UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------------
FORM 10-K
[Mark One]
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from __________to_________
Commission file number 0-17071
FIRST MERCHANTS CORPORATION
(Exact name of registrant as specified in its charter)
Indiana 35-1544218
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 East Jackson 47305-2814
Muncie, Indiana (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (765) 747-1500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.125 stated value per share
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant(1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definition of "large accelerated filer,""accelerated filer,"and "smaller
reporting company". Rule 12b-2 of the Exchange Act. Large accelerated filer [ ]
Accelerated filer[X] Non-accelerated filer[ ] Smaller Reporting Company [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No[X]
The aggregate market value (not necessarily a reliable indication of the
price at which more than a limited number of shares would trade) of the voting
stock held by non-affiliates of the registrant was $439,397,000 as of the last
business day of the registrant's most recently completed second fiscal quarter
(June 30, 2007).
As of February 20, 2008 there were 18,551,275 outstanding common shares,
without par value, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Documents Part of Form 10-K
------------ into which incorporated
Portions of the Registrant's Definitive --------------------------
Proxy Statement for Annual Meeting of Part III (Items 10 through 14)
Shareholders to be held April 29, 2008
Page 1
TABLE OF CONTENTS
FIRST MERCHANTS CORPORATION
- -------------------------------------------------------------------------------
Five-Year Summary of Selected Financial Data 3
Statement Regarding Forward-Looking Statements 4
PART I
Item 1. Business 5
Item 1A. Risk Factors 21
Item 1B. Unresolved Staff Comments 24
Item 2. Properties 25
Item 3. Legal Proceedings 25
Item 4. Submission of Matters to a
Vote of Security Holders 25
Supplemental Information -
Executive Officers of the Registrant 26
PART II
Item 5. Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer
Purchases of Equity Securities 27
Item 6. Selected Financial Data 29
Item 7. Management's Discussion and Analysis of
Financial Condition and Results
of Operations 30
Item 7A. Quantitative and Qualitative Disclosure
about Market Risk 41
Item 8. Financial Statements and Supplementary Data 42
Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure 71
Item 9A. Controls and Procedures 71
Item 9B. Other Information 72
PART III
Item 10. Directors, Executive Officers and
Corporate Governance 73
Item 11. Executive Compensation 73
Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related
Stockholder Matters 73
Item 13. Certain Relationships and Related
Transactions 73
Item 14. Principal Accountant Fees and Services 73
PART IV
Item 15. Exhibits and Financial Statement Schedules 74
Page 2
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
==================================================================================================================================
(Dollars in Thousands, except share data) 2007 2006 2005 2004 2003
==================================================================================================================================
Operations
Net Interest Income
Fully Taxable Equivalent (FTE) Basis .............. $ 117,247 $ 114,076 $ 114,907 $ 108,986 $ 106,899
Less Tax Equivalent Adjustment ......................... 4,127 3,981 3,778 3,597 3,757
---------- ---------- ---------- ---------- ----------
Net Interest Income .................................... 113,120 110,095 111,129 105,389 103,142
Provision for Loan Losses .............................. 8,507 6,258 8,354 5,705 9,477
---------- ---------- ---------- ---------- ----------
Net Interest Income
After Provision for Loan Losses ................... 104,613 103,837 102,775 99,684 93,665
Total Other Income ..................................... 40,551 34,613 34,717 34,554 35,902
Total Other Expenses ................................... 102,182 96,057 93,957 91,642 91,279
---------- ---------- ---------- ---------- ----------
Income Before Income Tax Expense .................. 42,982 42,393 43,535 42,596 38,288
Income Tax Expense ..................................... 11,343 12,195 13,296 13,185 10,717
---------- ---------- ---------- ---------- ----------
Net Income ............................................. $ 31,639 $ 30,198 $ 30,239 $ 29,411 $ 27,571
========== ========== ========== ========== ==========
Per Share Data
Basic Net Income ....................................... $ 1.73 $ 1.64 $ 1.64 $ 1.59 $ 1.51
Diluted Net Income ..................................... 1.73 1.64 1.63 1.58 1.50
Cash Dividends Paid .................................... .92 .92 .92 .92 .90
December 31 Book Value ................................. 18.88 17.75 17.02 16.93 16.42
December 31 Market Value (Bid Price) ................... 21.84 27.19 26.00 28.30 25.51
Average Balances
Total Assets ........................................... $3,639,772 $3,371,386 $3,179,464 $3,109,104 $2,960,195
Total Loans........ ................................ 2,794,824 2,569,847 2,434,134 2,369,017 2,281,614
Total Deposits ......................................... 2,752,443 2,568,070 2,418,752 2,365,306 2,257,075
Securities Sold Under Repurchase Agreements
(long-term portion) ............................... 181
Total Federal Home Loan Bank Advances .................. 259,463 234,629 227,311 225,375 208,733
Total Subordinated Debentures, Revolving
Credit Lines and Term Loans ...................... 104,680 99,456 106,811 96,230 94,203
Total Stockholders' Equity ............................. 330,786 319,519 315,525 310,004 293,603
Year-end Balances
Total Assets ........................................... $3,782,087 $3,554,870 $3,237,079 $3,191,668 $3,076,812
Total Loans ........................................ 2,880,578 2,698,014 2,462,337 2,431,418 2,356,546
Total Deposits ......................................... 2,884,121 2,750,538 2,382,576 2,408,150 2,362,101
Securities Sold Under Repurchase Agreements
(long-term portion) .............................. 320
Total Federal Home Loan Bank Advances .................. 294,101 242,408 247,865 223,663 212,779
Total Subordinated Debentures, Revolving
Credit Lines and Term Loans ...................... 115,826 83,956 103,956 97,206 97,782
Total Stockholders' Equity ............................. 339,936 327,325 313,396 314,603 303,965
Financial Ratios
Return on Average Assets ............................... .87% .90% .95% .95% .93%
Return on Average Stockholders' Equity ................. 9.56 9.45 9.58 9.49 9.39
Average Earning Assets to Total Assets ................. 90.91 91.15 90.93 90.28 89.99
Allowance for Loan Losses as % of Total Loans .......... .98 .99 1.02 .93 1.08
Dividend Payout Ratio .................................. 53.18 56.10 56.44 58.23 60.00
Average Stockholders' Equity to Average Assets ......... 9.09 9.48 9.92 9.97 9.92
Tax Equivalent Yield on Earning Assets ................ 7.10 6.92 6.26 5.72 5.98
Cost of Supporting Liabilities ......................... 3.55 3.21 2.29 1.84 1.97
Net Interest Margin on Earning Assets .................. 3.55 3.71 3.97 3.88 4.01
Restated for all stock dividends and stock splits.
Includes loans held for sale.
Page 3
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 "believe", "continue", "pattern", "estimate",
"project", "intend", "anticipate", "expect" and similar expressions or future or
conditional verbs such as "will", "would", "should", "could", "might", "can",
"may" or 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, those discussed in Item 1A,
"RISK FACTORS".
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.
Page 4
PART I: ITEM 1. BUSINESS
PART I
Item 1. BUSINESS
GENERAL
First Merchants Corporation (the "Corporation") is a financial holding company
headquartered in Muncie, Indiana. The Corporation's Common Stock is traded on
NASDAQ's National Market System under the symbol FRME and was organized in
September 1982. Since its organization, the Corporation has grown to include
four affiliate banks with sixty-six banking locations in eighteen Indiana and
three 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 bank subsidiaries of the Corporation include the following:
o First Merchants Bank, National Association ("First Merchants") in Delaware,
Hamilton, Marion, Henry, Randolph, Union, Fayette, Wayne, Butler (OH), Jay,
Adams, Wabash, Howard and Miami counties;
o First Merchants Bank of Central Indiana, National Association ("Central
Indiana") in Madison County;
o Lafayette Bank and Trust Company, National Association ("Lafayette"), in
Tippecanoe, Carroll, Jasper, and White counties; and
o Commerce National Bank ("Commerce") in Franklin and Hamilton counties in
Ohio.
The Corporation operates First Merchants Trust Company, National Association, a
trust and asset management services company. The Corporation also operates First
Merchants Insurance Services, Inc., a full-service property, casualty, personal
lines, and employee benefit insurance agency headquartered in Muncie, Indiana.
The Corporation is also the majority owner of Indiana Title Insurance Company,
LLC, which is a full-service title insurance agency. The Corporation operates
First Merchants Reinsurance Co. Ltd., a small life reinsurance company whose
primary business includes underwriting short-duration contracts of credit life
and accidental and health insurance policies and debt cancellation contracts.
Such policies and contracts are purchased by the Corporation's bank customers to
cover the amount of debt incurred by the insured. No policies are issued for
loans other than those originated by the subsidiary banks. First Merchants
Reinsurance Co. Ltd. limits its self-insurance risk to the first $15,000 of
exposure under each credit life policy and $350 per month on each accident and
health policy. The company maintains the same standard for its debt cancellation
contracts. The total self-insurance exposure as of December 31, 2007 totaled
$22.5 million. All inter-company transactions are eliminated during the
preparation of consolidated financial statements.
On April 1, 2007, the Corporation combined five of its bank charters into one.
Frances Slocum Bank & Trust Company, National Association, Decatur Bank & Trust
Company, National Association, The First National Bank of Portland and United
Communities National Bank combined with First Merchants Bank, N.A. Also on April
1, 2007, the name of The Madison Community Bank was changed to First Merchants
Bank of Central Indiana, National Association.
As of December 31, 2007, the Corporation had consolidated assets of $3.8
billion, consolidated deposits of $2.8 billion and stockholders' equity of $340
million. The Corporation is presently engaged in conducting commercial banking
business through the offices of its four banking subsidiaries. As of December
31, 2007, the Corporation and its subsidiaries had 1,121 full-time equivalent
employees.
Through its bank subsidiaries, the Corporation offers a broad range of financial
services, including accepting time, savings and demand deposits; making
consumer, commercial, agri-business and real estate mortgage loans; renting safe
deposit facilities; providing personal and corporate trust services; providing
full-service brokerage; and providing other corporate services, letters of
credit and repurchase agreements. Through various non-bank subsidiaries, the
Corporation also offers personal and commercial lines of insurance and engages
in the title agency business and the reinsurance of credit life, accident, and
health insurance.
AVAILABLE INFORMATION
The Corporation makes its Annual Report on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, available on its website at www.firstmerchants.com without
charge, as soon as reasonably practicable after such reports are electronically
filed with, or furnished to, the Securities and Exchange Commission. These
documents can also be read and copied at the Securities and Exchange
Commission's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.
Page 5
PART I: ITEM 1. BUSINESS
GENERAL continued
Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further
information on the public reference room. Our SEC filings are also available to
the public at the Securities and Exchange Commission's website at
http://www.sec.gov. Additionally, the Corporation will also provide without
charge, a copy of its Annual Report on Form 10-K to any shareholder by mail.
Requests should be sent to Ms. Cindy Holaday, Shareholder Relations Officer,
First Merchants Corporation, P.O. Box 792, Muncie, IN 47308-0792.
ACQUISITION POLICY
The Corporation anticipates that it will continue its policy of geographic
expansion of its banking business through the acquisition of banks whose
operations are consistent with its community banking philosophy. Management
routinely explores opportunities to acquire financial institutions and other
financial services-related businesses and to enter into strategic alliances to
expand the scope of its services and its customer base.
COMPETITION
The Corporation's banking subsidiaries are located in Indiana and Ohio counties
where other financial services companies provide similar banking services. In
addition to the competition provided by the lending and deposit gathering
subsidiaries of national manufacturers, retailers, insurance companies and
investment brokers, the banking subsidiaries compete vigorously with other
banks, thrift institutions, credit unions and finance companies located within
their service areas.
REGULATION AND SUPERVISION OF FIRST MERCHANTS CORPORATION AND SUBSIDIARIES
BANK HOLDING COMPANY REGULATION
The Corporation is registered as a bank holding company and has elected to be a
financial holding company. It is subject to the supervision of, and regulation
by the Board of Governors of the Federal Reserve System ("Federal Reserve")
under the Bank Holding Company Act of 1956, as amended (the "BHC Act"). Bank
holding companies are required to file periodic reports with and are subject to
periodic examination by the Federal Reserve. The Federal Reserve has issued
regulations under the BHC Act requiring a bank holding company to serve as a
source of financial and managerial strength to its subsidiary banks. Thus, it is
the policy of the Federal Reserve that a bank holding company should stand ready
to use its resources to provide adequate capital funds to its subsidiary banks
during periods of financial stress or adversity. Additionally, under the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), a bank holding
company is required to guarantee the compliance of any subsidiary bank that may
become "undercapitalized" (as defined in the FDICIA section of this Form 10-K)
with the terms of any capital restoration plan filed by such subsidiary with its
appropriate federal banking agency. Under the BHC Act, the Federal Reserve has
the authority to require a bank holding company to terminate any activity or
relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of
a bank) upon the determination that such activity constitutes a serious risk to
the financial stability of any bank subsidiary.
The BHC Act requires the Corporation to obtain the prior approval of the Federal
Reserve before:
1. Acquiring direct or indirect control or ownership of any voting shares of
any bank or bank holding company if, after such acquisition, the bank
holding company will directly or indirectly own or control more than 5% of
the voting shares of the bank or bank holding company;
2. Merging or consolidating with another bank holding company; or
3. Acquiring substantially all of the assets of any bank.
The BHC Act generally prohibits bank holding companies that have not become
financial holding companies from (i) engaging in activities other than banking
or managing or controlling banks or other permissible subsidiaries, and (ii)
acquiring or retaining direct or indirect control of any company engaged in the
activities other than those activities determined by the Federal Reserve to be
closely related to banking or managing or controlling banks.
The BHC Act does not place territorial restrictions on such non-banking related
activities.
CAPITAL ADEQUACY GUIDELINES FOR BANK HOLDING COMPANIES
The Corporation is required to comply with the Federal Reserve's risk-based
capital guidelines. These guidelines require a minimum ratio of capital to
risk-weighted assets of 8% (including certain off-balance sheet activities such
as standby letters of credit). At least half of the total required capital must
be "Tier 1 capital," consisting principally of stockholders' equity,
noncumulative perpetual preferred stock, a limited amount of cumulative
perpetual preferred stock and minority interest in the equity accounts of
consolidated subsidiaries, less certain goodwill items. The remainder may
consist of a limited amount of subordinate debt and intermediate-term preferred
stock, certain hybrid capital instruments and other debt securities, cumulative
perpetual preferred stock, and a limited amount of the general loan loss
allowance.
Page 6
PART I: ITEM 1. BUSINESS
CAPITAL ADEQUACY GUIDELINES FOR BANK HOLDING COMPANIES continued
In addition to the risk-based capital guidelines, the Federal Reserve has
adopted a Tier 1 (leverage) capital ratio under which the Corporation must
maintain a minimum level of Tier 1 capital to average total consolidated assets.
The ratio is 3% in the case of bank holding companies, which have the highest
regulatory examination ratings and are not contemplating significant growth or
expansion. All other bank holding companies are expected to maintain a ratio of
at least 1% to 2% above the stated minimum.
The following are the Corporation's regulatory capital ratios as of December 31,
2007:
=============================================================================
Regulatory Minimum
Corporation Requirement
=============================================================================
Tier 1 Capital: 8.8% 4.0%
(to Risk-weighted Assets)
Total Capital: 10.6% 8.0%
BANK REGULATION
Each of the Corporation's bank subsidiaries are national banks and are
supervised, regulated and examined by the Office of the Comptroller of the
Currency (the "OCC"). The OCC has the authority to issue cease-and-desist orders
if it determines that activities of the bank regularly represent an unsafe and
unsound banking practice or a violation of law. Federal law extensively
regulates various aspects of the banking business such as reserve requirements,
truth-in-lending and truth-in-savings disclosures, equal credit opportunity,
fair credit reporting, trading in securities and other aspects of banking
operations. Current federal law also requires banks, among other things, to make
deposited funds available within specified time periods.
BANK CAPITAL REQUIREMENTS
The OCC has adopted risk-based capital ratio guidelines to which national banks
are subject. The guidelines establish a framework that makes regulatory capital
requirements more sensitive to differences in risk profiles. Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
commitments to four risk-weighted categories, with higher levels of capital
being required for the categories perceived as representing greater risk.
Like the capital guidelines established by the Federal Reserve, these guidelines
divide a bank's capital into tiers. Banks are required to maintain a total
risk-based capital ratio of 8%. The OCC may, however, set higher capital
requirements when a bank's particular circumstances warrant. Banks experiencing
or anticipating significant growth are expected to maintain capital ratios,
including tangible capital positions, well above the minimum levels.
In addition, the OCC established guidelines prescribing a minimum Tier 1
leverage ratio (Tier 1 capital to adjusted total assets as specified in the
guidelines). These guidelines provide for a minimum Tier 1 leverage ratio of 3%
for banks that meet specified criteria, including that they have the highest
regulatory rating and are not experiencing or anticipating significant growth.
All other banks are required to maintain a Tier 1 leverage ratio of 3% plus an
additional 100 to 200 basis points.
All of the Corporation's affiliate banks exceed the risk-based capital
guidelines of the OCC as of December 31, 2007.
FDIC IMPROVEMENT ACT OF 1991
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
requires, among other things, federal bank regulatory authorities to take
"prompt corrective action" with respect to banks, which do not meet minimum
capital requirements. For these purposes, FDICIA establishes five capital tiers:
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized. The FDIC has adopted
regulations to implement the prompt corrective action provisions of FDICIA.
"Undercapitalized" banks are subject to growth limitations and are required to
submit a capital restoration plan. A bank's compliance with such plan is
required to be guaranteed by the bank's parent holding company. If an
"undercapitalized" bank fails to submit an acceptable plan, it is treated as if
it is significantly
Page 7
PART 1: ITEM 1. BUSINESS
FDIC IMPROVEMENT ACT OF 1991 continued
undercapitalized. "Significantly undercapitalized" banks are subject to one or
more restrictions, including an order by the FDIC to sell sufficient voting
stock to become adequately capitalized, requirements to reduce total assets and
cease receipt of deposits from correspondent banks, and restrictions on
compensation of executive officers. "Critically undercapitalized" institutions
may not, beginning 60 days after becoming "critically undercapitalized," make
any payment of principal or interest on certain subordinated debt or extend
credit for a highly leveraged transaction or enter into any transaction outside
the ordinary course of business. In addition, "critically undercapitalized"
institutions are subject to appointment of a receiver or conservator.
As of December 31, 2007, each bank subsidiary of First Merchants is "well
capitalized" based on the "prompt corrective action" ratios and deadlines
described above. It should be noted, however, that a bank's capital category is
determined solely for the purpose of applying the OCC's "prompt corrective
action" regulations and that the capital category may not constitute an accurate
representation of the bank's overall financial condition or prospects.
DEPOSIT INSURANCE
The Corporation's affiliated banks are insured up to regulatory limits by the
FDIC; and, accordingly, are subject to deposit insurance assessments to maintain
the Bank Insurance Fund (the "BIF") and the Savings Association Insurance Fund
("SAIF") administered by the FDIC. The FDIC has adopted regulations establishing
a permanent risk-related deposit insurance assessment system. Under this system,
the FDIC places each insured bank in one of nine risk categories based on (i)
the bank's capitalization, and (ii) supervisory evaluations provided to the FDIC
by the institution's primary federal regulator. Each insured bank's insurance
assessment rate is then determined by the risk category in which it is
classified by the FDIC.
DIVIDEND LIMITATIONS
National banking laws restrict the amount of dividends that an affiliate bank
may declare in a year without obtaining prior regulatory approval. 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, 2007, the
Corporation's affiliate banks had a total of $40,084,000 retained net profits
available for 2008 dividends to the Corporation without prior regulatory
approval.
BROKERED DEPOSITS
Under FDIC regulations, no FDIC-insured depository institution can accept
brokered deposits unless it (i) is well capitalized, or (ii) is adequately
capitalized and received a waiver from the FDIC. In addition, these regulations
prohibit any depository institution that is not well capitalized from (a) paying
an interest rate on deposits in excess of 76 basis points over certain
prevailing market rates or (b) offering "pass through" deposit insurance on
certain employee benefit plan accounts unless it provides certain notice to
affected depositors.
INTERSTATE BANKING AND BRANCHING
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Riegle-Neal"), subject to certain concentration limits, required regulatory
approvals and other requirements, (i) financial holding companies such as the
Corporation are permitted to acquire banks and bank holding companies located in
any state; (ii) any bank that is a subsidiary of a bank holding company is
permitted to receive deposits, renew time deposits, close loans, service loans
and receive loan payments as an agent for any other bank subsidiary of that
holding company; and (iii) banks are permitted to acquire branch offices outside
their home states by merging with out-of-state banks, purchasing branches in
other states, and establishing de novo branch offices in other states.
FINANCIAL SERVICES MODERNIZATION ACT
The Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization Act")
establishes a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the existing BHC Act. Under this
legislation, bank holding companies would be permitted to conduct essentially
unlimited securities and insurance activities as well as other activities
determined by the Federal Reserve Board to be financial in nature or related to
financial services. As a result, the Corporation is able to provide securities
and insurance services. Furthermore, under this legislation, the Corporation is
able to acquire, or be acquired, by brokerage and
Page 8
PART I: ITEM 1. BUSINESS
FINANCIAL SERVICES MODERNIZATION ACT continued
securities firms and insurance underwriters. In addition, the Financial Services
Modernization Act broadens the activities that may be conducted by national
banks through the formation of financial subsidiaries. Finally, the Financial
Services Modernization Act modifies the laws governing the implementation of the
Community Reinvestment Act and addresses a variety of other legal and regulatory
issues affecting both day-to-day operations and long-term activities of
financial institutions.
A bank holding company may become a financial holding company if each of its
subsidiary banks is well capitalized, is well managed and has at least a
satisfactory rating under the Community Reinvestment Act, by filing a
declaration that the bank holding company wishes to become a financial holding
company. Also effective March 11, 2000, no regulatory approval is required for a
financial holding company to acquire a company, other than a bank or savings
association, engaged in activities that are financial in nature or incidental to
activities that are financial in nature, as determined by the Federal Reserve
Board. The Federal Reserve Bank of Chicago approved the Corporation's
application to become a Financial Holding Company effective September 13, 2000.
USA PATRIOT ACT
As part of the USA Patriot Act, signed into law on October 26, 2001, Congress
adopted the International Money Laundering Abatement and Financial
Anti-Terrorism Act of 2001 (the "Act"). The Act authorizes the Secretary of the
Treasury, in consultation with the heads of other government agencies, to adopt
special measures applicable to financial institutions such as banks, bank
holding companies, broker-dealers and insurance companies. Among its other
provisions, the Act requires each financial institution: (i) to establish an
anti-money laundering program; (ii) to establish due diligence policies,
procedures and controls that are reasonably designed to detect and report
instances of money laundering in United States private banking accounts and
correspondent accounts maintained for non-United States persons or their
representatives; and (iii) to avoid establishing, maintaining, administering, or
managing correspondent accounts in the United States for, or on behalf of, a
foreign shell bank that does not have a physical presence in any country. In
addition, the Act expands the circumstances under which funds in a bank account
may be forfeited and requires covered financial institutions to respond under
certain circumstances to requests for information from federal banking agencies
within 120 hours.
Treasury regulations implementing the due diligence requirements were issued in
2002. These regulations required minimum standards to verify customer identity,
encouraged cooperation among financial institutions, federal banking agencies,
and law enforcement authorities regarding possible money laundering or terrorist
activities, prohibited the anonymous use of "concentration accounts," and
required all covered financial institutions to have in place an anti-money
laundering compliance program.
The Act also amended the Bank Holding Company Act and the Bank Merger Act to
require the federal banking agencies to consider the effectiveness of a
financial institution's anti-money laundering activities when reviewing an
application under these acts.
THE SARBANES-OXLEY ACT
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"), which became law on July
30, 2002, added new legal requirements for public companies affecting corporate
governance, accounting and corporate reporting. The Sarbanes-Oxley Act provides
for, among other things:
o a prohibition on personal loans made or arranged by the issuer to its
directors and executive officers (except for loans made by a bank subject
to Regulation O);
o independence requirements for audit committee members;
o independence requirements for company auditors;
o certification of financial statements on Forms 10-K and 10-Q reports by the
chief executive officer and the chief financial officer;
o the forfeiture by the chief executive officer and chief financial officer
of bonuses or other incentive-based compensation and profits from the sale
of an issuer's securities by such officers in the twelve-month period
following initial publication of any financial statements that later
require restatement due to corporate misconduct;
o disclosure of off-balance sheet transactions;
o two-business day filing requirements for insiders filing Form 4s;
o disclosure of a code of ethics for financial officers and filing a Form 8-K
for a change in or waiver of such code;
Page 9
PART I: ITEM 1. BUSINESS
THE SARBANES-OXLEY ACT continued
o the reporting of securities violations "up the ladder" by both in-house and
outside attorneys;
o restrictions on the use of non-GAAP financial measures in press releases
and SEC filings;
o the formation of a public accounting oversight board; and
o various increased criminal penalties for violations of securities laws.
The Sarbanes-Oxley Act contains provisions, which became effective upon
enactment on July 30, 2002, including provisions, which became effective from
within 30 days to one year from enactment. The SEC has been delegated the task
of enacting rules to implement various provisions. In addition, each of the
national stock exchanges developed new corporate governance rules, including
rules strengthening director independence requirements for boards, the adoption
of corporate governance codes and charters for the nominating, corporate
governance and audit committees.
ADDITIONAL MATTERS
The Corporation and its affiliate banks are subject to the Federal Reserve Act,
which restricts financial transactions between banks and affiliated companies.
The statute limits credit transactions between banks, affiliated companies and
its executive officers and its affiliates. The statute prescribes terms and
conditions for bank affiliate transactions deemed to be consistent with safe and
sound banking practices, and restricts the types of collateral security
permitted in connection with the bank's extension of credit to an affiliate.
Additionally, all transactions with an affiliate must be on terms substantially
the same or at least as favorable to the institution as those prevailing at the
time for comparable transactions with non-affiliated parties.
In addition to the matters discussed above, the Corporation's affiliate banks
are subject to additional regulation of their activities, including a variety of
consumer protection regulations affecting their lending, deposit and collection
activities and regulations affecting secondary mortgage market activities.
The earnings of financial institutions are also affected by general economic
conditions and prevailing interest rates, both domestic and foreign, and by the
monetary and fiscal policies of the United States Government and its various
agencies, particularly the Federal Reserve. The Federal Reserve regulates the
supply of credit in order to influence general economic conditions, primarily
through open market operations in United States government obligations, varying
the discount rate on financial institution borrowings, varying reserve
requirements against financial institution deposits, and restricting certain
borrowings by financial institutions and their subsidiaries. The monetary
policies of the Federal Reserve have had a significant effect on the operating
results of the bank subsidiaries in the past and are expected to continue to do
so in the future.
Additional legislation and administrative actions affecting the banking industry
may be considered by the United States Congress, state legislatures and various
regulatory agencies, including those referred to above. It cannot be predicted
with certainty whether such legislation or administrative action will be enacted
or the extent to which the banking industry in general or the Corporation and
its affiliate banks in particular would be affected.
Page 10
PART I: ITEM 1. BUSINESS
STATISTICAL DATA
The following tables set forth statistical data on the Corporation and its
subsidiaries.
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND
INTEREST DIFFERENTIAL
The daily average balance sheet amounts, the related interest income or expense,
and average rates earned or paid are presented in the following table:
====================================================================================================================================
Interest Interest Interest
Average Income/ Average Average Income/ Average Average Income/ Average
(Dollars in Thousands) Balance Balance Rate Balance Balance Rate Balance Balance Rate
====================================================================================================================================
2007 2006 2005
----- ----- -----
Assets:
Federal Funds Sold ............ $ 3,308 $ 172 5.2% $ 6,983 $ 373 5.3% $ 8,385 $ 264 3.1%
Interest-bearing Deposits...... 10,580 582 5.5 7,831 500 6.4 16,683 695 4.2
Federal Reserve and
Federal Home Loan Bank Stock. 24,221 1,299 5.4 23,473 1,256 5.4 23,019 1,185 5.1
Securities:
Taxable ....................... 300,854 13,744 4.6 289,692 12,316 4.3 263,435 9,612 3.6
Tax-exempt ................ 175,152 10,074 5.8 175,072 10,100 5.8 162,965 9,807 6.0
---------- -------- ---------- -------- ---------- --------
Total Securities............. 476,006 23,818 5.0 464,764 22,416 4.8 426,400 19,419 4.6
Mortgage Loans Held for Sale..... 6,107 549 9.0 4,620 176 3.8 2,746 113 4.1
Loans:
Commercial .................... 1,955,750 151,158 7.7 1,704,026 128,888 7.6 1,569,270 105,740 6.7
Real Estate Mortgage........... 412,008 26,288 6.4 441,407 27,813 6.3 464,426 27,334 5.9
Installment ................... 400,191 29,276 7.3 405,006 29,891 7.4 385,097 25,248 6.6
Tax-exempt ................ 20,768 1,718 8.3 14,788 1,274 8.6 12,595 989 7.9
---------- -------- ---------- -------- ---------- --------
Total Loans ................. 2,794,824 208,989 7.5 2,569,847 188,042 7.3 2,434,134 159,424 6.5
---------- -------- ---------- -------- ---------- --------
Total Earning Assets......... 3,308,939 234,860 7.1 3,072,898 212,587 6.9 2,908,621 180,987 6.3
---------- -------- ---------- -------- ---------- --------
Net Unrealized Gain (Loss) on Securities
Available for Sale........... (3,624) (7,353) (1,217)
Allowance for Loan Losses........ (27,495) (26,443) (24,889)
Cash and Due from Banks.......... 64,571 58,305 53,037
Premises and Equipment .......... 43,945 40,227 38,284
Other Assets .................... 253,436 233,752 205,628
--------- --------- ---------
Total Assets ................ $3,639,772 $3,371,386 $3,179,464
========== ========== ==========
Liabilities:
Interest-bearing Deposits:
NOW Accounts ................ $ 490,908 11,034 2.2% $ 396,477 6,065 1.5% $ 395,356 2,058 0.5%
Money Market Deposit Accounts 246,706 7,648 3.1 251,746 7,551 3.0 280,508 4,899 1.7
Savings Deposits ............ 264,134 4,604 1.7 259,052 3,927 1.5 319,552 2,583 0.8
Certificates and Other
Time Deposits ............. 1,407,151 66,635 4.7 1,333,408 56,771 4.3 1,149,679 36,581 3.2
---------- -------- ---------- -------- ---------- --------
Total Interest-bearing
Deposits..................... 2,408,899 89,921 3.7 2,240,683 74,314 3.3 2,145,095 46,121 2.2
Borrowings ...................... 515,562 27,692 5.4 445,806 24,197 5.4 412,091 19,959 4.8
---------- -------- ---------- -------- ---------- --------
Total Interest-bearing
Liabilities................. 2,924,461 117,613 4.0 2,686,489 98,511 3.7 2,557,186 66,080 2.6
Noninterest-bearing Deposits..... 343,544 327,387 273,657
Other Liabilities ............... 40,981 37,991 33,096
---------- ---------- ----------
Total Liabilities............ 3,308,986 3,051,867 2,863,939
Stockholders' Equity ............ 330,786 319,519 315,525
---------- ---------- ----------
Total Liabilities and
Stockholders' Equity........ $3,639,772 117,613 3.6 $3,371,386 98,511 3.2 $3,179,464 66,080 2.3
========== -------- ========== -------- ========== --------
Net Interest Income ......... $117,247 $114,076 $114,907
======== ======== ========
Net Interest Margin.......... 3.5 3.7 4.0
Average balance of securities is computed based on the average of the
historical amortized cost balances without the effects of the fair value
adjustment.
Tax-exempt securities and loans are presented on a fully taxable equivalent
basis, using a marginal tax rate of 35% from 2007, 2006, and 2005. Those totals
equal $4,127, $3,981 and $3,778, respectively.
Nonaccruing loans have been included in the average balances.
Page 11
PART I: ITEM 1. BUSINESS
ANALYSIS OF CHANGES IN NET INTEREST INCOME
The following table presents net interest income components on a tax-equivalent
basis and reflects changes between periods attributable to movement in either
the average balance or average interest rate for both earning assets and
interest-bearing liabilities. The volume differences were computed as the
difference in volume between the current and prior year times the interest rate
of the prior year, while the interest rate changes were computed as the
difference in rate between the current and prior year times the volume of the
prior year. Volume/rate variances have been allocated on the basis of the
absolute relationship between volume variances and rate variances.
====================================================================================================================================
(Dollars in Thousands on Fully 2007 Compared to 2006 2006 Compared to 2005
Taxable Equivalent Basis) Increase (Decrease) Due To Increase (Decrease) Due To
====================================================================================================================================
Volume Rate Total Volume Rate Total
======== ======== ======= ======== ======== =======
Interest Income:
Federal Funds Sold ............... $ (298) $ 97 $ (201) $ (50) $ 159 $ 109
Interest-bearing Deposits ........ 200 (118) 82 (467) 272 (195)
Federal Reserve and Federal
Home Loan Bank Stock ........... 40 3 43 24 47 71
Securities ....................... 550 852 1,402 1,809 1,188 2,997
Mortgage Loans Held for Sale ..... 71 302 373 72 (9) 63
Loans ............................ 16,640 3,934 20,574 9,098 19,457 28,555
-------- --------- --------- -------- --------- ---------
Totals ........................... 17,203 5,070 22,273 10,486 21,114 31,600
-------- --------- --------- -------- --------- ---------
Interest Expense:
NOW Accounts ..................... 1,673 3,296 4,969 6 4,001 4,007
Money Market Deposit
Accounts........................ (153) 250 97 (547) 3,199 2,652
Savings Deposits.................. 78 599 677 (565) 1,909 1,344
Certificates and Other
Time Deposits................... 3,256 6,608 9,864 6,480 13,710 20,190
Borrowings........................ 3,749 (254) 3,495 1,713 2,525 4,238
-------- --------- --------- -------- --------- ---------
Totals.......................... 8,603 10,499 19,102 7,087 25,344 32,431
-------- --------- --------- -------- --------- ---------
Change in Net Interest
Income (Fully Taxable
Equivalent Basis)................ $ 8,600 $ (5,429) $ 3,171 $ 3,399 $ (4,230) $ (831)
======== ========= ======== =========
Tax Equivalent Adjustment
Using Marginal Rate
of 35% for 2007, 2006,
and 2005.......................... (146) (203)
---------- ----------
Change in Net Interest
Income........................... $ 3,025 $ (1,034)
========= ==========
Page 12
PART I: ITEM 1. BUSINESS
INVESTMENT SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses and
approximate market value of the investment securities at the dates indicated
were:
====================================================================================================================================
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
(Dollars in Thousands) COST GAINS LOSSES VALUE
====================================================================================================================================
Available for Sale at December 31, 2007
U.S. Treasury ............................... $ 1,501 $ 18 $ 1,519
U.S. Government-sponsored Agency Securities.. 67,793 240 $ 98 67,935
State and Municipal ......................... 150,744 2,324 156 152,912
Mortgage-backed Securities .................. 199,591 1,654 1,444 199,801
Corporate Obligations........ ............... 13,740 1,294 12,446
Marketable Equity Securities ................ 6,835 612 6,223
-------- -------- -------- --------
Total Available for Sale ................. 440,204 4,236 3,604 440,836
-------- -------- -------- --------
Held to Maturity at December 31, 2007
State and Municipal ......................... 10,317 237 298 10,256
Mortgage-backed Securities .................. 14 14
-------- -------- -------- --------
Total Held to Maturity ................... 10,331 237 298 10,270
-------- -------- -------- --------
Total Investment Securities .............. $450,535 $ 4,473 $ 3,902 $451,106
======== ======== ======== ========
Available for Sale at December 31, 2006
U.S. Treasury .......................................... $ 1,502 $ 1 $ 1,503
U.S. Government-sponsored Agency Securities ............ 87,193 69 $ 1,284 85,978
State and Municipal .................................... 168,262 2,251 892 169,621
Mortgage-backed Securities ............................. 195,228 600 3,983 191,845
Other Asset-backed Securities ..........................
Marketable Equity Securities ........................... 7,296 310 6,986
-------- -------- -------- --------
Total Available for Sale ............................ 459,481 2,921 6,469 455,933
-------- -------- -------- --------
Held to Maturity at December 31, 2006
State and Municipal .................................... 9,266 432 200 9,498
Mortgage-backed Securities ............................. 18 18
-------- -------- -------- --------
Total Held to Maturity .............................. 9,284 432 200 9,516
-------- -------- -------- --------
Total Investment Securities ......................... $468,765 $ 3,353 $ 6,669 $465,449
======== ======== ======== ========
Available for Sale at December 31, 2005
U.S. Treasury .......................................... $ 1,586 $ 1 $ 1,585
U.S. Government-sponsored Agency Securities ............ 83,026 $ 1 1,836 81,191
State and Municipal .................................... 167,095 2,159 1,131 168,123
Mortgage-backed Securities ............................. 168,019 139 5,656 162,502
Other Asset-backed Securities .......................... 1 1
Marketable equity securities ........................... 9,660 435 9,225
-------- -------- -------- --------
Total Available for Sale ............................ 429,387 2,299 9,059 422,627
-------- -------- -------- --------
Held to Maturity at December 31, 2005
State and Municipal .................................... 11,609 283 412 11,480
Mortgage-backed Securities ............................. 30 30
-------- -------- -------- --------
Total Held to Maturity .............................. 11,639 283 412 11,510
-------- -------- -------- --------
Total Investment Securities ......................... $441,026 $ 2,582 $ 9,471 $434,137
======== ======== ======== ========
====================================================================================================================================
(Dollars in Thousands) Cost Yield Cost Yield Cost Yield
====================================================================================================================================
2007 2006 2005
----- ----- -----
Federal Reserve and Federal Home Loan
Bank Stock at December 31:
Federal Reserve Bank Stock .................... $ 9,223 6.0% $ 9,091 6.0% $ 8,913 6.0%
Federal Home Loan Bank Stock .................. 16,027 4.3 14,600 4.3 14,287 4.3
------- ------- -------
Total ..................................... $25,250 4.9% $23,691 4.9% $23,200 4.9%
======= ======= =======
The fair value of Federal Reserve and Federal Home Loan Bank stock approximates cost.
Page 13
PART I: ITEM 1. BUSINESS
INVESTMENT SECURITIES continued
There were no issuers included in our investment security portfolio at December
31, 2007, 2006 or 2005 where the aggregate carrying value of any one issuer
exceeded 10 percent of the Corporation's stockholders' equity at those dates.
The term "issuer" excludes the U.S. Government and its sponsored agencies and
corporations.
The maturity distribution (Dollars in Thousands) and average yields for the
securities portfolio at December 31, 2007 were:
Securities available for sale December 31, 2007:
====================================================================================================================================
Within 1 Year 1-5 Years 5-10 Years
(Dollars in Thousands) Amount Yield Amount Yield Amount
Yield(1)
====================================================================================================================================
U.S. Treasury................................ $ 1,519 4.8%
U.S. Government-sponsored Agency Securities.. 43,357 3.8 $ 24,479 4.7 $ 99 4.6%
State and Municipal.......................... 31,580 4.4 74,076 5.3 39,371 6.6
Corporate Obligations ....................... 30 0.0
------- -------- -------
Total.................................... $76,456 4.1% $ 98,585 5.1% $39,470 6.6%
======= ======== =======
Marketable Equity
and Mortgage -
Due After Ten Years Backed Securities Total
------------------- ----------------------- -----
Amount Yield Amount Yield Amount Yield
------ ------ ------ ------ ------ ------
U.S. Treasury........................ $ 1,519 4.8%
U.S. Government-sponsored
Agency Securities................. 67,935 4.1
State and Municipal.................. $ 7,885 7.8% 152,912 5.6
Marketable Equity Securities......... $ 6,223 5.5% 6,223 5.5
Corporate Obligations ............... 12,416 6.5 12,446 6.5
Mortgage-backed Securities........... 199,801 4.8 199,801 4.8
-------- --------- --------
Total............................ $ 20,301 7.0% $ 206,024 4.8% $440,836 5.0%
======== ========= ========
Securities held to maturity at December 31, 2007:
====================================================================================================================================
Within 1 Year 1-5 Years 5-10 Years
(Dollars in Thousands) Amount Yield Amount Yield Amount Yield
====================================================================================================================================
State and Municipal.................. $ 704 7.4% $ 276 7.8% $ 810 6.0%
Interest yields on state and municipal securities are presented on a fully taxable equivalent basis using a 35% tax rate.
Mortgage-Backed
Due After Ten Years Securities Total
===================== ================= =======
Amount Yield(1) Amount Yield(1) Amount Yield(1)
------ ------ ------ ------ ------ ------
State and Municipal.................. $ 8,527 7.1% $10,317 7.1%
Other Asset-backed Securities........ $ 14 8.4% 14 8.4
------- ------- -------
Total............................ $ 8,527 7.1% $ 14 8.4% $10,331 7.1%
======= ======= ======
Page 14
PART I: ITEM 1. BUSINESS
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,
2007 and 2006:
====================================================================================================================================
GROSS GROSS GROSS
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
(Dollars in Thousands) VALUE LOSSES VALUE LOSSES VALUE LOSSES
====================================================================================================================================
Less than 12 12 Months or
Months Longer Total
-------------- -------------- ---------
Temporarily Impaired Investment
Securities at December 31, 2007:
U.S. Government-sponsored Agency Securities ............... $ 45,572 $ (98) $45,572 $ (98)
State and Municipal ....................................... $ 858 $ (7) 60,996 (447) 61,854 (454)
Mortgage-backed Securities ................................ 3,489 (30) 86,161 (1,414) 89,560 (1,444)
Corporate Obligations ..................................... 12,415 (1,294) 12,415 (1,294)
Marketable Equity Securities .............................. 900 (612) 900 (612)
-------- ------- -------- ------- -------- --------
Total Temporarily Impaired Investment Securities ....... $ 16,762 $(1,331) $193,629 $(2,571) $210,391 $ (3,902)
======== ======= ======== ======= ======== ========
---------------------------------------------------------------------
GROSS GROSS GROSS
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
---------------------------------------------------------------------
Less than 12 12 Months or
Months Longer Total
-------------- -------------- ---------
Temporarily Impaired Investment
Securities at December 31, 2006:
U.S. Government-sponsored agency securities ............... $ 1,576 $ (3) $ 71,702 $(1,281) $ 73,278 $ (1,284)
State and Municipal ....................................... 9,608 (35) 81,841 (1,057) 91,449 (1,092)
Mortgage-backed Securities ................................ 7,459 (20) 126,555 (3,963) 134,014 (3,983)
Corporate Obligations .................................... 28 (6) 28 (6)
Marketable Equity Securities .............................. 1,215 (304) 1,215 (304)
-------- ------- -------- ------- -------- --------
Total Temporarily Impaired Investment Securities ....... $ 19,858 $ (362) $280,126 $(6,307) $299,984 $ (6,669)
======== ======= ======== ======= ======== ========
LOAN PORTFOLIO
TYPES OF LOANS
====================================================================================================================================
(Dollars in Thousands) 2007 2006 2005 2004 2003
====================================================================================================================================
Loans at December 31:
Commercial and Industrial Loans.............. $ 662,701 $ 537,305 $ 461,102 $ 451,227 $ 435,221
Agricultural Production
Financing and Other Loans to Farmers....... 114,324 100,098 95,130 98,902 95,048
Real Estate Loans:
Construction............................... 165,425 169,491 174,783 164,738 149,865
Commercial and Farmland.................... 947,234 861,429 734,865 709,163 564,578
Residential................................ 744,627 749,921 751,217 761,163 866,477
Individuals' Loans for
Household and Other Personal Expenditures.. 187,880 223,504 200,139 198,532 196,093
Tax-exempt Loans............................. 16,423 14,423 8,263 8,203 16,363
Lease Financing Receivables,
Net of Unearned Income .................... 8,351 8,010 8,713 11,311 7,919
Other Loans.................................. 29,878 28,420 23,215 24,812 21,939
---------- ---------- ---------- ---------- ----------
2,876,843 2,692,601 2,457,427 2,428,501 2,353,503
Allowance for Loan Losses................... (28,228) (26,540) (25,188) (22,548) (25,493)
---------- ---------- ---------- ---------- ----------
Total Loans............................. $2,848,615 $2,666,061 $2,432,239 $2,405,503 $2,328,010
========== ========== ========== ========== ==========
Residential Real Estate Loans Held for Sale at December 31, 2007, 2006, 2005,
2004 and 2003 were $3,735,000, $5,413,000, $4,910,000, $3,367,000, and
$3,043,000, respectively.
Page 15
PART I: ITEM 1. BUSINESS
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
Presented in the table below are the maturities of loans (excluding residential
real estate, individuals' loans for household and other personal expenditures
and lease financing) outstanding as of December 31, 2007. Also presented are the
amounts due after one year classified according to the sensitivity to changes in
interest rates.
====================================================================================================================================
Maturing Maturing Maturing
Within 1 - 5 Over
(Dollars in Thousands) 1 Year Years 5 Years Total
====================================================================================================================================
Commercial and Industrial Loans................ $ 365,246 $ 215,075 $ 82,380 $ 662,701
Agricultural Production Financing
and Other Loans to Farmers................... 88,359 17,721 8,244 114,324
Real Estate - Construction..................... 121,260 40,901 3,264 165,425
Real Estate - Commercial and Farmland.......... 342,938 469,754 134,542 947,234
Tax-exempt Loans............................... 9,953 3,363 3,107 16,423
Other Loans.................................... 21,465 5,158 3,255 29,878
---------- --------- --------- ----------
Total.................................... $ 949,221 $ 751,972 $234,792 $1,935,985
========== ========= ========= ==========
================================================
Maturing Maturing
1 - 5 Over
Years 5 Years
================================================
Loans Maturing After One Year with:
Fixed Rate.............................. $ 259,354 $ 211,689
Variable Rate........................... 492,618 23,103
------------- ------------
Total................................. $ 751,972 $ 234,792
============= ============
NONACCRUING, CONTRACTUALLY PAST DUE 90 DAYS OR MORE OTHER THAN NONACCRUING AND
RESTRUCTURED LOANS
====================================================================================================================================
(Dollars in Thousands) 2007 2006 2005 2004 2003
====================================================================================================================================
Non-accrual Loans......................... $ 29,031 $ 17,926 $ 10,030 $ 15,355 $ 19,453
Loans Contractually Past Due 90
Days or More Other Than Nonaccruing..... 3,578 2,870 3,965 1,907 6,530
Restructured Loans........................ 145 84 310 2,019 641
------- ------- ------- ------- -------
Total Non-performing Loans........... $32,754 $ 20,880 $ 14,305 $ 19,281 $ 26,624
======= ======= ======= ======= =======
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.
Interest income of $1,143,000 for the year ended December 31, 2007, was
recognized on the nonaccruing and restructured loans listed in the table above,
whereas interest income of $2,009,000 would have been recognized under their
original loan terms.
Potential problem loans:
Management has identified certain other loans totaling $65,867,000 as of
December 31, 2007, not included in the table above, or the impaired loan table
in the footnotes to the consolidated financial statements, about which there are
doubts as to the borrowers' ability to comply with present repayment terms. For
the Corporation, all criticized loans, including substandard, doubtful and loss
credits are included in the impaired loan total.
The Corporation's affiliate banks generate commercial, mortgage and consumer
loans 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.
Page 16
PART I: ITEM 1. BUSINESS
SUMMARY OF LOAN LOSS EXPERIENCE
The following table summarizes the loan loss experience for the years indicated.
====================================================================================================================================
(Dollars in Thousands) 2007 2006 2005 2004 2003
====================================================================================================================================
Allowance for Loan Losses:
Balance at January.................... $ 26,540 $ 25,188 $ 22,548 $ 25,493 $ 22,417
Charge offs:
Commercial and Industrial........... 2,403 1,369 3,763 7,455 5,023
Real Estate Mortgage................ 4,309 3,613 2,117 1,588 2,111
Individuals' Loans for Household and
Other Personal Expenditures,
Including Other Loans................. 1,845 1,528 1,864 1,858 5,005
-------- -------- -------- -------- --------
Total Charge offs..................... 8,557 6,510 7,744 10,901 12,139
-------- -------- -------- -------- --------
Recoveries:
Commercial and Industrial............ 551 291 1,283 1,629 1,002
Real Estate Mortgage ................ 750 863 122 161 421
Individuals' Loans For Household and
Other Personal Expenditures,
Including Other Loans.................. 437 450 625 461 588
-------- -------- -------- -------- --------
Total Recoveries....................... 1,738 1,604 2,030 2,251 2,011
-------- -------- -------- -------- --------
Net Charge offs............................ 6,819 4,906 5,714 8,650 10,128
-------- -------- -------- -------- --------
Provisions for Loan Losses................. 8,507 6,258 8,354 5,705 9,477
Allowance Acquired in Purchase............. 3,727
-------- -------- -------- -------- --------
Balance at December 31..................... $28,228 $26,540 $25,188 $22,548 $25,493
======== ======== ======== ======== ========
Ratio of Net Charge offs During the
Period to Average Loans
Outstanding During the Period............. .24% .19% .23% .37% .44%
Category also includes the charge offs for lease financing, loans to
financial institutions, tax-exempt loans and agricultural production financing
and other loans to farmers.
Category includes the charge offs for construction, commercial and farmland
and residential real estate loans.
Category also includes the recoveries for lease financing, loans to
financial institutions, tax-exempt loans and agricultural production financing
and other loans to farmers.
Category includes the recoveries for construction, commercial and farmland
and residential real estate loans.
See the information regarding the analysis of loan loss experience in the Asset
Quality/Provision for Loan Losses section of Management's Discussion and
Analysis of Financial Condition and Results of Operations included as Item 7 of
this Annual Report on Form 10-K.
Page 17
PART I: ITEM 1. BUSINESS
SUMMARY OF LOAN LOSS EXPERIENCE continued
Allocation of the Allowance for Loan Losses at December 31:
Presented below is an analysis of the composition of the allowance for loan
losses and percent of loans in each category to total loans.
==============================================================================================================================
2007 2006
(Dollars in Thousands) Amount Percent Amount Percent
==============================================================================================================================
Balance at December 31:
Commercial and Industrial ................ $ 9,598 34.1% $ 9,598 31.0%
Real Estate Mortgage ..................... 12,561 58.8 12,479 60.5
Individuals' Loans for Household and
Other Personal Expenditures,
Including Other Loans..................... 5,969 7.1 4,363 8.5
Unallocated................................. 100 N/A 100 N/A
-------- ------ -------- ------
Totals...................................... $ 28,228 100.0% $ 26,540 100.0%
======== ====== ======== ======
2005 2004
------------------------- -------------------------
Amount Per Cent Amount Per Cent
-------- -------- -------- --------
Balance at December 31:
Commercial and Industrial .............. $ 7,430 30.9% $ 16,821 30.9%
Real Estate Mortgage ................... 13,149 60.6 1,916 60.9
Individuals' Loans for Household and
Other Personal Expenditures,
Including Other Loans..................... 4,509 8.5 3,711 8.5
Unallocated................................. 100 N/A 100 N/A
-------- ------ -------- ------
Totals...................................... $ 25,188 100.0% $ 22,548 100.0%
======== ====== ======== ======
2003
-------------------------
Amount Per Cent
-------- --------
Balance at December 31:
Commercial and industrial .............. $ 17,517 29.9%
Real estate mortgage ................... 4,441 60.8
Individuals' Loans for Household and
Other Personal Expenditures,
Including Other Loans..................... 3,435 9.3
Unallocated. .... .......................... 100 N/A
-------- ------
Totals...................................... $ 25,493 100.0%
======== ======
Category also includes the allowance for loan losses and percent of loans
for lease financing, loans to financial institutions, tax-exempt loans,
agricultural production financing and other loans to farmers and construction
real estate loans.
Category includes the allowance for loan losses and percent of loans for
commercial real estate, farmland and residential real estate loans.
At December 31, 2007, the Corporation had no concentration of loans exceeding 10
percent of total loans, which are not otherwise disclosed. Loan concentrations
are considered to exist when there are amounts loaned to a multiple number of
borrowers engaged in similar activities, which would cause them to be similarly
impacted by economic or other conditions.
Loan Administration and Loan Loss Charge-off Procedures
Primary responsibility and accountability for day-to-day lending activities
rests with the Corporation's affiliate banks. Loan personnel at each bank have
the authority to extend credit under guidelines approved by the bank's board of
directors. Executive committees active at each bank serve as vehicles for
communication between the banks and for the pooling of knowledge, judgment and
experience of the Corporation's affiliate banks. These committees provide
valuable input to lending personnel, act as an approval body, and monitor the
overall quality of the banks' loan portfolios. The Corporation also maintains a
loan grading and review program for its affiliate banks, which includes
quarterly reviews of problem loans, delinquencies and charge offs. The purpose
of this program is to evaluate loan administration, credit quality, loan
documentation and the adequacy of the allowance for loan losses.
Page 18
PART I: ITEM 1. BUSINESS
Loan Administration and Loan Loss Charge-off Procedures continued
The Corporation maintains an allowance for loan losses to cover probable credit
losses identified during its loan review process. The allowance is increased by
the provision for loan losses and decreased by charge offs less recoveries. All
charge offs are approved by the Banks' senior loan officer and are reported to
the Banks' Boards. The Banks charge off loans when a determination is made that
all or a portion of a loan is uncollectible or as a result of examinations by
regulators and the independent auditors.
Provision for Loan Losses
In banking, loan losses are one of the costs of doing business. Although the
Banks' management emphasize the early detection and charge-off of loan losses,
it is inevitable that at any time certain losses exist in the portfolio, which
have not been specifically identified. Accordingly, the provision for loan
losses is charged to earnings on an anticipatory basis, and recognized loan
losses are deducted from the allowance so established. Over time, all net loan
losses must be charged to earnings. During the year, an estimate of the loss
experience for the year serves as a starting point in determining the
appropriate level for the provision. However, the amount actually provided in
any period may be greater or less than net loan losses, based on management's
judgment as to the appropriate level of the allowance for loan losses. The
determination of the provision in any period is based on management's continuing
review and evaluation of the loan portfolio, and its judgment as to the impact
of current economic conditions on the portfolio. The evaluation by management
includes consideration of past loan loss experience, changes in the composition
of the loan portfolio, and the current condition and amount of loans
outstanding.
Impaired loans are measured by the present value of expected future cash flows,
or the fair value of the collateral of the loans, if collateral dependent. For
the Corporation, all criticized loans, including sub standard, doubtfulness and
loss credits are included in the impaired loan total. Information on impaired
loans is summarized below:
===================================================================================================================================
(Dollars in Thousands) 2007 2006 2005
===================================================================================================================================
As of, and for the Year Ending December 31:
Impaired Loans With an Allowance............................ $ 21,304 $ 17,291 $ 7,540
Impaired Loans for which the Discounted
Cash Flows or Collateral Value Exceeds the
Carrying Value of the Loan................................ 65,645 43,029 44,840
------------ ------------ ------------
Total Impaired Loans.................................. $ 86,949 $ 60,320 $ 52,380
============== ============== ==============
Total Impaired Loans as a Percent of Total Loans.............. 3.02% 2.24% 2.13%
Allowance for Impaired Loans (Included in the
Corporation's Allowance for Loan Losses).................. $ 6,034 $ 4,130 $ 2,824
Average Balance of Impaired Loans........................... 103,272 66,139 44,790
Interest Income Recognized on Impaired Loans................ 6,675 5,143 3,511
Cash Basis Interest Included Above.......................... 1,143 1,364 650
DEPOSITS
The average balances, interest income and expense and average rates on deposits
for the years ended December 2007, 2006 and 2005 are presented within the
"Distribution of Assets, Liabilities and Stockholders' Equity, Interest Rates
and Interest Differential" table on page 11 of this Form 10-K.
As of December 31, 2007, certificates of deposit and other time deposits of
$100,000 or more mature as follows:
=====================================================================================================================
Maturing Maturing Maturing Maturing
3 Months 3-6 6-12 Over 12
(Dollars in Thousands) or less Months Months Months Total
=====================================================================================================================
Certificates of Deposit and
Other Time Deposits.......... $269,578 $ 91,199 $ 85,216 $ 49,637 $495,630
Percent ....................... 54% 19% 17% 10% 100%
Page 19
PART I: ITEM 1. BUSINESS
RETURN ON EQUITY AND ASSETS
See the information regarding return on equity and assets presented within the
"Five - Year Summary of Selected Financial Data" on page 3 of this Form 10-K.
SHORT-TERM BORROWINGS
=============================================================================================
(Dollars in Thousands) 2007 2006 2005
=============================================================================================
Balance at December 31:
Securities Sold Under Repurchase
Agreements (Short-term Portion).................. $ 72,247 $ 42,750 $106,415
Federal Funds Purchased............................ 52,350 56,150 50,000
-------- -------- --------
Total Short-term Borrowings................ $124,597 $ 98,900 $156,415
======== ======== ========
Securities sold under repurchase agreements are borrowings maturing within one
year and are secured by U.S. Treasury and U.S. Government-sponsored agency
securities.
Pertinent information with respect to short-term borrowings is summarized below:
=============================================================================================
(Dollars in Thousands) 2007 2006 2005
=============================================================================================
Weighted Average Interest Rate on Outstanding
Balance at December 31:
Securities Sold Under Repurchase
Agreements (Short-term Portion).............. 3.7% 4.4% 3.8%
Total Short-term Borrowings..................... 3.9 4.9 4.3
Weighted Average Interest Rate During the Year:
Securities Sold Under Repurchase
Agreements(Short-term Portion)............... 4.3% 4.4% 2.1%
Total Short-term Borrowings..................... 4.9 4.6 2.3
Highest Amount Outstanding at Any Month End
During the Year:
Securities Sold Under Repurchase
Agreements (Short-term Portion).............. $ 98,735 $ 98,765 $ 68,198
Total Short-term Borrowings..................... 226,894 219,337 144,898
Average Amount Outstanding During the Year:
Securities Sold Under Repurchase
Agreements (Short-term Portion).............. $ 62,040 $ 73,818 $ 77,969
Total Short-term Borrowings..................... 127,345 109,577 95,447
Page 20
PART I: ITEM 1A. AND ITEM 1B.
ITEM 1A. RISK FACTORS
RISK FACTORS
There are a number of factors, including those specified below, that may
adversely affect the Corporation's business, financial results or stock price.
Additional risks that the Corporation currently does not know about or currently
views as immaterial may also impair the Corporation's business or adversely
impact its financial results or stock price.
INDUSTRY RISK FACTORS
o The Corporation's business and financial results are significantly affected
by general business and economic conditions.
The Corporation's business activities and earnings are affected by general
business conditions in the United States and abroad. These conditions include
short-term and long-term interest rates, inflation, monetary supply,
fluctuations in both debt and equity capital markets, and the strength of the
United States economy and the state and local economies in which the Corporation
operates. For example, an economic downturn, an increase in unemployment, or
other events that affect household and/or corporate incomes could result in a
deterioration of credit quality, a change in the allowance for loan losses, or
reduced demand for loan or fee-based products and services. Changes in the
financial performance and condition of the Corporation's borrowers could
negatively affect repayment of those borrowers' loans. In addition, changes in
securities market conditions and monetary fluctuations could adversely affect
the availability and terms of funding necessary to meet the Corporation's
liquidity needs.
o Changes in the domestic interest rate environment could reduce the
Corporation's net interest income.
The operations of financial institutions, such as the Corporation, are dependent
to a large degree on net interest income, which is the difference between
interest income from loans and investments and interest expense on deposits and
borrowings. An institution's net interest income is significantly affected by
market rates of interest, which in turn are affected by prevailing economic
conditions, by the fiscal and monetary policies of the federal government and by
the policies of various regulatory agencies. Like all financial institutions,
the Corporation's balance sheet is affected by fluctuations in interest rates.
Volatility in interest rates can also result in the flow of funds away from
financial institutions into direct investments. Direct investments, such as U.S.
Government and corporate securities and other investment vehicles, including
mutual funds, generally pay higher rates of return than financial institutions,
because of the absence of federal insurance premiums and reserve requirements.
o Changes in the laws, regulations and policies governing banks and financial
services companies could alter the Corporation's business environment and
adversely affect operations.
The Board of Governors of the Federal Reserve System regulates the supply of
money and credit in the United States. Its fiscal and monetary policies
determine in a large part the Corporation's cost of funds for lending and
investing and the return that can be earned on those loans and investments, both
of which affect the Corporation's net interest margin. Federal Reserve Board
policies can also materially affect the value of financial instruments that the
Corporation holds, such as debt securities. The Corporation and its bank
subsidiaries are heavily regulated at the federal and state levels. This
regulation is to protect depositors, federal deposit insurance funds and the
banking system as a whole. Congress and state legislatures and federal and state
agencies continually review banking laws, regulations and policies for possible
changes. Changes in statutes, regulations or policies could affect the
Corporation in substantial and unpredictable ways, including limiting the types
of financial services and products that the Corporation offers and/or increasing
the ability of non-banks to offer competing financial services and products. The
Corporation cannot predict whether any of this potential legislation will be
enacted, and if enacted, the effect that it or any regulations would have on the
Corporation's financial condition or results of operations.
o The banking and financial services industry is highly competitive, and
competitive pressures could intensify and adversely affect the
Corporation's financial results.
The Corporation operates in a highly competitive industry that could become even
more competitive as a result of legislative, regulatory and technological
changes and continued consolidation. The Corporation competes with other banks,
savings and loan associations, mutual savings banks, finance companies, mortgage
banking companies, credit unions and investment companies. In addition,
technology has lowered barriers to entry and made it possible for non-banks to
offer products and services traditionally provided by banks. Many of the
Corporation's competitors have fewer regulatory constraints and some have lower
cost structures. Also, the potential need to adapt to industry changes in
information technology systems, on which the Corporation and financial services
industry are highly dependent, could present operational issues and require
capital spending.
Page 21
PART I: ITEM 1A. AND ITEM 1B.
INDUSTRY RISK FACTORS continued
o Acts or threats of terrorism and political or military actions taken by the
United States or other governments could adversely affect general economic
or industry conditions.
Geopolitical conditions may also affect the Corporation's earnings. Acts or
threats or terrorism and political or military actions taken by the United
States or other governments in response to terrorism, or similar activity, could
adversely affect general economic or industry conditions.
CORPORATION RISK FACTORS
o The Corporation's allowance for loan losses may not be adequate to cover
actual losses.
The Corporation maintains an allowance for loan losses to provide for loan
defaults and non-performance. The allowance for loan losses represents
management's estimate of probable losses inherent in the Corporation's loan
portfolio. 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. 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 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.
o The Corporation may suffer losses in its loan portfolio despite its
underwriting practices.
The Corporation seeks to mitigate the risks inherent in its loan portfolio by
adhering to specific underwriting practices. 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. There is a continuous review of
the loan portfolio, including an internally administered loan "watch" list and
an independent loan review. 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. Although the Corporation
believes that its underwriting criteria are appropriate for the various kinds of
loans it makes, the Corporation may incur losses on loans due to the factors
previously discussed.
o Because the nature of the financial services business involves a high
volume of transactions, the Corporation faces significant operational
risks.
The Corporation operates in diverse markets and relies on the ability of its
employees and systems to process a high number of transactions. Operational risk
is the risk of loss resulting from the Corporation's operations, including, but
not limited to, the risk of fraud by employees or persons outside of the
Corporation, the execution of unauthorized transactions by employees, errors
relating to transaction processing and technology, breaches of the internal
control system and compliance requirements and business continuation and
disaster recovery. This risk of loss also includes the potential legal actions
that could arise as a result of an operational deficiency or as a result of
noncompliance with applicable regulatory standards, adverse business decisions
or their implementation, and customer attrition due to potential negative
publicity. In the event of a breakdown in the internal control system, improper
operation of systems or improper employee actions, the Corporation could suffer
financial loss, face regulatory action and suffer damage to its reputation.
o A natural disaster could harm the Corporation's business.
Natural disasters could harm the Corporation's operations directly through
interference with communications, as well as through the destruction of
facilities and operational, financial and management information systems. These
events could prevent the Corporation from gathering deposits, originating loans
and processing and controlling its flow of business.
Page 22
PART I: ITEM 1A. AND ITEM 1B.
CORPORATION RISK FACTORS continued
o The Corporation faces systems failure risks as well as security
risks,including "hacking" and "identity theft".
The computer systems and network infrastructure the Corporation uses could be
vulnerable to unforeseen problems. Our operations are dependent upon our ability
to protect computer equipment against damage from fire, power loss or
telecommunication failure. Any damage or failure that causes an interruption in
our operations could adversely affect our business and financial results. In
addition, our computer systems and network infrastructure present security
risks, and could be susceptible to hacking or identity theft.
o The Corporation relies on dividends from its subsidiaries for its liquidity
needs.
The Corporation is a separate and distinct legal entity from its bank and
non-bank subsidiaries. The Corporation receives substantially all of its cash
from dividends paid by its subsidiaries. These dividends are the principal
source of funds to pay dividends on the Corporation's stock and interest and
principal on its debt. Various federal and state laws and regulations limit the
amount of dividends that our bank subsidiaries may pay to the Corporation.
o The Corporation's reported financial results depend on management's
selection of accounting methods and certain assumptions and estimates.
The Corporation's accounting policies and methods are fundamental to how it
records and reports its financial condition and results of operations. The
Corporation's management must exercise judgment in selecting and applying many
of these accounting policies and methods, so they comply with Generally Accepted
Accounting Principles and reflect management's judgment of the most appropriate
manner to report the Corporation's financial condition and results. In some
cases, management must select the accounting policy or method to apply from two
or more alternatives, any of which might be reasonable under the circumstances
yet might result in the Corporation's reporting materially different results
than would have been reported under a different alternative. Certain accounting
policies are critical to presenting the Corporation's financial condition and
results, and require management to make difficult, subjective or complex
judgments about matters that are uncertain. Materially different amounts could
be reported under different conditions or using different assumptions or
estimates. These critical accounting policies include: the allowance for loan
losses; the valuation of investment securities; the valuation of goodwill and
intangible assets; and pension accounting. Because of the uncertainty of
estimates involved in these matters, the Corporation may be required to do one
or more of the following: significantly increase the allowance for loan losses
and/or sustain loan losses that are significantly higher than the reserve
provided; recognize significant provision for impairment of its investment
securities; recognize significant impairment on its goodwill and intangible
assets; or significantly increase its pension liability. For more information,
refer to "Critical Accounting Policies" under Item 7. Part II. Management's
Discussion and Analysis of Financial Condition and Results of Operations.
o Changes in accounting standards could materially impact the Corporation's
financial statements.
From time to time, the Financial Accounting Standards Board changes the
financial accounting and reporting standards that govern the preparation of the
Corporation's financial statements. These changes can be hard to predict and can
materially impact how the Corporation records and reports its financial
condition and results of operations. In some cases, the Corporation could be
required to apply a new or revised standard retroactively, resulting in the
Corporation's restating prior period financial statements.
o Significant legal actions could subject the Corporation to substantial
uninsured liabilities.
The Corporation is from time to time subject to claims related to its
operations. These claims and legal actions, including supervisory actions by the
Corporation's regulators, could involve large monetary claims and significant
defense costs. To protect itself from the cost of these claims, the Corporation
maintains insurance coverage in amounts and with deductibles that it believes
are appropriate for its operations. However, the Corporation's insurance
coverage may not cover all claims against the Corporation or continue to be
available to the Corporation at a reasonable cost. As a result, the Corporation
may be exposed to substantial uninsured liabilities, which could adversely
affect the Corporation's results of operations and financial condition.
Page 23
PART I: ITEM 1A. AND ITEM 1B.
CORPORATION RISK FACTORS continued
o Negative publicity could damage the Corporation's reputation and adversely
impact its business and financial results.
Reputation risk, or the risk to the Corporation's earnings and capital from
negative publicity, is inherent in the Corporation's business. Negative
publicity can result from the Corporation's actual or alleged conduct in any
number of activities, including lending practices, corporate governance and
acquisitions, and actions taken by government regulators and community
organizations in response to those activities. Negative publicity can adversely
affect the Corporation's ability to keep and attract customers and can expose
the Corporation to litigation and regulatory action. Although the Corporation
takes steps to minimize reputation risk in dealing with customers and other
constituencies, the Corporation is inherently exposed to this risk.
o Acquisitions may not produce revenue enhancements or cost savings at levels
or within timeframes originally anticipated and may result in unforeseen
integration difficulties.
The Corporation regularly explores opportunities to acquire banks, financial
institutions, or other financial services businesses or assets. The Corporation
cannot predict the number, size or timing of acquisitions. Difficulty in
integrating an acquired business or company may cause the Corporation not to
realize expected revenue increases, cost savings, increases in geographic or
product presence, and/or other projected benefits from the acquisition. The
integration could result in higher than expected deposit attrition (run-off),
loss of key employees, disruption of the Corporation's business or the business
of the acquired company, or otherwise adversely affect the Corporation's ability
to maintain relationships with customers and employees or achieve the
anticipated benefits of the acquisition. Also, the negative effect of any
divestitures required by regulatory authorities in acquisitions or business
combinations may be greater than expected.
o The Corporation's stock price can be volatile.
The Corporation's stock price can fluctuate widely in response to a variety of
factors, including: actual or anticipated variations in the Corporation's
quarterly operating results; recommendations by securities analysts; significant
acquisitions or business combinations; strategic partnerships, joint ventures or
capital commitments; operating and stock price performance of other companies
that investors deem comparable to the Corporation; new technology used or
services offered by the Corporation's competitors; news reports relating to
trends, concerns and other issues in the banking and financial services
industry, and changes in government regulations. General market fluctuations,
industry factors and general economic and political conditions and events,
including terrorist attacks, economic slowdowns or recessions, interest rate
changes, credit loss trends or currency fluctuations, could also cause the
Corporation's stock price to decrease, regardless of the Corporation's operating
results.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
Page 24
PART I: ITEM 2., ITEM 3., AND ITEM 4.
ITEM 2. PROPERTIES.
The headquarters of the Corporation and First Merchants are located in a
five-story building at 200 East Jackson Street, Muncie, Indiana. The building is
owned by First Merchants.
The Corporation's affiliate banks conduct business through numerous facilities
owned and leased by the respective affiliate banks. Of the 66 banking offices
operated by the Corporation's affiliate banks, 46 are owned by the respective
banks and 20 are leased from non-affiliated third parties.
None of the properties owned by the Corporation's affiliate banks are subject to
any major encumbrances. The net investment of the Corporation and subsidiaries
in real estate and equipment at December 31, 2007 was $44,445,000.
ITEM 3. LEGAL PROCEEDINGS.
There is no pending legal proceeding, other than ordinary routine litigation
incidental to the business of the Corporation or its subsidiaries, of a material
nature to which the Corporation or its subsidiaries is a party or of which any
of their properties are subject. Further, there is no material legal proceeding
in which any director, officer, principal shareholder, or affiliate of the
Corporation, or any associate of any such director, officer or principal
shareholder, is a party, or has a material interest, adverse to the Corporation
or any of its subsidiaries.
None of the routine legal proceedings, individually or in the aggregate, in
which the Corporation or its affiliates are involved are expected to have a
material adverse impact on the financial position or the results of operations
of the Corporation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted during the fourth quarter of 2007 to a vote of
security holders, through the solicitation of proxies or otherwise.
Page 25
SUPPLEMENTAL INFORMATION
SUPPLEMENTAL INFORMATION - EXECUTIVE OFFICERS OF THE REGISTRANT.
The names, ages, and positions with the Corporation and subsidiary banks of all
executive officers of the Corporation and all persons chosen to become executive
officers are listed below. The officers are elected by the Board of Directors of
the Corporation for a term of one (1) year or until the election of their
successors. There are no arrangements between any officer and any other person
pursuant to which he was selected as an officer.
Michael C. Rechin, 49, President and Chief Executive Officer, Corporation (1)
Chief Executive Officer of the Corporation since April 2007; Chief Operating
Officer, Corporation since November 2005; Executive Vice President, Corporate
Banking National City Bank from 1995 to November 2005.(1)
Mark K. Hardwick, 37, Executive Vice President and Chief Financial Officer,
Corporation Executive Vice President and Chief Financial Officer of the
Corporation since December 2005; Senior Vice President and Chief Financial
Officer from April 2002 to December 2005; Corporate Controller, Corporation from
November 1997 to April 2002.
Jami L. Bradshaw, 45, Senior Vice President and Chief Accounting Officer,
Corporation Senior Vice President and Chief Accounting Officer since May 2007;
Vice President and Corporate Controller, Corporation from 2006 to May 2007;
Assistant Vice President and Assistant Controller from 2002 to 2006.
Robert R. Connors, 58, Senior Vice President, Chief Information Officer,
Corporation and First Merchants Senior Vice President and Chief Information
Officer of the Corporation and First Merchants since January 2006; Senior Vice
President of Operations and Technology, Corporation and First Merchants from
August 2002 to January 2006.
Kimberly J. Ellington, 48, Senior Vice President and Director of Human
Resources, Corporation Senior Vice President and Director of Human Resources
since 2004; Vice President and Director of Human Resources, Corporation from
1999 to 2004.
Jeffrey B. Lorentson, 44, Senior Vice President and Chief Risk Officer,
Corporation Senior Vice President and Chief Risk Officer since June 2007;
Corporate Controller of First Indiana Bank from June 2006 to June 2007; First
Vice President and Corporate Controller of the Corporation from 2003 to 2006;
Vice President and Corporate Controller of the Corporation from 2002 to 2003.
David W. Spade, 55, Senior Vice President and Chief Credit Officer, Corporation
Senior Vice President and Chief Credit Officer of the Corporation since February
2007; Vice President and Chief Credit Officer of the Corporation from December
2006 to February 2007;
(1) Michael L. Cox retired as the President and Chief Executive Officer of the
Corporation on April 24, 2007, the date of the Corporation's annual meeting of
shareholders. Mr. Rechin became the President and Chief Executive Officer at
that time.
Page 26
PART II: ITEM 5. AND ITEM 6.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, AND RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
PERFORMANCE GRAPH
The following graph compares the cumulative 5-year total return to shareholders
on First Merchants Corporation's common stock relative to the cumulative total
returns of the Russell 2000 index and the Russell 2000 Financial Services index.
The graph assumes that the value of the investment in the Corporation's common
stock and in each of the indexes (including reinvestment of dividends) was $100
on December 31, 2002 and tracks it through December 31, 2007.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among First Merchants Corporation, The Russell 2000 Index
And The Russell 2000 Financial Services Index
[LINE GRAPH OMITTED]
* $100 invested on 12/31/01 in stock or index-including reinvestment of
dividends. Fiscal year ending December 31.
- ---------------------------------------------------------------------------------------------------------------------------
12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07
- ---------------------------------------------------------------------------------------------------------------------------
First Merchants Corporation 100.00 121.92 140.26 133.47 144.77 121.13
Russell 2000 100.00 147.25 174.24 182.18 215.64 212.26
Russell 2000 Financial Services 100.00 139.84 169.34 173.06 206.72 171.95
The stock price performance included in this graph is not necessarily indicative
of future stock price performance.
Page 27
PART II: ITEM 5. AND ITEM 6.
STOCK INFORMATION
====================================================================================================================================
PRICE PER SHARE
QUARTER HIGH LOW DIVIDENDS DECLARED
====================================================================================================================================
2007 2006 2007 2006 2007 2006
-------------------------- --------------------------- ---------------------------
First Quarter ............. $ 27.46 $ 29.42 $ 22.75 $ 24.37 $ .23 $ .23
Second Quarter ............. 25.00 26.50 21.51 22.20 .23 .23
Third Quarter .............. 24.95 25.00 18.30 22.51 .23 .23
Fourth Quarter ............. 23.44 27.99 19.92 22.81 .23 .23
The table above lists per share prices and dividend payments during 2007 and
2006. Prices are as reported by the National Association of Securities Dealers
Automated Quotation - National Market System.
Numbers rounded to nearest cent when applicable.
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 February
20, 2008, the number of shares outstanding was 18,551,275. There were 6,180
stockholders of record on that date.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASES
The following table presents information relating to the Corporation's purchases
of its equity securities during the quarter ended December 31, 2007, as
follows:
=========================================================================================================================
TOTAL NUMBER OF MAXIMUM NUMBER OF
TOTAL NUMBER OF AVERAGE PRICE SHARES PURCHASED AS PART SHARES THAT MAY YET
PERIOD SHARES PURCHASED PAID PER SHARE OF PUBLICALLY ANNOUNCED BE PURCHASED UNDER
PLANS OR PROGRAMS THE PLANS OR PROGRAMS
=========================================================================================================================
October 1-31, 2007 0 0 0 150,000
November 1-30, 2007 124,063 20.87 124,000 26,000
December 1-31, 2007 41,198 22.29 41,000 485,000
The Liquidity section of Management's Discussion & Analysis of Financial
Condition and Results of Operations included as Item 7 of this Annual Report on
Form 10-K and Note 14 to Consolidated Financial Statements included as Item 5 of
this Annual Report on Form 10-K include discussions regarding dividend
restrictions from the bank subsidiaries to the Corporation.
Of the 124,063 shares, 124,000 were purchased in open market transactions
pursuant to the above-listed authorizations. The remaining 63 shares were
purchased in connection with the exercise of certain outstanding stock options.
Of the 41,198 shares, 41,000 were purchased in open market transactions
pursuant to the above-listed authorizations. The remaining 198 shares were
purchased in connection with the exercise of certain outstanding stock options.
On January 23, 2007, the Corporation's Board authorized management to repurchase
up to 250,000 shares of the Corporation's Common Stock. This authorization was
not publicly announced and expired January 22, 2008.
On July 24, 2007, the Corporation's Board authorized management to repurchase up
to 150,000 shares of the Corporation's Common Stock. This authorization was not
publicly announced and also expired on January 22, 2008.
On October 23, 2007 the Corporation's Board authorized management to repurchase
up to 150,000 shares of the Corporation's Common Stock. This authorization
expired on January 22, 2008 and was publicly announced on Form 8-K filed on
October 29, 2007.
On December 4, 2007, the Corporation's Board authorized management to repurchase
up to 500,000 shares of the Corporation's Common Stock. This authorization
expires on December 31, 2008 and was publicly announced on Form 8-K filed on
December 11, 2007.
Page 28
PART II: ITEM 5. AND ITEM 6.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information about the Corporation's common stock
that may be issued under equity compensation plans as of December 31, 2007.
====================================================================================================================================
Number of securities remaining
Number of securities to Weighted-average available for future issuance
be issued upon exercise exercise price of under equity compensations
of outstanding options, outstanding options, plans (excluding securities
Plan category warrants and rights warrants and rights reflected in first column)
====================================================================================================================================
Equity Compensation Plans Approved
by Stockholders 1,018,076 $ 24.37 400,000
Equity Compensation Plans Not
Approved by Stockholders 36,354 22.33
----------------------- -------------------- -----------------------------
Total 1,054,430 $ 24.30 400,000(1)
======================= ==================== =============================
This number does not include shares remaining available for future issuance
under the 1999 Long-term Equity Incentive Plan, which 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% of the number of common shares of the Corporation
outstanding as of the last day of the preceding calednar year; plus (b> the
number of shares that were available for grants, but not granted, under the Plan
in any previous year; but in now event will the number of shares available for
grants in any calednar year exceed 1.5% of the number of common shares of the
Corporation outstanding as of the last day of the preceding calendar year. The
1999 Long-term Equity Incentive Plan will expire in 2009.
The only plan reflected above that was not approved by the Corporation's
stockholders relates to certain First Merchants Corporation Stock Option
Agreements ("Agreements"). These Agreements provided for non-qualified stock
options of the common stock of the Corporation, awarded between 1995 and 2002 to
each director of First Merchants Bank, National Association who, on the date of
the grants: (a) were serving as a director of First Merchants; (b) were not an
employee of the Corporation, First Merchants, or any of the Corporation's other
affiliated banks or the non-bank subsidiaries; and (c) were not serving as a
director of the Corporation. The exercise price of the shares was equal to the
fair market value of the shares upon the grant of the option. Options became 100
percent vested when granted and are fully exercisable six months after the date
of the grant, for a period of ten years.
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data is presented within the "Five - Year Summary of
Selected Financial Data" on page 3 of this Annual Report on Form 10-K.
Page 29
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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 Form 10-K. 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 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. Reserves are established for each pool of
loans using loss rates based on a three-year average net charge-off history by
loan category.
Historical loss allocations 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 loan growth and charge-off rates, changes in mix, concentrations of loans in
specific industries, asset quality trends (delinquencies, charge offs and
nonaccrual loans), risk management and loan administration, changes in the
internal lending policies and credit standards, 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 allocations are reviewed quarterly and
adjusted as necessary based on changing borrower and/or collateral conditions.
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
Page 30
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES continued
length of time the fair value has been below cost, the expectation for that
security's performance, the creditworthiness 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 the funded status of the plan in the balance
sheet. The measurement of the funded status 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 2007 discount rate of
5.5 percent would increase the Corporation's 2007 pension expense by
approximately $95,000. In addition, each 25 basis point reduction in the 2007
expected rate of return of 7.75 percent would increase the Corporation's 2007
pension expense by approximately $101,000.
Goodwill and Intangibles. For purchase acquisitions, the Corporation 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 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.
Derivative Instruments. As part of our asset/liability management program, the
Corporation will utilize, from time-to-time, interest rate floors, caps or swaps
to reduce its sensitivity to interest rate fluctuations. These are derivative
instruments, which are recorded as assets or liabilities in the consolidated
balance sheets at fair value. Changes in the fair values of derivatives are
reported in the consolidated income statements or other comprehensive income
(OCI) depending on the use of the derivative and whether the instrument
qualifies for hedge accounting. The key criterion for the hedge accounting is
that the hedged relationship must be highly effective in achieving offsetting
changes in those cash flows that are attributable to the hedged risk, both at
inception of the hedge and on an ongoing basis.
Derivatives that qualify for the hedge accounting treatment are designated as
either: a hedge of the fair value of the recognized asset or liability or of an
unrecognized firm commitment (a fair value hedge) or a hedge of a forecasted
transaction or the variability of cash flows to be received or paid related to a
recognized asset or liability (a cash flow hedge). To date, the Corporation has
only entered into a cash flow hedge. For cash flow hedges, changes in the fair
values of the derivative instruments are reported in OCI to the extent the hedge
is effective. The gains and losses on derivative instruments that are reported
in OCI are reflected in the consolidated income statement in the periods in
which the results of operations are impacted by the variability of the cash
flows of the hedged item. Generally, net interest income is increased or
decreased by amounts receivable or payable with respect to the derivatives,
which qualify for hedge accounting. At inception of the hedge, the Corporation
establishes the method it uses for assessing the effectiveness of the hedging
derivative and the measurement approach for determining the ineffective aspect
of the hedge. The ineffective portion of the hedge, if any, is recognized
currently in the consolidated statements of income. The Corporation excludes the
time value expiration of the hedge when measuring ineffectiveness.
RESULTS OF OPERATIONS
As of December 31, 2007 total assets equaled $3,782,087,000, an increase of
$227,217,000 from December 31, 2006. Loans and investments, the Corporation's
primary earning assets, increased by $168,500,000, or 5.4 percent. During 2007,
management strategically reduced several earning asset categories, with a view
toward higher performance and capital maximization. Details of these changes are
discussed within the "EARNING ASSETS" section of Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Page 31
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS continued
As of December 31, 2006 total assets equaled $3,554,870,000, an increase of
$317,791,000 from December 31, 2005. Of this amount, loans increased
$235,677,000, investments increased $30,951,000, intangibles, including
goodwill, decreased $195,000 and cash value of life insurance increased by
$20,634,000. Details of these changes are discussed within the "EARNING ASSETS"
section of Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Net income for 2007 totaled $31,639,000, an increase of $1,441,000, or 4.8
percent from 2006. Diluted earnings per share totaled $1.73, a 5.6 percent
increase from $1.64 reported in 2006. The increase was primarily attributed to
increases in earning assets. This volume increase was offset by a decrease in
net interest margin of 16 basis points and increased expenses related to two
strategic non-recurring expenses. The first is related to the early redemption
of the Corporation's subordinated debentures payable to First Merchants Capital
Trust I and subsequent redemption by First Merchants Capital Trust I of its
outstanding common and preferred fixed rate securities (NASDAQ-FRMEP). The early
redemption of the debentures required the Corporation to accelerate the
recognition of the remaining unamortized underwriting fee of approximately $1.8
million, or $.06 per share. The second is related to expenses of $1.1 million
related to the successful completion of the Corporation's integration of
Commerce National Bank, as well as the charter and data mergers of four banks
into First Merchants Bank, National Association. These factors and others are
discussed within the respective sections of Management's Discussion and Analysis
of Financial condition and Results of Operations.
Net income for 2006 totaled $30,198,000, a decrease of $41,000, or .1 percent
from 2005. Diluted earnings per share totaled $1.64, a .6 percent increase from
$1.63 reported in 2005. Net interest margin declined by 26 basis points in 2006
to 3.71 percent from 3.97 percent in 2005. As a result, net interest income
declined by $1,034,000 despite strong improvements in earning assets. These
factors and others are discussed within the respective sections of Management's
Discussion and Analysis of Financial condition and Results of Operations.
Return on equity totaled 9.56 percent in 2007, 9.45 percent in 2006, and 9.58
percent in 2005. Return on assets totaled .87 percent in 2007, .90 percent in
2006 and .95 percent in 2005. 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.
CAPITAL
The Corporation's regulatory capital continues to exceed regulatory "well
capitalized" standards. 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. 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 or losses. The
Corporation's Tier I capital to average assets ratio was 7.19 percent and 7.37
percent at December 31, 2007 and 2006, respectively.
In addition, at December 31, 2007, the Corporation had a Tier I risk-based
capital ratio of 8.75 percent and total risk-based capital ratio of 10.55
percent. Regulatory capital guidelines require a Tier I risk-based capital ratio
of at least 4.0 percent and a total risk-based capital ratio of at least 8.0
percent.
The Corporation's GAAP capital ratio, defined as total stockholders' equity to
total assets, equaled 8.99 percent as of December 31, 2007, down from 9.21
percent in 2006.
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
5.72 percent as of December 31, 2007, up from 5.67 percent in 2006.
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.
Page 32
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAPITAL continued
========================================================================================
December 31,
(Dollars in Thousands) 2007 2006
========================================================================================
Average Goodwill..................................... $ 123,191 $ 121,831
Average Core Deposit Intangible (CDI)................ 13,868 16,103
Average Deferred Tax on CDI.......................... (3,659) (4,994)
---------- ----------
Intangible Adjustment.............................. $ 133,400 $ 132,940
========== ==========
Average Stockholders' Equity (GAAP Capital).......... $ 330,786 $ 319,519
Intangible Adjustment................................ (133,400) (132,940)
---------- ----------
Average Tangible Capital........................... $ 197,386 $ 186,579
========== ==========
Average Assets....................................... $3,639,772 $3,371,386
Intangible Adjustment................................ (133,400) (132,940)
---------- ----------
Average Tangible Assets............................ $3,506,372 $3,328,446
========== ==========
Net Income........................................... $ 31,639 $ 30,198
CDI Amortization, Net of Tax......................... 1,919 1,920
---------- ----------
Tangible Net Income................................ $ 33,558 $ 32,118
========== ==========
Diluted Earnings Per Share........................... $ 1.73 $ 1.64
Diluted Tangible Earnings Per Share.................. $ 1.83 $ 1.75
Return on Average GAAP Capital....................... 9.56% 9.45%
Return on Average Tangible Capital................... 17.00% 17.21%
Return on Average Assets............................. 0.87% 0.90%
Return on Average Tangible Assets.................... 0.96% 0.99%
ASSET QUALITY/PROVISION FOR LOAN LOSSES
The Corporation's primary business focus is small business and 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. 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, 2007, non-performing loans totaled $32,754,000, an increase of
$11,874,000. Loans 90 days past due other than non-accrual and restructured
loans increased by $769,000. The amount of non-accrual loans totaled $29,031,000
at December 31, 2007. Non-performing loans will increase or decrease going
forward due to portfolio growth, routine problem loan 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, 2007, impaired loans totaled $86,949,000, an increase of
$26,629,000 from year-end 2006. At December 31, 2007, a specific allowance for
losses was not deemed necessary for impaired loans totaling $65,645,000, but a
specific allowance of $6,034,000 was recorded for the remaining balance of
impaired loans of $21,304,000 and is included in the Corporation's allowance for
loan losses. The average balance of impaired loans for 2007 was $103,272,000.
The increase of total impaired loans 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 criticized loans including substandard,
doubtful and loss credits are included in the impaired loan total.
At December 31, 2007, the allowance for loan losses was $28,228,000, an increase
of $1,688,000 from year-end 2006. As a percent of loans, the allowance was .98
percent at December 31, 2007 and .99 percent at December 31, 2006. Management
believes that the allowance for loan losses is adequate to cover losses inherent
in the loan portfolio at December 31, 2007. The process for determining the
adequacy of the allowance for loan losses is critical to our financial results.
It requires management to make difficult,
Page 33
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ASSET QUALITY/PROVISION FOR LOAN LOSSES continued
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
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 2007 was $8,507,000, or 30 basis points, an
increase of $2,249,000 from $6,258,000, or 24 basis points, in 2006, reflecting
the increase of 5 basis points in net charge offs during the year.
The provision for loan losses in 2006 was $6,258,000, or 24 basis points, a
decrease of $2,096,000 from $8,354,000, or 34 basis points, in 2005, reflecting
the decline of 4 basis points in net charge offs during the year.
The following table summarizes the non-accrual, contractually past due 90 days
or more other than non-accruing and restructured loans for the Corporation.
================================================================================
December 31,
(Dollars in Thousands) 2007 2006
================================================================================
Non-accrual Loans .............................. $29,031 $17,926
Loans Contractually
Past Due 90 Days or More
Other than Non-accruing ..................... 3,578 2,870
Restructured Loans ............................. 145 84
------- -------
Total ....................................... $32,754 $20,880
======= =======
The table below represents loan loss experience for the years indicated.
========================================================================================================
(Dollars in Thousands) 2007 2006 2005
========================================================================================================
Allowance for Loan Losses:
Balance at January 1 .................................. $26,540 $25,188 $22,548
------- ------- -------
Charge offs ........................................... 8,557 6,510 7,744
Recoveries ............................................ 1,738 1,604 2,030
------- ------- -------
Net charge offs ....................................... 6,819 4,906 5,714
Provision for Loan Losses ............................. 8,507 6,258 8,354
------- ------- -------
Balance at December 31 ................................ $28,228 $26,540 $25,188
======= ======= =======
Ratio of Net Charge offs During the Period to
Average Loans Outstanding During the Period .......... .24% .19% .23%
Page 34
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
LIQUIDITY
Liquidity management is the process by which the Corporation ensures that
adequate liquid funds are available. 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
committee at each subsidiary and by the Corporation's asset/liability committee.
Liquidity is dependent upon the receipt of dividends from 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 our bank subsidiaries is derived primarily from core deposit
growth, principal payments received on loans, the sale and maturity of
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") and a revolving line of credit with LaSalle Bank, N.A. ("LaSalle") as
funding sources. At December 31, 2007, total borrowings from the FHLB were
$294,101,000. Our bank subsidiaries have pledged certain mortgage loans and
certain investments to the FHLB. The total available remaining borrowing
capacity from FHLB at December 31, 2007, was $18,486,000. At December 31, 2007,
the revolving line of credit with LaSalle Bank had a balance of $25,000,000 with
no remaining borrowing capacity.
For further discussion, see Note 10 to the Consolidated Financial Statements
included in Item 8 of this Annual Report on Form 10-K.
The principal source of asset-funded liquidity is investment securities
classified as available-for-sale, the market values of which totaled
$440,836,000 at December 31, 2007, a decrease of $15,097,000, or 3.3 percent
below December 31, 2006. 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 $704,000 at December 31, 2007. 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, commitments under
operating leases and long-term debt.
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, 2007 are as follows:
=======================================================================================
At December 31,
(Dollars in Thousands) 2007
=======================================================================================
Amounts of Commitments:
Loan Commitments to Extend Credit ...................... $ 747,070
Standby Letters of Credit .............................. 25,431
----------
$ 772,501
==========
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.
Page 35
PART II: ITEM 7. 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. The
required payments under such commitments and other borrowing arrangements at
December 31, 2007 are as follows:
===========================================================================================================
2013 and
(Dollars in Thousands) 2008 2009 2010 2011 2012 after Total
===========================================================================================================
Operating Leases $ 1,708 $ 1,385 $ 1,178 $ 953 $ 600 $ 73 $ 5,897
Federal Funds Purchased 52,350 52,350
Securities Sold Under
Repurchase Agreements 72,247 10,000 14,250 10,000 106,497
Federal Home Loan Bank advances 108,398 53,351 46,080 18,944 51,679 15,649 294,101
Subordinated Debentures,
Revolving Credit Lines and
Term Loans 25,000 90,826 115,826
-------- ------- ------- ------- -------- -------- --------
Total $259,703 $54,736 $57,258 $19,897 $ 66,529 $116,548 $574,671
======== ======= ======= ======= ======== ======== ========
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.
Management believes that the Corporation's liquidity and interest sensitivity
position at December 31, 2007, 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, 2007.
===================================================================================================================================
At December 31, 2007
(Dollars in Thousands) 1-180 DAYS 181-365 DAYS 1-5 YEARS BEYOND 5 YEARS TOTAL
===================================================================================================================================
Rate-Sensitive Assets:
Interest-bearing Deposits ............................... $ 24,931 $ 24,931
Investment Securities ................................... 68,237 $ 48,785 $ 294,972 $ 39,173 451,167
Loans ................................................... 1,418,945 445,722 914,738 101,173 2,880,578
Federal Reserve and Federal Home Loan Bank stock ........ 25,250 25,250
---------- ---------- ---------- ---------- ----------
Total Rate-sensitive Assets ........................ 1,512,113 494,507 1,234,960 140,346 3,381,926
---------- ---------- ---------- ---------- ----------
Rate-Sensitive Liabilities:
Federal Funds Purchased ................................. 52,350 52,350
Interest-bearing Deposits ............................... 1,843,652 301,391 318,066 20,463 2,478,421
Securities Sold Under Repurchase Agreements ............. 72,247 10,000 24,250 106,497
Federal Home Loan Bank Advances ......................... 109,050 10,631 119,837 54,583 294,101
Subordinated Debentures, Revolving Credit
Lines and Term Loans ................................. 55,000 60,826 115,826
---------- ---------- ---------- ---------- ----------
Total Rate-sensitive Liabilities ................... 2,132,299 312,022 447,903 160,122 3,047,195
---------- ---------- ---------- ---------- ----------
Interest Rate Sensitivity gap by Period .................... $ (613,597) $ 182,485 $ 787,057 $ (16,517)
Cumulative Rate Sensitivity gap ............................ (613,597) (431,113) 355,945 339,428
Cumulative Rate Sensitivity gap Ratio
at December 31, 2007 .................................... 71.1% 82.3% 112.3% 111.2%
at December 31, 2006 .................................... 73.5% 78.0% 113.3% 113.0%
The Corporation had a cumulative negative gap of $437,207,000 in the one-year
horizon at December 31, 2007, just over 11.6 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.
Page 36
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued
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, such as savings, money market, NOW and demand deposits,
reflect management's best estimate of expected future behavior.
The comparative rising and falling scenarios below 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 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 (193)
FHLB Advances 200 (200)
Results for the base, rising and falling interest rate scenarios are listed
below based upon the Corporation's rate sensitive assets and liabilities at
December 31, 2007. 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) $117,693 $120,089 $116,063
Variance from Base $ 2,396 $ (1,630)
Percent of Change from Base 2.0% (1.4)%
The comparative rising and falling scenarios below 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 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)
Three-Year CMT 200 (200)
Five-Year CMT 200 (200)
CD's 200 (191)
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) $109,090 $108,036 $108,429
Variance from Base $ (1,054) $ (631)
Percent of Change from Base (.96)% (.58)%
Page 37
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
EARNING ASSETS
The following table presents the earning asset mix as of December 31, 2007, and
December 31, 2006. Earnings assets increased by $183,720,000. Loans increased by
$182,564,000. The largest loan segments that increased were in commercial and
industrial of $125,396,000 and commercial and farmland real estate of
$85,805,000. Loan categories that decreased included residential real estate and
loans to individuals. The residential real estate loan category decreased
primarily due the sale of $27 million of seasoned, long-duration conforming
mortgage loans. The loans to individuals decreased as management strategically
reduced its indirect lending function, our lowest yielding loan category.
Investments decreased by $14,050,000 as lower yielding investments matured and
were reinvested in the higher yielding loans.
==================================================================================================
(Dollars in Thousands) December 31,
==================================================================================================
2007 2006
-------- --------
Interest-bearing Time Deposits $ 24,931 $ 11,284
Investment Securities Available for Sale ............ 440,836 455,933
Investment Securities Held to Maturity .............. 10,331 9,284
Mortgage Loans Held for Sale ........................ 3,735 5,413
Loans ............................................... 2,876,843 2,692,601
Federal Reserve and Federal Home Loan Bank stock .... 25,250 23,691
--------- ---------
Total ........................................... $3,381,926 $3,198,206
========= =========
DEPOSITS AND BORROWINGS
The table below reflects the level of deposits and borrowed funds (federal funds
purchased; repurchase agreements; Federal Home Loan Bank advances; subordinated
debentures, revolving credit lines and term loans) based on year-end levels at
December 31, 2007 and 2006.
==================================================================================================
(Dollars in Thousands) December 31,
==================================================================================================
2007 2006
---------- ----------
Deposits ........................................ $2,844,121 $2,750,538
Federal Funds Purchased.......................... 52,350 56,150
Securities Sold Under Repurchase Agreements...... 106,497 42,750
Federal Home Loan Bank Advances ................. 294,101 242,408
Subordinated Debentures, Revolving Credit Lines
and Term Loans................................ 115,826 99,456
---------- ----------
$3,412,895 $3,191,302
========== ==========
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 presents 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 2007.
In 2007, asset yields increased 18 basis points on a fully taxable equivalent
basis (FTE) and interest cost increased 34 basis points, resulting in a 16 basis
point (FTE) decrease in net interest margin as compared to 2006. During the
period, growth in earning assets produced a positive volume variance of
$8,600,000 (FTE), while interest rate compression produced a negative rate
variance of $5,429,000 (FTE), resulting in an increase of $3,025,000 in net
interest income.
In 2006, asset yields increased 66 basis points (FTE) and interest cost
increased 92 basis points, resulting in a 26 basis point (FTE) decrease in net
interest margin as compared to 2005. The increase in interest income and
interest expense was primarily a result of four 25 basis point overnight federal
funds rate increases by the Federal Open Market Committee during this period.
During the period, interest rate compression produced a negative rate variance
of $8,021,000, while growth in earning assets produced a positive volume
variance of $6,987,000, resulting in a decline of $1,034,000 in net interest
income.
Page 38
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
NET INTEREST INCOME continued
=========================================================================================================
(Dollars in Thousands) December 31,
=========================================================================================================
2007 2006 2005
------ ------ ------
Net Interest Income................................... $ 113,120 $ 110,095 $ 111,129
FTE Adjustment........................................ $ 4,127 $ 3,981 $ 3,778
Net Interest Income
on a Fully Taxable Equivalent Basis................. $ 117,247 $ 114,076 $ 114,907
Average Earning Assets................................ $3,308,939 $3,072,898 $2,891,121
Interest Income (FTE) as a Percent
of Average Earning Assets........................... 7.10% 6.92% 6.26%
Interest Expense as a Percent
of Average Earning Assets........................... 3.55% 3.21% 2.29%
Net Interest Income (FTE) as a Percent
of Average Earning Assets........................... 3.55% 3.71% 3.97%
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 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 2007 amounted to $40,551,000, a 17.2 percent increase from 2006.
The change in other income from 2007 to 2006 was primarily attributable to
fluctuations within the following other income items:
o Earnings on bank-owned life insurance increased $1,365,000 compared to the
same period in 2006 due to a purchase of $18,000,000 of new life insurance
policies in mid-2006, and $4,500,000 in 2007. Additionally, a death benefit
of $440,000 was received in 2007.
o Service charges for 2007 were $1,159,000 higher than in 2006 due to fee
increases.
o The sale of a branch building and other real estate resulted in gains of
$987,000 in 2007.
o Insurance commissions increased $811,000 from 2006 due to the purchase of
an insurance agency in late 2006.
o Trust fees increased $747,000 compared to the same period in 2006 as a
result of increased trust business.
Other income in 2006 amounted to $34,613,000, a .3 percent decrease from 2005.
The change in other income from 2006 to 2005 was minor and primarily
attributable to fluctuations within the following other income items:
o Fees on debit cards and ATMs increased by approximately $297,000 as
compared to the same period in 2005. This was primarily a result of
increase card usage by customers.
o Earnings on cash surrender value of life insurance increased approximately
$619,000 compared to the same period in 2005 due to a purchase of
$18,000,000 of new life insurance policies in 2006.
o Net gains and fees on sales of mortgage loans decreased by $731,000 from
the same period in 2005 due to stabilizing mortgage interest rates
resulting in reduced mortgage originations.
o A cash payment was received in 2005 of approximately $232,000, related to
our membership in a credit card network that was merged with another card
network.No such payment was received during 2006.
OTHER EXPENSES
Other expenses represent non-interest operating expenses of the Corporation.
Total other expenses for 2007 were $102,182,000, $6,125,000 or 6.4 percent
higher than the prior year of $96,057,000. The change in other expenses from
2007 to 2006 was primarily attributable to fluctuations within the following
other expense items:
o Salary and employee benefits grew $2,718,000, or 4.8 percent due to staff
additions and normal salary increases. Approximately $635,000 of the
increase is due to share-based compensation expense recorded in 2007.
Page 39
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OTHER EXPENSES continued
o The Corporation wrote off $1,800,000 in unamortized underwriting fees
associated with the First Merchants Capital Trust I subordinated debentures
being called during 2007. Going forward, this early redemption will provide
the Corporation with savings of $1.2 million annually.
o Other expenses increased $1,129,000 primarily due to integration expenses
related to bank combinations and name changes.
Other expenses amounted to $96,057,000 in 2006, an increase of 2.2 percent from
the prior year. Salaries and benefit expense grew $2,100,000, or 3.9 percent,
due to staff additions and normal salary increases. Approximately $833,000 of
the increase is due to share-based compensation expense recorded in 2006.
INCOME TAXES
Income tax expense totaled $11,343,000 for 2007, which is a decrease of $852,000
from 2006. The effective tax rates for the periods ending December 31, 2007,
2006 and 2005 were 26.4 percent, 28.8 percent and 30.5 percent, respectively.
The effective tax rate has remained lower than the federal statutory income tax
rate of 35 percent, primarily due to the Corporation's tax-exempt investment
income on securities and loan income generated by subsidiaries domiciled in a
state with no state or local income tax, income tax credits generated from
investments in affordable housing projects, 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 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.
OTHER
The Securities and Exchange Commission maintains a website that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the commission, including the
Corporation, and that address is (http://www.sec.gov).
Page 40
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The quantitative and qualitative disclosures about market risk information are
presented under Item 7 under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations" within the section "Interest
Sensitivity and Disclosures About Market Risk", of this Annual Report on Form
10-K.
Page 41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 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, 2007, and 2006, and the related consolidated
statements of income, comprehensive income, stockholders' equity and cash flows
for each of the years in the three-year period ended December 31, 2007. The
Company's management is responsible for these financial statements. 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 audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. Our audits included
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management and 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, 2007 and 2006, and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 2007, in conformity with accounting principles generally accepted in the
Unites States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), First Merchants Corporation's
internal control over financial reporting as of December 31, 2007, 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 February 8, 2008, expressed an unqualified opinion on the
effectiveness of the Company's internal control over financial reporting.
BKD, LLP
Indianapolis, Indiana
February 8, 2008
Page 42
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data) December 31,
===================================================================================================================================
2007 2006
====================================================================================================================================
Assets
Cash and Due From Banks .......................................................... $ 134,683 $ 89,957
Interest-bearing Time Deposits ................................................... 24,931 11,284
Investment Securities
Available for Sale ............................................................ 440,836 455,933
Held to Maturity (Fair Value of $10,270 and $9,516) ........................... 10,331 9,284
----------- -----------
Total Investment Securities ................................................. 451,167 465,217
Mortgage Loans Held for Sale ..................................................... 3,735 5,413
Loans, Net of Allowance for Loan Losses of $28,228 and $26,540.................... 2,848,615 2,666,061
Premises and Equipment ........................................................... 44,445 42,393
Federal Reserve and Federal Home Loan Bank Stock ................................. 25,250 23,691
Interest Receivable .............................................................. 23,402 24,345
Core Deposit Intangibles ........................................................ 12,412 15,470
Goodwill.......................................................................... 123,444 123,168
Cash value of Life Insurance...................................................... 70,970 64,213
Other Assets ..................................................................... 19,033 23,658
----------- -----------
Total Assets ................................................................. $ 3,782,087 $ 3,554,870
=========== ===========
Liabilities
Deposits
Noninterest-bearing ............................................................ $ 370,397 $ 362,058
Interest-bearing ............................................................... 2,473,724 2,388,480
----------- -----------
Total Deposits ............................................................... 2,844,121 2,750,538
Borrowings ....................................................................... 568,774 440,764
Interest Payable ................................................................. 8,325 9,326
Other Liabilities ................................................................ 20,931 26,917
----------- -----------
Total Liabilities ............................................................ 3,442,151 3,227,545
----------- -----------
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 - 18,002,787 and 18,439,843 Shares .................... 2,250 2,305
Additional Paid-in Capital ....................................................... 137,801 146,460
Retained Earnings ................................................................ 202,750 187,965
Accumulated Other Comprehensive Loss ............................................. (2,865) (9,405)
----------- -----------
Total Stockholders' Equity .................................................. 339,936 327,325
----------- -----------
Total Liabilities and Stockholders' Equity .................................. $ 3,782,087 $ 3,554,870
=========== ===========
See notes to consolidated financial statements.
Page 43
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data) Year Ended December 31,
===================================================================================================================================
2007 2006 2005
====================================================================================================================================
Interest Income
Loans Receivable
Taxable ............................................................. $207,268 $186,768 $158,436
Tax Exempt .......................................................... 1,120 828 643
Investment Securities
Taxable ............................................................. 13,744 12,316 9,612
Tax Exempt .......................................................... 6,548 6,565 6,374
Federal Funds Sold .................................................... 172 373 264
Deposits with Financial Institutions .................................. 582 500 695
Federal Reserve and Federal Home Loan Bank Stock ...................... 1,299 1,256 1,185
-------- -------- --------
Total Interest Income ............................................. 230,733 208,606 177,209
-------- -------- --------
Interest Expense
Deposits .............................................................. 89,921 74,314 46,121
Federal Funds Purchased ............................................... 3,589 1,842 623
Securities Sold Under Repurchase Agreements ........................... 3,856 3,228 1,612
Federal Home Loan Bank Advances ....................................... 12,497 10,734 9,777
Subordinated Debentures, Revolving
Credit Lines and Term Loans ......................................... 7,750 8,124 7,432
Other Borrowings ...................................................... 269 515
-------- -------- --------
Total Interest Expense ........................................... 117,613 98,511 66,080
-------- -------- --------
Net Interest Income ...................................................... 113,120 110,095 111,129
Provision for Loan Losses ............................................. 8,507 6,258 8,354
-------- -------- --------
Net Interest Income After Provision for Loan Losses ...................... 104,613 103,837 102,775
-------- -------- --------
Other Income
Fiduciary Activities .................................................. 8,372 7,625 7,481
Service Charges on Deposit Accounts ................................... 12,421 11,262 11,298
Other Customer Fees ................................................... 6,479 5,517 5,094
Net Realized Gains (Losses) on
Sales of Available-for-sale Securities .............................. (4) (2)
Commission Income ..................................................... 5,113 4,302 3,821
Earnings on Cash Surrender Value
of Life Insurance ................................................... 3,651 2,286 1,667
Net Gains and Fees on Sales of Loans .................................. 2,438 2,171 2,902
Other Income .......................................................... 2,077 1,454 2,456
-------- -------- --------
Total Other Income ............................................... 40,551 34,613 34,717
-------- -------- --------
Other Expenses
Salaries and Employee Benefits ........................................ 58,843 56,125 54,059
Net Occupancy Expenses ................................................ 6,647 5,886 5,796
Equipment Expenses .................................................... 6,769 7,947 7,562
Marketing Expenses..................................................... 2,205 1,932 2,012
Outside Data Processing Fees .......................................... 3,831 3,449 4,010
Printing and Office Supplies .......................................... 1,410 1,496 1,369
Core Deposit Amortization.............................................. 3,159 3,066 3,102
Write-off of Unamortized Underwriting Expenses ........................ 1,771
Other Expenses ........................................................ 17,547 16,156 16,047
-------- -------- --------
Total Other Expenses ............................................. 102,182 96,057 93,957
-------- -------- --------
Income Before Income Tax ................................................. 42,982 42,393 43,535
Income Tax Expense .................................................... 11,343 12,195 13,296
-------- -------- --------
Net Income ............................................................... $ 31,639 $ 30,198 $ 30,239
======== ======== ========
Net Income Per Share:
Basic ................................................................. $ 1.73 $ 1.64 $ 1.64
Diluted ............................................................... 1.73 1.64 1.63
See notes to consolidated financial statements.
Page 44
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
====================================================================================================================================
Year Ended December 31,
(in thousands, except share data) 2007 2006 2005
====================================================================================================================================
Net Income ........................................................................... $ 31,639 $ 30,198 $ 30,239
-------- -------- --------
Other Comprehensive Income (Loss), Net of Tax:
Unrealized Losses on Securities Available for Sale:
Unrealized Holding Gains/(Losses) Arising During the Period,
Net of Income Tax Benefit (Expense) of $(1,437), $(1,242), and $3,562.......... 2,743 2,087 (6,615)
Reclassification Adjustment for Gains (Losses) Included in Net Income,
Net of Income Tax (Expenses) Benefit of $0, $(2), and $(1)..................... 2 1
Unrealized Gains (Losses) on Cash Flow Hedge Assets:
Unrealized Gain (Loss) Arising During the Period,
Net of Income Tax Benefit of $(501), $83, and $0............................... 1,057 (125)
Unrealized Loss on Pension Minimum Funding Liability:
Unrealized Loss Arising During the Period,
Net of Income Tax Benefit of $0, $0, and $1,767 ............................... (2.651)
Defined Benefit Pension Plans, Net of Income Tax Expense of ($1,827)
Net Gain Arising During Period .................................................. 2,725
Prior Service Cost Arising During Period ........................................ 30
Amortization of Prior Service Cost .............................................. (15)
-------- -------- ---------
6,540 1,964 (9,265)
-------- -------- ---------
COMPREHENSIVE INCOME $ 38,179 $ 32,162 $ 20,974
======== ======== =========
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK
======================= ADDITIONAL RETAINED ACCUMULATED OTHER
SHARES AMOUNT PAID-IN CAPITAL EARNINGS COMPREHENSIVE TOTAL
INCOME (LOSS)
----------- -------- -------------- --------- ------------------- --------
Balances, December 31, 2004 18,573,997 $ 2,322 $150,862 $161,459 $ (40) $314,603
Net Income for 2005.......................... 30,239 30,239
Cash Dividends ($.92 per Share).............. (16,981) (16,981)
Other Comprehensive Income (Loss),
Net of Tax ............................... (9,265) (9,265)
Stock Issued Under Employee Benefit Plans ... 43,238 6 908 914
Stock Issued Under Dividend Reinvestment
and Stock Purchase Plan .................. 35,565 4 929 933
Stock Options Exercised ..................... 121,750 15 2,159 2,174
Stock Redeemed .............................. (374,598) (47) (9,611) (9,658)
Issuance of Stock Related to Acquisition..... 16,762 2 435 437
----------- -------- -------- --------- --------- ---------
Balances, December 31, 2005 18,416,714 2,302 145,682 174,717 (9,305) 313,396
=========== ======== ======== ========= ========= =========
Net Income for 2006.......................... 30,198 30,198
Cash Dividends ($.92 per Share).............. (16,950) (16,950)
Other Comprehensive Income (Loss),
Net of Tax ............................... 1,964 1,964
Adjustment to Initially Apply FASB Statement
No. 158, Net of Tax ...................... (2,064) (2,064)
Share-based Compensation .................... 972 972
Stock Issued Under Employee Benefit Plans ... 41,391 5 852 857
Stock Issued Under Dividend Reinvestment
and Stock Purchase Plan .................. 48,788 6 1,184 1,190
Stock Options Exercised ..................... 90,138 11 1,598 1,609
Stock Redeemed .............................. (234,495) (29) (5,661) (5,690)
Issuance of Stock Related to Acquisition..... 77,307 10 1,833 1,843
----------- -------- -------- --------- --------- ---------
Balances, December 31, 2006 18,439,843 $ 2,305 $146,460 $ 187,965 $ (9,405) $ 327,325
----------- -------- -------- --------- --------- ---------
Net Income for 2007.......................... 31,639 31,639
Cash Dividends ($.92 per Share).............. (16,854) (16,854)
Other Comprehensive Income (Loss),
Net of Tax ............................... 6,540 6,540
Tax Benefit from Stock Options Exercised .... 116 116
Share-based Compensation .................... 3,292 1,468 1,468
Stock Issued Under Employee Benefit Plans ... 38,537 5 782 787
Stock Issued Under Dividend Reinvestment
and Stock Purchase Plan .................. 51,168 6 1,164 1,170
Stock Options Exercised ..................... 35,142 5 491 496
Stock Redeemed .............................. (565,195) (71) (12,680) (12,751)
----------- -------- -------- --------- --------- ---------
Balances, December 31, 2007 18,002,787 $ 2,250 $137,801 $ 202,750 $ (2,865) $ 339,936
=========== ======== ======== ========= ========= =========
See notes to consolidated financial statements.
Page 45
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOWS
====================================================================================================================================
Year Ended December 31,
(in thousands, except share data) 2007 2006 2005
====================================================================================================================================
Operating Activities:
Net Income ......................................................... $ 31,639 $ 30,198 $ 30,239
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Provision for Loan Losses ........................................ 8,507 6,258 8,354
Depreciation and Amortization..................................... 4,331 5,382 5,070
Share-based Compensation ......................................... 1,468 833
Tax Benefits from Stock Options Exercised ........................ (116) (139)
Mortgage Loans Originated for Sale ............................... (123,051) (123,256) (86,122)
Proceeds from Sales of Mortgage Loans ............................ 124,729 122,753 84,579
Net Change in:
Interest Receivable .......................................... 943 (4,655) (2,372)
Interest Payable ............................................. (1,001) 3,452 1,463
Other Adjustments ................................................ 2,165 (4,549) 5,283
--------- --------- ---------
Net Cash Provided by Operating Activities .................... 49,614 36,277 46,494
--------- --------- ---------
Investing Activities:
Net Change in Interest-bearing Deposits ............................ (13,647) (2,536) 595
Purchases of
Securities Available for Sale .................................... (69,536) (100,355) (97,861)
Securities Held to Maturity ...................................... (8,466)
Proceeds from Maturities of
Securities Available for Sale .................................... 81,069 64,778 69,236
Securities Held to Maturity ...................................... 7,418 6,526
Proceeds from Sales of
Securities Available for Sale .................................... 7,219 575 4,718
Proceeds from Sales of Mortgages ................................... 26,773
Purchase of Federal Reserve and Federal Home Loan Bank stock ....... (1,559) (491) (342)
Purchase of Bank-owned Life Insurance .............................. (4,500) (18,000)
Net Change in Loans ................................................ (217,834) (240,080) (35,090)
Net Cash Paid in Acquisition ........................................ (370) (59) (213)
Other Adjustments .................................................. (4,143) (8,358) (6,233)
--------- --------- ---------
Net Cash Used by Investing Activities......................... (197,576) (298,000) (65,190)
--------- --------- ---------
Cash Flows from Financing Activities:
Net Change in:
Demand and Savings Deposits ...................................... 65,035 133,591 (80,986)
Certificates of Deposit and Other Time Deposits .................. 28,548 234,372 55,412
Receipt of Borrowings .............................................. 457,157 182,454 191,002
Repayment of Borrowings ............................................ (331,016) (249,927) (123,657)
Cash Dividends ..................................................... (16,854) (16,899) (16,981)
Stock Issued Under Employee Benefit Plans .......................... 787 857 914
Stock Issued Under Dividend Reinvestment
and Stock Purchase Plan .......................................... 1,170 1,190 933
Stock Options Exercised ............................................ 496 1,228 2,174
Tax Benefits from Stock Options Exercised .......................... 116 139
Stock Redeemed ..................................................... (12,751) (5,690) (9,658)
--------- --------- ---------
Net Cash Provided by Financing Activities .................... 192,688 281,263 19,153
--------- --------- ---------
Net Change in Cash and Cash Equivalents ............................... 44,726 19,540 457
Cash and Cash Equivalents, Beginning of Year .......................... 89,957 70,417 69,960
--------- --------- ---------
Cash and Cash Equivalents, End of Year................................. $ 134,683 $ 89,957 $ 70,417
========= ========= =========
Additional Cash Flows Information:
Interest Paid ....................................................... $ 118,614 $ 95,059 $ 64,617
Income Tax Paid ..................................................... 12,206 14,385 16,775
See notes to consolidated financial statements.
Page 46
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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"), First Merchants Bank of Central Indiana, N.A. ("Central
Indiana"), Lafayette Bank and Trust Company, N.A. ("Lafayette"), and Commerce
National Bank ("Commerce National"), (collectively the "Banks"), First Merchants
Trust Company, National Association ("FMTC"), First Merchants Insurance
Services, Inc. ("FMIS"), First Merchants Reinsurance Company ("FMRC") and
Indiana Title Insurance Company ("ITIC"), conform to accounting principles
generally accepted in the United States of America and reporting practices
followed by the banking industry.
On April 1, 2007, the Corporation combined five of its bank charters into one.
Frances Slocum Bank & Trust Company, National Association, Decatur Bank & Trust
Company, National Association, The First National Bank of Portland and United
Communities National Bank combined with First Merchants Bank, N.A. Also on April
1, 2007, the name of The Madison Community Bank was changed to First Merchants
Bank of Central Indiana, National Association.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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. 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.
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 creditworthiness 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
Page 47
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
CONSOLIDATION continued
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.
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. Reserves are established for each pool of
loans using loss rates based on a three-year average net charge-off history by
loan category.
Historical loss allocations 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 loan growth and charge-off rates, changes in mix, concentration of loans in
specific industries, asset quality trends (delinquencies, charge offs and
nonaccrual loans), risk management and loan administration, changes in the
internal lending policies and credit standards, 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 allocations are reviewed quarterly and
adjusted as necessary based on changing borrower and/or collateral conditions.
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 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 3 to 20 years. Intangible assets are periodically evaluated as to the
recoverability of their carrying value.
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.
DERIVATIVE INSTRUMENTS are carried at the fair value of the derivatives reflects
the estimated amounts that we would receive to terminate these contracts at the
reporting date based upon pricing or valuation models applied to current market
information. Interest rate floors are valued using the market standard
Page 48
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
CONSOLIDATION continued
methodology of discounting the future expected cash receipts that would occur if
variable interest rates fell below the strike rate of the floors. The projected
cash receipts on the floor are based on an expectation of future interest rates
derived from observed market interest rate curves and volatilities.
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.
The Corporation adopted the provisions of the Financial Accounting Standards
Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement No. 109, on January 1, 2007.
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. As a result of the implementation of FIN 48,
the Corporation did not identify any uncertain tax positions that it believes
should be recognized in the financial statements. The tax years still subject to
examination by taxing authorities are years subsequent to 2003.
STOCK OPTION AND RESTRICTED STOCK AWARD PLANS are maintained by the Corporation
and are described more fully in Note 16. Prior to 2006, the Corporation
accounted for these plans under the recognition and measurement principles of
APB Opinion No. 25., Accounting for Stock Issued to Employees, and related
Interpretations. Accordingly, in 2005 no stock-based employee compensation cost
is reflected in net income, as all awards granted under these plans had an
exercise price equal to the market value of the underlying common stock at the
grant date.
Effective January 1, 2006 the Corporation adopted the fair value recognition
provisions of Statement of Financial Accounting Standards (SFAS) No. 123R,
Share-Based Payment. The Corporation selected the modified prospective
application. Accordingly, after January 1, 2006, the Corporation began expensing
the fair value of stock awards granted, modified, repurchased or cancelled.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value provisions of SFAS No. 123,
Accounting for Stock-Based Compensation, to stock-based compensation in 2005.
Year Ended December 31
2005
=========
Net Income, as Reported ...................... $30,239
Add: Total Stock-based Employee Compensation
Cost Included in Reported Net Income, Net
of Income Taxes ...........................
Less: Total Stock-based Employee Compensation
Cost Determined Under the Fair Value Based
Method, Net of Income Taxes ............... (2,159)
-------
Pro Forma Net Income $28,080
=======
Earnings per Share:
Basic - as Reported ....................... $ 1.64
Basic - Pro Forma ......................... $ 1.52
Diluted - as Reported ..................... $ 1.63
Diluted - Pro Forma ....................... $ 1.51
EARNINGS PER SHARE have been computed based upon the weighted average common and
common equivalent shares outstanding during each year.
Certain reclassifications have been made to the 2006 financial statements to
conform to the 2007 financial statement presentation. These reclassifications
had no effect on net income.
NOTE 2
BUSINESS COMBINATIONS
Effective December 31, 2007, the Corporation acquired Oliver-Dorton Insurance of
Muncie, Indiana, which has been merged into FMIS, a wholly owned subsidiary of
the Corporation. The cash purchase price was $370,000. The acquisition was
deemed to be an immaterial acquisition.
Effective October 13, 2006, the Corporation acquired Armstrong Insurance, Inc.
of Parker City, an Indiana corporation, which has merged into FMIS, a wholly
owned subsidiary of the Corporation. The Corporation issued 77,307 shares of its
common stock at a cost of $23.845 per share to complete the transaction. The
acquisition was deemed to be an immaterial acquisition.
Page 49
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 2
BUSINESS COMBINATIONS continued
Effective September 1, 2005, the Corporation acquired Trustcorp Financial
Services of Greenville, Inc., an Ohio corporation, which was merged into FMIS, a
wholly owned subsidiary of the Corporation. The Corporation issued 16,762 shares
of its common stock at a cost of $26.10 per share to complete the transaction.
The 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, 2007, was
$15,896,000.
NOTE 4
INVESTMENT SECURITIES
====================================================================================================================================
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
====================================================================================================================================
Available for Sale at December 31, 2007
U.S. Treasury ............................... $ 1,501 $ 18 $ 1,519
U.S. Government-sponsored Agency Securities.. 67,793 240 $ 98 67,935
State and Municipal ......................... 150,744 2,324 156 152,912
Mortgage-backed Securities .................. 199,591 1,654 1,444 199,801
Corporate Obligations........ ............... 13,740 1,294 12,446
Marketable Equity Securities ................ 6,835 612 6,223
-------- -------- -------- --------
Total Available for Sale ................. 440,204 4,236 3,604 440,836
-------- -------- -------- --------
Held to maturity at December 31, 2007
State and Municipal ......................... 10,317 237 298 10,256
Mortgage-backed Securities .................. 14 14
-------- -------- -------- --------
Total Held to Maturity ................... 10,331 237 298 10,270
-------- -------- -------- --------
Total Investment Securities .............. $450,535 $ 4,473 $ 3,902 $451,106
======== ======== ======== ========
Available for Sale at December 31, 2006
U.S. Treasury .......................................... $ 1,502 $ 1 $ 1,503
U.S. Government-sponsored Agency Securities ............ 87,193 69 $ 1,284 85,978
State and Municipal .................................... 168,262 2,251 892 169,621
Mortgage-backed Securities ............................. 195,228 600 3,983 191,845
Marketable Equity and Other Securities.................. 7,296 310 6,986
-------- -------- -------- --------
Total Available for Sale ............................ 459,481 2,921 6,469 455,933
-------- -------- -------- --------
Held to Maturity at December 31, 2006
State and Municipal .................................... 9,266 432 200 9,498
Mortgage-backed Securities ............................. 18 18
-------- -------- -------- --------
Total Held to Maturity .............................. 9,284 432 200 9,516
-------- -------- -------- --------
Total Investment Securities ......................... $468,765 $ 3,353 $ 6,669 $465,449
======== ======== ======== ========
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 $214,293,000 and $306,650,000 at December 31, 2007 and 2006,
respectively. Total fair value of these investments was $210,391,000 and
$299,984,000, which is approximately 46.6 and 64.5 percent of the Corporation's
available-for-sale and held-to-maturity investment portfolio at December 31,
2007 and 2006, respectively. These declines primarily resulted from 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.
Page 50
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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,
2007 and 2006:
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, 2007:
U.S. Government-sponsored Agency Securities ............... $ 45,572 $ (98) $ 45,572 $ (98)
State and Municipal ....................................... $ 858 $ (7) 60,996 (447) 61,854 (454)
Mortgage-backed Securities ................................ 3,489 (30) 86,161 (1,414) 89,650 (1,444)
Corporate Obligations ..................................... 12,415 (1,294) 12,415 (1,294)
Marketable Equity Securities .............................. 900 (612) 900 (612)
-------- ------- -------- ------- -------- --------
Total Temporarily Impaired Investment Securities ....... $ 16,762 $(1,331) $193,629 $(2,571) $210,391 $ (3,902)
======== ======= ======== ======= ======== ========
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, 2006:
U.S. Government-sponsored Agency Securities ............... $ 1,576 $ (3) $ 71,702 $(1,281) $ 73,278 $ (1,284)
State and Municipal ....................................... 9,608 (35) 81,841 (1,057) 91,449 (1,092)
Mortgage-backed Securities ................................ 7,459 (20) 126,555 (3,963) 134,014 (3,983)
Corporate Obligations .................................... 28 (6) 28 (6)
Marketable Equity Securities .............................. 1,215 (304) 1,215 (304)
-------- ------- -------- ------- -------- --------
Total Temporarily Impaired Investment Securities ....... $ 19,858 $ (362) $280,126 $(6,307) $299,984 $ (6,669)
======== ======= ======== ======= ======== ========
The amortized cost and fair value of securities available for sale and held to
maturity at December 31, 2007, 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 Sistribution at December 31, 2007:
Due in One Year or Less.......................................... $ 76,553 $ 76,456 $ 704 $ 705
Due After One Through Five Years ................................ 97,649 98,585 276 280
Due After Five Through Ten Years ................................ 38,253 39,470 810 801
Due After Ten Years ............................................. 21,323 20,301 8,527 8,470
-------- -------- -------- --------
233,778 234,812 10,317 10,256
Mortgage-backed Securities ...................................... 199,591 199,801 11 11
Other Asset-backed Securities ................................... 3 3
Marketable Equity Securities .................................... 6,835 6,223
-------- -------- -------- --------
Totals ........................................................ $440,204 $440,836 $ 10,331 $ 10,270
Securities with a carrying value of approximately $191,470,000, 143,652,000 and
$190,079,000 were pledged at December 31, 2007, 2006 and 2005 respectively 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 2007, 2006 and 2005
were $7,219,000, $575,000 and $4,718,000 respectively. Gross gains of $0, $0 and
$28,000 in 2007, 2006 and 2005, and gross losses of $0, $4,000, and $30,000 in
2007, 2006 and 2005 were realized on those sales.
Page 51
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 5
LOANS AND ALLOWANCE
2007 2006
==================================
Loans at December 31:
Commercial and Industrial Loans.............. $ 662,701 $ 537,305
Agricultural Production
Financing and Other Loans to Farmers....... 114,324 100,098
Real Estate Loans:
Construction............................... 165,425 169,491
Commercial and Farmland.................... 947,234 861,429
Residential................................ 744,627 749,921
Individuals' Loans for
Household and Other Personal Expenditures.. 187,880 223,504
Tax-exempt Loans............................. 16,423 14,423
Lease Financing Receivables,
Net of Unearned Income .................... 8,351 8,010
Other Loans.................................. 29,878 28,420
---------- ----------
2,786,843 2,692,601
Allowance for Loan Losses................... (28,228) (26,540)
---------- ----------
Total Loans........................ $2,848,615 $2,666,061
========== ==========
Residential Real Estate Loans Held for Sale at December 31, 2007 and 2006 were
$3,735,000 and $5,413,000 respectively.
2007 2006
==================================
Allowance for Loan Losses
Balance, January 1 ......................... $ 26,540 $ 25,188
Provision for Losses ....................... 8,507 6,258
Recoveries on Loans ........................ 1,738 1,604
Loans Charged Off .......................... (8,557) (6,510)
---------- ----------
Balance, December 31 ....................... $ 28,228 $ 26,540
========== ==========
Information on nonaccruing, contractually past due 90 days or more other than
nonaccruing and restructured loans is summarized below:
2007 2006
==================================
Non-accrual Loans......................... $ 29,031 $ 17,926
Loans Contractually Past Due 90
Days or More Other Than Nonaccruing..... 3,578 2,870
Restructured Loans........................ 145 84
-------- --------
Total Non-performing Loans........... $ 32,754 $ 20,880
======== =========
Page 52
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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:
2007 2006 2005
=====================================================================================================================
As of, and for the Year Ending December 31:
Impaired Loans with an Allowance .......................... $ 21,304 $ 17,291 $ 7,540
Impaired Loans for which the Discounted
Cash Flows or Collateral Value Exceeds the
Carrying Value of the Loan ............................ 65,645 43,029 44,840
------- ------- -------
Total Impaired Loans ............................... $86,949 $60,320 $52,380
======= ======= =======
Total Impaired Loans as a Percent
of Total Loans ........................................ 3.02% 2.24% 2.13%
Allowance for Impaired Loans (Included in the
Corporation's Allowance for Loan Losses) .............. $ 6,034 $ 4,130 $ 2,824
Average Balance of Impaired Loans ......................... 103,272 66,139 44,790
Interest Income Recognized on Impaired Loans .............. 6,675 5,143 3,511
Cash Basis Interest Included Above ........................ 1,143 1,364 650
NOTE 6
PREMISES AND EQUIPMENT
2007 2006
================================================================================
Cost at December 31:
Land .......................................... $ 7,993 $ 7,767
Buildings and Leasehold Improvements .......... 47,853 37,791
Equipment ..................................... 40,455 46,895
-------- --------
Total Cost ................................ 96,301 92,453
Accumulated Depreciation and Amortization ..... (51,856) (50,060)
-------- --------
Net ....................................... $ 44,445 $ 42,393
======== ========
The Corporation is committed under various noncancelable lease contracts for
certain subsidiary office facilities and equipment. Total lease expense for
2007, 2006 and 2005 was $2,477,000, $2,651,000 and $2,391,000, respectively. The
future minimum rental commitments required under the operating leases in effect
at December 31, 2007, expiring at various dates through the year 2016 are as
follows for the years ending December 31:
====================================================
2008 ................................ $1,708
2009 ................................ 1,385
2010 ................................ 1,178
2011 ................................ 953
2012 ................................ 600
After 2012 ........................... 73
------
Total Future Minimum Obligations $5,897
======
NOTE 7
GOODWILL
The changes in the carrying amount of goodwill at December 31 are noted below.
No impairment loss was recorded in 2007 and 2006.
2007 2006
================================================================================
Balance, January 1 .............................. $ 123,168 $ 121,266
Goodwill Acquired ............................... 276 1,902
--------- ---------
Balance, December 31 ............................ $ 123,444 $ 123,168
========= =========
Page 53
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 8
CORE DEPOSIT AND OTHER INTANGIBLES
The carrying basis and accumulated amortization of recognized core deposit and
other intangibles at December 31 were:
2007 2006
================================================================================
Gross Carrying Amount ........................... $ 32,126 $ 32,025
Accumulated Amortization ........................ (19,714) (16,555)
--------- ---------
Core Deposit and Other Intangibles ........... $ 12,412 $ 15,470
========= =========
Amortization expense for the years ended December 31, 2007, 2006 and 2005, was
$3,159,000, $3,066,000 and $3,102,000, respectively. Estimated amortization
expense for each of the following five years is:
====================================================
2008 ................................ $ 3,159
2009 ................................ 3,157
2010 ................................ 3,048
2011 ................................ 2,114
2012 ................................ 528
After 2012 .......................... 406
------
$12,412
======
NOTE 9
DEPOSITS
2007 2006
================================================================================
Deposits at December 31:
Demand Deposits ............................. $ 903,380 $ 883,294
Savings Deposits ............................ 552,380 507,431
Certificates and Other Time Deposits
of $100,000 or more ....................... 495,630 431,068
Other Certificates and Time Deposits ........ 892,731 928,745
---------- ----------
Total Deposits .......................... $2,844,121 $2,750,538
========== ==========
=====================================================
Certificates and Other Time Deposits Maturing
in Years Ending December 31:
2008 ....................... $1,053,782
2009 ....................... 175,108
2010 ....................... 63,000
2011 ....................... 35,739
2012 ....................... 43,774
After 2012 ................. 16,958
----------
$1,388,361
==========
Time deposits obtained through brokers were $239,019,000 and $256,632,000 at
December 31, 2007 and 2006, respectively.
Page 54
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 10
BORROWINGS
2007 2006
===================================================================================
Borrowings at December 31:
Federal Funds Purchased ........................... $ 52,350 $ 56,150
Securities Sold Under Repurchase Agreements ....... 106,497 42,750
Federal Home Loan Bank Advances ................... 294,101 242,408
Subordinated Debentures, Revolving Credit
Lines and Term Loans ............................ 115,826 99,456
-------- --------
Total Borrowings .............................. $568,774 $440,764
======== ========
Securities sold under repurchase agreements consist of obligations of the Banks
to other parties. The obligations are secured by U.S. Treasury, U.S.
Government-sponsored agency security obligations and corporate asset-backed
securities. The maximum amount of outstanding agreements at any month-end during
2007 and 2006 totaled $128,023,000 and $98,765,000 respectively, and the average
of such agreements totaled $85,853,000 and $73,818,000 during 2007 and 2006
respectively.
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, 2007, are as follows:
SUBORDINATED DEBENTURES
SECURITIES SOLD UNDER FEDERAL HOME LOAN REVOLVING CREDIT LINES
REPURCHASE AGREEMENTS BANK ADVANCES AND TERM LOANS
==================================================================================================================================
AMOUNT AMOUNT AMOUNT
==================================================================================================================================
Maturities in Years Ending December 31:
2008 .............. $ 72,247 $108,398 $ 25,000
2009 .............. 53,351
2010 .............. 10,000 46,080
2011 .............. 18,944
2012 .............. 14,250 51,679
After 2012 ........ 10,000 15,649 90,826
-------- -------- --------
Total ...... $106,497 $294,101 $115,826
======== ======== ========
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 145
percent of these advances. Advances, with interest rates from 2.36 to 6.84
percent, are subject to restrictions or penalties in the event of prepayment.
The total available remaining borrowing capacity from the FHLB at December 31,
2007, was $18,487,000.
Subordinated Debentures, Revolving Credit Lines and Term Loans. Three borrowings
were outstanding on December 31, 2007, for $115,826,000.
o First Merchants Capital Trust II. The subordinated debenture, entered into
on July 2, 2007, for $56,702,000 will mature on September 15, 2037. The
Corporation may redeem the debenture no earlier than September 15, 2012,
subject to the prior approval of the Federal Reserve, as required by law or
regulation. Interest is fixed at 6.495 percent for the period from the date
of issuance through September 15, 2012, and thereafter, at an annual
floating rate equal to the three-month LIBOR plus 1.56 percent, reset
quarterly. Interest is payable in March, June, September and December of
each year. First Merchants Capital Trust II is a wholly owned subsidiary of
the Corporation.
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. CNBC Statutory Trust I is a wholly owned subsidiary
of the Corporation.
Page 55
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 10
BORROWINGS continued
o LaSalle Bank, N.A. A Loan and Subordinated Debenture Loan Agreement
("LaSalle Agreement") was entered into with LaSalle Bank, N.A. on March 25,
2003 and later amended as of September 5, 2007. The LaSalle Agreement
includes three credit facilities:
o The Term Loan of $5,000,000 matures on March 7, 2014. Interest is
calculated at a floating rate equal to the lender's base rate or LIBOR
plus 1.00 percent. The Term Loan is secured by 100 percent of the
common stock of First Merchants. 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 $25,000,000 at December 31, 2007.
Interest is payable quarterly based on a floating rate equal to the
lender's base rate or LIBOR plus 1.00 percent. Principal and interest
are due on or before March 5, 2008. The total principal amount
outstanding at any one time may not exceed $25,000,000. The Revolving
Loan is secured by 100 percent of the common stock of First Merchants.
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 Subordinated Debenture of $25,000,000 matures on March 7, 2014.
Interest is calculated at a floating rate equal to the lender's base
rate or LIBOR plus 1.25 percent. The Subordinated Debenture is treated
as Tier 2 Capital for regulatory capital purposes and is
unconditionally guaranteed by the Corporation.
The Corporation redeemed its subordinated debentures payable to First Merchants
Capital Trust I during 2007. The aggregate redemption price was the principal
amount of $54,832,000 plus any accrued but unpaid interest. The redemption of
the debentures was immediately followed by the redemption by First Merchants
Capital Trust I of its outstanding common and preferred securities at their $25
liquidation value, plus any accrued but unpaid distributions.
Subordinated Debentures, Revolving Credit Lines and Term Loans. Three borrowings
were outstanding on December 31, 2006, for $99,456,000.
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. A Loan and Subordinated Debenture Loan Agreement
("LaSalle Agreement") was entered into with LaSalle Bank, N.A. on March 25,
2003 and later amended as of March 7, 2006. The LaSalle Agreement includes
three credit facilities:
o The Term Loan of $5,000,000 matures on March 7, 2012. Interest is
calculated at a floating rate equal to the lender's prime rate or
LIBOR plus 1.00 percent. The Term Loan is secured by 100 percent of
the common stock of First Merchants. 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.
Page 56
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 10
BORROWINGS continued
o The Revolving Loan had a balance of $10,500,000 at December 31, 2006.
Interest is payable quarterly based on LIBOR plus 1 percent. Principal
and interest are due on or before March 6,2007. 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. 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 Subordinated Debenture of $25,000,000 matures on March 7, 2012.
Interest is calculated at a floating rate equal to, at the
Corporation's option, either the lender's prime rate or LIBOR plus
1.50 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 $115,618,000,
$98,538,000 and $107,730,000 at December 31, 2007, 2006 and 2005 respectively
the amount of capitalized servicing assets is considered immaterial.
NOTE 12
INCOME TAX
2007 2006 2005
=================================================================================================================================
Income Tax Expense for the Year Ended December 31:
Currently Payable:
Federal ................................................................ $ 13,343 $ 13,192 $ 14,814
State .................................................................. 162 1,415 2,231
Deferred:
Federal ................................................................ (1,664) (1,785) (3,248)
State .................................................................. (498) (627) (501)
-------- -------- --------
Total Income Tax Expense ............................................ $ 11,343 $ 12,195 $ 13,296
======== ======== ========
Reconciliation of Federal Statutory to Actual Tax Expense:
Federal Statutory Income Tax at 35% .................................... $ 15,043 $ 14,837 $ 15,158
Tax-exempt Interest .................................................... (2,259) (2,215) (2,204)
Effect of State Income Taxes ........................................... (220) 475 1,115
Earnings on Life Insurance ............................................. (1,064) (594) (452)
Tax Credits ............................................................ (348) (391) (395)
Other .................................................................. 191 83 74
-------- -------- --------
Actual Tax Expense ................................................. $ 11,343 $ 12,195 $ 13,296
======== ======== ========
Tax expense (benefit) applicable to security gains and losses for the years
ended December 31, 2007, 2006 and 2005, was $0, $(2,000) and $(1,000),
respectively.
Page 57
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 12
INCOME TAX continued
A cumulative net deferred tax asset is included in other assets in the
consolidated balance sheets. The components of the net asset are as follows:
2007 2006
======================================================================================================================
Deferred Tax Asset at December 31:
Assets:
Differences in Accounting for Loan Losses ............................. $11,086 $10,641
Deferred Compensation ................................................. 3,841 3,078
Difference in Accounting for Pensions
and Other Employee Benefits ......................................... 3,071 5,442
State Income Tax ...................................................... 156 187
Net Unrealized Loss on Securities Available for Sale................... 1,241
Other ................................................................. 322 399
------ ------
Total Assets ...................................................... 18,476 20,988
------ ------
Liabilities:
Differences in Depreciation Methods ................................... 3,508 3,114
Differences in Accounting for Loans and Securities .................... 3,889 4,974
Differences in Accounting for Loan Fees ............................... 399 534
Net Unrealized Gain on Securities Available for Sale................... 220
Other ................................................................. 2,344 2,381
------ ------
Total Liabilities ................................................. 10,360 11,003
------ ------
Net Deferred Tax Asset ............................................ $ 8,116 $ 9,985
====== ======
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:
2007 2006
======== ========
Commitments
to Extend Credit $747,070 $681,462
Standby Letters
of Credit 25,431 23,286
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
creditworthiness 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 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.
Page 58
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
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.
The amount at December 31, 2007, available for 2008 dividends from First
Merchants, Central Indiana, Lafayette, Commerce National, FMTC and FMIS to the
Corporation totaled $18,719,000, $1,877,000, $1,039,000, $8,313,000, $520,000
and $9,616,000, respectively.
Total stockholders' equity for all subsidiaries at December 31, 2007, was
$445,104,000 of which $405,020,000 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.
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, 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, 2007, 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.
Page 59
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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.
====================================================================================================================================
2007 2006
REQUIRED FOR REQUIRED FOR
ACTUAL ADEQUATE CAPITAL ACTUAL ADEQUATE CAPITAL
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
====================================================================================================================================
December 31
Total Capital,, (to Risk-weighted Assets)
Consolidated ...................... $312,080 10.55% $236,636 8.00% $299,353 11.09% $215,906 8.00%
First Merchants ................... 169,678 11.07 122,567 8.00 77,072 10.46 58,965 8.00
Central Indiana.................... 29,268 11.72 19,984 8.00 28,541 11.06 20,637 8.00
United Communities ................ 27,723 11.21 19,790 8.00
First National .................... 10,881 11.13 7,820 8.00
Decatur ........................... 12,200 11.06 8,828 8.00
Frances Slocum .................... 20,016 11.87 13,488 8.00
Lafayette ......................... 79,692 11.46 55,646 8.00 79,106 11.60 54,539 8.00
Commerce National ................. 52,353 10.76 38,922 8.00 46,997 11.28 33,320 8.00
Tier I Capital,, (to Risk-weighted Assets)
Consolidated ...................... $258,918 8.75% $118,318 4.00% $247,813 9.18% $107,953 4.00%
First Merchants ................... 154,624 10.09 61,284 4.00 69,957 9.45 29,482 4.00
Central Indiana.................... 26,669 10.68 9,992 4.00 26,036 10.09 10,318 4.00
United Communities ................ 25,201 10.19 9,895 4.00
First National .................... 10,126 10.36 3,910 4.00
Decatur ........................... 11,261 10.20 4,414 4.00
Frances Slocum..................... 17,918 10.63 6,744 4.00
Lafayette ......................... 73,437 10.56 27,823 4.00 72,646 10.66 27,269 4.00
Commerce National ................. 48,099 9.89 19,461 4.00 43,149 10.36 16,660 4.00
Tier I Capital,, (to Average Assets)
Consolidated ...................... $258,918 7.19% $144,000 4.00% $247,813 7.37% $134,443 4.00%
First Merchants ................... 154,624 8.10 76,293 4.00 69,657 7.33 38,005 4.00
Central Indiana.................... 26,669 8.91 11,966 4.00 26,036 8.63 12,068 4.00
United Communities ................ 25,201 7.91 12,747 4.00
First National .................... 10,126 8.04 5,040 4.00
Decatur ........................... 11,261 7,31 6,162 4.00
Frances Slocum..................... 17,918 9.08 7,895 4.00
Lafayette ......................... 73,437 8.01 36,669 4.00 72,646 7.99 36,385 4.00
Commerce National ................. 48,099 9.11 21,119 4.00 43,149 8.99 19,203 4.00
As defined by regulatory agencies
Effective April 1, 2007, United Communities, First National, Decatur and
Frances Slocum were merged into First Merchants Bank, N.A.
Effective April 1, 2007, Madison's name was changed to First Merchants Bank
of Central Indiana, National Association.
NOTE 16
SHARE-BASED COMPENSATION
Stock options and restricted stock awards ("RSAs"), which are non-vested shares,
have been issued to directors, officers and other management employees under the
Corporation's 1994 Stock Option Plan and The 1999 Long-term Equity Incentive
Plan. The stock options, which have a ten-year life, become 100 percent vested
ranging from three months to two years and are fully exercisable when vested.
Option exercise prices equal the Corporation's common stock closing price on
NASDAQ on the date of grant. RSAs provide for the issuance of shares of the
Corporation's common stock at no cost to the holder and generally vest after
three years. The RSAs only vest if the employee is actively employed by the
Corporation on the vesting date.
The Corporation's 2004 Employee Stock Purchase Plan ("ESPP") provides 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. The price of the stock to be paid by the employees 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.
SFAS 123(R) required the Corporation to begin recording compensation expense in
2006 related to unvested share-based awards outstanding as of December 31, 2005,
by recognizing the un-amortized grant date fair value of these awards over the
remaining service periods of those awards, with no change in historical reported
fair values and earnings. Awards granted after December 31, 2005 are valued at
fair value in accordance with provisions of SFAS 123(R) and are recognized on a
straight-line basis over the service periods of each award. To complete the
exercise of vested stock options, RSA's and ESPP options, the Corporation
generally issues new shares from its authorized but unissued share pool.
Share-based
Page 60
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
SHARE-BASED COMPENSATION continued
compensation for the years ended December 31, 2007 and 2006 totaled $1,468,000
and $833,000, respectively, and has been recognized as a component of salaries
and benefits expense in the accompanying Consolidated Condensed Statements of
Income.
Prior to 2006, the Corporation accounted for share-based compensation in
accordance with APB 25 using the intrinsic value method, which did not require
that compensation expense be recognized for the Corporation's stock and ESPP
options. However, under APB 25, the Corporation was required to record
compensation expense over the vesting period for the value of RSAs granted, if
any.
The Corporation provided pro forma disclosure amounts in accordance with SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure"
(SFAS No. 148), as if the fair value method defined by SFAS No. 123 had been
applied to its share-based compensation. The Corporation's net income and net
income per share for the period ended December 31, 2005 would have been reduced
if compensation expense related to stock and ESPP options had been recorded in
the financial statements, based on fair value at the grant dates.
The estimated fair value of the stock options granted during 2007, 2006 and 2005
was calculated using a Black Scholes options pricing model. The following
summarizes the assumptions used in the Black Scholes model:
2007 2006 2005
---- ---- ----
Risk-free Interest Rate ................................. 4.67% 4.59% 4.05%
Expected Price Volatility ............................... 29.76% 29.84% 30.20%
Dividend Yield .......................................... 3.64% 3.54% 3.56%
Forfeiture Rate ......................................... 5.00% 4.00% 4.00%
Weighted-average Expected Life, Until Exercise .......... 5.99 years 5.75 years 8.50 years
The Black Scholes model incorporates assumptions to value share-based awards.
The risk-free rate of interest, for periods equal to the expected life of the
option, is based on a zero-coupon U.S. government instrument over a similar
contractual term of the equity instrument. Expected price volatility is based on
historical volatility of the Corporation's common stock. In addition, the
Corporation generally uses historical information to determine the dividend
yield and weighted-average expected life of the options, until exercise.
Separate groups of employees that have similar historical exercise behavior with
regard to option exercise timing and forfeiture rates are considered separately
for valuation and attribution purposes.
Share-based compensation expense recognized in the Consolidated Condensed
Statements of Income is based on awards ultimately expected to vest and is
reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods,
if actual forfeitures differ from those estimates. Pre-vesting forfeitures were
estimated to be approximately 5 percent for the year ended December 31, 2007,
based on historical experience. In the Corporation's pro forma disclosures
required under SFAS 123(R) for the periods prior to fiscal 2006, the Corporation
accounted for forfeitures as they occurred.
As a result of adopting SFAS 123(R), net income of the Corporation for the year
ended December 31, 2007 and 2006 were $1,124,000 and $656,000, respectively,
lower (net of $344,000 and $177,000 in tax benefits), than if it had continued
to account for share-based compensation under APB 25. The impact on both basic
and diluted earnings per share for the year ended December 31, 2007 and 2006
were $.06 and $.04 per share.
Page 61
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
SHARE-BASED COMPENSATION continued
The following table summarizes the components of the Corporation's share-based
compensation awards recorded as expense.
Components of the share-based compensation:
Year Ended Year Ended
December 31, 2007 December 31, 2006
----------------- -----------------
Stock and ESPP Options:
Pre-tax Compensation Expense ...................... $ 602 $ 449
Income Tax Benefit ................................ (41) (42)
----------------- -----------------
Stock and ESPP Options Expense, Net of Income........ $ 561 $ 407
================= =================
Restricted Stock Awards:
Pre-tax Compensation Expense ...................... $ 866 $ 384
Income Tax Benefit ................................ (303) (135)
----------------- -----------------
Restricted Stock Awards Expense, Net of Tax ......... $ 563 $ 249
================= =================
Total Share-based Compensation:
Pre-tax Compensation Expense ...................... $ 1,468 $ 833
Income Tax Benefit ................................ (344) (177)
----------------- -----------------
Total Share-based Compensation Expense, Net of Tax... $ 1,124 $ 656
================= =================
As of December 31, 2007, unrecognized compensation expense related to stock
options, RSAs and ESPP options totaling $221,000, $1,320,000 and $92,000,
respectively, is expected to be recognized over weighted-average periods of .61,
1.67 and .5 years, respectively.
Stock option activity under the Corporation's stock option plans as of December
31, 2007 and changes during the year ended December 31, 2007 were as follows:
Weighted-
Average
Weighted- Remaining
Number Average Contractual Aggregate
of Exercise Term Intrinsic
Shares Price (in Years) Value
---------- ------------ ----------- ----------
Outstanding at January 1, 2007 .................. 1,067,247 $ 23.87
Granted ......................................... 75,968 26.00
Exercised ....................................... (48,609) 18.11
Cancelled ....................................... (40,176) 23.68
----------
Outstanding at December 31, 2007 ................ 1,054,430 $ 24.30 5.33 $568,511
==========
Vested and Expected to Vest at December 31, 2007. 1,042,511 $ 24.28 5.29 $568,511
Exercisable at December 31, 2007 ................ 924,467 $ 24.12 4.86 $568,511
The weighted-average grant date fair value was $5.85, $6.22 and $6.93 for stock
options granted during the year ended December 31, 2007, 2006 and 2005,
respectively.
The aggregate intrinsic value in the table above represents the total pre-tax
intrinsic value (the difference between the Corporation's closing stock price on
the last trading day of 2007 and the exercise price, multiplied by the number of
in-the-money options) that would have been received by the option holders had
all option holders exercised their stock options on the last trading day of
2007. The amount of aggregate intrinsic value will change based on the fair
market value of the Corporation's common stock.
The aggregate intrinsic value of stock options exercised during the years ended
December 31, 2007, 2006 and 2005 were $250,185, $665,000 and $903,000,
respectively. Exercise of options during these same periods resulted in cash
receipts of $496,000, $1,228,000 and $1,347,000, respectively. The Corporation
recognized a tax benefit of approximately $116,000 for the year ended December
31, 2007, related to the exercise of employee stock options and has been
recorded as an increase to additional paid-in capital.
Page 62
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
SHARE-BASED COMPENSATION continued
The following table summarizes information on unvested restricted stock awards
outstanding as of December 31, 2007:
Number of Grant-Date
Shares Fair Value
---------- ----------
Unvested RSAs at January 1, 2007 ........... 55,000 $ 27.83
Granted .................................... 57,775 26.07
Forfeited .................................. 6,306 25.78
Vested ..................................... 8,442 25.56
----------
Unvested RSAs at December 31, 2007 ......... 98,027 $ 27.12
========== ========
The grant date fair value of ESPP options was estimated at the beginning of the
July 1, 2007 offering period and approximates $184,000. The ESPP options vested
during the twelve-month period ending June 30, 2008. At December 31, 2007, total
unrecognized compensation expense related to unvested ESPP options was $92,000,
which is expected to be recognized over a six-month period ending June 30, 2008.
NOTE 17
PENSION AND OTHER POST RETIREMENT BENEFIT PLANS
The Corporation's defined-benefit pension plans cover substantially all of the
Corporation's employees. On December 31, 2006 the Corporation adopted the
recognition provision of SFAS No. 158 Employers' Accounting for Defined Benefit,
Pension and other Post-Retirement Plans. 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.
The table below sets forth the plans' funded status and amounts recognized in
the consolidated balance sheet at December 31, using measurement dates of
September 30, 2007 and 2006.
December 31
2007 2006
=====================================================================================
Change in Benefit Obligation
Benefit Obligation at Beginning of Year ............ $ 58,078 $ 55,484
Service Cost ....................................... 671 688
Interest Cost ...................................... 3,146 2,985
Actuarial (Gain)/Loss .............................. (1,640) 1,303
Benefits Paid ...................................... (2,755) (2,382)
-------- --------
Benefit Obligation at End of Year .................. 57,500 58,078
-------- --------
Change in Plan Assets
Fair Value of Plan Assets at Beginning of Year ..... 41,591 39,913
Actual Return on Plan Assets ....................... 6,563 3,243
Employer Contributions ............................. 853 817
Benefits Paid ...................................... (2,755) (2,382)
-------- --------
End of Year ........................................ 46,252 41,591
-------- --------
Funded Status at End of Year ............................ $ 11,248 $ 16,487
======== ========
Assets and Liabilities Recognized in the Balance Sheets:
Deferred Tax Assets ................................ $ 2,804 $ 4,654
Liabilities ........................................ $ 11,248 $ 16,487
Amounts Recognized in Accumulated Other Comprehensive Income Not Yet Recognized
as Components of Net Periodic Benefit Cost Consist of:
Net Loss (Gain) .................................... $ 4,089 $ 6,701
Prior Service Cost (Credit) ........................ 118 34
-------- --------
$ 4,207 $ 6,735
======== ========
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 incurred a
$1,630,000 pension curtailment loss to record previously unrecognized prior
service costs in accordance with SFAS No. 88,
Page 63
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 17
PENSION AND OTHER POST RETIREMENT BENEFIT PLANS continued
"Employers' Accounting for Settlements and Curtailments of Defined Benefit Plans
and for Termination Benefits." This loss was recognized and recorded by the
Corporation in 2005.
The accumulated benefit obligation for all defined benefit plans was $56,739,000
and $51,732,000 at December 31, 2007 and 2006, respectively.
Information for pension plans with an accumulated benefit obligation in excess
of plan assets:
December 31
2007 2006
=====================================================================================
Projected Benefit Obligation ....................... $ 57,500 $ 58,078
======== ========
Accumulated Benefit Obligation ..................... $ 51,770 $ 56,583
======== ========
Fair Value of Plan Assets .......................... $ 46,252 $ 41,591
======== ========
Components of net periodic pension cost:
December 31
2007 2006
=====================================================================================
Service Cost ....................................... $ 671 $ 688
Interest Cost ...................................... 3,146 2,985
Expected Return on Plan Assets...................... (3,164) (2,913)
Amortization of Prior Service Costs ................ 25 26
Amortization of Net (Gain) Loss .................... 527 445
-------- --------
Net Periodic Pension Cost .......................... $ 1,205 $ 1,231
======== ========
Other changes in plan assets and benefit obligations recognized in other
comprehensive income:
December 31,
2007
=========================================================================================
Net Periodic Pension Cost .............................................. $ 1,205
Defined Benefit Pension Plans, Net of Income Tax Expense of ($1,475)
Net Gain Arising During Period ...................................... 2,725
Prior Service Cost Arising During Period ............................ 30
Amortization of Prior Service Cost .................................. (15)
-------
Total Recognized in Other Comprehensive Income ...................... 2,740
-------
Total Recognized in NPPC and OCI ....................................... $ 3,945
=======
The estimated net loss and transition obligation for the defined benefit pension
plans that will be amortized from accumulated other comprehensive income into
net periodic pension cost over the next fiscal year are:
==========================================================================================
Amortization of Net Loss (Gain) ......................... $ 152
Amortization of Prior Service Cost ...................... 16
---------
Total ............................................... $ 168
=========
Significant assumptions include:
December 31
2007 2006
=====================================================================================
Weighted-average Assumptions Used to Determine Benefit Obligation:
Discount Rate ...................................... 5.50% 5.50%
Rate of Compensation Increase ...................... 3.50% 3.50%
Weighted-average Assumptions Used to Determine Benefit Cost:
Discount Rate ...................................... 5.50% 5.50%
Expected Return on Plan Assets ..................... 7.75% 7.50%
Rate of Compensation Increase ...................... 3.52% 4.00%
At September 30, 2007 and 2006, 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
Page 64
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 17
PENSION AND OTHER POST RETIREMENT BENEFIT PLANS continued
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.
At December 31, 2007, the maturities of the plans' debt securities ranged from
18 days to 8.7 years, with a weighted average maturity of 3.2 years. At December
31, 2006, the maturities of the plans' debt securities ranged from 1 day to 10.4
years, with a weighted average maturity of 3.0 years.
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid as of December 31, 2007. The Corporation
plans to contribute as least $386,000 to the plans in 2008.
======================================================
2008 ................................ $ 2,672
2009 ................................ 2,777
2010 ................................ 2,990
2011 ................................ 3,207
2012 ................................ 3,401
2013 and After ....................... 18,340
Plan assets are re-balanced quarterly. At December 31, 2007 and 2006, plan
assets by category are as follows:
December 31
2007 2006
==============================================================================
Equity Securities ................................ 65% 66%
Debt Securities .................................. 32% 32%
Other ............................................ 3% 2%
-------- --------
100% 100%
======== ========
The following table reflects the adjustments recorded during 2006 in accordance
with the adoption of the recognition and disclosure requirement of SFAS No. 158:
Before After
Application of Application of
Statement 158 Adjustments Statement 158
=======================================================================================================
Other Assets ................................. $ 22,281 $ 1,377 $ 23,658
Total Assets ................................. 3,553,493 1,377 3,554,870
Other Liabilities ............................ 23,486 3,431 26,917
Total Liabilities ............................ 3,224,114 3,431 3,227,545
Accumulated Other Comprehensive Loss ......... (7,341) (2,064) (9,405)
Total Stockholders' Equity ................... 329,389 (2,064) 327,325
The First Merchants Corporation Retirement and Income Savings Plan (the "Savings
Plan"), a Section 401(k) qualified defined contribution plan, was amended on
March 1, 2005 to provide enhanced retirement benefits, including employer and
matching contributions, for eligible employees of the Corporation and its
subsidiaries. The Corporation matches employees' contributions primarily at the
rate of 50 percent for the first 6 percent of base salary contributed by
participants. Beginning in 2005, employees who have completed 1,000 hours of
service and are an active employee on the last day of the year receive an
additional retirement contribution after year-end. The amount of a participant's
retirement contribution varies from 2 to 7 percent of salary based upon years of
service. Full vesting occurs after 5 years of service. The Corporation's expense
for the Savings Plan was $2,454,000 for 2007, $2,026,000 for 2006 and $2,052,000
for 2005.
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 $1,317,000 and $1,089,000 at December 31, 2007
and 2006. Post-retirement plan expense totaled $171,000, $127,000 and $120,000
for the years ending December 31, 2007, 2006 and 2005, respectively.
Page 65
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 18
NET INCOME PER SHARE
====================================================================================================================================
Year Ended December 31, 2007 2006 2005
- ----------------------------------------------------------------------------------------------------------------------------------
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 .......... $31,639 18,249,919 $1.73 $30,198 18,383,074 $1.64 $30,239 18,484,832 $1.64
===== ===== =====
Effect of Dilutive Stock Options.. 64,843 83,679 110,863
------- ---------- ------- ---------- ------- ----------
Diluted Net Income Per Share:
Net Income Available to
Common Stockholders
and Assumed Conversions ...... $31,639 18,313,964 $1.73 $30,198 18,466,753 $1.64 $30,239 18,595,695 $1.63
======= ========== ===== ======= ========== ===== ======= ========== =====
Options to purchase 831,795, 590,736, and 214,840 shares of common stock with
weighted average exercise prices of $25.67, $26.21 and $26.81 at December 31,
2007, 2006 and 2005, respectively, were excluded from the computation of diluted
net income per share because the options exercise price was greater than the
average market price of the common stock.
NOTE 19
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.
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.
DERIVATIVE INSTRUMENTS The fair value of the derivatives reflects the estimated
amounts that we would receive to terminate these contracts at the reporting date
based upon pricing or valuation models applied to current market information.
Interest rate floors are valued using the market standard methodology of
discounting the future expected cash receipts that would occur if variable
interest rates fell below the strike rate of the floors. The projected cash
receipts on the floor are based on an expectation of future interest rates
derived from observed market interest rate curves and volatilities.
Page 66
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 19
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:
2007 2006
====================================================================================================================================
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
====================================================================================================================================
Assets at December 31:
Cash and Due from Banks .................................... $ 134,683 $ 134,683 $ 89,957 $ 89,957
Interest-bearing Time Deposits ............................. 24,931 24,931 11,284 11,284
Investment Securities Available for Sale ................... 440,836 440,836 455,933 455,933
Investment Securities Held to Maturity ..................... 10,331 10,270 9,284 9,516
Mortgage Loans Held for Sale ............................... 3,735 3,735 5,413 5,413
Loans ...................................................... 2,848,615 2,846,625 2,666,061 2,649,916
FRB and FHLB Stock ......................................... 25,250 25,250 23,691 23,691
Interest Receivable ........................................ 23,402 23,402 24,345 24,345
Interest Rate Floors ....................................... 2,001 2,001 428 428
Liabilities at December 31:
Deposits ................................................... $2,844,121 $2,731,895 $2,750,538 $2,661,866
Borrowings:
Federal Funds Purchased ................................ 52,350 52,350 56,150 56,150
Securities Sold Under Repurchase Agreements ............ 106,497 106,497 42,750 42,750
FHLB Advances .......................................... 294,101 298,574 242,408 242,954
Subordinated Debentures, Revolving Credit
Lines and Term Loans ................................. 115,826 121,177 99,456 112,966
Interest Payable ........................................... 8,325 8,325 9,326 9,326
NOTE 20
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,
2007 2006
================================================================================
Assets
Cash .............................................. $ 8,192 $ 6,122
Investment in Subsidiaries ........................ 445,104 417,287
Goodwill .......................................... 448 448
Other Assets ...................................... 12,282 15,425
-------- --------
Total Assets ................................... $466,026 $439,282
======== ========
Liabilities
Borrowings ........................................ $115,826 $ 99,456
Other Liabilities ................................. 10,264 12,501
-------- --------
Total Liabilities .............................. 126,090 111,957
Stockholders' Equity ................................. 339,936 327,325
-------- --------
Total Liabilities and Stockholders' Equity ..... $466,026 $439,282
======== ========
Page 67
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 20
CONDENSED FINANCIAL INFORMATION (parent company only) continued
CONDENSED STATEMENTS OF INCOME
December 31,
2007 2006 2005
===================================================================================================================================
Income
Dividends from Subsidiaries ................................................ $ 20,979 $ 33,919 $ 30,930
Administrative Services Fees from Subsidiaries.............................. 17,670 15,104 13,823
Other Income ............................................................... 102 240 644
-------- -------- --------
Total Income ............................................................ 38,750 49,263 45,397
-------- -------- --------
Expenses
Amortization of Core Deposit Intangibles
and Fair Value Adjustments ................................................ 11 11 11
Interest Expense............................................................ 7,750 8,124 7,432
Salaries and Employee Benefits.............................................. 16,111 13,934 12,500
Net Occupancy Expenses...................................................... 1,198 1,232 1,294
Equipment Expenses.......................................................... 3,772 4,210 3,418
Telephone Expenses.......................................................... 915 1,108 1,181
Postage and Courier Expenses................................................ 1,797 1,658 1,528
Other Expenses.............................................................. 5,898 2,548 2,394
-------- -------- --------
Total Expenses .......................................................... 37,452 32,825 29,758
-------- -------- --------
Income Before Income Tax Benefit and Equity in
Undistributed Income of Subsidiaries ......................................... 1,298 16,438 15,639
Income Tax Benefit ...................................................... 7,355 6,771 5,404
-------- -------- --------
Income Before Equity in Undistributed Income of Subsidiaries ................. 8,653 23,209 21,043
Equity in Undistributed (Distributions in Excess of)
Income of Subsidiaries ................................................... 22,986 6,989 9,196
-------- -------- --------
Net Income ................................................................... $ 31,639 $ 30,198 $ 30,239
======== ======== ========
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
=====================================================================================================================
2007 2006 2005
=====================================================================================================================
Operating Activities:
Net Income ........................................................ $ 31,639 $ 30,198 $ 30,239
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Amortization .................................................... 11 11 11
Share-based Compensation ........................................ 723 41
Distributions in Excess of (Equity in Undistributed)
Income of Subsidiaries ............... ........................ (22,986) (6,989) (9,196)
Net Change in:
Other Assets ................................................. 3,143 (3,166) (2,220)
Other Liabilities ............................................ (2,237) 5,923 1,680
-------- -------- --------
Net Cash Provided by Operating Activities ................. 10,293 26,018 20,514
-------- -------- --------
Investing Activities - Investment in Subsidiaries .................... 2,559 840 (2,884)
-------- -------- --------
Net Cash Provided (Used) by Investing Activities .......... 2,559 840 (2,884)
-------- -------- --------
Financing Activities:
Cash Dividends .................................................... (16,854) (16,951) (16,981)
Borrowings......................................................... 73,202 3,750 9,833
Repayment of Borrowings ........................................... (56,832) (8,250) (3,083)
Stock Issued Under Employee Benefit Plans ......................... 787 857 914
Stock Issued Under Dividend Reinvestment
and Stock Purchase Plan ......................................... 1,170 1,190 933
Stock Options Exercised ........................................... 496 1,228 2,174
Stock Redeemed .................................................... (12,751) (5,690) (9,658)
Other ............................................................. 381
-------- -------- --------
Net Cash Used by Financing Activities ..................... (10,782) (23,485) (15,868)
-------- -------- --------
Net Change in Cash ................................................... 2,070 3,373 1,762
Cash, Beginning of Year .............................................. 6,122 2,749 987
-------- -------- --------
Cash, End of Year .................................................... $ 8,192 $ 6,122 $ 2,749
======== ======== ========
Page 68
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 21
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth certain quarterly results for the years ended
December 31, 2007 and 2006:
- -----------------------------------------------------------------------------------------------------------------------------------
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
2007:
March ............ $ 55,241 $ 28,166 $ 27,075 $ 1,599 $ 7,771 18,410,958 18,495,926 $ .42 $ .42
June ............. 57,008 29,393 27,615 1,648 6,208 18,290,918 18,368,513 .34 .34
September......... 59,157 30,622 28,535 2,810 8,350 18,221,467 18,276,180 .46 .46
December.......... 59,327 29,432 29,895 2,450 9,310 18,080,281 18,137,667 .51 .51
---------- ---------- ----------- -------- -------- ----- -----
$ 230,733 $ 117,613 $ 113,120 $ 8,507 $ 31,639 18,249,919 18,313,964 $1.73 $1.73
========== ========== =========== ======== ======== ===== =====
2006:
March ............ $ 48,062 $ 20,473 $ 27,589 $ 1,726 $ 7,509 18,425,047 18,532,136 $ .41 $ .41
June ............. 51,047 23,281 27,766 1,729 7,291 18,385,298 18,463,278 .39 .39
September......... 54,325 26,701 27,624 1,558 7,739 18,317,558 18,380,631 .42 .42
December.......... 55,172 28,056 27,116 1,245 7,659 18,405,330 18,497,507 .42 .42
---------- ---------- ----------- -------- -------- ----- -----
$ 208,606 $ 98,511 $ 110,095 $ 6,258 $ 30,198 18,383,074 18,466,753 $1.64 $1.64
========== ========== =========== ======== ======== ===== =====
NOTE 22
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133), as amended and interpreted,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. As required by SFAS 133, the Corporation records all
derivatives on the balance sheet at fair value. The accounting for changes in
the fair value of derivatives depends on the intended use of the derivative and
the resulting designation. Derivatives used to hedge the exposure to changes in
the fair value of an asset, liability, or firm commitment attributable to a
particular risk, such as interest rate risk, are considered fair value hedges.
Derivatives used to hedge the exposure to variability in expected future cash
flows, or other types of forecasted transactions, are considered cash flow
hedges. To qualify for hedge accounting, the Corporation must comply with the
detailed rules and strict documentation requirements at the inception of the
hedge, and hedge effectiveness is assessed at inception and periodically
throughout the life of each hedging relationship. Hedge ineffectiveness, if any,
is measured periodically throughout the life of the hedging relationship.
The Corporation's objective in using derivatives is to add stability to interest
income and to manage its exposure to changes in interest rates. To accomplish
this objective, the Corporation uses interest rate floors to protect against
movements in interest rates below the floors' strike rates over the life of the
agreements. The interest rate floors have notional amounts of $50,000,000,
$100,000,000 and $1,000,000 with corresponding strike rates of 6.0%, 7.0% and
7.5% respectively. All of the floors have maturity dates of August 1, 2009.
During 2007, the floors were used to hedge the variable cash flows associated
with existing variable-rate loan assets that are based on the prime rate
(Prime). For accounting purposes, the floors are designated as a cash flow hedge
of the overall changes in cash flows on the first Prime-based interest payments
received by the Corporation each calendar month during the term of the hedges
that, in aggregate for each period, are interest payments on principal from
specified portfolios equal to the notional amount of the floors.
For derivatives designated as cash flow hedges, the effective portion of changes
in the fair value of the derivative is initially reported in other comprehensive
income (outside of earnings) and subsequently reclassified to earnings
("interest income on loans") when the hedged transaction affects earnings.
Ineffectiveness resulting from the hedging relationship, if any, is recorded as
a gain or loss in earnings as part of non-interest income. Based on the
Corporation's assessments both at inception and throughout the life of the
hedging relationship, it is probable that sufficient Prime-based interest
receipts will exist through the maturity dates of the floors.
The Corporation uses the "Hypothetical Derivative Method" described in Statement
133 Implementation Issue No. G20, "Cash Flow Hedges: Assessing and Measuring the
Effectiveness of a Purchased Option Used in a Cash Flow Hedge," for quarterly
prospective and retrospective assessments of hedge effectiveness, as well as for
measurements of hedge ineffectiveness. The effective portion of changes in the
fair value of the derivative is initially reported in other comprehensive income
(outside of earnings) and subsequently reclassified to earnings ("interest
income on loans") when the hedged transactions affect earnings. Ineffectiveness
resulting from the hedge is recorded as a gain or loss in the consolidated
statement of income as part of non-interest income. The Corporation also
monitors the risk of counterparty default on an ongoing basis.
Prepayments in hedged loan portfolios are treated in a manner consistent with
the guidance in Statement 133 Implementation Issue No. G25, "Cash Flow hedges:
Using the First-Payments-Received Technique in Hedging the Variable Interest
Payments on a Group of Non-Benchmark-Rate-Based Loans," which allows the
designated forecasted transactions to be the variable, Prime-rate-based interest
payments on a rolling portfolio of prepayable interest-bearing loans using the
first-payments-received technique, thereby allowing interest payments from loans
that prepay to be replaced with interest payments from new loan originations.
Page 69
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 22
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES continued
As of December 31, 2007, no derivatives were designated as fair value hedges or
hedges of net investments in foreign operations. Additionally, the Corporation
does not use derivatives for trading or speculative purposes.
For the years ended December 31, 2007 and 2006, the interest rate floors
designated as cash flow hedges had a fair value of $2,001,000 and $428,000,
respectively, which were included in "Other Assets". The change in net
unrealized gains/losses on cash flow hedges reported in the consolidated
statements of changes in shareholders' equity was a net of tax gain of
$1,057,000 during 2007, and a loss of $125,000 during 2006.
For the year ended December 31, 2007, the Corporation recognized a gain of
$64,000 for hedge ineffectiveness due to mismatches in the terms of the floor
and the hedged loans, which is reported in other income in the consolidated
statements of income.
Amounts reported in accumulated other comprehensive income related to the
interest rate floor will be reclassified to interest income as interest payments
are received on the Corporation's variable-rate assets. The change in net
unrealized gains/losses on cash flow hedges reflects a reclassification of
$48,000 of net unrealized gains and $38,000 of net unrealized losses from
accumulated other comprehensive income to interest income during 2007 and 2006,
respectively. During 2008, the Corporation estimates that an additional $787,000
will be reclassified.
Interest rate floors are valued using market standard methodologies that
incorporate implied forward interest rates and implied volatility as inputs. The
fair value of each floor is obtained by summing the values of each individual
floorlet - which are monthly European-style options on the
daily-weighted-average Prime rate. The fair value of each floorlet is calculated
using the Black-Scholes Model.
NOTE 23
ACCOUNTING MATTERS
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS
No. 157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting standards, and expands disclosures about fair
value measurements. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. We do not expect that the adoption of SFAS No. 157 will have
a material impact on our financial condition or results of operations.
The Corporation adopted the provisions of the Financial Accounting Standards
Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement No. 109, on January 1, 2007.
FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. As a result of the implementation of FIN 48,
the Corporation did not identify any uncertain tax positions that it believes
should be recognized in the financial statements. The tax years still subject to
examination by taxing authorities are years subsequent to 2003.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities; including an Amendment of FASB
Statement No. 115" (SFAS 159). SFAS 159 permits entities with an irrevocable
option to report most financial assets and liabilities at fair value, with
subsequent changes in fair value reported in earnings. The election can be
applied on an instrument-by-instrument basis. The statement establishes
presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types
of assets and liabilities. Unrealized gains and losses on items for which the
fair value option has been elected will be recognized in earnings at each
subsequent reporting date. The provisions of FAS 159 are effective for the
fiscal year beginning January 1, 2008. The Corporation does not expect the
adoption of SFAS No. 159 to have a material impact on the operations of the
Corporation.
Page 70
PART II: ITEM 9., ITEM 9A. AND ITEM 9B.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
In connection with its audits for the two most recent fiscal years ended
December 31, 2007, there have been no disagreements with the Corporation's
independent registered public accounting firm on any matter of accounting
principles or practices, financial statement disclosure or audit scope or
procedure, nor have there been any changes in accountants.
ITEM 9A. CONTROLS AND PROCEDURES
At the end of the period covered by this report (the "Evaluation Date"), the
Corporation carried out an evaluation, under the supervision and with the
participation of the Corporation's management, including the Corporation's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of its disclosure controls and procedures pursuant to Rule
13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934 ("Exchange Act").
Based upon that evaluation, the Corporation's Chief Executive Officer and Chief
Financial Officer concluded that, as of the Evaluation Date, the Corporation's
disclosure controls and procedures are effective. Disclosure controls and
procedures are controls and procedures that are designed to ensure that
information required to be disclosed in Corporation reports filed or submitted
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission's rules and
forms.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Corporation is responsible for establishing and maintaining
effective internal control over financial reporting as defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934. The Corporation's internal control
over financial reporting is designed to provide reasonable assurance to the
Corporation's management and board of directors regarding the preparation and
fair presentation of published financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Accordingly, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.
Management assessed the effectiveness of the Corporation's internal control over
financial reporting as of December 31, 2007. In making this assessment,
management used the criteria set forth in "Internal Control - Integrated
Framework" issued by the Committee of Sponsoring Organizations (COSO) of the
Treadway Commission. Based on this assessment, management has determined that
the Corporation's internal control over financial reporting as of December 31,
2007 is effective based on the specified criteria.
There have been no changes in the Corporation's internal controls over financial
reporting identified in connection with the evaluation referenced above that
occurred during the Corporation's last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Corporation's
internal control over financial reporting.
Page 71
PART II: ITEM 9., ITEM 9A. AND ITEM 9B.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee, Board of Directors and Stockholders
First Merchants Corporation
Muncie, Indiana
We have audited First Merchants Corporation's internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying Management's Report on Internal Control
Over Financial Reporting. Our responsibility is to express an opinion on the
Company's internal control over financial reporting based on our audit.
We conducted our audit 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, First Merchants Corporation maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2007, based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of First Merchants Corporation and our report dated February 8, 2008,
expressed an unqualified opinion thereon.
BKD, LLP
Indianapolis, Indiana
February 8, 2008
ITEM 9B. OTHER INFORMATION
None
Page 72
Part III: ITEM 10., ITEM 11., ITEM 12., ITEM 13., AND ITEM 14.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information in the Corporation's Proxy Statement dated March 19, 2008
furnished to its stockholders in connection with an annual meeting to be held
April 29, 2008 (the "2008 Proxy Statement"), under the captions "INFORMATION
REGARDING DIRECTORS", "COMMITTEES OF THE BOARD" and "SECTION 16(a) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE", is expressly incorporated herein by reference.
The information required under this item relating to executive officers is set
forth in Part I, "Supplemental Information - Executive Officers of the
Registrant" on this Annual Report on Form 10-K.
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 Business Conduct may be obtained, free of charge, by writing
to First Merchants Corporation at 200 East Jackson Street, Muncie, IN 47305. In
addition, the Code of Ethics is maintained on the Corporation's website, which
can be accessed at http://www.firstmerchants.com.
ITEM 11. EXECUTIVE COMPENSATION
The information in the Corporation's 2008 Proxy Statement, under the captions,
"COMPENSATION OF DIRECTORS", "COMPENSATION OF EXECUTIVE OFFICERS", "COMMITTEES
OF THE BOARD-Compensation and Human Resources Committee Interlocks and Insider
Participation" and "COMMITTEES OF THE BOARD-Compensation and Human Resources
Committee Report" is expressly incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information in the Corporation's 2008 Proxy Statement, under the caption,
"SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT-Securities Ownership of
Certain Beneficial Owners" and "SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND
MANAGEMENT-Security Ownership of Directors and Executive Officers", is expressly
incorporated herein by reference. The information required under this item
relating to equity compensation plans is set forth in Part II, Item 5 under the
table entitled "Equity Compensation Plan Information" on this Annual Report on
Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in the Corporation's 2008 Proxy Statement, under the captions,
SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT-Securities Ownership of
Certian Beneficial Owners" and "TRANSACTIONS WITH RELATED PERSONS", is expressly
incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information in the Corporation's 2008 Proxy Statement, under the caption
"INDEPENDENT AUDITOR", is expressly incorporated herein by reference.
Page 73
Part IV: ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS
PART IV
ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS.
- --------------------------------------------------------------------------------
(a) 1. Financial Statements:
Independent accountants' report
Consolidated balance sheets at
December 31, 2007 and 2006
Consolidated statements of income,
years ended December 31, 2007,
2006 and 2005
Consolidated statements of comprehensive income,
years ended December 31, 2007, 2006 and 2005
Consolidated statements of stockholders' equity,
years ended December 31, 2007, 2006 and 2005
Consolidated statements of cash flows,
years ended December 31, 2007,
2006 and 2005
Notes to consolidated financial
statements
(a) 2. Financial statement schedules:
All schedules are omitted because they are not applicable or
not required, or because the required information is
included in the consolidated financial statements or related
notes.
(a) 3. Exhibits:
Exhibit No: Description of Exhibits:
- ----------- ------------------------
3a First Merchants Corporation Articles of Incorporation. (Incorporated
by reference to registrant's Form 10-Q for quarter ended June 30,
1999)
3b Bylaws of First Merchants Corporation dated October 23, 2007
(Incorporated by reference to registrant's Form 10-Q for the quarter
ended September 30, 2007)
4.1 First Merchants Corporation Amended and Restated Declaration of Trust
of First Merchants Capital Trust II dated as of July 2, 2007
(Incorporated by reference to registrant's Form 8-K filed on July 3,
2007)
4.2 Indenture dated as of July 2, 2007 (Incorporated by reference to
registrant's Form 8-K filed on July 3, 2007)
4.3 Guarantee Agreement dated as of July 2, 2007 (Incorporated by
reference to registrant's Form 8-K filed on July 3, 2007)
4.4 Form of Capital Securities Certification of First Merchants Capital
Trust II (Incorporated by reference to registrant's Form 8-K filed on
July 3, 2007)
10.1 Placement Agreement dated June 29, 2007 (Incorporated by reference to
registrant's Form 8-K filed on July 3, 2007)
Page 74
ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS (continued)
- --------------------------------------------------------------------------------
10a First Merchants Corporation Senior Management Incentive Compensation
Program, dated February 27, 2008.(2)
10b First Merchants Corporation 1994 Stock Option Plan. (Incorporated by
reference to registrant's Form 10-K for year ended December 31,
1993)(1)
10c First Merchants Corporation Change of Control Agreement, as amended,
with Mark K. Hardwick dated February 14, 2006. (Incorporated by
reference to registrant's Form 8-K filed on March 9, 2006)(1)
10d First Merchants Corporation Change of Control Agreement with Michael
C. Rechin dated December 13, 2005. (Incorporated by reference to
registrant's Form 8-K filed on December 19, 2005)(1)
10e First Merchants Corporation Change of Control Agreement with Robert R.
Connors dated August 26, 2002 as amended on January 1, 2008.
(Incorporated by reference to registrant's Form 8-K filed on January
3, 2008)(1)
10f First Merchants Corporation Change of Control Agreement with Kimberly
J. Ellington dated January 1, 2005 as amended on January 1, 2008.
(Incorporated by reference to registrant's Form 8-K filed on January
3, 2008)(1)
10g First Merchants Corporation Change of Control Agreement with Jami L.
Bradshaw dated October 23, 2007. (Incorporated by reference to
registrant's Form 8-K filed on October 29, 2007)(1)
10h First Merchants Corporation Change of Control Agreement with David W.
Spade dated October 23, 2007. (Incorporated by reference to
registrant's Form 8-K filed on October 29, 2007)(1)
10i First Merchants Corporation Change of Control Agreement with Jeffrey
B. Lorentson dated October 23, 2007. (Incorporated by reference to
registrant's Form 8-K filed on October 29, 2007)(1)
10j Resolution of the Board of Directors of First Merchants Corporation on
director compensation dated December 4, 2007. (2)
10k First Merchants Corporation Supplemental Executive Retirement Plan and
amendments thereto. (Incorporated by reference to registrant's Form
10-K for year ended December 31, 1997)(1)
10l First Merchants Corporation 1999 Long-Term Equity Incentive Plan, as
amended. (Incorporated by reference to registrant's Form 10-Q for
quarter ended September 30, 2004) (1)
10m First Merchants Corporation Letter Agreement between the Corporation
and Michael L. Cox, dated January 23, 2007. (Incorporated by reference
to registrant's Form 8-K filed on January 24, 2007)
10n First Merchants Corporation Defined Contribution Supplemental
Retirement Plan dated January 1, 2006. (Incorporated by reference to
registrant's Form 8-K filed on February 6, 2007)
10o First Merchants Corporation Participation Agreement of Michael C.
Rechin dated January 26, 2007. (Incorporated by reference to
registrant's Form 8-K filed on February 6, 2007)
21 Subsidiaries of Registrant(2)
23 Consent of Independent Registered Public Accounting Firm(2)
24 Limited Power of Attorney(2)
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes - Oxley Act of 2002(2)
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes - Oxley Act of 2002(2)
32 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002(2)
99.1 Financial statements and independent registered public accounting
firm's report for First Merchants Corporation Employee Stock Purchase
Plan (2)
(1) Management contract or compensatory plan.
(2) Filed here within.
Page 75
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on this 17th day of March,
2008.
FIRST MERCHANTS CORPORATION
By: /s/ Michael C. Rechin
-----------------------------
Michael C. Rechin, President and
Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
on Form 10-K has been signed by the following persons on behalf of the
registrant and in the capacities indicated, on this 17th day of March, 2008.
/s/ Michael C. Rechin* /s/ Mark K. Hardwick
- -------------------------------------- --------------------------------------
Michael C. Rechin President and Mark K. Hardwick Executive Vice
Chief Executive President and Chief
Officer (Principal Financial Officer
Executive Officer) (Principal Financial
Officer)
/s/ Richard A. Boehning* /s/
- ------------------------------------ ------------------------------------
Richard A. Boehning Director Barry J. Hudson Director
/s/ Thomas B. Clark* /s/ Michael C. Rechin*
- ------------------------------------ ------------------------------------
Thomas B. Clark Director Michael C. Rechin Director
/s/ Michael L. Cox* /s/ Charles E. Schalliol*
- ------------------------------------ ------------------------------------
Michael L. Cox Director Charles E. Schalliol Director
/s/ Roderick English* /s/ Terry L. Walker*
- ------------------------------------ ------------------------------------
Roderick English Director Teryy L. Walker Director
/s/ Dr. Jo Ann Gora* /s/ Jean L. Wojtowicz*
- ------------------------------------ ------------------------------------
Dr. Jo Ann Gora Director Jean L. Wojtowicz Director
/s/ William L. Hoy*
- ------------------------------------
William L. Hoy Director
* By Mark K. Hardwick as Attorney-in Fact pursuant to a Limited Power of
Attorney executed by the directors listed above, which Power of Attorney is
being filed with the Securities and Exchange Commission as an exhibit hereto.
By /s/ Mark K. Hardwick
------------------------------
Mark K. Hardwick
As Attorney-in-Fact
March 17, 2008
Page 76
INDEX TO EXHIBITS
- --------------------------------------------------------------------------------
(a) 3. Exhibits:
Exhibit No: Description of Exhibits:
- ----------- ------------------------
3a First Merchants Corporation Articles of Incorporation. (Incorporated
by reference to registrant's Form 10-Q for quarter ended June 30,
1999)
3b Bylaws of First Merchants Corporation dated October 23, 2007
(Incorporated by reference to registrant's Form 10-Q for the quarter
ended September 30, 2007)
4.1 First Merchants Corporation Amended and Restated Declaration of Trust
of First Merchants Capital Trust II dated as of July 2, 2007
(Incorporated by reference to registrant's Form 8-K filed on July 3,
2007)
4.2 Indenture dated as of July 2, 2007 (Incorporated by reference to
registrant's Form 8-K filed on July 3, 2007)
4.3 Guarantee Agreement dated as of July 2, 2007 (Incorporated by
reference to registrant's Form 8-K filed on July 3, 2007)
4.4 Form of Capital Securities Certification of First Merchants Capital
Trust II (Incorporated by reference to registrant's Form 8-K filed on
July 3, 2007)
10.1 Placement Agreement dated June 29, 2007 (Incorporated by reference to
registrant's Form 8-K filed on July 3, 2007)
Page 77
ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS (continued)
- --------------------------------------------------------------------------------
10a First Merchants Corporation Senior Management Incentive Compensation
Program, dated February 27, 2008.(2)
10b First Merchants Corporation 1994 Stock Option Plan. (Incorporated by
reference to registrant's Form 10-K for year ended December 31,
1993)(1)
10c First Merchants Corporation Change of Control Agreement, as amended,
with Mark K. Hardwick dated February 14, 2006. (Incorporated by
reference to registrant's Form 8-K filed on March 9, 2006)(1)
10d First Merchants Corporation Change of Control Agreement with Michael
C. Rechin dated December 13, 2005. (Incorporated by reference to
registrant's Form 8-K filed on December 19, 2005)(1)
10e First Merchants Corporation Change of Control Agreement with Robert R.
Connors dated August 26, 2002 as amended on January 1, 2008.
(Incorporated by reference to registrant's Form 8-K filed on January
3, 2008)(1)
10f First Merchants Corporation Change of Control Agreement with Kimberly
J. Ellington dated January 1, 2005 as amended on January 1, 2008.
(Incorporated by reference to registrant's Form 8-K filed on January
3, 2008)(1)
10g First Merchants Corporation Change of Control Agreement with Jami L.
Bradshaw dated October 23, 2007. (Incorporated by reference to
registrant's Form 8-K filed on October 29, 2007)(1)
10h First Merchants Corporation Change of Control Agreement with David W.
Spade dated October 23, 2007. (Incorporated by reference to
registrant's Form 8-K filed on October 29, 2007)(1)
10i First Merchants Corporation Change of Control Agreement with Jeffrey
B. Lorentson dated October 23, 2007. (Incorporated by reference to
registrant's Form 8-K filed on October 29, 2007)(1)
10j Resolution of the Board of Directors of First Merchants Corporation on
director compensation dated December 4, 2007. (2)
10k First Merchants Corporation Supplemental Executive Retirement Plan and
amendments thereto. (Incorporated by reference to registrant's Form
10-K for year ended December 31, 1997)(1)
10l First Merchants Corporation 1999 Long-Term Equity Incentive Plan, as
amended. (Incorporated by reference to registrant's Form 10-Q for
quarter ended September 30, 2004) (1)
10m First Merchants Corporation Letter Agreement between the Corporation
and Michael L. Cox, dated January 23, 2007. (Incorporated by reference
to registrant's Form 8-K filed on January 24, 2007)
10n First Merchants Corporation Defined Contribution Supplemental
Retirement Plan dated January 1, 2006. (Incorporated by reference to
registrant's Form 8-K filed on February 6, 2007)
10o First Merchants Corporation Participation Agreement of Michael C.
Rechin dated January 26, 2007. (Incorporated by reference to
registrant's Form 8-K filed on February 6, 2007)
21 Subsidiaries of Registrant(2)
23 Consent of Independent Registered Public Accounting Firm(2)
24 Limited Power of Attorney(2)
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes - Oxley Act of 2002(2)
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes - Oxley Act of 2002(2)
32 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002(2)
99.1 Financial statements and independent registered public accounting
firm's report for First Merchants Corporation Employee Stock Purchase
Plan (2)
(1) Management contract or compensatory plan.
(2) Filed here within.
Page 78
EXHIBIT-10a
First Merchants Corporation
Senior Management Incentive
Compensation Program
Approved February 27, 2008
I. Purpose
The Board of Directors of First Merchants Corporation (FMC) has established
an executive compensation program, which is designed to closely align the
interests of executives with those of our shareholders by rewarding senior
managers for achieving short-term and long-term strategic management and
earnings goals, with the ultimate objective of obtaining a superior return
on the shareholders' investment.
II. Administration
This plan will be administered solely by the Compensation and Human
Resources Committee (Committee) of FMC, with supporting documentation and
recommendations provided by the Chief Executive Officer (CEO) of FMC. The
Committee will annually review the targets for applicability and
competitiveness.
The Committee will have the authority to: (a) modify the formal plan
document; (b) make the final award determinations; (c) set conditions for
eligibility and awards; (d) define extraordinary accounting events in
calculating earnings; (e) establish future payout schedules; (f) determine
circumstances/causes for which payouts can be withheld; and (g) abolish the
plan.
III. Covered Individuals by Officer Level/Role
A. President and Chief Executive Officer of FMC;
B. Executive Vice Presidents of FMC;
C. Executive Officers and Bank CEOs;
D. Non-Bank CEOs and Regional Presidents;
E. Senior Management/Leadership;
F. Department Heads, Division Heads and Other Management Leadership; and
G. Mortgage Sales Managers.
In order to receive an award, a participant must be employed at the time of
the award except for conditions of death, disability or retirement.
Participants will be disqualified if their individual overall performance
is rated "improvement needed" or "unacceptable."
IV. Implementation Parameters
A. The FMC CEO and EVP earnings component payouts will be determined by
changes in FMC EPS calculated on a diluted GAAP basis.
Payouts to affiliate participants on their respective company earnings
component will be determined by changes in "operating earnings" (net income
plus or minus non-operating items including goodwill amortization and
corporate administrative charges.)
B. When utilized, balanced scorecards will be tailored to each unit
incorporating a specific weighting on various operating initiatives as set
by the CEO and COO.
Page 79
V. Plan Structure
All payouts will be determined from the schedules of percentage change in
EPS (Section VI.B.). Participants will be notified in writing at the
beginning of the plan year.
- ------------ ------- -------- ----------------- ----------------------------------
A B C D
- ------------ ------- -------- ----------------- ----------------------------------
- ------------ ------- -------- ----------------- ----------------------------------
Target %: 45% 40% 30% 25%
- ------------ ------- -------- ----------------- ----------------------------------
- ------------ ------- -------- ----------------- ----------------------------------
Participants: FMC FMC EVP o Executive o Non-Bank
CEO Officers Presidents
o Bank o Regional
CEO Presidents
- ------------ ------- -------- --------------------- -----------------------------------
- ------------ ------- -------- -------- ------- -------- ------- --------
Incentive Operating Operating Non-bank Bank FMIS: FMTC: Bank
Components: EPS at EPS at participants participants Change in Change in Participants:
100% 100% Change in Balanced EPS at FMTC at Balanced
(calculated (calculated EPS at 70% Scorecards 70%; 75%; Change Scorecard
on GAAP on GAAP Personal Personal in EPS at
basis) basis) Objectives Objectives 15%;
at 30% at 30% Personal
Objectives
at 10%
- ------------ ----------- -------- -------- -------- -------- ------- --------
- ------------ ------------------------------------- -------------------------- --------
E F G
- ------------ ------------------------------------- -------------------------- --------
- ------------ ------------------------------------- -------------------------- --------
Target %: 15% - 20% 10%- 15% 5 bps
- ------------ ------------------------------------- -------------------------- --------
- ------------ ------------------------------------- -------------------------- --------
Participants: o Department Mortgage
Senior Management/ Heads Sales
Leadership o Division Heads Managers
o Other Management
Leadership
- ------------ ------------------------------------- -------------------------- --------
- ------------ -------- --------- -------- -------- -------- -------- --------
Incentive Bank FMIS: FMTC: FMIS: Bank FMTC: 5 bps
Components: Participants: Change in EPS Change in Change in EPS Participants: Change in of
Balanced at 70%; FMTC at at 70%; Balanced FMTC at subordinate
Scorecard Personal 75%; Change Personal Scorecard 75%; Change mortgage
Objectives Change in Objectives Change in volume
at 30% EPS at 15%; at 30% EPS at 15%;
Personal Personal
Objectives Objectives
at 10% at 10%
- ------------ -------- --------- -------- -------- -------- -------- --------
Page 80
VI. Supporting Parameters
A. Where individual components are applicable, they must be measurable with
both beginning points and standard targets cited.
B. Schedule Determining EPS on a diluted GAAP basis and Operating Earnings
Payouts for Year 2008
% Change* Payout %
<3% 0%
3% 30%
4% 40%
5% 50%
6% 60%
7% 70%
8% 80%
9% 90%
Target 10% 100%
12% 120%
14% 140%
16% 160%
18% 180%
20% 200%
* Operating earnings adds back charges for amortization of goodwill and other
non-operating expenses and excludes unplanned extraordinary income or expenses,
all as determined by the Committee
C. Schedule Determining Operating Earnings Payouts for Year 2008 for FMTC and
FMIS
Operating Earnings % Change* Payout %
<10% 0%
10% 40%
12.5% 50%
15% 60%
17.5% 70%
20% 80%
22.5% 90%
Target 25% 100%
27.5% 110%
30% 120%
32.5% 130%
35.0% 140%
37.5% 150%
40% 160%
42.5% 170%
45% 180%
47.5% 190%
=>50% 200%
* Operating earnings adds back charges for amortization of goodwill and other
non-operating expenses and excludes unplanned extraordinary income or expenses,
all as determined by the Committee. Operating earnings will also be normalized
for subsidiary acquisitions.
Page 81
D. Schedule of Participants (referenced in Section III)
Section Company Target Name Job Title
A. FMC 45% Michael Rechin Chief Executive Officer
B. FMC 40% Mark Hardwick Chief Financial Officer
FMC Michael Stewart Chief Banking Officer
C LBTC 30% Tony Albrecht Bank President & CEO
FMBCI Michael Baker Bank President & CEO
FMC Jeff Lorentson Senior Vice President
FMC Robert Connors Senior Vice President
FMC Kimberly Ellington Senior Vice President
FMB James Meinerding Bank President & CEO
CNB Tom McAuliffe Bank President & CEO
FMC David Spade Senior Vice President
FMC Jami Bradshaw Senior Vice President
D. Decatur Region 25% Steven Bailey Regional President
Portland Region Robert Bell Regional President
Muncie Region Jack Demaree Regional President
FMC Karen Evens Vice President
Wabash Region Ron Kerby Regional President
FMTC Terri Matchett Trust President & CEO
FMIS Curt Stephenson FMIS President & CEO
FMB Scott McKee Regional President
FMB Bill Redman Market Executive
E. FMBCI 20% Stephen Bill Senior Vice President
FMTC Terry Blaker Senior Vice President
LBTC Todd Burklow Executive Vice President
FMTC David Forbes Senior Vice President
LBTC Dan Gick Executive Vice President
Wabash Region John Gouveia Senior Vice President
Portland Region Chuck Huffman Senior Vice President
LBTC Sherry Keith Senior Vice President
FMBCI Kirk Klabunde Senior Vice President
Wabash Region Tony Millspaugh Senior Vice President
Muncie Region Chris Parker Senior Vice President
Portland Region Duane Sautbine Senior Vice President
Richmond Region Rick Tudor Senior Vice President
CNB Jennifer Griffith Senior Vice President
CNB Catherine Dieckman Senior Vice President
LBT David Flint Senior Vice President
CNB Pamela Miller Senior Vice President
FMC Michael Sipos First Vice President
CNB Paul Carlin Regional President
FMIS Michael Gilbert Senior Vice President
FMB Jennifer Phillips Vice President
Wabash Region 15% Duane Davis Vice President
FMC Stephan Fluhler First Vice President
FMC Philip Fortner Vice President
LBT David Flint Vice President
FMC Jeff Davis First Vice President
FMC David Ortega Vice President
FMC John Martin First Vice President
FMC Julie Crabtree Vice President
FMC Brad Wise First Vice President
F. FMTC 15% Pam Haager Vice President
FMTC Nichole Kinghorn Vice President
FMC Gretchen Patterson Vice President
Indy Region Cindy White Vice President
FMTC Jane Smith Vice President
FMTC 10% Larry Anthrop Senior Vice President
FMTC Neal Barnum Vice President
FMTC Jim Keene Vice President
CNB Mike Higbee Vice President
Decatur Region Dennis Bieberich Senior Executive
CNB Amy Mollenkopf Vice President
FMC Rick Bantz Assistant Vice President
FMC Diane Bolser Vice President
CNB Jessica Homan Vice President
CNB Joseph Sauline Vice President
CNB Christina Kessler Vice President
CNB Andrew Reardon Vice President
CNB David Benjamin Assistant Vice President
G. LBT 5 bps Janell Commons Vice President
FMB Jim Sprouse Vice President
Page 82
EXHIBIT-10j
RESOLUTIONS OF THE BOARD OF DIRECTORS
OF FIRST MERCHANTS CORPORATION
WHEREAS, the responsibilities of the Compensation and Human Resources
Committee ("Committee") of the Corporation include, amongst others: (a)
overseeing the development and implementation of compensation policies and
programs to carry out the compensation philosophy, (b) administering the
Corporation's incentive compensation plans, equity-based compensation plans, and
deferred compensation plans, (c) making recommendations to the Board of
Directors ("Board") with respect to the adoption, amendment, or termination of
incentive compensation plans, equity-based compensation plans, and deferred
compensation plans, and (d) reviewing and making recommendations to the Board
regarding the compensation of non-employee directors, and
WHEREAS, the Committee engaged in a thorough review of the amount and
composition of director compensation, and
WHEREAS, the Committee determined that part of director compensation should
be in the form of equity and guidelines should be adopted to encourage directors
to acquire and hold material amounts of the Corporation's stock, while serving
on the Board, and
WHEREAS, Indiana law empowers the Board to set director compensation, but
to the extent such compensation includes equity in addition to the annual stock
option grants to non-employee directors previously authorized by the
Corporation's shareholders under the Corporation's 1999 Long Term Equity
Incentive Plan, the NASDAQ Marketplace Rules require shareholder approval, and
WHEREAS, the Committee recommended a modified non-employee director
compensation program to be adopted beginning in 2008 to the Board at its October
23, 2007 regular meeting for consideration and possible adoption at the December
3-4, 2007 Board meetings, and
WHEREAS, the components of the proposal are as follows:
1. Directors would not receive meeting fees.
2. Directors' annual retainers would be increased to $40,000,
commencing January 1, 2008, payable in quarterly installments in
cash for the first quarter of 2008 and, for subsequent quarters
(if approved by the shareholders at the 2008 annual meeting), at
least one-half in restricted shares of the Corporation's stock
vesting three years after issuance or upon a director's
retirement, if sooner.
3. The Audit Committee Chair would receive an additional $10,000 and
the other committee chairs an additional $5,000 annually, also
divided between cash and restricted stock as described above.
4. The Board Chair's annual retainer would be increased to $75,000,
with no additional compensation for chairing committees, also
divided between cash and restricted stock as described above.
5. A guideline would be adopted under which directors would be
expected to acquire and hold stock in the Corporation equal to at
least three times their total annual director compensation, such
guideline to be met as soon as reasonably possible (taking into
account the director's relevant financial and other
circumstances) but in no event more than six years after the
director is first elected to the Board.
6. During 2008, the Compensation and Human Resources Committee would
review the current program providing that directors will receive
annual stock option grants (the program expires following the
July 1, 2008 awards) and make a recommendation to the Board
whether to continue the program in the future (subject to
shareholder approval).
NOW, THEREFORE, BE IT RESOLVED, that the Board of Directors determines that
it is in the best interest of the Corporation to adopt the Committee's
recommended modified non-employee director compensation program as set forth
above, and hereby approves said program, and
BE IT FURTHER RESOLVED that the Board authorizes the executive officers of
management to take such actions as are necessary to present said program with
the Board's recommendation for approval by the shareholders at the Corporation's
annual meeting to be held April 29, 2008.
December 4, 2007.
Page 83
EXHIBIT-21
SUBSIDIARIES OF THE REGISTRANT
EXHIBIT 21--SUBSIDIARIES OF THE REGISTRANT
- --------------------------------------------------------------------------------
State of
Name Incorporation
- ---- -------------
First Merchants Bank, National Association..................U.S.
First Merchants Bank of Central Indiana,
National Association........................................U.S.
Lafayette Bank and Trust Company, National Association......U.S.
Commerce National Bank......................................U.S.
First Merchants Capital Trust II........................Delaware
First Merchants Insurance Services, Inc..................Indiana
First Merchants Reinsurance Co. Ltd.....................Providencials Turkes and
Caicos, Island
Indiana Title Insurance Company..........................Indiana
Indiana Title Insurance Company, LLC.....................Indiana
FMB Portfolio Management, Inc...........................Delaware
Wabash Valley Investments, Inc............................Nevada
Wabash Valley, LLC........................................Nevada
Wabash Valley Holdings, Inc...............................Nevada
First Merchants Trust Company, National Association.........U.S.
CNBC Statutory Trust I...............................Connecticut
Page 84
EXHIBIT-23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
EXHIBIT 23 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the registration statement on
Form S-8 (File Nos. 033-54065, 333-116074, 333-50484, 333-80119 and 333-80117)
of First Merchants Corporation (the "Corporation") of our reports dated February
8, 2008 on the consolidated financial statements of the Corporation as of
December 31, 2007 and 2006, and for each of the three years in the period ended
December 31, 2007, and on our audit of internal control over financial reporting
of the Corporation as of December 31, 2007, which reports are included in this
Annual Report on Form 10-K.
/s/ BKD, LLP
Indianapolis, Indiana
March 14, 2008
Page 85
EXHIBIT-24
LIMITED POWER OF ATTORNEY
EXHIBIT 24--LIMITED POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that the undersigned directors and officers of
First Merchants Corporation, an Indiana corporation, hereby constitute and
appoint Mark K. Hardwick, the true and lawful agent and attorney-in-fact of the
undersigned with full power and authority in said agent and attorney-in-fact to
sign for the undersigned and in their respective names as directors and officers
of the Corporation the Form 10-K of the Corporation to be filed with the
Securities and Exchange Commission, Washington, D.C., under the Securities
Exchange Act of 1934, as amended, and to sign any amendment to such Form 10-K,
hereby ratifying and confirming all acts taken by such agent and
attorney-in-fact, as herein authorized.
Dated: January 29, 2008
/s/ Michael C. Rechin /s/ Richard A. Boehning
- -------------------------------------- ------------------------------------
Michael C. Rechin President and Richard A. Boehning Director
Chief Executive
Officer (Principal
Executive Officer)
/s/ Mark K. Hardwick /s/ Thomas B. Clark
- -------------------------------------- ------------------------------------
Mark K. Hardwick Executive Vice Thomas B. Clark Director
President and Chief
Financial Officer
(Principal Financial
Officer)
/s/ Michael L. Cox
------------------------------------
Michael L. Cox Director
/s/ Roderick English
------------------------------------
Roderick English Director
/s/ Dr. Jo Ann M. Gora
------------------------------------
Dr. Jo Ann M. Gora Director
/s/ William L. Hoy
-------------------------------------
William L. Hoy Director
/s/
------------------------------------
Barry J. Hudson Director
/s/ Michael C. Rechin
------------------------------------
Michael C. Rechin Director
/s/ Charles E. Schalliol
------------------------------------
Charles E. Schalliol Director
/s/ Terry L. Walker
------------------------------------
Terry L. Walker Director
/s/ Jean L. Wojtowicz
------------------------------------
Jean L. Wojtowicz Director
Page 86
EXHIBIT-31.1
FIRST MERCHANTS CORPORATION
FORM 10-K
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
- -------------
I, Michael C. Rechin, President and Chief Executive Officer of First Merchants
Corporation, certify that:
1. I have reviewed this Annual Report on Form 10-K of First Merchants
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in the Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report, based on such evaluation;
and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board or directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 17, 2008 /s/ Michael C. Rechin
----------------------------------------
Michael C. Rechin
President and Chief Executive Officer
(Principal Executive Officer)
Page 87
EXHIBIT-31.2
FIRST MERCHANTS CORPORATION
FORM 10-K
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
- -------------
I, Mark K. Hardwick, Executive Vice President and Chief Financial Officer of
First Merchants Corporation, certify that:
1. I have reviewed this Annual Report on Form 10-K of First Merchants
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in the Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report, based on such evaluation;
and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board or directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 17, 2008 /s/ Mark K. Hardwick
----------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Page 88
EXHIBIT-32
CERTIFICATIONS PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the annual report of First Merchants Corporation (the
"Corporation") on Form 10-K for the period ending December 31, 2007 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"), I
Michael C. Rechin, President and Chief Executive Officer of the Corporation, do
hereby certify, in accordance with 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)); and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Corporation.
Date March 17, 2008 by /s/ Michael C. Rechin
------------------------- -------------------------------------
Michael C. Rechin
President and Chief Executive Officer
(Principal Executive Officer)
A signed copy of this written statement required by Section 906 has been
provided to First Merchants Corporation and will be retained by First Merchants
Corporation and furnished to the Securities and Exchange Commission or its staff
upon request.
In connection with the annual report of First Merchants Corporation (the
"Corporation") on Form 10-K for the period ending December 31, 2007 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"), I
Mark K. Hardwick, Executive Vice President and Chief Financial Officer of the
Corporation, do hereby certify, in accordance with 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)); and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Corporation.
Date March 17, 2008 by /s/ Mark K. Hardwick
------------------------- -------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
A signed copy of this written statement required by Section 906 has been
provided to First Merchants Corporation and will be retained by First Merchants
Corporation and furnished to the Securities and Exchange Commission or its staff
upon request.
Page 89
EXHIBIT-99.1
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT
FOR FIRST MERCHANTS CORPORATION EMPLOYEE STOCK PURCHASE PLAN
EXHIBIT 99.1--FINANCIAL STATEMENTS AND INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM'S REPORT FOR FIRST MERCHANTS CORPORATION EMPLOYEE STOCK
PURCHASE PLAN
- --------------------------------------------------------------------------------
The annual financial statements and independent registered public accounting
firm's report thereon for First Merchants Corporation Employee Stock Purchase
Plan for the year ending December 31, 2007, will be filed as an amendment to the
2007 Annual Report on Form 10-K.
Page 90
