter how complex, no matter what the shape or size.
From Decatur to Liberty and from Lafayette to Columbus, Ohio, our affiliate
companies provide unmatched local service with local decision-making that their
clients have always valued.
Whether it's cash management products to help a growing business, a loan to
purchase equipment for a family farm, or just a trusted friend to help with your
personal finances, First Merchants Corporation's affiliate companies provide
their customers the piece that completes their financial picture.
Our Mission
First Merchants Corporation is a regional financial holding company dedicated to
be the provider of choice in banking, trust and insurance services to our
communities.
Our Operating Philosophy
First Merchants Corporation's operating philosophy is to be client-focused,
value-driven, plan-disciplined, and managed for achievers from both an employee
and shareholder perspective.
- --------------------------------------------------------------------------------
[GRAPHIC] [LOGO] First Merchants Corporation
your partners in success
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www.firstmerchants.com