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, 2008
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. [ ]
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 $330,723,000 as of the last
business day of the registrant's most recently completed second fiscal quarter
(June 30, 2008).
As of February 27, 2009 there were 21,178,488 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 Part III (Items 10 through 14)
Definitive Proxy Statement for
Annual Meeting of Shareholders to
be held May 6, 2009
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 23
Item 1B. Unresolved Staff Comments 27
Item 2. Properties 28
Item 3. Legal Proceedings 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Supplemental Information - Executive Officers of the Registrant 29
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 30
Item 6. Selected Financial Data 32
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 33
Item 7A. Quantitative and Qualitative Disclosure about Market Risk 44
Item 8. Financial Statements and Supplementary Data 45
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 82
Item 9A. Controls and Procedures 82
Item 9B. Other Information 83
PART III
Item 10. Directors, Executive Officers and Corporate Governance 84
Item 11. Executive Compensation 84
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 84
Item 13. Certain Relationships and Related Transactions 84
Item 14. Principal Accountant Fees and Services 84
PART IV
Item 15. Exhibits and Financial Statement Schedules 85
2
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
==================================================================================================================================
(Dollars in Thousands, except share data) 2008 2007 2006 2005 2004
==================================================================================================================================
Operations
Net Interest Income
Fully Taxable Equivalent (FTE) Basis .............. $ 133,083 $ 117,247 $ 114,076 $ 114,907 $ 108,986
Less Tax Equivalent Adjustment ......................... 3,699 4,127 3,981 3,778 3,597
---------- ---------- ---------- ---------- ----------
Net Interest Income .................................... 129,384 113,120 110,095 111,129 105,389
Provision for Loan Losses .............................. 28,238 8,507 6,258 8,354 5,705
---------- ---------- ---------- ---------- ----------
Net Interest Income
After Provision for Loan Losses ................... 101,146 104,613 103,837 102,775 99,684
Total Other Income ..................................... 36,367 40,551 34,613 34,717 34,554
Total Other Expenses ................................... 108,792 102,182 93,057 93,957 91,642
---------- ---------- ---------- ---------- ----------
Income Before Income Tax Expense .................. 28,721 42,982 42,393 43,535 42,596
Income Tax Expense ..................................... 8,083 11,343 12,195 13,296 13,185
---------- ---------- ---------- ---------- ----------
Net Income ............................................. $ 20,638 $ 31,639 $ 30,198 $ 30,239 $ 29,411
========== ========== ========== ========== ==========
Per Share Data (1)
Basic Net Income ....................................... $ 1.14 $ 1.73 $ 1.64 $ 1.64 $ 1.59
Diluted Net Income ..................................... 1.14 1.73 1.64 1.63 1.58
Cash Dividends Paid .................................... .92 .92 .92 .92 .92
December 31 Book Value ................................. 18.69 18.88 17.75 17.02 16.93
December 31 Market Value (Bid Price) ................... 22.21 27.84 27.19 26.00 28.30
Average Balances (2)
Total Assets ........................................... $3,811,166 $3,639,772 $3,371,386 $3,179,464 $3,109,104
Total Loans (3) ........................................ 3,002,628 2,794,824 2,569,847 2,434,134 2,369,017
Total Deposits ......................................... 2,902,902 2,752,443 2,568,070 2,418,752 2,365,306
Securities Sold Under Repurchase Agreements
(long-term portion) ............................... 34,250 23,813 181
Total Federal Home Loan Bank Advances .................. 237,791 259,463 234,629 227,311 225,375
Total Subordinated Debentures, Revolving
Credit Lines and Term Loans ...................... 107,752 104,680 99,456 106,811 96,230
Total Stockholders' Equity ............................. 349,594 330,786 319,519 315,525 310,004
Year-end Balances (2)
Total Assets ........................................... $4,784,155 $3,782,087 $3,554,870 $3,237,079 $3,191,668
Total Loans (3) ........................................ 3,726,247 2,880,578 2,698,014 2,462,337 2,431,418
Total Deposits ......................................... 3,718,811 2,884,121 2,750,538 2,382,576 2,408,150
Securities Sold Under Repurchase Agreements
(long-term portion) .............................. 34,250 34,250 320
Total Federal Home Loan Bank Advances .................. 360,217 294,101 242,408 247,865 223,663
Total Subordinated Debentures, Revolving
Credit Lines and Term Loans ...................... 135,826 115,826 83,956 103,956 97,206
Total Stockholders' Equity ............................. 395,903 339,936 327,325 313,396 314,603
Financial Ratios
Return on Average Assets ............................... .54% .87% .90% .95% .95%
Return on Average Stockholders' Equity ................. 5.90 9.56 9.45 9.58 9.49
Average Earning Assets to Total Assets (2) ............. 72.39 90.15 91.15 90.93 90.28
Allowance for Loan Losses as % of Total Loans .......... 1.33 .98 .99 1.02 .93
Dividend Payout Ratio .................................. 80.70 53.18 56.10 56.44 58.23
Average Stockholders' Equity to Average Assets ......... 9.17 9.09 9.48 9.92 9.97
Tax Equivalent Yield on Earning Assets .............. 6.44 7.10 6.92 6.26 5.72
Cost of Supporting Liabilities ......................... 2.60 3.55 3.21 2.29 1.84
Net Interest Margin on Earning Assets .................. 3.84 3.55 3.71 3.97 3.88
(1) Restated for all stock dividends and stock splits.
(2) On December 31, 2008, the corporation acquired 100 percent of the
outstanding stock of Lincoln Bancorp, the holding company of Lincoln Bank,
which is located in Plainfield, Indiana. Lincoln Bank is a state chartered
bank with branches in central Indiana. Lincoln Bancorp was merged into the
Corporation and Lincoln Bank maintained its bank charter as a subsidiary of
the Corporation. The Corporation issued approximately 3,040,415 shares of
its common stock at a cost of $19.78 per share and approximately $16.8
million in cash to complete the transaction. As a result of the
acquisition, the Corporation has an opportunity to increase its customer
base and continue to increase its market share. The purchase had a recorded
acquisition price of $77,290,000, including investments of $122,093,000;
loans of $628,277,000, premises and equipment of $15,624,000; other assets
of $86,091,000; deposits of $655,370,000; other liabilities of $136,280,000
and goodwill of $19,813,000. Additionally, core deposit intangibles
totaling $12,461,000 were recognized and will be amortized over ten years.
The combination was accounted for under the purchase method of accounting.
All assets and liabilities were recorded at their fair values as of
December 31, 2008. The purchase accounting adjustments are being amortized
over the life of the respective asset or liability.
(3) Includes loans held for sale.
3
FORWARD-LOOKING STATEMENTS
First Merchants Corporation (the "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 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.
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 Global Select Market System under the symbol FRME and was organized in
September 1982. Since its organization, the Corporation has grown to include
five affiliate banks with eighty-two locations in twenty-four 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;
o Commerce National Bank ("Commerce") in Franklin and Hamilton counties
in Ohio; and
o Lincoln Bank ("Lincoln") in Brown, Clinton, Hamilton, Hendricks,
Johnson, Montgomery and Morgan counties.
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.
In addition, the Corporation operates First Merchants Reinsurance Co. Ltd.
("FMRC"), a small life reinsurance company whose primary business includes
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. FMRC 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 company also issues guaranteed asset protection
contracts, which are limited to the amount of the loan on these guaranteed asset
protection contracts and are issued on loans up to a maximum of $50,000. The
total self-insurance exposure for all contracts as of December 31, 2008 totaled
$19.1 million.
All inter-company transactions are eliminated during the preparation of
consolidated financial statements.
On December 31, 2008, the Corporation acquired Lincoln Bancorp, parent company
of Lincoln Bank, through a merger of Lincoln Bancorp into the Corporation.
Lincoln Bank adds seventeen Indiana banking locations in the Indianapolis area.
The banking locations are in Avon, Bargersville, Brownsburg, Crawfordsville,
Frankfort, Franklin, Greenwood, Mooresville, Morgantown, Nashville, Plainfield
and Trafalgar. Lincoln also has two loan production offices located in Carmel
and Greenwood, Indiana.
On December 31, 2008, the Corporation sold its interest in Indiana Title
Insurance Company, LLC, a full service title insurance agency.
As of December 31, 2008, the Corporation had consolidated assets of $4.8
billion, consolidated deposits of $3.7 billion and stockholders' equity of $396
million. The Corporation is presently engaged in conducting commercial banking
business through the offices of its five banking subsidiaries. As of December
31, 2008, the Corporation and its subsidiaries had 1,367 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 the
reinsurance of credit life, accident, and health insurance.
5
PART I: ITEM 1. BUSINESS
GENERAL continued
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.
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. Cynthia 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 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 percent 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.
6
PART I: ITEM 1. BUSINESS
CAPITAL ADEQUACY GUIDELINES FOR BANK HOLDING COMPANIES
The BHC Act does not place territorial restrictions on such non-banking related
activities. 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 percent (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.
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 percent 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 percent above the stated minimum.
The following are the Corporation's regulatory capital ratios as of December 31,
2008:
=============================================================================
Regulatory Minimum
Corporation Requirement
=============================================================================
Tier 1 Capital: 7.71% 4.0%
(to Risk-weighted Assets)
Total Capital: 10.24% 8.0%
BANK REGULATION
Four 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.
Lincoln is an Indiana commercial bank, subject to examination by the Indiana
Department of Financial Institutions ("IDFI") and the Federal Deposit Insurance
Corporation ("FDIC"). The IDFI and the FDIC regulate or monitor virtually all
areas of Lincoln's operations. Lincoln must undergo regular on-site examinations
by the FDIC and IDFI and must submit periodic reports to the FDIC and the IDFI.
The Corporation plans to merge Lincoln with Central Indiana under the Central
Indiana charter and has applied to the OCC for approval of the merger.
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 percent. 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
percent 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
percent plus an additional 1 to 2 percent.
All of the Corporation's affiliate banks exceed the minimum risk-based capital
guidelines of the OCC as of December 31, 2008.
7
PART I: ITEM 1. BUSINESS
FDIC IMPROVEMENT ACT OF 1991
The 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 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, 2008, four of the five bank subsidiaries of the Corporation
were "well capitalized" based on the "prompt corrective action" ratios and
deadlines described above. Lincoln was not considered well capitalized at
December 31, 2008. However, on February 20, 2009, the Corporation added $30
million in capital to Lincoln, which returned them to well capitalized status.
It should be noted 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.
PARTICPATION IN THE CPP UNDER EESA
In response to the ongoing financial crisis affecting the banking system and
financial markets, the Emergency Economic Stabilization Act of 2008 ("EESA") was
signed into law on October 3, 2008, which established the Troubled Assets Relief
Program ("TARP"). As part of TARP, the United States Department of the Treasury
(the "Treasury") established the Capital Purchase Program ("CPP") to provide up
to $700 billion of funding to eligible financial institutions through the
purchase of mortgages, mortgage-backed securities, capital stock and other
financial instruments for the purpose of stabilizing and providing liquidity to
the U.S. financial markets.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009
("ARRA") was signed into law by President Obama. ARRA includes a wide variety of
programs intended to stimulate the economy and provide for extensive
infrastructure, energy, health, and education needs. In addition, ARRA imposes
certain new executive compensation and corporate expenditure limits on all
current and future TARP recipients, including the Corporation, until the
institution has repaid the Treasury, which is now permitted under ARRA without
penalty and without the need to raise new capital, subject to the Treasury's
consultation with the recipient's appropriate regulatory agency.
On February 20, 2009, First Merchants completed the sale to the Treasury of
$116.0 million of newly issued First Merchants non-voting preferred shares as
part of the CPP enacted as part of the TARP, under the ESSA. The Treasury has
certain supervisory and oversight duties and responsibilities under EESA and the
CPP and, pursuant to the terms of a Letter Agreement and a Securities Purchase
Agreement - Standard Terms attached thereto (collectively, the "Securities
Purchase Agreement"), the Treasury is empowered to unilaterally amend any
provision of the Securities Purchase Agreement with First Merchants to the
extent required to comply with any changes in applicable federal statutes.
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.
8
PART I: ITEM 1. BUSINESS
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, 2008, the
Corporation's affiliate banks had a total of $42,856,000 retained net profits
available for 2009 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 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
9
PART I: ITEM 1. BUSINESS
USA PATRIOT ACT continued
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;
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. It also 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
10
PART I: ITEM 1. BUSINESS
ADDITIONAL MATTERS Continued
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.
11
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
=================================================================================================================================
2008 2007 2006
---- ---- ----
Assets:
Federal Funds Sold ............ $ 2,604 $ 28 1.1% $ 3,308 $ 172 5.2% $ 6,983 $ 373 5.3%
Interest-bearing Deposits...... 22,576 755 3.3 10,580 582 5.5 7,831 500 6.4
Federal Reserve and
Federal Home Loan Bank Stock. 25,425 1,391 5.5 24,221 1,299 5.4 23,473 1,256 5.4
Securities: (1)
Taxable ....................... 259,013 12,046 4.7 300,854 13,744 4.6 289,692 12,316 4.3
Tax-exempt (2) ................ 151,231 9,009 6.0 175,152 10,074 5.8 175,072 10,100 5.8
---------- -------- ---------- -------- ---------- --------
Total Securities............. 410,244 21,055 5.1 476,006 23,818 5.0 464,764 22,416 4.8
Mortgage Loans Held for Sale..... 3,614 268 7.4 6,107 549 9.0 4,620 176 3.8
Loans: (3)
Commercial .................... 2,248,255 149,988 6.7 1,955,750 151,158 7.7 1,704,026 128,888 7.6
Real Estate Mortgage........... 355,540 22,357 6.3 412,008 26,288 6.4 441,407 27,813 6.3
Installment ................... 371,813 25,771 6.9 400,191 29,276 7.3 405,006 29,891 7.4
Tax-exempt (2) ................ 23,406 1,558 6.7 20,768 1,718 8.3 14,788 1,274 8.6
---------- -------- ---------- -------- ---------- --------
Total Loans ................. 3,002,628 199,942 6.7 2,794,824 208,989 7.5 2,569,847 188,042 7.3
---------- -------- ---------- -------- ---------- --------
Total Earning Assets......... 3,463,477 223,172 6.4 3,308,939 234,860 7.1 3,072,898 212,587 6.9
---------- -------- ---------- -------- ---------- --------
Net Unrealized Gain (Loss) on Securities
Available for Sale........... 1,383 (3,624) (7,353)
Allowance for Loan Losses........ (32,383) (27,495) (26,443)
Cash and Due from Banks.......... 75,553 64,571 58,305
Premises and Equipment .......... 44,601 43,945 40,227
Other Assets .................... 258,535 253,436 233,752
--------- --------- ---------
Total Assets ................ $3,811,166 $3,639,772 $3,371,386
========== ========== ==========
Liabilities:
Interest-bearing Deposits:
NOW Accounts ................ $ 527,993 5,526 1.0% $ 490,908 11,034 2.2% $ 396,477 $ 6,065 1.5%
Money Market Deposit Accounts 276,579 3,954 1.4 246,706 7,648 3.1 251,746 7,551 3.0
Savings Deposits ............ 274,320 2,075 0.8 264,134 4,604 1.7 259,052 3,927 1.5
Certificates and Other
Time Deposits ............. 1,445,843 56,026 3.9 1,407,151 66,635 4.7 1,333,408 56,771 4.3
---------- -------- ---------- -------- ---------- --------
Total Interest-bearing
Deposits..................... 2,524,735 67,581 2.7 2,408,899 89,921 3.7 2,240,683 74,314 3.3
Borrowings ...................... 528,397 22,508 4.3 515,562 27,692 5.4 445,806 24,197 5.4
---------- -------- ---------- -------- ---------- --------
Total Interest-bearing
Liabilities................. 3,053,132 90,089 3.0 2,924,461 117,613 4.0 2,686,489 98,511 3.7
Noninterest-bearing Deposits..... 378,167 343,544 327,387
Other Liabilities ............... 30,273 40,981 37,991
---------- ---------- ----------
Total Liabilities............ 3,461,572 3,308,986 3,051,867
Stockholders' Equity ............ 349,594 330,786 319,519
---------- -------- ---------- ------- ---------- --------
Total Liabilities and
Stockholders' Equity........ $3,811,166 90,089 2.6 $3,639,772 117,613 3.6 $3,371,386 98,511 3.2
========== -------- ========== -------- ========== --------
Net Interest Income ......... $133,083 $117,247 $114,076
======== ======== ========
Net Interest Margin.......... 3.8% 3.5% 3.7%
(1) Average balance of securities is computed based on the average of the
historical amortized cost balances without the effects of the fair value
adjustment.
(2) Tax-exempt securities and loans are presented on a fully taxable equivalent
basis, using a marginal tax rate of 35% for 2008, 2007 and 2006. Those
totals equal $3,699, $4,127, and $3,981, respectively.
(3) Nonaccruing loans have been included in the average balances.
12
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 2008 Compared to 2007 2007 Compared to 2006
Taxable Equivalent Basis) Increase (Decrease) Due To Increase (Decrease) Due To
===============================================================================================================================
Volume Rate Total Volume Rate Total
======== ======== ======= ======== ======== =======
Interest Income:
Federal Funds Sold ............... $ (30) $ (114) $ (144) $ (298) $ 97 $ (201)
Interest-bearing Deposits ........ 468 (295) 173 200 (118) 82
Federal Reserve and Federal
Home Loan Bank Stock ........... 65 27 92 40 3 43
Securities ....................... (3,362) 599 (2,763) 550 852 1,402
Mortgage Loans Held for Sale ..... (197) (84) (281) 71 302 373
Loans ............................ 15,017 (23,782) (8,765) 16,640 3,934 20,574
------- -------- -------- ------- -------- --------
Totals ........................... 11,961 (23,649) (11,688) 17,203 5,070 22,273
------- -------- -------- ------- -------- --------
Interest Expense:
NOW Accounts ..................... 778 (6,286) (5,508) 1,673 3,296 4,969
Money Market Deposit
Accounts........................ 835 (4,529) (3,694) (153) 250 97
Savings Deposits.................. 171 (2,700) (2,529) 78 599 677
Certificates and Other
Time Deposits................... 1,788 (12,397) (10,609) 3,256 6,608 9,864
Borrowings........................ 674 (5,858) (5,184) 3,749 (254) 3,495
------- --------- -------- ------- -------- --------
Totals.......................... 4,246 (31,770) (27,524) 8,603 10,499 19,102
------- --------- -------- ------- -------- --------
Change in Net Interest
Income (Fully Taxable
Equivalent Basis)................ $ 7,715 $ 8,121 $ 15,836 $ 8,600 $ (5,429) $ 3,171
======= ======== ======= ========
Tax Equivalent Adjustment
Using Marginal Rate
of 35% for 2008, 2007,
and 2006.......................... 428 (146)
--------- ---------
Change in Net Interest
Income........................... $ 16,264 $ 3,025
========= =========
INVESTMENT SECURITIES
The Corporation's management has evaluated all securities with unrealized losses
for other than temporary impairment as of December 31, 2008. The evaluations are
based on the nature of the securities, the extent and duration of the loss and
the intent and ability of the Corporation to hold these securities either to
maturity or through the expected recovery period.
The current unrealized losses are primarily concentrated within trust preferred
securities held by the Corporation. The Corporation holds ten trust preferred
pool securities and four single issuer securities. Such investments have an
amortized cost of $18.8 million and a fair value of $9.8, which is only 2
percent of the Corporation's entire investment portfolio. On all but one small
pool investment, the Corporation utilized broker quotes to determine their fair
value.
The Corporation utilizes a third party for portfolio accounting services,
including market value input. The Corporation has obtained an understanding of
what inputs are being used by the vendor in pricing our portfolio and how the
vendor was classifying these securities based upon these inputs. From these
discussions, the Corporation's management is comfortable the classifications are
proper. The Corporation has gained trust in the data for two reasons: (a)
independent spot testing of the data is conducted by the Corporation through
obtaining market quotes from various brokers on a periodic basis and (b) actual
gains or loss resulting from the sale of certain securities has proven the data
to be accurate over time.
13
PART I: ITEM 1. BUSINESS
INVESTMENT SECURITIES continued
The fair values of the investments have been impacted by the recent market
conditions which have caused risk and liquidity premiums to increase resulting
in a significant decline in the fair value of the Corporation's trust preferred
securities, or the value the Corporation could realize if it were forced to
immediately sell the securities into the secondary market. Management has
determined that (a) the drop in market value is primarily a result of
illiquidity in the current market rather than poor performance, and (b) there
has not been an adverse change in future cash flows of the securities.
The Corporation has the intent and ability to hold these, and all other,
investment securities until the fair value is recovered, which may be maturity,
and therefore, does not consider them, with one exception, to be
other-than-temporarily impaired at December 31, 2008. The one exception is a
smaller trust preferred pool that has been deemed other than temporarily
impaired, due to a higher rate of defaults and deferrals from the underlying
banks in the pool and collateral position. A $1.2 million loss was included in
the earnings for 2008 establishing a new cost basis of $770,000.
During 2008, the Corporation owned shares of a series of preferred stock issued
by the Federal Home Loan Mortgage Corporation ("FHLMC"). On September 7, 2008,
the Federal Housing Finance Agency ("FHFA") was appointed as conservator of
FHLMC, and the U.S. Treasury Department disclosed that it had entered into a
Senior Preferred Stock Purchase Agreement with FHLMC, contemplating an
investment of up to $100 billion. The senior preferred stock has a liquidation
preference senior to all FHLMC stock, including the series of preferred stock
held by the Corporation. In addition, the terms of the senior preferred stock
prohibit FHLMC from declaring or paying any dividend or making any other
distribution with respect to any stock other than the senior preferred stock
without the consent of the U.S. Treasury Department. In connection with the
appointment of the FHFA as conservator, the FHFA announced that it was
eliminating the payment of all future dividends on all FHLMC stock, including
dividends on the series of preferred stock that the Corporation owns. After
assessing these events, during the third quarter of 2008, the
Corporation recorded an other-than-temporary impairment write-down of $1,458,000
related to its investments in the preferred securities issued by FHLMC. The
investment was sold during the fourth quarter of 2008 triggering an additional
$47,000 loss.
14
PART I: ITEM 1. BUSINESS
INVESTMENT SECURITIES continued
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, 2008
U.S. Government-sponsored Agency Securities.. $ 15,451 $ 218 $ 15,669
State and Municipal ......................... 156,426 3,220 $ 107 159,539
Mortgage-backed Securities .................. 265,820 4,472 215
270,077
Corporate Obligations........ ............... 19,822 8,978 10,844
Marketable Equity Securities ................ 3,507 3,507
-------- -------- -------- --------
Total Available for Sale ................. 461,026 7,910 9,300 459,636
-------- -------- -------- --------
Held to Maturity at December 31, 2008
U.S. Treasury ............................... 11,675 1 11,674
State and Municipal ......................... 10,666 93 264 10,495
Mortgage-backed Securities .................. 7 7
-------- -------- -------- --------
Total Held to Maturity ................... 22,348 93 265 22,176
-------- -------- -------- --------
Total Investment Securities .............. $483,374 $ 8,003 $ 9,565 $481,812
======== ======== ======== ========
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
======== ======== ======== ========
15
PART I: ITEM 1. BUSINESS
INVESTMENT SECURITIES continued
===============================================================================================================
(Dollars in Thousands) Cost Yield Cost Yield Cost Yield
===============================================================================================================
2008 2007 2006
---- ---- ----
Federal Reserve and Federal Home Loan
Bank Stock at December 31:
Federal Reserve Bank Stock .................... $ 9,276 6.0% $ 9,223 6.0% $ 9,091 6.0%
Federal Home Loan Bank Stock .................. 25,043 4.3 16,027 4.3 14,600 4.3
------- ------- -------
Total ..................................... $34,319 4.7% $25,250 4.9% $23,691 4.9%
======= ======= =======
The fair value of Federal Reserve and Federal Home Loan Bank stock approximates
cost.
There were no issuers included in our investment security portfolio at December
31, 2008, 2007 or 2006 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, 2008 were:
Securities available for sale December 31, 2008:
====================================================================================================================================
Within 1 Year 1-5 Years 5-10 Years
(Dollars in Thousands) Amount Yield(1) Amount Yield(1) Amount Yield(1)
====================================================================================================================================
U.S. Government-sponsored Agency Securities.. $ 8,088 4.8% $ 7,482 3.9% $ 99 4.8%
State and Municipal.......................... 22,858 4.7 67,861 5.7 35,219 6.5
Corporate Obligations ....................... 1,034 5.0
------- -------- -------
Total.................................... $30,946 4.7% $ 76,377 5.5% $35,318 6.5%
======= ======== =======
Marketable Equity
and Mortgage -
Due After Ten Years Backed Securities Total
------------------- ----------------------- -----
Amount Yield(1) Amount Yield(1) Amount Yield(1)
------ ------ ------ ------ ------ ------
U.S. Government-sponsored
Agency Securities................. $ 15,669 4.3%
State and Municipal.................. $ 33,601 7.3% 159,539 6.1
Marketable Equity Securities......... $ 3,507 4.1% 3,507 4.1
Corporate Obligations ............... 9,810 3.3 10,844 3.5
Mortgage-backed Securities........... 253,325 5.5 253,325 5.5
Other Asset Backed Securities........ 16,752 4.0 16,752 4.0
-------- --------- --------
Total............................ $ 43,411 6.4% $ 273,584 5.4% $459,636 5.5%
======== ========= ========
Securities held to maturity at December 31, 2008:
====================================================================================================================================
Within 1 Year 1-5 Years 5-10 Years
(Dollars in Thousands) Amount Yield(1) Amount Yield(1) Amount Yield(1)
====================================================================================================================================
U.S. Treasury........................ $ 11,675 0.0%
State and Municipal.................. 1,456 5.5 $ 435 7.0% $ 3,990 5.9%
-------- --------- ---------
Total............................ $ 13,131 0.6% $ 435 7.0% $ 3,990 5.9%
======== ========= =========
Mortgage-Backed
Due After Ten Years Securities Total
===================== ================= =======
Amount Yield(1) Amount Yield(1) Amount Yield(1)
------ ------ ------- ----- ------- ------
U.S. Treasury........................ $ 11,675 0.0%
State and Municipal.................. $ 4,785 8.1% 10,666 6.9
Other Asset-backed Securities........ $ 7 8.4% 7 8.4
-------- --------- --------
Total............................ $ 4,785 8.1% $ 7 8.4% $ 22,348 3.3%
======== ========= =========
(1) Interest yields on state and municipal securities are presented on a fully
taxable equivalent basis using a 35% tax rate.
16
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,
2008 and 2007:
====================================================================================================================================
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, 2008:
U.S. Treasury........................ $ 11,374 $ (1) $11,374 $ (1)
U.S. Government-sponsored Agency Securities ...............
State and Municipal ....................................... 10,274 (124) $ 3,582 $ (247) 13,856 (371)
Mortgage-backed Securities ................................ 13,315 (47) 11,755 (168) 25,070 (215)
Corporate Obligations ..................................... 7,302 (69) 2,741 (8,909) 10,043 (8,978)
Marketable Equity Securities ..............................
-------- ------ --------- ------- -------- --------
Total Temporarily Impaired Investment Securities ....... $ 42,265 $(241) $18,078 $(9,324) $60,343 $ (9,565)
======== ====== ======== ======= ======== ========
---------------------------------------------------------------------
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, 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)
======== ======= ======== ======= ======== ========
LOAN PORTFOLIO
TYPES OF LOANS
====================================================================================================================================
(Dollars in Thousands) 2008 2007 2006 2005 2004
====================================================================================================================================
Loans at December 31:
Commercial and Industrial Loans.............. $ 904,646 $ 662,701 $ 537,305 $ 461,102 $ 451,227
Agricultural Production
Financing and Other Loans to Farmers....... 135,099 114,324 100,098 95,130 98,902
Real Estate Loans:
Construction............................... 252,487 165,425 169,491 174,783 164,738
Commercial and Farmland.................... 1,202,372 947,234 861,429 734,865 709,163
Residential................................ 956,245 744,627 749,921 751,217 761,163
Individuals' Loans for
Household and Other Personal Expenditures.. 201,632 187,880 223,504 200,139 198,532
Tax-exempt Loans............................. 28,070 16,423 14,423 8,263 8,203
Lease Financing Receivables,
Net of Unearned Income .................... 8,996 8,351 8,010 8,713 11,311
Other Loans.................................. 32,405 29,878 28,420 23,215 24,812
---------- ---------- ---------- ---------- ----------
3,721,952 2,876,843 2,692,601 2,457,427 2,428,501
Allowance for Loan Losses................... (49,543) (28,228) (26,540) (25,188) (22,548)
---------- ---------- ---------- ---------- ----------
Total Loans............................. $3,672,409 $2,848,615 $2,666,061 $2,432,239 $2,405,503
========== ========== ========== ========== ==========
Residential Real Estate Loans Held for Sale at December 31, 2008, 2007, 2006,
2005 and 2004 were $4,295,000, $3,735,000, $5,413,000, $4,910,000, and
$3,367,000, respectively.
17
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, 2008. 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................ $ 465,929 $ 321,246 $ 117,471 $ 904,646
Agricultural Production Financing
and Other Loans to Farmers................... 97,335 32,362 5,402 135,099
Real Estate - Construction..................... 162,326 82,166 7,995 252,487
Real Estate - Commercial and Farmland.......... 372,301 590,368 239,703 1,202,372
Tax-exempt Loans............................... 8,363 11,386 8,321 28,070
Other Loans.................................... 16,125 13,297 2,983 32,405
---------- ---------- --------- ----------
Total.................................... $1,122,379 $1,050,825 $ 381,875 $2,555,079
========== ========== ========= ==========
==========================================
Maturing Maturing
1 - 5 Over
Years 5 Years
==========================================
Loans Maturing After One Year with:
Fixed Rate.............................. $ 385,767 $ 277,585
Variable Rate........................... 665,058 104,290
------------- ------------
Total................................. $ 1,050,825 $ 381,875
============= ============
NONACCRUING, CONTRACTUALLY PAST DUE 90 DAYS OR MORE OTHER THAN NONACCRUING AND
RESTRUCTURED LOANS
====================================================================================================================================
(Dollars in Thousands) 2008 2007 2006 2005 2004
====================================================================================================================================
Non-accrual Loans......................... $ 87,546 $ 29,031 $ 17,926 $ 10,030 $ 15,355
Loans Contractually Past Due 90
Days or More Other Than Nonaccruing..... 5,982 3,578 2,870 3,965 1,907
Restructured Loans........................ 130 145 84 310 2,019
------- -------- -------- -------- --------
Total Non-performing Loans........... $93,658 $ 32,754 $ 20,880 $ 14,305 $ 19,281
======= ======== ======== ======== ========
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. Lincoln accounted for
$35,839,000 of the increase in non-performing loans.
Restructured loans are loans for which the contractual interest rate has been
reduced or other concessions are granted to the borrower, because of
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 $997,000 for the year ended December 31, 2008, was recognized
on the nonaccruing and restructured loans listed in the table above, whereas
interest income of $4,056,000 would have been recognized under their original
loan terms.
Potential problem loans:
Management has identified certain other loans totaling $132,391,000 as of
December 31, 2008, not included in the table above, or the impaired loan table
in the footnotes to the consolidated financial statements, about which there are
concerns as to the borrowers' ability to comply with present repayment terms.
For the Corporation, all classified 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 central, 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.
18
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) 2008 2007 2006 2005 2004
==============================================================================================================================
Allowance for Loan Losses:
Balance at January(1)................... $ 28,228 $ 26,540 $ 25,188 $ 22,548 $ 25,493
Charge offs:
Commercial and Industrial(1).......... 9,449 2,403 1,369 3,763 7,455
Real Estate Mortgage(2)............... 10,142 4,309 3,613 2,117 1,588
Individuals' Loans for Household and
Other Personal Expenditures,
Including Other Loans................ 3,035 1,845 1,528 1,864 1,858
-------- -------- -------- -------- --------
Total Charge offs.................... 22,626 8,557 6,510 7,744 10,901
-------- -------- -------- -------- --------
Recoveries:
Commercial and Industrial(3). ......... 3,401 551 291 1,283 1,629
Real Estate Mortgage(4). .............. 2,621 750 863 122 161
Individuals' Loans For Household and
Other Personal Expenditures,
Including Other Loans................ 1,002 437 450 625 461
-------- -------- -------- -------- --------
Total Recoveries..................... 7,024 1,738 1,604 2,030 2,251
-------- -------- -------- -------- --------
Net Charge offs.......................... 15,602 6,819 4,906 5,714 8,650
-------- -------- -------- -------- --------
Provisions for Loan Losses............... 28,238 8,507 6,258 8,354 5,705
Allowance Acquired in Acquisition........ 8,679
-------- -------- -------- -------- --------
Balance at December 31................... $49,543 $28,228 $26,540 $25,188 $22,548
======== ======== ======== ======== ========
Ratio of Net Charge offs During the
Period to Average Loans
Outstanding During the Period.......... .52% .24% .19% .23% .37%
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.
(1) 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.
(2) Category includes the charge offs for construction, commercial and farmland
and residential real estate loans.
(3) Category also includes the recoveries for lease financing, loans to
financial institutions, tax-exempt loans and agricultural production
financing and other loans to farmers.
(4) Category includes the recoveries for construction, commercial and farmland
and residential real estate loans.
19
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.
===================================================================================================================
2008 2007
(Dollars in Thousands) Amount Percent Amount Percent
===================================================================================================================
Balance at December 31:
Commercial and Industrial (1)............... $ 20,709 36.0% $ 9,598 34.1%
Real Estate Mortgage (2).................... 22,195 58.6 12,561 58.8
Individuals' Loans for Household and
Other Personal Expenditures,
Including Other Loans..................... 6,539 5.4 5,969 7.1
Unallocated................................. 100 N/A 100 N/A
-------- ------ -------- ------
Totals...................................... $ 49,543 100.0% $ 28,228 100.0%
======== ====== ======== ======
2006 2005
------------------------- -------------------------
Amount Percent Amount Percent
-------- -------- -------- --------
Balance at December 31:
Commercial and Industrial(1) ............... $ 9,598 31.0% $ 7,430 30.9%
Real Estate Mortgage (2).................... 12,479 60.5 13,149 60.6
Individuals' Loans for Household and
Other Personal Expenditures,
Including Other Loans..................... 4,363 8.5 4,509 8.5
Unallocated................................. 100 N/A 100 N/A
-------- ------ -------- ------
Totals...................................... $ 26,540 100.0% $ 25,188 100.0%
======== ====== ======== ======
2004
-------------------------
Amount Percent
-------- --------
Balance at December 31:
Commercial and industrial(1) ............... $ 16,821 30.9%
Real estate mortgage (2).................... 1,916 60.9
Individuals' Loans for Household and
Other Personal Expenditures,
Including Other Loans..................... 3,711 8.5
Unallocated. .... .......................... 100 N/A
-------- ------
Totals...................................... $ 22,548 100.0%
======== ======
(1) 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.
(2) Category includes the allowance for loan losses and percent of loans for
commercial real estate, farmland and residential real estate loans.
At December 31, 2008, 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 respective
bank's board of directors. Executive and board loan 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.
20
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 classified loans, including substandard, doubtful and loss
credits, are included in the impaired loan total. The fair value for impaired
loans is measured based on the value of the collateral securing those loans and
is determined using several methods. The fair value of real estate is generally
determined based on appraisals by qualified licensed appraisers. The appraisers
typically determine the value of the real estate by utilizing an income or
market valuation approach. If an appraisal is not available, the fair value may
be determined by using a cash flow analysis. Fair value on other collateral such
as business assets is typically valued by using the financial information such
as financial statements and aging reports provided by the borrower and is
discounted as considered appropriate. Information on impaired loans is
summarized below:
=======================================================================================================================
(Dollars in Thousands) 2008 2007 2006
=======================================================================================================================
As of, and for the Year Ending December 31:
Impaired Loans With an Allowance............................ $ 25,397 $ 21,304 $ 17,291
Impaired Loans for which the Discounted
Cash Flows or Collateral Value Exceeds the
Carrying Value of the Loan................................ 180,729 65,645 43,029
------------ ------------ ------------
Total Impaired Loans.................................. $ 206,126 $ 86,949 $ 60,320
============ ============ ============
Total Impaired Loans as a Percent of Total Loans.............. 5.53% 3.02% 2.24%
Allowance for Impaired Loans (Included in the
Corporation's Allowance for Loan Losses).................. $ 9,790 $ 6,034 $ 4,130
Average Balance of Impaired Loans........................... 229,608 103,272 66,139
Interest Income Recognized on Impaired Loans................ 8,078 6,675 5,143
Cash Basis Interest Included Above.......................... 997 1,143 1,364
Lincoln accounted for $56,107,000 of the increase in impaired loans, which were
at their fair value on the acquisition date of December 31, 2009.
21
Part I: Item 1. Business
DEPOSITS
The average balances, interest income and expense and average rates on deposits
for the years ended December 2008, 2007 and 2006 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, 2008, 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.......... $190,738 $108,604 $108,982 $137,757 $546,081
Percent ....................... 35% 20% 20% 25% 100%
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 Annual Report
on Form 10-K.
SHORT-TERM BORROWINGS
=============================================================================================
(Dollars in Thousands) 2008 2007 2006
=============================================================================================
Balance at December 31:
Securities Sold Under Repurchase
Agreements (Short-term Portion).................. $122,311 $ 72,247 $ 42,750
Federal Funds Purchased............................ 52,350 56,150
-------- -------- --------
Total Short-term Borrowings................ $122,311 $124,597 $ 98,900
======== ======== ========
Securities sold under repurchase agreements are borrowings maturing within one
year and are secured by U.S. Treasury and U.S. Government Sponsored Enterprise
obligations.
Pertinent information with respect to short-term borrowings is summarized below:
=============================================================================================
(Dollars in Thousands) 2008 2007 2006
=============================================================================================
Weighted Average Interest Rate on Outstanding
Balance at December 31:
Securities Sold Under Repurchase
Agreements (Short-term Portion).............. 0.3% 3.7% 4.4%
Total Short-term Borrowings..................... 0.3 3.9 4.9
Weighted Average Interest Rate During the Year:
Securities Sold Under Repurchase
Agreements(Short-term Portion)............... 1.7% 4.3% 4.4%
Total Short-term Borrowings..................... 2.1 4.9 4.6
Highest Amount Outstanding at Any Month End
During the Year:
Securities Sold Under Repurchase
Agreements (Short-term Portion).............. $129,273 $ 98,735 $ 98,765
Total Short-term Borrowings..................... 281,359 226,894 219,337
Average Amount Outstanding During the Year:
Securities Sold Under Repurchase
Agreements (Short-term Portion).............. $ 65,590 $ 62,040 $ 73,818
Total Short-term Borrowings..................... 139,545 127,345 109,577
22
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 current banking crisis, including the Enactment of EESA and ARRA,
may significantly affect our financial condition, results of
operations, liquidity or stock price.
The capital and credit markets have been experiencing volatility and disruption
for more than a year. In recent months, the volatility and disruption has
reached unprecedented levels. In some cases, the markets have produced downward
pressure on stock prices and credit availability for certain issuers seemingly
without regard to those issuers' underlying financial strength.
EESA, which established TARP, was signed into law in October 2008. As part of
TARP, the Treasury established the CPP to provide up to $700 billion of funding
to eligible financial institutions through the purchase of capital stock and
other financial instruments for the purpose of stabilizing and providing
liquidity to the U.S. financial markets. Then, on February 17, 2009, President
Obama signed ARRA, as a sweeping economic recovery package intended to stimulate
the economy and provide for broad infrastructure, energy, health, and education
needs. There can be no assurance as to the actual impact that EESA or its
programs, including the CPP, and ARRA or its programs, will have on the national
economy or financial markets. The failure of these significant legislative
measures to help stabilize the financial markets and a continuation or worsening
of current financial market conditions could materially and adversely affect our
business, financial condition, results of operations, access to credit or the
trading price of our common shares.
There have been numerous actions undertaken in connection with or following EESA
and ARRA by the Federal Reserve Board, Congress, the Treasury, the FDIC, the SEC
and others in efforts to address the current liquidity and credit crisis in the
financial industry that followed the sub-prime mortgage market meltdown which
began in 2007. These measures include homeowner relief that encourages loan
restructuring and modification; the establishment of significant liquidity and
credit facilities for financial institutions and investment banks; the lowering
of the federal funds rate; emergency action against short selling practices; a
temporary guaranty program for money market funds; the establishment of a
commercial paper funding facility to provide back-stop liquidity to commercial
paper issuers; and coordinated international efforts to address illiquidity and
other weaknesses in the banking sector. The purpose of these legislative and
regulatory actions is to help stabilize the U.S. banking system. EESA, ARRA and
the other regulatory initiatives described above may not have their desired
effects. If the volatility in the markets continues and economic conditions fail
to improve or worsen, our business, financial condition and results of
operations could be materially and adversely affected.
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, a prolonged economic downturn, continued increase in
unemployment, or other events that affect household and/or corporate incomes
could result in further deterioration of credit quality, an increase 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
23
PART I: ITEM 1A. AND ITEM 1B.
INDUSTRY RISK FACTORS continued
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.
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 of 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.
In connection with recent economic developments, many financial institutions,
including the Corporation, have experienced unusual and significant declines in
the performance of their loan portfolios, and the values of real estate
collateral supporting many loans have declined. If current trends in the housing
and real estate markets continue, we expect that loan delinquencies and credit
losses may increase. Although the Corporation believes its underwriting and loan
review procedures are appropriate for the various kinds of loans it makes, the
Corporation's results of operations and financial condition will be adversely
affected in the event the quality of its loan portfolio deteriorates. As of
December 31, 2008, the Corporation had $93,658,000 in non-performing loans and
an additional $49,543,000 in allowance for loan losses.
24
PART I: ITEM 1A. AND ITEM 1B.
CORPORATION RISK FACTORS continued
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.
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
25
PART I: ITEM 1A. AND ITEM 1B.
CORPORATION RISK FACTORS continued
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 A write-down of all or part of the Corporation's goodwill could
materially reduce its net income and net worth.
At December 31, 2008, the Corporation had over $143 million of goodwill recorded
on its consolidated balance sheet. Under SFAS No. 142, "Goodwill and Other
Intangible Assets," the Corporation is required to evaluate goodwill for
impairment on an annual basis, as well as on an interim basis, if events or
changes indicate that the asset may be impaired. An impairment loss must be
recognized for any excess of carrying value over the "fair value" of goodwill.
"Fair value" is determined 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
result in material write-downs of goodwill and recording of impairment losses.
Such a write-down could materially reduce the Corporation's net income and
overall net worth. The Corporation also cannot predict the occurrence of
certain future events that might adversely affect the fair value of goodwill.
Such events include, but are not limited to, strategic decisions made in
response to economic and competitive conditions, the effect of the economic
environment on the Corporation's customer base, or a material negative change in
its relationship with significant customers.
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.
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
26
PART I: ITEM 1A. AND ITEM 1B.
CORPORATION RISK FACTORS continued
of any divestitures required by regulatory authorities in acquisitions or
business combinations may be greater than expected.
o The Corporation may not be able to pay dividends in the future in
accordance with past practice.
The Corporation has traditionally paid a quarterly dividend to common
stockholders. The payment of dividends is subject to legal and regulatory
restrictions. Any payment of dividends in the future will depend, in large part,
on the Corporation's earnings, capital requirements, financial condition and
other factors considered relevant by the Corporation's Board of Directors.
Additionally, due to our participation in the CPP, we may not increase our
dividend for three years from the date of the Agreement without the consent of
the U.S. Treasury, unless the preferred shares sold to the U.S. Treasury have
been redeemed in whole or transferred to a third party which is not an affiliate
of the Corporation.
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.
27
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 eighty-two banking
offices operated by the Corporation's affiliate banks, fifty-five are owned by
the respective banks and twenty-seven 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, 2008 was $59,641,000.
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 2008 to a vote of
security holders, through the solicitation of proxies or otherwise.
28
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, 50, President and Chief Executive Officer, Corporation Chief
Executive Officer of the Corporation since April 2007; Chief Operating Officer,
Corporation from November 2005 to April 2007; Executive Vice President,
Corporate Banking National City Bank from 1995 to November 2005.
Mark K. Hardwick, 38, 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.
Michael J. Stewart, 43, Executive Vice President and Chief Banking Officer,
Corporation Executive Vice President and Chief Banking Officer of the
Corporation since February 2008; Executive Vice President, Director of Large
Corporate Commercial Banking from December 2006 to February 2008 for National
City Corp; Executive Vice President and Chief Credit Officer for National City
Bank of Indiana from December 2002 to December 2006.
Jami L. Bradshaw, 46, 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, 59, 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, 49, 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, 45, 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, 56, 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; Executive Vice President Commercial Banking Division of
First Merchants Bank from 2005 to December 2006; Executive Vice President and
Northern Division Chief Credit Officer of Old National Bank from 2001 to 2005.
29
PART II: ITEM 5. AND ITEM 6.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, 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, 2003 and tracks it through December 31, 2008.
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.
- ---------------------------------------------------------------------------------------------------------------------------
12/31/03 12/31/04 12/31/05 12/31/06 12/31/07 12/31/08
- ---------------------------------------------------------------------------------------------------------------------------
First Merchants Corporation 100.00 115.05 109.48 118.74 99.35 105.35
Russell 2000 100.00 118.33 123.72 146.44 144.15 95.44
Russell 2000 Financial Services 100.00 121.10 123.76 147.83 122.96 91.75
The stock price performance included in this graph is not necessarily indicative
of future stock price performance.
30
Part II: Item 5. and Item 6.
STOCK INFORMATION
================================================================================================================================
PRICE PER SHARE
QUARTER HIGH LOW DIVIDENDS DECLARED(1)
================================================================================================================================
2008 2007 2008 2007 2008 2007
-------------------------- --------------------------- ---------------------------
First Quarter ............. $ 30.00 $ 27.46 $ 18.76 $ 22.75 $ .23 $ .23
Second Quarter ............. 29.98 25.00 18.15 21.51 .23 .23
Third Quarter .............. 27.40 24.95 16.58 18.30 .23 .23
Fourth Quarter ............. 22.87 23.44 16.17 19.92 .23 .23
The table above lists per share prices and dividend payments during 2008 and
2007. Prices are as reported by the National Association of Securities Dealers
Automated Quotation - Global Select 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 Global Select 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 27, 2009, the number of shares outstanding was 21,178,488. There were
8,405 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, 2008, as
follows:(2)
=====================================================================================================================
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(1) THE PLANS OR PROGRAMS(2)
=====================================================================================================================
October 1-31, 2008 0 $ 0 0 0
November 1-30, 2008 90(2) 21.17 0 0
December 1-31, 2008 198(2) 18.28 0 0
(1) 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 8 of this Annual Report on Form 10-K include discussions
regarding dividend restrictions from the bank subsidiaries to the
Corporation.
(2) The shares were purchased in connection with the exercise of certain
outstanding stock options.
31
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, 2008.
=========================================================================================================================
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 921 214 $ 24.80 226,815(1)
Equity Compensation Plans Not
Approved by Stockholders(2) 30 108 21.50
----------------------- -------------------- -----------------------------
Total 951 322 $ 24.70 226,815(1)
======================= ==================== =============================
(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 calendar year;
plus (b) the number of shares that were available for grants, but not
granted, under the Plan in any previous year; but in no event will the
number of shares available for grants in any calendar year exceed 1.5% 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.
(2) 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.
32
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 Annual Report on 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 Statement of
Financial Accounting Standards ("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 central, 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-
33
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES continued
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.
Pension. The Corporation provides pension benefits to its employees. Its
accounting policies related to pensions and other postretirement benefits
reflect the guidance in SFAS No. 158 "Employers' Accounting for Defined Benefit
Pension and Other Postretirement Plans". 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. Various statistical and other factors, which
attempt to anticipate future events, are used in calculating the expense and
liabilities related to the plans. Key factors include assumptions on the
expected rates of return on plan assets, discount rates, expected rates of
salary increases and health care costs and trends. The Corporation considers
market conditions, including changes in investment returns and interest rates in
making these assumptions. The primary assumptions used in determining the
Corporation's pension and postretirement benefit obligations and related
expenses are presented in Note 16 "Employee Benefit Plans" in the Annual Report
for the specific assumptions used by the Corporation.
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.
Under SFAS No. 142, "Goodwill and Other Intangible Assets", the Corporation is
required to evaluate goodwill for impairment on an annual basis, as well as on
an interim basis, if events or changes indicate that the asset may be impaired,
indicating that the carrying value may not be recoverable. The Corporation has
elected to test for goodwill impairment as of September 30 of each year. 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.
The Corporation cannot predict the occurrence of certain future events that
might adversely affect the reported value of goodwill. Such events include, but
are not limited to, strategic decisions made in response to economic and
competitive conditions, the effect of the economic environment on the
Corporation's customer base, or a material negative change in its relationship
with significant customers.
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.
34
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS - 2008
As of December 31, 2008 total assets equaled $4.8 billion, an increase of $1
billion from December 31, 2007. Loans and investments, the Corporation's primary
earning assets, totaled $4.2 billion, an increase of $876 million over the prior
year. Loans accounted for $846 million of the increase as investment securities
increased by $31 million. Of the $876 million increase, the addition of Lincoln
accounted for $637 million in loans and $122 million in investments. During 2007
and 2008, 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.
Net income for 2008 totaled $20.6 million, a decrease of $11 million from 2007.
Diluted earnings per share totaled $1.14, a decline of $.59 from the 2007 total
of $1.73. Net interest margin expanded by 29 basis points from 3.55 percent in
2007 to 3.84 percent in 2008. As a result, net-interest income increased by
$16.3 million, or 14.4 percent. Net interest margin remained strong even during
the fourth quarter as the Federal Reserve Board lowered the target Fed Funds
rate to just 25 basis points. Aggressive deposit pricing and the use of interest
rate floors on over $360 million of the Corporation's prime rate indexed loans
helped preserve the Corporation's net interest margin.
Provision expense totaled $28.2 million in 2008, an increase of $19.7 million
over the prior. The increase in provision expense exceeded the expansion of net
interest income by $3.4 million.
Non-interest income decreased $4.2 million in 2008. Income from changes in the
cash surrender value of bank owned life insurance (BOLI) declined by $3.9
million. During the fourth quarter the Corporation recorded a loss of $2.1
million due to declines in market value below the stable value wrap. BOLI losses
are not tax deductible resulting in a $3.9 million decrease in net income. On
December 18, 2008, management changed the investment elections under the
separate account policy structure to more conservative investments. The
Corporation also recorded an other than temporary loss of $1.5 million on
Federal Home Loan Mortgage Corporation preferred stock. The Corporation has no
additional equity exposure to FHLMC and FNMA and no remaining exposure to
private label mortgage backed investment securities.
Additionally, the Corporation recorded an other than temporary loss of $1.2
million of its $15.5 million original book balance trust preferred pooled
investment exposure. The loss is attributable to a Trapeza IV pool, the only
pool deemed to be other-than-temporarily impaired as of year-end. The remaining
$13.5 million of exposure to trust preferred pools is diversified among eight
FTN PreTsl investments.
Total non-interest expenses for the year increased by $6.6 million or 6.5
percent as salary and benefit expense increased by $4.2 million. The remaining
increases in other expense include an increase of $1.8 million in other real
estate expense and $860,000 of professional services related to loan workouts.
First Merchants also sold the assets of Indiana Title Insurance Company, LLC
resulting in a $560,000 loss during the month of December.
Return on equity was 5.90 percent in 2008, 9.56 percent in 2007 and 9.45 percent
in 2006. Return on assets totaled .54 percent in 2008, .87 percent in 2007 and
..90 percent in 2006. 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.
RESULTS OF OPERATIONS - 2007 and 2006
As of December 31, 2007 total assets equaled $3.8 billion, an increase of $227.2
million from December 31, 2006. Loans and investments, the Corporation's primary
earning assets, increased by $168.5 million, 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.
Net income for 2007 totaled $31.6 million, an increase of $1.4 million, 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. These factors and others are discussed within the
respective sections of Management's Discussion and Analysis of Financial
condition and Results of Operations.
35
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAPITAL
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. The Corporation's regulatory capital fell slightly below the
regulatory "well capitalized" standard at December 31, 2008.
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
7.73 percent and 7.19 percent at December 31, 2008 and 2007, respectively.
At December 31, 2008, the Corporation had a Tier I risk-based capital ratio of
7.71 percent and total risk-based capital ratio of 10.24 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 decrease in the Corporation's regulatory capital ratios for the year is
primarily attributable to two factors. The first factor of note is the decline
in First Merchants other comprehensive income resulting from investment security
write-downs under SFAS 115 totaling $1.3 million during the year. The second
factor is a combination of items related to the Lincoln Bancorp acquisition. The
Corporation used cash of $16.8 million as part of the $77.3 million purchase
price resulting in increased common equity of $60.1 million to acquire an $876
million institution. Additionally, as a result of the acquisition, First
Merchants added $32.3 million of intangibles from the closing of Lincoln
Bancorp.
The Corporation's GAAP capital ratio, defined as total stockholders' equity to
total assets, equaled 8.27 percent as of December 31, 2008, down from 8.99
percent in 2007.
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
5.01 percent as of December 31, 2008, down from 5.72 percent in 2007.
Management believes that all of the above capital ratios are meaningful
measurements for evaluating the safety and soundness of the Corporation.
Additionally, management believes the following table is also meaningful when
considering performance measures of the Corporation. The table details and
reconciles tangible earnings per share, return on tangible capital and tangible
assets to traditional GAAP measures.
========================================================================================
December 31,
(Dollars in Thousands) 2008 2007
========================================================================================
Average Goodwill..................................... $ 124,403 $ 123,191
Average Core Deposit Intangible (CDI)................ 11,388 13,868
Average Deferred Tax on CDI.......................... (2,867) (3,659)
---------- ----------
Intangible Adjustment.............................. $ 132,924 $ 133,400
========== ==========
Average Stockholders' Equity (GAAP Capital).......... $ 349,594 $ 330,786
Intangible Adjustment................................ (132,924) (133,400)
---------- ----------
Average Tangible Capital........................... $ 216,670 $ 197,386
========== ==========
Average Assets....................................... $3,811,166 $3,639,772
Intangible Adjustment................................ (132,924) (133,400)
---------- ----------
Average Tangible Assets............................ $3,678,242 $3,506,372
========== ==========
Net Income........................................... $ 20,638 $ 31,539
CDI Amortization, Net of Tax......................... 1,919 1,919
---------- ----------
Tangible Net Income................................ $ 22,557 $ 33,558
========== ==========
Diluted Earnings Per Share........................... $ 1.14 $ 1.73
Diluted Tangible Earnings Per Share.................. $ 1.24 $ 1.83
Return on Average GAAP Capital....................... 5.90% 9.56%
Return on Average Tangible Capital................... 10.41% 17.00%
Return on Average Assets............................. 0.54% 0.87%
Return on Average Tangible Assets.................... 0.61% 0.96%
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
36
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ASSET QUALITY/PROVISION FOR LOAN LOSSES continued
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)
In connection with recent economic developments, many financial institutions,
including the Corporation, have experienced unusual and significant declines in
the performance of their loan portfolios, and the values of real estate
collateral supporting many loans have declined. If current trends in the housing
and real estate markets continue, we expect that loan delinquencies and credit
losses may increase. Although the Corporation believes its underwriting and loan
review procedures are appropriate for the various kinds of loans it makes, the
Corporation's results of operations and financial condition will be adversely
affected in the event the quality of its loan portfolio deteriorates.
At December 31, 2008, non-performing loans totaled $93,658,000, an increase of
$60,904,000, of which the addition of Lincoln at December 31 accounted for
$35,839,000 of the increase. Loans 90 days past due other than non-accrual and
restructured loans increased by $2,404,000. The amount of non-accrual loans
totaled $87,546,000 at December 31, 2008 and Lincoln accounted for $33,669,000
of non-accrual loans. 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, 2008, impaired loans totaled $206,126,000, an increase of
$119,177,000 from year-end 2007. Lincoln accounted for $56,107,000 of the
increase in impaired loans, which were at their fair value on the acquisition
date of December 31, 2009. At December 31, 2008, a specific allowance for losses
was not deemed necessary for impaired loans totaling $180,729,000, but a
specific allowance of $9,790,000 was recorded for the remaining balance of
impaired loans of $25,397,000 and is included in the Corporation's allowance for
loan losses. The average balance of impaired loans for 2008 was $229,608,000.
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 classified loans, including substandard,
doubtful and loss credits, are included in the impaired loan total.
In 2008, total net charge-offs were $15,602,000, an increase of $8,873,000 from
2007 of $6,819,000. Net charge-offs included commercial and residential real
estate of $7,521,000, commercial and industrial of $6,048,000 and individual
loans for household and other personal expenditures, including other loans of
$2,033,000.
Commercial construction and land development loans were $252,487,000 at December
31, 2008, an increase of $87,062,000 from December 31, 2007. The addition of
Lincoln at December 31 accounted for $66,907,000 of the increase. Construction
and land development represents 63.8 percent of total capital and 6.8 percent of
total loans. Management continues to closely monitor this portfolio for existing
projects, as well as being very selective with additional exposure to this
industry.
At December 31, 2008, the allowance for loan losses was $49,543,000, an increase
of $21,315,000 from year-end 2007. As a percent of loans, the allowance was 1.33
percent at December 31, 2008 and .98 percent at December 31, 2007. Management
believes that the allowance for loan losses is adequate to cover losses inherent
in the loan portfolio at December 31, 2008. 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.
The provision for loan losses in 2008 was $28,238,000, an increase of
$19,731,000 from $8,507,000, in 2007, reflecting an increase of 46 basis points
in net charge offs during the year.
37
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ASSET QUALITY/PROVISION FOR LOAN LOSSES continued
The provision for loan losses in 2007 was $8,507,000, an increase of $2,249,000
from $6,258,000, in 2006, reflecting an increase of 5 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) 2008 2007
================================================================================
Non-accrual Loans .............................. $87,546 $29,031
Loans Contractually
Past Due 90 Days or More
Other than Non-accruing ..................... 5,982 3,578
Restructured Loans ............................. 130 145
------- -------
Total ....................................... $93,658 $32,754
======= =======
The table below represents loan loss experience for the years indicated.
========================================================================================================
(Dollars in Thousands) 2008 2007 2006
========================================================================================================
Allowance for Loan Losses:
Balance at January 1 .................................. $28,228 $26,540 $25,188
------- ------- -------
Charge offs ............................................ 22,626 8,557 6,510
Recoveries ............................................ 7,024 1,738 1,604
------- ------- -------
Net charge offs ........................................ 15,602 6,819 4,906
Provision for Loan Losses ............................. 28,238 8,507 6,258
Allowance Acquired in Acquisition....................... 8,679
------- ------- -------
Balance at December 31 ................................ $49,543 $28,228 $26,540
======= ======= =======
Ratio of Net Charge offs During the Period to
Average Loans Outstanding During the Period .......... .52% .24% .19%
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 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, 2008, total borrowings from the FHLB were
$360,217,000. 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, 2008, was $95,214,000. At December 31, 2008,
the revolving line of credit with LaSalle Bank had a balance of $20,000,000 with
$5,000,000 remaining borrowing capacity.
On February 20, 2009, First Merchants completed the sale to the Treasury of
$116.0 million of newly issued First Merchants non-voting preferred shares as
part of the CPP enacted as part of the TARP, under the ESSA. The Treasury has
certain supervisory and oversight duties and responsibilities under EESA and the
CPP and, pursuant to the terms of a Letter Agreement and a Securities Purchase
Agreement - Standard Terms attached thereto (collectively, the "Securities
Purchase Agreement"), the Treasury is empowered to unilaterally amend any
provision of the Securities Purchase Agreement with First Merchants to the
extent required to comply with any changes in applicable federal statutes.
38
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
LIQUIDITY continued
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
$459,636,000 at December 31, 2008, an increase of $18,800,000, or 4.3 percent
over December 31, 2007. 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 $13,131,000 at December 31, 2008. 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, 2008 are as follows:
=============================================================================
At December 31,
(Dollars in Thousands) 2008
=============================================================================
Amounts of Commitments:
Loan Commitments to Extend Credit ...................... $ 794,240
Standby Letters of Credit .............................. 31,194
----------
$ 825,434
==========
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.
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, 2008 are as follows:
========================================================================================================
2014 and
(Dollars in Thousands) 2009 2010 2011 2012 2013 after Total
========================================================================================================
Operating Leases $ 2,010 $ 1,844 $ 1,647 $ 1,104 $ 461 $ 677 $ 7,743
Federal Funds Purchased
Securities Sold Under
Repurchase Agreements 88,061 10,000 14,250 10,000 122,311
Federal Home Loan Bank Advances 137,015 86,183 32,163 72,097 7,756 25,003 360,217
Subordinated Debentures,
Revolving Credit Lines and
Term Loans 20,000 115,826 135,826
-------- ------- ------- ------- -------- -------- --------
Total $247,086 $98,027 $33,810 $87,451 $ 8,217 $151,506 $626,097
======== ======= ======= ======= ======== ======== ========
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 constructed, presented and monitored quarterly.
39
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued
Management believes that the Corporation's liquidity and interest sensitivity
position at December 31, 2008, 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, 2008.
===================================================================================================================================
At December 31, 2008
(Dollars in Thousands) 1-180 DAYS 181-365 DAYS 1-5 YEARS BEYOND 5 YEARS TOTAL
===================================================================================================================================
Rate-Sensitive Assets:
Federal Funds Sold....................................... $ 66,237 $ 66,237
Interest-bearing Deposits ............................... 38,823 38,823
Investment Securities ................................... 61,040 $ 67,712 $ 245,718 $ 107,514 481,984
Loans ................................................... 1,806,018 484,436 1,270,494 165,299 3,726,247
Federal Reserve and Federal Home Loan Bank Stock ........ 34,319 34,319
---------- ---------- ---------- ---------- ----------
Total Rate-sensitive Assets ........................ 1,972,118 552,148 1,550,531 272,813 4,347,610
---------- ---------- ---------- ---------- ----------
Rate-Sensitive Liabilities:
Interest-bearing Deposits ............................... 2,193,749 399,526 651,874 13,143 3,258,292
Securities Sold Under Repurchase Agreements ............. 88,061 24,250 10,000 122,311
Federal Home Loan Bank Advances ......................... 97,630 49,633 202,795 10,159 360,217
Subordinated Debentures, Revolving Credit
Lines and Term Loans ................................. 64,926 10,074 60,826 135,826
---------- ---------- ---------- ---------- ----------
Total Rate-sensitive Liabilities ................... 2,444,366 459,233 939,745 33,302 3,876,646
---------- ---------- ---------- ---------- ----------
Interest Rate Sensitivity Gap by Period .................... $ (472,248) $ 92,915 $ 610,786 $ 239,511
Cumulative Rate Sensitivity Gap ............................ (472,248) (379,333) 231,453 470,964
Cumulative Rate Sensitivity Gap Ratio
at December 31, 2008 .................................... 80.7% 86.9% 106.0% 112.1%
at December 31, 2007 .................................... 71.1% 82.3% 112.3% 111.2%
The Corporation had a cumulative negative gap of $379,333,000 in the one-year
horizon at December 31, 2008, 7.9 percent of total assets.
The Corporation places its greatest credence in net interest income simulation
modeling. The above GAP/Interest Rate Sensitivity Report is believed by the
Corporation's management to have two major shortfalls. The GAP/Interest Rate
Sensitivity Report fails to precisely gauge how often an interest rate sensitive
product reprices, nor is it able to measure the magnitude of potential future
rate movements.
Net interest income simulation modeling, or earnings-at-risk, measures the
sensitivity of net interest income to various interest rate movements. The
Corporation's asset liability process monitors simulated net interest income
under three separate interest rate scenarios; base, rising and falling.
Estimated net interest income for each scenario is calculated over a 12-month
horizon. The immediate and parallel changes to the base case scenario used in
the model are presented below. The interest rate scenarios are used for
analytical purposes and do not necessarily represent management's view of future
market movements. Rather, these are intended to provide a measure of the degree
of volatility interest rate movements may introduce into the earnings of the
Corporation.
The base scenario is highly dependent on numerous assumptions embedded in the
model, including assumptions related to future interest rates. While the base
sensitivity analysis incorporates management's best estimate of interest rate
and balance sheet dynamics under various market rate movements, the actual
behavior and resulting earnings impact will likely differ from that projected.
For mortgage-related assets, the base simulation model captures the expected
prepayment behavior under changing interest rate environments. Assumptions and
methodologies regarding the interest rate or balance behavior of indeterminate
maturity products, such as savings, money market, NOW and demand deposits,
reflect management's best estimate of expected future behavior.
The comparative rising 200 basis points and falling 100 basis points scenarios
below, as of December 31, 2008, 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 the current rate environment, many driver
rates are at or near historical lows, thus total rate movements (beginning point
minus ending point) to each of the various driver rates utilized by management
have the following results:
====================================================================================
Driver Rates RISING (200 basis points) FALLING (100 basis points)
====================================================================================
Prime 200 0
Federal Funds 200 0
One-Year CMT 200 (6)
Three-Year CMT 200 (24)
Five-Year CMT 200 (24)
CD's 200 (96)
FHLB Advances 200 (30)
40
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued
Results for the base, rising 200 basis points, and falling 100 basis points
interest rate scenarios are listed below based upon the Corporation's rate
sensitive assets and liabilities at December 31, 2008. 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 (200 basis points) FALLING (100 basis points)
================================================================================================================================
Net Interest Income (Dollars in Thousands) $144,038 $154,398 $145,606
Variance from Base $ 10,359 $ 1,568
Percent of Change from Base 7.19% 1.09%
The comparative rising 200 basis points and falling 200 basis points scenarios
below, as of December 31, 2007, 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 (200 basis points) FALLING (200 basis points)
=====================================================================================
Prime 200 (200)
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 200 basis points, and falling 200 basis points
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 (200 Basis Points) FALLING (200 Basis Points)
================================================================================================================================
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)%
EARNING ASSETS
The following table presents the earning asset mix as of December 31, 2008, and
December 31, 2007. Earnings assets increased by $965,684,000. Loans increased by
$845,109,000, of which $626,058,000 of the increase was related to the addition
of Lincoln on December 31, 2008. Of the remaining increase of $219,051,000, the
largest loan segments that increased were in commercial and industrial of
$197,236,000 and commercial and farmland real estate of $31,609,000. The largest
loan category that decreased was in loans to individuals. This category
decreased as management strategically reduced its indirect lending function, our
lowest yielding loan category.
Investments increased by $30,817,000. The addition of Lincoln on December 31,
2008, brought an investment portfolio of $122,093,000. The decrease in the
portfolio of $91,276,000 during the period was related to a strategic decision
to reinvest investment portfolio maturities in higher yielding loans.
=========================================================================================
(Dollars in Thousands) December 31,
=========================================================================================
2008 2007
-------- --------
Federal Funds Sold................................... $ 66,237 $ 495
Interest-bearing Time Deposits....................... 38,823 24,931
Investment Securities Available for Sale ............ 459,636 440,836
Investment Securities Held to Maturity............... 22,348 10,331
Mortgage Loans Held for Sale ........................ 4,295 3,735
Loans................................................ 3,721,952 2,876,843
Federal Reserve and Federal Home Loan Bank Stock..... 34,319 25,250
--------- ---------
Total ........................................... $4,347,610 $3,382,421
========= =========
41
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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, 2008 and 2007.
===================================================================================
(Dollars in Thousands) December 31,
===================================================================================
2008 2007
---------- ----------
Deposits ........................................ $3,718,811 $2,844,121
Federal Funds Purchased.......................... 52,350
Securities Sold Under Repurchase Agreements...... 122,311 106,497
Federal Home Loan Bank Advances ................. 360,217 294,101
Subordinated Debentures, Revolving Credit Lines
and Term Loans................................ 135,826 115,826
---------- ----------
$4,337,165 $3,412,895
========== ==========
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 2008.
In 2008, asset yields decreased 66 basis points on a fully taxable equivalent
basis (FTE) and interest cost decreased 95 basis points, resulting in a 29 basis
point increase in the interest margin compared to 2007. The decrease in interest
income and interest expense was primarily a result of seven federal funds rate
decreases of approximately 350 basis points by the Federal Open Market Committee
during this period. Growth in earning assets produced a positive volume variance
of $7,715,000 (FTE), and a declining interest rate environment produced a
positive rate variance of $8,549,000 (FTE), resulting in an increase of
$16,264,000 in net interest income.
In 2007, asset yields increased 18 basis points (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 $8,665,000 (FTE), while interest rate
compression produced a negative rate variance of $5,640,000 (FTE), resulting in
an increase of $3,025,000 in net interest income.
==============================================================================================
(Dollars in Thousands) December 31,
==============================================================================================
2008 2007 2006
------ ------ ------
Net Interest Income................................... $ 129,384 $ 113,120 $ 110,095
FTE Adjustment........................................ $ 3,699 $ 4,127 $ 3,981
Net Interest Income
on a Fully Taxable Equivalent Basis................. $ 133,083 $ 117,247 $ 114,076
Average Earning Assets................................ $3,463,477 $3,308,939 $3,072,898
Interest Income (FTE) as a Percent
of Average Earning Assets........................... 6.44% 7.10% 6.92%
Interest Expense as a Percent
of Average Earning Assets........................... 2.60% 3.55% 3.21%
Net Interest Income (FTE) as a Percent
of Average Earning Assets........................... 3.84% 3.55% 3.71%
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.
42
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 2008 amounted to $36,367,000, a 10.3 percent decrease from 2007.
The change in other income from 2008 to 2007 was primarily attributable to
fluctuations within the following other income items:
o Insurance commissions increased $711,000 from 2007 due to the purchase
of an insurance agency in April 2008.
o Service Charges increased $581,000 from the same period in 2007 due to
increased fees.
o Fees related to derivative hedge agreements were $510,000. No such
fees were collected in 2007.
o Other than temporary impairments of $2,682,000 were recognized on
FHLMC Preferred Stock and Trust Preferred Securities held in the
investment portfolio. This was offset by approximately $599,000 in net
gains from the sale of various investment securities.
o Earnings on bank-owned life insurance decreased $3,918,000 from the
same period in 2007 as discussed in "RESULTS OF OPERATIONS" section of
Management's Discussion and Analysis of Financial Condition and
Results of Operations.
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 EXPENSES
Other expenses represent non-interest operating expenses of the Corporation.
Total other expenses for 2008 were $108,792,000, an increase of $6,610,000 or
6.5 percent from 2007. The change in other expenses from 2008 to 2007 was
primarily attributable to fluctuations within the following other expense items:
o Salary and employee benefits grew $4,163,000, or 7.1 percent, due to
staff additions and normal salary increases. Approximately $451,000 of
the increase is due to share-based compensation expense recorded in
2008.
o Expenses related to other real estate owned and repossessed assets
were $1,809,000 higher in 2008 than in the same period of 2007.
o Premises expenses were $1,064,000 higher than the same period in 2007
primarily due to higher real estate taxes and fees paid to a
third-party property management company.
o On December 31, 2008, the Corporation sold its interest in Indiana
Title Insurance Company, LLC, for a loss of $560,000.
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.
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.
o Other expenses increased $1,129,000 primarily due to integration
expenses related to bank combinations and name changes.
43
PART II: ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INCOME TAXES
Income tax expense totaled $8,083,000 for 2008, which is a decrease of
$3,260,000 from 2007. The effective tax rates for the periods ending December
31, 2008, 2007 and 2006 were 28.1 percent, 26.4 percent and 28.8 percent,
respectively. The Corporation's federal statutory income tax rate is 35 percent
and its state tax rate varies from 0 to 8.5 percent depending on the state in
which the subsidiary company is domiciled. The effective tax rate is lower than
the blended effective statutory federal and state rates primarily due to the
Corporation's income on tax exempt securities and loans, income generated by the
subsidiaries domiciled in a state with no state or local income tax, income tax
credits generated from investments in affordable housing projects, 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 and loan
volume. 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).
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.
44
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
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, 2008 and 2007, 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, 2008. 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, 2008 and 2007, and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 2008, in conformity with accounting principles generally accepted in the
Unites States of America.
As discussed in Note 19, the Company changed its method of accounting for fair
value measurements in accordance with Statement of Financial Accounting
Standards No. 157 in 2008.
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, 2008, 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 March 16, 2009, expressed an unqualified opinion on the
effectiveness of the Company's internal control over financial reporting.
Indianapolis, Indiana
March 16, 2009
45
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data) December 31,
===================================================================================================================================
2008 2007
===================================================================================================================================
Assets
Cash and Cash Equivalents
Cash and Due From Banks ....................................................... $ 84,249 $ 134,188
Federal Funds Sold............................................................. 66,237 495
----------- -----------
Total Cash and Cash Equivalents.............................................. 150,486 134,683
Interest-bearing Time Deposits ................................................... 38,823 24,931
Investment Securities
Available for Sale ............................................................ 459,636 440,836
Held to Maturity (Fair Value of $22,176 and $10,270)........................... 22,348 10,331
----------- -----------
Total Investment Securities ................................................. 481,984 451,167
Mortgage Loans Held for Sale ..................................................... 4,295 3,735
Loans, Net of Allowance for Loan Losses of $49,543 and $28,228.................... 3,672,409 2,848,615
Premises and Equipment ........................................................... 59,641 44,445
Federal Reserve and Federal Home Loan Bank Stock ................................. 34,319 25,250
Interest Receivable .............................................................. 23,976 23,402
Core Deposit Intangibles ........................................................ 22,492 12,412
Goodwill.......................................................................... 143,482 123,444
Cash Value of Life Insurance...................................................... 93,222 70,970
Other Real Estate Owned........................................................... 18,458 2,573
Other Assets ..................................................................... 40,568 16,460
----------- -----------
Total Assets ................................................................ $ 4,784,155 $ 3,782,087
=========== ===========
Liabilities
Deposits
Noninterest-bearing ........................................................... $ 460,519 $ 370,397
Interest-bearing .............................................................. 3,258,292 2,473,724
----------- -----------
Total Deposits .............................................................. 3,718,811 2,844,121
Borrowings
Fed Funds Purchased............................................................ 52,350
Securities Sold Under Repurchase Agreements.................................... 122,311 106,497
Federal Home Loan Bank Advances................................................ 360,217 294,101
Subordinated Debentures, Revolving Credit Lines and Term Loans................. 135,826 115,826
----------- -----------
Total Borrowings............................................................. 618,354 568,774
Interest Payable ................................................................. 8,844 8,325
Other Liabilities ................................................................ 42,243 20,931
----------- -----------
Total Liabilities ........................................................... 4,388,252 3,442,151
----------- -----------
Commitments and Contingent Liabilities
Stockholders' Equity
Preferred Stock, No-par Value
Authorized and Unissued -- 500,000 Shares
Cumulative Preferred Stock, $1,000 Par Value:
Authorized -- 600 Shares
Isssued and Outstanding -- 125 Shares 125
Common Stock, $.125 Stated Value
Authorized -- 50,000,000 Shares
Issued and Outstanding - 21,178,123 and 18,002,787 Shares .................... 2,647 2,250
Additional Paid-in Capital ....................................................... 202,299 137,801
Retained Earnings ................................................................ 206,496 202,750
Accumulated Other Comprehensive Loss ............................................. (15,664) (2,865)
----------- -----------
Total Stockholders' Equity .................................................. 395,903 339,936
----------- -----------
Total Liabilities and Stockholders' Equity .................................. $ 4,784,155 $ 3,782,087
=========== ===========
See notes to consolidated financial statements.
46
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data) Year Ended December 31,
===================================================================================================================================
2008 2007 2006
===================================================================================================================================
Interest Income
Loans Receivable
Taxable ............................................................. $198,385 $207,268 $186,768
Tax Exempt .......................................................... 1,013 1,120 828
Investment Securities
Taxable ............................................................. 12,046 13,744 12,316
Tax Exempt .......................................................... 5,855 6,548 6,565
Federal Funds Sold .................................................... 28 172 373
Deposits with Financial Institutions .................................. 755 582 500
Federal Reserve and Federal Home Loan Bank Stock ...................... 1,391 1,299 1,256
-------- -------- --------
Total Interest Income ............................................ 219,473 230,733 208,606
-------- -------- --------
Interest Expense
Deposits .............................................................. 67,581 89,921 74,314
Federal Funds Purchased ............................................... 1,856 3,589 1,842
Securities Sold Under Repurchase Agreements ........................... 2,600 3,856 3,228
Federal Home Loan Bank Advances ....................................... 11,168 12,497 10,734
Subordinated Debentures, Revolving
Credit Lines and Term Loans ......................................... 6,884 7,750 8,124
Other Borrowings ...................................................... 269
-------- -------- --------
Total Interest Expense ........................................... 90,089 117,613 98,511
-------- -------- --------
Net Interest Income ...................................................... 129,384 113,120 110,095
Provision for Loan Losses ............................................. 28,238 8,507 6,258
-------- -------- --------
Net Interest Income After Provision for Loan Losses ...................... 101,146 104,613 103,837
-------- -------- --------
Other Income
Service Charges on Deposit Accounts ................................... 13,002 12,421 11,262
Fiduciary Activities ........................... ...................... 8,031 8,372 7,625
Other Customer Fees ................................................... 6,776 6,479 5,517
Commission Income ..................................................... 5,824 5,113 4,302
Earnings on Cash Surrender Value
of Life Insurance ................................................... (267) 3,651 2,286
Net Gains and Fees on Sales of Loans .................................. 2,490 2,438 2,171
Net Realized and Unrealized Gains (Losses) on
Available-for-sale Securities .............................. ........ (2,083) (4)
Other Income .......................................................... 2,594 2,077 1,454
-------- -------- --------
Total Other Income ............................................... 36,367 40,551 34,613
-------- -------- --------
Other Expenses
Salaries and Employee Benefits ........................................ 63,006 58,843 56,125
Net Occupancy Expenses ................................................ 7,711 6,647 5,886
Equipment Expenses .................................................... 6,659 6,769 7,947
Marketing Expenses..................................................... 2,311 2,205 1,932
Outside Data Processing Fees .......................................... 4,087 3,831 3,449
Printing and Office Supplies .......................................... 1,214 1,410 1,496
Core Deposit Amortization.............................................. 3,216 3,159 3,066
Write-off of Unamortized Underwriting Expenses ........................ 1,771
Other Expenses ........................................................ 20,588 17,547 16,156
-------- -------- --------
Total Other Expenses ............................................. 108,792 102,182 96,057
-------- -------- --------
Income Before Income Tax ................................................. 28,721 42,982 42,393
Income Tax Expense .................................................... 8,083 11,343 12,195
-------- -------- --------
Net Income ............................................................... $ 20,638 $ 31,639 $ 30,198
======== ======== ========
Net Income Per Share:
Basic ................................................................. $ 1.14 $ 1.73 $ 1.64
Diluted ............................................................... 1.14 1.73 1.64
See notes to consolidated financial statements.
47
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
===================================================================================================================================
Year Ended December 31,
(in thousands, except share data) 2008 2007 2006
===================================================================================================================================
Net Income ........................................................................... $ 20,638 $ 31,639 $ 30,198
-------- -------- --------
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 $1,356, $(1,437), and $(1,242).......... (2,518) 2,743 2,087
Reclassification Adjustment for (Gains) Losses Included in Net Income,
Net of Income Tax Expenses (Benefit) of $(833), $0, and $(1)................... 1,250 2
Unrealized Gains (Losses) on Cash Flow Hedge Assets:
Unrealized (Gains) Losses Arising During the Period,
Net of Income Tax Benefit of $(1), $(501), and $83............................. 2 1,057 (125)
Defined Benefit Pension Plans, Net of Income Tax Expense of $7,689, ($1,827) and $0
Net Gain Arising During Period................................................... (11,518) 2,725
Prior Service Cost Arising During Period ........................................ 30
Amortization of Prior Service Cost............................................... (15) (15)
-------- -------- ---------
(12,799) 6,540 1,964
-------- -------- ---------
COMPREHENSIVE INCOME $ 7,839 $ 38,179 $ 32,162
======== ======== =========
48
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED COMMON STOCK ACCUMULATED OTHER
================ ===================== ADDITIONAL RETAINED COMPREHENSIVE
(in thousands, except share data) SHARES AMOUNT SHARES AMOUNT PAID-IN CAPITAL EARNINGS INCOME (LOSS) TOTAL
------- --------- ----------- -------- -------------- -------- ----------------- -------
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 SFAS
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) $339,936
----------- -------- -------- --------- -------- ---------
Net Income for 2008...................... 20,638 20,638
Cash Dividends ($.92 per Share).......... (16,775) (16,775)
Effects of changing the pension plan
measurement date pursuant to FASB
No. 158
Service cost, interest cost and
expected rate of return on plan
assets for October 1 - December
31, 2009 net of tax............... (64) (64)
Amortization of prior service costs
for October 1 - December 31,
2007, net of tax ................. (53) (53)
Cumulative preferred stock
Issued ................................ 125 $125 125
Other Comprehensive Income (Loss),
Net of Tax ........................... (12,799) (12,799)
Tax Benefit from Stock Options Exercised 156 156
Share-based Compensation ................ 225 1 1,897 1,898
Stock Issued Under Employee Benefit Plans 50,119 6 767 773
Stock Issued Under Dividend Reinvestment
and Stock Purchase Plan .............. 44,554 6 1,015 1,021
Stock Options Exercised ................. 122,890 15 1,618 1,633
Stock Redeemed .......................... (134,169) (17) (2,171) (2,188)
Issuance of Stock Related to Acquisitions 3,091,717 386 61,216 61,602
------- --------- ----------- -------- -------- --------- --------- ---------
Balances, December 31, 2008 125 $125 21,178,123 $ 2,647 $202,299 $ 206,496 $ (15,664) $395,903
======= ========= =========== ======== ======== ========= ========= =========
See notes to consolidated financial statements.
49
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOWS
================================================================================================================================
Year Ended December 31,
(in thousands, except share data) 2008 2007 2006
================================================================================================================================
Operating Activities:
Net Income ......................................................... $ 20,638 $ 31,639 $ 30,198
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Provision for Loan Losses ........................................ 28,238 8,507 6,258
Depreciation and Amortization..................................... 4,613 4,331 5,382
Change in tax accruals............................................ (8,666) (2,162) (2,412)
Share-based Compensation.......................................... 1,898 1,468 833
Tax Benefits from Stock Options Exercised......................... (156) (116) (139)
Mortgage Loans Originated for Sale................................ (102,591) (123,051) (123,256)
Proceeds from Sales of Mortgage Loans ............................ 104,250 124,729 122,753
Net Change in:
Interest Receivable .......................................... 2,858 943 (4,655)
Interest Payable.............................................. (1,217) (1,001) 3,452
Gains on Sales of Securities Available for Sale 599 (4)
Recognized Loss on Other-than-Temporary Impairment (2,682)
Pension Adjustments for Measurement Date Change (117)
Other Adjustments................................................. (8,652) 4,731 (2,829)
--------- --------- ---------
Net Cash Provided by Operating Activities..................... 39,013 50,018 35,581
--------- --------- ---------
Investing Activities:
Net Change in Interest-bearing Deposits ............................ 10,716 (13,647) (2,536)
Purchases of
Securities Available for Sale..................................... (100,988) (69,536) (100,355)
Securities Held to Maturity....................................... (29,058) (8,466)
Proceeds from Maturities of
Securities Available for Sale .................................... 139,825 81,069 64,778
Securities Held to Maturity....................................... 17,042 7,418 6,526
Proceeds from Sales of
Securities Available for Sale .................................... 60,335 7,219 575
Proceeds from Sales of Mortgages.................................... 26,773
Purchase of Federal Reserve and Federal Home Loan Bank Stock........ (261) (1,559) (491)
Purchase of Bank-owned Life Insurance............................... (706) (4,500) (18,000)
Net Change in Loans................................................. (250,621) (221,873) (245,685)
Net Cash Received (Paid) in Acquisition.............................. 6,934 (370) (59)
Other Adjustments................................................... (4,181) (4,143 (8,358)
--------- --------- ---------
Net Cash Used by Investing Activities......................... (150,963) (201,615) (303,605)
--------- --------- ---------
Cash Flows from Financing Activities:
Net Change in:
Demand and Savings Deposits....................................... 74,992 65,035 133,591
Certificates of Deposit and Other Time Deposits .................. 144,328 28,548 234,372
Proceeds from the Sale of Other Real Estate Owned 10,775 3,633 6,301
Receipt of Borrowings .............................................. 961,074 457,157 182,454
Repayment of Borrowings............................................. (1,048,161) (331,016) (249,927)
Cash Dividends...................................................... (16,775) (16,852) (16,951)
Stock Issued Under Employee Benefit Plans........................... 773 787 857
Stock Issued Under Dividend Reinvestment
and Stock Purchase Plan .......................................... 1,021 1,170 1,190
Stock Options Exercised............................................. 1,633 496 1,228
Cumulative Preferred Stock Issued................................... 125
Tax Benefits from Stock Options Exercised........................... 156 116 139
Stock Redeemed...................................................... (2,188) (12,751) (5,690)
--------- --------- ---------
Net Cash Provided by Financing Activities..................... 127,753 196,323 287,564
--------- --------- ---------
Net Change in Cash and Cash Equivalents ............................... 15,803 44,726 19,540
Cash and Cash Equivalents, Beginning of Year........................... 134,683 89,957 70,417
--------- --------- ---------
Cash and Cash Equivalents, End of Year................................. $ 150,486 $ 134,683 $ 89,957
========= ========= =========
Additional Cash Flows Information:
Interest Paid ....................................................... $ 89,570 $ 118,614 $ 95,059
Income Tax Paid...................................................... 18,393 12,206 14,385
Loans Transferred to Other Real Estate Owned......................... 24,647 4,038 5,605
See notes to consolidated financial statements.
50
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS 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"), Commerce
National Bank ("Commerce National"), and Lincoln Bank ("Lincoln"), (collectively
the "Banks"), First Merchants Trust Company, National Association ("FMTC"),
First Merchants Insurance Services, Inc. ("FMIS"), and First Merchants
Reinsurance Company ("FMRC"), conform to accounting principles generally
accepted in the United States of America and reporting practices followed by the
banking industry.
On December 31, 2008, the Corporation acquired Lincoln Bancorp, parent company
of Lincoln Bank, through a merger of Lincoln Bancorp into the Corporation.
Lincoln Bank adds seventeen Indiana banking locations in the Indianapolis area.
The banking locations are in Avon, Bargersville, Brownsburg, Crawfordsville,
Frankfort, Franklin, Greenwood, Mooresville, Morgantown, Nashville, Plainfield
and Trafalgar. Lincoln also has two loan production offices located in Carmel
and Greenwood, Indiana.
On December 31, 2008, the Corporation sold its interest in Indiana Title
Insurance Company, LLC, a full service title insurance agency.
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. Four of 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 Comptroller of the Currency ("OCC") and the Federal
Deposit Insurance Corporation ("FDIC"). Lincoln is an Indiana commercial bank,
subject to examination by the Indiana Department of Financial Institutions
("IDFI") and FDIC. The IDFI and the FDIC regulate or monitor virtually all areas
of the Bank's operations. The banks must undergo regular on-site examinations by
the FDIC and IDFI and must submit periodic reports to the FDIC and the IDFI. The
Corporation plans to merge Lincoln with Central Indiana under the Central
Indiana charter and has applied to the OCC for approval of the merger.
The Banks generate commercial, mortgage, and consumer loans and receive deposits
from customers located primarily in central, north-central and east-central
Indiana and Butler, Franklin and Hamilton counties in Ohio. The addition of
Lincoln adds seventeen locations to central Indiana. 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.
FAIR VALUE MEASUREMENTS
The Corporation used fair value measurements to record fair value adjustments,
to certain assets, and liabilities and to determine fair value disclosures.
Effective January 1, 2008, the Corporation adopted SFAS No. 157 for all
applicable financial and nonfinancial assets and liabilities. The accounting
guidance defines fair value, establishes a framework for measuring fair value
and expands disclosures about fair value measurements. SFAS No. 157 applies only
when other guidance requires or permits assets or liabilities to be measured at
fair value; it does not expand the use of fair value in any new circumstances.
As defined in SFAS No. 157, fair value is the price to sell an asset or transfer
a liability in an orderly transaction between market participants. It represents
an exit price at the measurement date. Market participants are buyers and
sellers, who are independent, knowledgeable, and willing and able to transact in
the principal (or most advantageous) market for the asset or liability being
measured. Current market conditions, including imbalances between supply and
demand, are considered in determining fair value. The Corporation values its
assets and liabilities in the principal market where it sells the particular
asset or transfers the liability with the greatest volume and level of activity.
In the absence of a principal market, the valuation is based on the most
advantageous market for the asset or liability (i.e., the market where the asset
could be sold or the liability transferred at a price that maximized the amount
to be received for the asset for minimizes the amount to be paid to transfer the
liability).
Valuation inputs refer to the assumptions market participants would use in
pricing a given asset or liability. Inputs can be observable or unobservable.
Observable inputs are those assumptions which market participants would use in
pricing the particular asset or liability. These inputs are based on market data
51
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLOIDATED FINANCIALS STATEMENTS (table dollar amounts in thousands, except
share data)
NOTE 1
FAIR VALUE MEASUREMENTS continued
and are obtained from a source independent of the Corporation. Unobservable
inputs are assumptions based on the Corporation's own information or estimate of
assumptions used by market participants in pricing the asset or liability.
Unobservable inputs are based on the best and most current information available
on the measurement date. All inputs, whether observable or unobservable, are
ranked in accordance with a prescribed fair value hierarchy which gives the
highest ranking to quoted prices (unadjusted) in active markets for identical
assets or liabilities (Level 1) and the lowest ranking to unobservable inputs
(Level 3). Fair values for assets or liabilities classified as Level 2 are based
on one or a combination of the following factors: (i) quoted prices for similar
assets; (ii) observable inputs for the asset or liability, such as interest
rates or yield curves; or (iii) inputs derived principally from or corroborated
by observable market data. The level in the fair value hierarchy within which
the fair value measurement in its entirety falls is determined based on the
lowest level input that is significant to the fair value measurement in its
entirety. The Corporation considers an input to be significant if it drives 10
percent or more of the total fair value of a particular asset or liability.
Assets and liabilities are considered to be fair valued on a recurring basis if
fair value is measured regularly (i.e., daily, weekly, monthly or quarterly).
Recurring valuation occurs at a minimum on the measurement date. Assets and
liabilities are considered to be fair valued on a nonrecurring basis if the fair
value measurement of the instrument does not necessarily result in a change in
the amount recorded on the balance sheet. Generally, nonrecurring valuation is
the result of the application of other accounting pronouncements which require
assets or liabilities to be assessed for impairment or recorded at the lower of
cost or fair value. The fair value of assets or liabilities transferred in or
out of Level 3 is measured on the transfer date, with any additional changes in
fair value subsequent to the transfer considered to be realized or unrealized
gains or losses.
A brief description of current accounting practices and current valuation
methodologies are presented below.
HELD TO MATURITY 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.
AVAILABLE FOR SALE SECURITIES are recorded at fair value on a recurring basis.
Fair value measurement is based upon quoted prices when available. If quoted
prices are not available, fair values are measured using independent third-party
pricing services.
Where quoted market prices are available in an active market, securities are
classified within Level 1 of the valuation hierarchy. There are no securities
classified within Level 1 of the hierarchy. If quoted market prices are not
available, then fair values are estimated by using pricing models, quoted prices
of securities with similar characteristics or discounted cash flows. Level 2
securities include treasury securities, agencies, mortgage backs, state and
municipal, corporate obligations, and marketable equity securities. In certain
cases where Level 1 or Level 2 inputs are not available, securities are
classified within Level 3 of the hierarchy and include corporate obligations and
municipal securities.
The Corporation has certain securities that have had a drop in fair market value
as a result of the widening in market spreads that many sectors have experienced
in recent months. Management has determined that most of these securities are
not deemed to be other-than-temporarily impaired as the drop in market value is
a result of illiquidity in the current market rather than poor performance.
Additionally, based on managements analysis, there has not been an adverse
change in future cash flows of the securities. Securities available-for-sale are
carried at fair value with unrealized gains and losses reported separately in
accumulated other comprehensive income, net of tax. As discussed in Note 4
INVESTMENT SECURITIES, two securities were deemed to be other than temporarily
impaired in 2008.
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.
INTEREST RATE SWAP AGREEMENTS are estimated by a third-party using inputs that
are primarily unobservable and cannot be corroborated by observable market data
and, therefore, are classified within Level 3 of the valuation hierarchy.
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
52
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 1
FAIR VALUE MEASUREMENTS continued
due (principal and interest) according to the contractual terms of the loan
agreement. In applying the provisions of SFAS No. 114, the Corporation considers
its investment in one-to-four family residential loans and consumer installment
loans to be homogeneous and therefore excluded from separate identification for
evaluation of impairment. Interest income is accrued on the principal balances
of loans, except for installment loans with add-on interest, for which a method
that approximates the level yield method is used. The accrual of interest on
impaired loans is discontinued when, in management's opinion, the borrower may
be unable to meet payments as they become due. When interest accrual is
discontinued, all unpaid accrued interest is reversed when considered
uncollectable. Interest income is subsequently recognized only to the extent
cash payments are received. Certain loan fees and direct costs are being
deferred and amortized as an adjustment of yield on the loans.
Impaired loans are carried at the present value of estimated future cash flows
using the loan's existing rate, or the fair value of collateral if the loan is
collateral dependent. A portion of the allowance for loan losses is allocated to
impaired loans if the value of such loans is deemed to be less than the unpaid
balance. If these allocations cause the allowance for loan losses to increase,
such increase is reported as a component of the provision for loan losses. Loan
losses are charged against the allowance when management believes the
uncollectability of the loan is confirmed. The valuation would be considered
Level 3, consisting of appraisals of underlying collateral and discounted cash
flow analysis.
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.
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 is 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 ranging from three to forty
years. 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.
53
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 1
FAIR VALUE MEASUREMENTS continued
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
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.
The Corporation offers interest rate derivative products (e.g. interest rate
swaps) to certain of its high-quality commercial borrowers. This product allows
customers to enter into an agreement with the Corporation to swap their variable
rate loan to a fixed rate. These derivative products are designed to reduce,
eliminate or modify the risk of changes in the borrower's interest rate or
market price risk. The extension of credit incurred through the execution of
these derivative products is subject to the same approvals and rigorous
underwriting standards as the related traditional credit product. The
Corporation limits its risk exposure to these products by entering into a
mirror-image, offsetting swap agreement with a separate, well-capitalized and
rated counterparty previously approved by the Credit and Asset Liability
Committee. By using these interest rate swap arrangements, the Corporation is
also better insulated from the interest rate risk associated with underwriting
fixed-rate loans. These derivative contracts are not designated against specific
assets or liabilities under SFAS No. 133 and, therefore, do not qualify for
hedge accounting. The derivatives are recorded on the balance sheet at fair
value and changes in fair value of both the customer and the offsetting swaps
agreements are recorded (and essentially offset) in non-interest income. The
fair value of the derivative instruments incorporates a consideration of credit
risk (in accordance with SFAS No. 157), resulting in some volatility in earnings
each period.
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.
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 prior financial statements to
conform to the current financial statement presentation. These reclassifications
had no effect on net income.
Current Economic Conditions
The current economic environment presents financial institutions with
unprecedented circumstances and challenges that in some cases have resulted in
large declines in the fair values of investments and other assets, constraints
on liquidity and significant credit quality problems, including severe
volatility in the valuation of real estate and other collateral supporting
loans. The financial statements have been prepared using values and information
currently available to the Corporation.
Given the volatility of current economic conditions, the values of assets and
liabilities recorded in the financial statements could change rapidly, resulting
in material future adjustments in asset values, the allowance for loan losses,
capital that could negatively impact the Corporation's ability to meet
regulatory capital requirements and maintain sufficient liquidity.
54
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 2
BUSINESS COMBINATIONS
On December 31, 2008, the Corporation acquired 100 percent of the outstanding
shares of Lincoln Bancorp, the holding company of Lincoln Bank. Lincoln Bank is
a state chartered bank headquartered in Plainfield, Indiana. Lincoln Bancorp was
merged into the Corporation and Lincoln Bank maintained its state charter as a
wholly owned subsidiary of the Corporation. Lincoln Bank has seventeen banking
centers in Brown, Clinton, Hamilton, Hendricks, Johnson, Montgomery and Morgan
counties in Indiana. As a result of this acquisition,
the Corporation will have the opportunity to increase its customer base and
continue to increase its market share in the Indianapolis area.
The aggregate purchase price was $77.3 million comprised of $16.8 million in
cash, $60.1 million in stock issued and $.4 million in legal and audit fees
related to the acquisition. The purchase price resulted in approximately $19.8
million in goodwill and $12.5 million in core deposit intangible. The core
deposit intangible asset is being amortized over ten years, using an accelerated
method. Goodwill will not be amortized but will instead be evaluated at least
annually for impairment.
The following table summarizes the estimated fair value of assets acquired and
liabilities assumed at the date of acquisition.
=================================================================
(Dollars in Thousands) December 31,
=================================================================
2008
----------
Cash............................................. $ 7,177
Interest bearing time deposits................... 24,608
Investment securities............................ 122,093
Mortgage loans held for sale..................... 2,219
Loans, net of allowance for loan losses of $8,679 626,058
Premises and equipment........................... 15,624
Federal Home Loan Bank stock..................... 8,808
Interest receivable.............................. 3,465
Core Deposit Intangible.......................... 12,461
Goodwill......................................... 19,813
Cash Surrender value of life insurance........... 21,903
Other real estate owned.......................... 3,017
Other assets..................................... 11,788
----------
Total assets acquired.................. $ 879,034
----------
Deposits......................................... $ 653,157
Securities sold under repurchase agreements...... 15,300
FHLB advances.................................... 121,367
Interest payable................................. 1,736
Other liabilities................................ 10,184
----------
Total liabilities....................... 801,744
----------
Net assets acquired............ $ 77,290
==========
The following table presents pro forma information for the periods ended
December 31, 2008 as if the acquisitions had occurred at the beginning of 2008
and 2007. The pro forma financial information is not indicative of the results
of operations had the transaction been effected on the assumed dates and is not
intended to be a projection of future results.
===================================================================================
(Dollars in Thousands except per share data) December 31,
===================================================================================
2008 2007
---------- --------
Net Interest Income.............................. $ 106,495 $ 134,906
Net Income (loss)................................ $ (13,638) $ 33,387
Per share - combined:
Basic net income....................... $ (5.20) $ 2.08
Diluted net income..................... $ (5.20) $ 2.07
On April 1, 2008, the Corporation acquired Patishall Insurance Agency, Inc.
("Patishall"), which was merged into First Merchants Insurance Services, Inc., a
wholly owned subsidiary of the Corporation. The Corporation issued approximately
51,302 shares of its common stock at a cost of $28.513 per share to complete the
transaction. This transaction was deemed to be an immaterial acquisition.
55
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 2
BUSINESS COMBINATIONS continued
Purchased Loans subject to SOP 03-3
The American Institute of Public Accountants Statement of Position 03-3,
"Accounting for Certain Loans or Debt Securities Acquired in a Transfer" ("SOP
03-3") addresses accounting for differences between contractual cash flows of
certain loans and debt securities and the cash flows expected to be collected
when loans or debt securities are acquired in a transfer and those cash flow
differences are attributable, at least in part, to credit quality. As such, SOP
03-3 applies to loans and debt securities acquired individually, in pools, or as
a part of a business combination. It is not applicable to loans originated by
the lender. The application of SOP 03-3 limits interest income, including
accretion of purchase price discounts that may be recognized for certain loans
and debt securities. Additionally, SOP-3 does not allow the excess of
contractual cash flows over cash flows expected to be collected to be recognized
as an adjustment of yield, loss accrual or valuation allowance, such as the
allowance for possible loan losses. SOP 03-3 requires that increases in expected
cash flows subsequent to the initial investment be recognized prospectively
through adjustment of the yield on the loan or debt security over it's remaining
life. Decreases in expected cash flows should be recognized as impairment.
The Corporation has purchased loans on December 31, 2008, for which there was,
at acquisition, evidence of deterioration of credit quality since origination
and it was probable, at acquisition, that all contractually required payments
would not be collected. The carrying amount of these loans was reduced by
$2,003,000. The carrying amount of these loans is as follows as of December 31,
2008:
===============================================================
(Dollars in Thousands except per share data) December 31,
===============================================================
2008
---------
Commercial real estate $ 10,320
---------
Outstanding Balance 10,320
---------
Carrying amount, net of allowance $ 8,317
=========
These loans were considered impaired at December 31, 2008 and no accretable
yield was assigned at the date of 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, 2008, was
$17,275,000.
NOTE 4
INVESTMENT SECURITIES
The Corporation's management has evaluated all securities with unrealized losses
for other than temporary impairment as of December 31, 2008. The evaluations are
based on the nature of the securities, the extent and duration of the loss and
the intent and ability of the Corporation to hold these securities either to
maturity or through the expected recovery period.
The current unrealized losses are primarily concentrated within trust preferred
securities held by the Corporation. The Corporation holds ten trust preferred
pool securities and four single issuer securities. Such investments have a book
value of $18.8 million and a fair value of $9.8, which is only 2 percent of the
Corporation's entire investment portfolio. On all but one small pool investment,
the Corporation utilizes broker quotes to determine their fair value.
The Corporation utilizes a third party for portfolio accounting services,
including market value input. The Corporation has obtained an understanding of
what inputs are being used by the vendor in pricing our portfolio and how the
vendor was classifying these securities based upon these inputs. From these
discussions, the Corporation's management is comfortable the classifications are
proper. The Corporation has gained trust in the data for two reasons: (a)
independent spot testing of the data is conducted by the Corporation through
obtaining market quotes from various brokers on a periodic basis and (b) actual
gains or loss resulting from the sale of certain securities has proven the data
to be accurate over time.
56
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 4
INVESTMENT SECURITIES continued
The fair values of the investments have been impacted by the recent market
conditions which have caused risk and liquidity premiums to increase resulting
in a significant decline in the fair value of the Corporation's trust preferred
securities, or the value the Corporation could realize if it were forced to
immediately sell the securities into the secondary market. Management has
determined that (a) the drop in market value is a result of illiquidity in the
current market rather than poor performance, and (b) there has not been an
adverse change in future cash flows of the securities.
The Corporation has the intent and ability to hold these, and all other,
investment securities until the fair value is recovered, which may be maturity,
and therefore, does not consider them, with one exception, to be
other-than-temporarily impaired at December 31, 2008. The one exception is a
smaller trust preferred pool that has been deemed other than temporarily
impaired, due to a higher rate of defaults and deferrals from the underlying
banks in the pool. A $1.2 million loss was included in the earnings for 2008
establishing a new cost basis of $770,000.
During 2008, the Corporation owned shares of a series of preferred stock issued
by the Federal Home Loan Mortgage Corporation ("FHLMC"). On September 7, 2008,
the Federal Housing Finance Agency ("FHFA") was appointed as conservator of
FHLMC, and the U.S. Treasury Department disclosed that it had entered into a
Senior Preferred Stock Purchase Agreement with FHLMC, contemplating an
investment of up to $100 billion. The senior preferred stock has a liquidation
preference senior to all FHLMC stock, including the series of preferred stock
held by the Corporation. In addition, the terms of the senior preferred stock
prohibit FHLMC from declaring or paying any dividend or making any other
distribution with respect to any stock other than the senior preferred stock
without the consent of the U.S. Treasury Department. In connection with the
appointment of the FHFA as conservator, the FHFA announced that it was
eliminating the payment of all future dividends on all FHLMC stock, including
dividends on the series of preferred stock that the Corporation owns. After
assessing these events, during the third quarter of 2008, the
Corporation recorded an other-than-temporary impairment write-down of $1,458,000
related to its investments in the preferred securities issued by FHLMC. The
investment was sold during the fourth quarter of 2008 triggering an additional
$47,000 loss.
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, 2008
U.S. Government-sponsored Agency Securities.. $ 15,451 $ 218 $ 15,669
State and Municipal ......................... 156,426 3,220 $ 107 159,539
Mortgage-backed Securities .................. 265,820 4,472 215 270,077
Corporate Obligations........ ............... 19,822 8,978 10,844
Marketable Equity Securities ................ 3,507 3,507
-------- -------- -------- --------
Total Available for Sale ................. 461,026 7,910 9,300 459,636
-------- -------- -------- --------
Held to Maturity at December 31, 2008
U.S. Treasury ............................... 11,675 1 11,674
State and Municipal ......................... 10,666 93 264 10,495
Mortgage-backed Securities .................. 7 7
-------- -------- -------- --------
Total Held to Maturity ................... 22,348 93 265 22,176
-------- -------- -------- --------
Total Investment Securities .............. $483,374 $ 8,003 $ 9,565 $481,812
======== ======== ======== ========
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
======== ======== ======== ========
57
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 4
INVESTMENT SECURITIES continued
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 $69,909,000 and $214,293,000 at December 31, 2008 and 2007,
respectively. Total fair value of these investments was $60,343,000 and
$210,391,000, which is approximately 12.5 and 46.6 percent of the Corporation's
available-for-sale and held-to-maturity investment portfolio at December 31,
2008 and 2007, respectively.
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.
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,
2008 and 2007:
====================================================================================================================================
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, 2008:
U.S. Treasury........................ ..................... $ 11,374 $ (1) $ 11,374 $ (1)
U.S. Government-sponsored Agency Securities ...............
State and Municipal ....................................... 10,274 (124) $ 3,582 $ (247) 13,856 (371)
Mortgage-backed Securities ................................ 13,315 (47) 11,755 (168) 25,070 (215)
Corporate Obligations ..................................... 7,302 (69) 2,741 (8,909) 10,043 (8,978)
Marketable Equity Securities ..............................
-------- ------- -------- ------- -------- --------
Total Temporarily Impaired Investment Securities ....... $ 42,265 $ (241) $ 18,078 $(9,324) $ 60,343 $ (9,565)
======== ======= ======== ======= ======== ========
---------------------------------------------------------------------
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, 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)
======== ======= ======== ======= ======== ========
The amortized cost and fair value of securities available for sale and held to
maturity at December 31, 2008 by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
===================================================================================================================================
AVAILABLE FOR SALE HELD TO MATURITY
AMORTIZED COST FAIR VALUE AMORTIZED COST FAIR VALUE
===================================================================================================================================
Maturity Distribution at December 31, 2008:
Due in One Year or Less.......................................... $ 30,737 $ 30,946 $ 13,131 $ 13,130
Due After One Through Five Years................................. 75,159 76,377 435 441
Due After Five Through Ten Years................................. 34,700 35,318 3,990 3,767
Due After Ten Years ............................................. 51,103 43,411 4,785 4,831
-------- -------- -------- --------
$191,699 $186,052 $ 22,341 $ 22,169
Mortgage-backed Securities....................................... 265,820 270,077 7 7
Marketable Equity Securities .................................... 3,507 3,507
-------- -------- -------- --------
Totals......................................................... $461,026 $459,636 $ 22,348 $ 22,176
======== ======== ======== ========
58
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 4
INVESTMENT SECURITIES continued
Securities with a carrying value of approximately $281,925,000, $191,470,000 and
143,652,000 were pledged at December 31, 2008, 2007 and 2006, 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 2008, 2007 and 2006
were $60,335,000, $7,219,000 and $575,000, respectively. Gross gains of
$653,000, $0 and $0 in 2008, 2007 and 2006, and gross losses of $54,000, $0 and
$4,000 in 2008, 2007 and 2006, were realized on those sales.
NOTE 5
LOANS AND ALLOWANCE
2008 2007
=============================
Loans at December 31:
Commercial and Industrial Loans.............. $ 904,646 $ 662,701
Agricultural Production
Financing and Other Loans to Farmers....... 135,099 114,324
Real Estate Loans:
Construction............................... 252,487 165,425
Commercial and Farmland.................... 1,202,372 947,234
Residential................................ 956,245 744,627
Individuals' Loans for
Household and Other Personal Expenditures.. 201,632 187,880
Tax-exempt Loans............................. 28,070 16,423
Lease Financing Receivables,
Net of Unearned Income .................... 8,996 8,351
Other Loans.................................. 32,405 29,878
---------- ----------
3,721,952 2,876,843
Allowance for Loan Losses................... (49,543) (28,228)
---------- ----------
Total Loans........................ $3,672,409 $2,848,615
========== ==========
Residential Real Estate Loans Held for Sale at December 31, 2008 and 2007 were
$4,295,000 and $3,735,000, respectively.
2008 2007 2006
==============================================
Allowance for Loan Losses
Balance, January 1 ......................... $ 28,228 $ 26,540 $ 25,188
Provision for Losses ....................... 28,238 8,507 6,258
Recoveries on Loans ........................ 7,024 1,738 1,604
Loans Charged Off .......................... (22,626) (8,557) (6,510)
Allowance Acquired in Acquisition........... 8,679
--------- ---------- -----------
Balance, December 31 ....................... $ 49,543 $ 28,228 $ 26,540
========= ========== ===========
Information on nonaccruing, contractually past due 90 days or more other than
nonaccruing and restructured loans is summarized below:
2008 2007
============================
Non-accrual Loans......................... $ 87,546 $ 29,031
Loans Contractually Past Due 90
Days or More Other Than Nonaccruing..... 5,982 3,578
Restructured Loans........................ 130 145
-------- --------
Total Non-performing Loans........... $ 93,658 $ 32,754
======== =========
59
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 5
LOANS AND ALLOWANCE continued
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 classified loans, including substandard, doubtful and loss
credits, are included in the impaired loan total. The fair value for impaired
loans is measured based on the value of the collateral securing those loans and
is determined using several methods. The fair value of real estate is generally
determined based on appraisals by qualified licensed appraisers. The appraisers
typically determine the value of the real estate by utilizing an income or
market valuation approach. If an appraisal is not available, the fair value may
be determined by using a cash flow analysis. Fair value on other collateral such
as business assets is typically valued by using the financial information such
as financial statements and aging reports provided by the borrower and is
discounted as considered appropriate. Information on impaired loans is
summarized below:
Information on impaired loans is summarized below:
2008 2007 2006
=====================================================================================================================
As of, and for the Year Ending December 31:
Impaired Loans with an Allowance .......................... $ 25,397 $ 21,304 $ 17,291
Impaired Loans for which the Discounted
Cash Flows or Collateral Value Exceeds the
Carrying Value of the Loan ............................ 180,729 65,645 43,029
-------- ------- --------
Total Impaired Loans ............................... $206,126 $86,949 $ 60,320
======== ======= ========
Total Impaired Loans as a Percent
of Total Loans ........................................ 5.53% 3.02% 2.24%
Allowance for Impaired Loans (Included in the
Corporation's Allowance for Loan Losses) .............. $ 9,790 $ 6,034 $ 4,130
Average Balance of Impaired Loans ......................... 229,608 103,272 66,139
Interest Income Recognized on Impaired Loans .............. 8,078 6,675 5,143
Cash Basis Interest Included Above ........................ 997 1,143 1,364
NOTE 6
PREMISES AND EQUIPMENT
2008 2007
================================================================================
Cost at December 31:
Land .......................................... $ 14,839 $ 7,993
Buildings and Leasehold Improvements .......... 61,295 47,853
Equipment ..................................... 49,817 40,455
-------- --------
Total Cost ................................ 125,951 96,301
Accumulated Depreciation and Amortization ..... (66,310) (51,856)
-------- --------
Net ....................................... $ 59,641 $ 44,445
======== ========
The Corporation is committed under various noncancelable lease contracts for
certain subsidiary office facilities and equipment. Total lease expense for
2008, 2007 and 2006 was $2,213,000, $2,477,000 and $2,651,000, respectively. The
future minimum rental commitments required under the operating leases in effect
at December 31, 2008, expiring at various dates through the year 2016 are as
follows for the years ending December 31:
====================================================
2009 ................................ $ 2,010
2010 ................................ 1,844
2011 ................................ 1,647
2012 ................................ 1,104
2013 ................................ 461
After 2013 ........................... 677
-------
Total Future Minimum Obligations $ 7,743
=======
60
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 7
GOODWILL
The changes in the carrying amount of goodwill at December 31 are noted below.
During 2008, the Corporation purchased Lincoln Bancorp and Patishall, as
discussed in Note 2, Business Combinations. These purchases resulted in acquired
Goodwill of approximately $19,813,000 for Lincoln and $1,415,000 for Patishall.
Also, on December 31, 2008, the Corporation sold its interest in the assets of
Indiana Title Insurance Company, LLC (ITIC). This sale resulted in a write-off
of Goodwill of approximately $1,190,000. No impairment loss was recorded in 2008
and 2007.
2008 2007
=============================================================================
Balance, January 1 .............................. $ 123,444 $ 123,168
Goodwill acquired ............................... 21,228 276
Write-off from sale of subsidiary assets (1,190)
--------- ---------
Balance, December 31 ............................ $ 143,482 $ 123,444
========= =========
NOTE 8
CORE DEPOSIT AND OTHER INTANGIBLES
The carrying basis and accumulated amortization of recognized core deposit and
other intangibles are noted below. On December 31, 2008, the Corporation
purchased Lincoln Bancorp and Patishall, as discussed in Note 2, Business
Combinations. This purchase resulted in acquired core deposit intangibles of
$12,461,000 for Lincoln and other intangibles for Patishall of $$835,000.
2008 2007
=============================================================================
Gross Carrying Amount ........................... $ 45,422 $ 32,126
Accumulated Amortization ........................ (22,930) (19,714)
--------- ---------
Core Deposit and Other Intangibles ........... $ 22,492 $ 12,412
========= =========
Amortization expense for the years ended December 31, 2008, 2007 and 2006, was
$3,216,000, $3,159,000 and $3,066,000, respectively. Estimated amortization
expense for each of the following five years is:
====================================================
2009 ................................ $ 5,109
2010 ................................ 4,721
2011 ................................ 3,548
2012 ................................ 1,858
2013 ................................ 1,441
After 2013 .......................... 5,815
------
$22,492
=======
NOTE 9
DEPOSITS
2008 2007
============================================================================
Deposits at December 31:
Demand Deposits ............................. $1,136,267 $ 903,380
Savings Deposits ............................ 721,387 552,380
Certificates and Other Time Deposits
of $100,000 or more ....................... 546,081 495,630
Other Certificates and Time Deposits ........ 1,315,076 892,731
---------- ----------
Total Deposits .......................... $3,718,811 $2,844,121
========== ==========
=====================================================
Certificates and Other Time Deposits Maturing
in Years Ending December 31:
2009 ....................... $1,187,569
2010 ....................... 373,533
2011 ....................... 200,841
2012 ....................... 55,779
2013 ....................... 28,943
After 2013 ................. 14,492
----------
$1,861,157
==========
61
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 9
DEPOSITS continued
Time deposits obtained through brokers were $477,283,000 and $239,019,000 at
December 31, 2008 and 2007, respectively.
NOTE 10
BORROWINGS
2008 2007
================================================================================
Borrowings at December 31:
Federal Funds Purchased ........................... $ 52,350
Securities Sold Under Repurchase Agreements ....... $122,311 106,497
Federal Home Loan Bank Advances ................... 360,217 294,101
Subordinated Debentures, Revolving Credit
Lines and Term Loans ............................ 135,826 115,826
-------- --------
Total Borrowings .............................. $618,354 $568,774
======== ========
Securities sold under repurchase agreements consist of obligations of the Banks
to other parties. The obligations are secured by U.S. Treasury and U.S.
Government Sponsored Enterprise obligations. The maximum amount of outstanding
agreements at any month-end during 2008 and 2007 totaled $122,311,000 and
$128,023,000, respectively, and the average of such agreements totaled
$99,840,000 and $85,853,000 during 2008 and 2007, 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, 2008, 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:
2009 .............. $ 88,061 $137,015 $ 20,000
2010 .............. 10,000 86,183
2011 .............. 32,163
2012 .............. 14,250 72,097
2013 .............. 7,756
After 2013 ........ 10,000 25,003 115,826
-------- -------- --------
Total ...... $122,311 $360,217 $135,826
======== ======== ========
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 0.39 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,
2008, was $95,214,000.
Subordinated Debentures, Revolving Credit Lines and Term Loans. Three borrowings
were outstanding on December 31, 2008, for $135,826,000.
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 Board of Governors of the Federal
Reserve System, 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.
62
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
Note 10
BORROWINGS continued
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.
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 February 15, 2008. The LaSalle Agreement
includes three credit facilities:
o The Term Loan of $5,000,000 matures on February 15, 2015. 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 and Lafayette. 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 $20,000,000 at December 31, 2008.
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 February 15, 2009. 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
and Lafayette. 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. At December 31, 2008, the
Corporation was in violation of capital and earnings covenants with
LaSalle on this Revolving Loan. The covenant requires the Corporation
to exceed a minimum return on average assets of 75 basis points over
the most recent four quarter period. The Corporation was not provided
a loan covenant waiver as LaSalle is currently in the process of
renewing the Revolving Loan Agreement. LaSalle required the
Corporation to pay down the outstanding balance by $10 million in
order to renew the agreement. Accordingly, on February 20, 2009, the
Corporation reduced the outstanding balance to $10 million and has the
ability to further reduce the outstanding balance to zero. When
renewed, the Corporation will have a reduced borrowing capacity on
this Revolving Loan of $10 million.
o The Subordinated Debenture of $50,000,000 matures on February 15,
2015. 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.
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 Board of Governors of the Federal
Reserve System, 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.
63
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS 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.
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 $231,548,000
$115,618,000 and $98,538,000 at December 31, 2008, 2007 and 2006, respectively,
the amount of capitalized servicing assets is considered immaterial.
NOTE 12
INCOME TAX
2008 2007 2006
=================================================================================================================================
Income Tax Expense for the Year Ended December 31:
Currently Payable:
Federal ................................................................ $ 16,533 $ 13,343 $ 13,192
State .................................................................. 216 162 1,415
Deferred:
Federal ................................................................ (8,450) (1,664) (1,785)
State .................................................................. (216) (498) (627)
-------- -------- --------
Total Income Tax Expense ............................................ $ 8,083 $ 11,343 $ 12,195
======== ======== ========
Reconciliation of Federal Statutory to Actual Tax Expense:
Federal Statutory Income Tax at 35% .................................... $ 10,052 $ 15,043 $ 14,837
Tax-exempt Interest .................................................... (2,226) (2,259) (2,215)
Effect of State Income Taxes ........................................... (220) 475
Earnings on Life Insurance ............................................. 300 (1,064) (594)
Tax Credits ............................................................ (177) (348) (391)
Other .................................................................. 134 191 83
-------- -------- --------
Actual Tax Expense ................................................. $ 8,083 $ 11,343 $ 12,195
======== ======== ========
Tax expense (benefit) applicable to security gains and losses, including
unrealized losses relating to other than temporary impairment charges, for the
years ended December 31, 2008, 2007 and 2006, was $(833,000), $0 and $(2,000),
respectively.
64
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS 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:
2008 2007
======================================================================================================================
Deferred Tax Asset at December 31:
Assets:
Differences in Accounting for Loan Losses ............................. $20,946 $11,086
Differences in Accounting for Loan Fees ............................... 386
Deferred Compensation ................................................. 6,564 3,841
Difference in Accounting for Pensions
and Other Employee Benefits ......................................... 4,207 3,071
Federal Income Tax Loss Carryforward and Credits ...................... 3,706
State Income Tax ...................................................... 156
Net Unrealized Loss on Securities Available for Sale................... 2,688
Other ................................................................. 814 322
------- -------
Total Assets ...................................................... 39,311 18,476
------- -------
Liabilities:
Differences in Depreciation Methods ................................... 4,053 3,508
Differences in Accounting for Loans and Securities .................... 2,822 3,889
Differences in Accounting for Loan Fees ............................... 399
State Income Tax ...................................................... 332
Net Unrealized Gain on Securities Available for Sale................... 220
Other ................................................................. 3,711 2,344
------- -------
Total Liabilities ................................................. 10,918 10,360
------- -------
Net Deferred Tax Asset ............................................ $28,393 $ 8,116
======= =======
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:
2008 2007
======== ========
Commitments
to Extend Credit $794,240 $747,070
Standby Letters
of Credit 31,194 25,431
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.
65
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS 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, 2008, available for 2009 dividends from First
Merchants, Central Indiana, Lafayette, Commerce National, Lincoln, FMTC and FMIS
to the Corporation totaled $20,235,000, $1,115,000, $0, $10,678,000, $0,
$294,000 and $10,534,000, respectively.
Total stockholders' equity for all subsidiaries at December 31, 2008, was
$527,166,000 of which $484,698,000 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, 2008, 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 four of the Corporation's
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.
As of December 31, 2008, four of the five bank subsidiaries of the Corporation
were "well capitalized" based on the "prompt corrective action" ratios and
deadlines described above. Lincoln was not considered well capitalized at
December 31, 2008. However, on February 20, 2009, the Corporation added $30
million in capital to Lincoln, which returned them to well capitalized status.
It should be noted 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.
66
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 15
REGULATORY CAPITAL continued
Actual and required capital amounts and ratios are listed below.
=================================================================================================================================
2008 2007
REQUIRED FOR REQUIRED FOR
ACTUAL ADEQUATE CAPITAL(1) ACTUAL ADEQUATE CAPITAL(1)
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
=================================================================================================================================
December 31
Total Capital(1) (to Risk-weighted Assets)
Consolidated ...................... $385,452 10.24% $313,423 8.00% $312,080 10.55% $236,636 8.00%
First Merchants ................... 181,281 10.52 137,842 8.00 169,678 11.07 122,567 8.00
Central Indiana.................... 28,830 11.42 20,205 8.00 29,268 11.72 19,984 8.00
Lincoln.... ...... ................ 56,010 7.86 57,012 8.00
Lafayette ......................... 84,568 12.94 55,306 8.00 79,692 11.46 55,646 8.00
Commerce National ................. 57,367 10.58 43,385 8.00 52,353 10.76 38,922 8.00
Tier I Capital(1) (to Risk-weighted Assets)
Consolidated ...................... $286,473 7.71% $156,711 4.00% $258,918 8.75% $118,318 4.00%
First Merchants ................... 159,767 9.27 68,921 4.00 154,624 10.09 61,284 4.00
Central Indiana.................... 26,089 10.33 10,102 4.00 26,669 10.68 9,992 4.00
Lincoln.... ...... ................ 47,975 6.64 28,506 4.00
Lafayette ......................... 75,920 11.69 27,653 4.00 73,437 10.56 27,823 4.00
Commerce National ................. 51,884 9.57 21,692 4.00 48,099 9.89 19,461 4.00
Tier I Capital(1) (to Average Assets)
Consolidated ...................... $286,473 8.16% $148,164 4.00% $258,918 7.19% $144,000 4.00%
First Merchants ................... 159,767 8.05 79,366 4.00 154,624 8.10 76,293 4.00
Central Indiana.................... 26,089 8.41 12,401 4.00 26,669 8.91 11,966 4.00
Lincoln.... ...... ................ 47,975 5.90 32,071 4.00
Lafayette ......................... 75,920 9.28 34,834 4.00 73,437 8.01 36,669 4.00
Commerce National ................. 51,884 8.51 24,379 4.00 48,099 9.11 21,119 4.00
(1) As defined by regulatory agencies
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 and, therefore, any unvested shares are
forfeited. Deferred stock units ("DSUs") have been credited to non-employee
directors who have elected to defer payment of compensation under the
Corporation's 2008 Equity Compensation plan for Non-employee Directors. DSUs
credited are equal to the restricted shares that the non-employee directors
would have received under the plan. As of December 31, 2008, there were 1,620
DSUs credited to the non-employee directors.
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 No. 123(R) requires the Corporation to record compensation expense related
to unvested share-based awards by recognizing the unamortized 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 are valued at
fair value in accordance with provisions of SFAS No. 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 compensation for the years ended December 31, 2008, 2007 and 2006
totaled $1,898,000, $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.
67
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 16
SHARE-BASED COMPENSATION continued
The estimated fair value of the stock options granted during 2008, 2007, and
2006 was calculated using a Black Scholes options pricing model. The following
summarizes the assumptions used in the Black Scholes model:
2008 2007 2006
---- ---- ----
Risk-free Interest Rate ................................. 2.69% 4.67% 4.59%
Expected Price Volatility ............................... 32.13% 29.76% 29.84%
Dividend Yield .......................................... 3.68% 3.64% 3.54%
Forfeiture Rate ......................................... 5.00% 5.00% 4.00%
Weighted-average Expected Life, Until Exercise .......... 6.53 years 5.99 years 5.75 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 No. 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, 2008,
based on historical experience.
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 Year Ended
December 31, 2008 December 31, 2007 December 31, 2006
----------------- ----------------- -----------------
Stock and ESPP Options:
Pre-tax Compensation Expense ...................... $ 650 $ 602 $ 449
Income Tax Benefit ................................ (49) (41) (42)
---------------- ---------------- ----------------
Stock and ESPP Options Expense, Net of Income........ $ 601 $ 561 $ 407
================ ================ ================
Restricted Stock Awards:
Pre-tax Compensation Expense ...................... $ 1,248 $ 866 $ 384
Income Tax Benefit ................................ (437) (303) (135)
---------------- ---------------- ----------------
Restricted Stock Awards Expense, Net of Tax ......... $ 811 $ 563 $ 249
================ ================ ================
Total Share-based Compensation:
Pre-tax Compensation Expense ...................... $ 1,898 $ 1,468 $ 833
Income Tax Benefit ................................ (486) (344) (177)
---------------- ---------------- ----------------
Total Share-based Compensation Expense, Net of Tax... $ 1,412 $ 1,124 $ 656
================ ================ ================
As of December 31, 2008, unrecognized compensation expense related to stock
options, RSAs and ESPP options totaling $259,000, $1,681,000 and $119,000,
respectively, is expected to be recognized over weighted-average periods of .67,
1.31 and .5 years, respectively.
68
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 16
SHARE-BASED COMPENSATION continued
Stock option activity under the Corporation's stock option plans as of December
31, 2008 and changes during the year ended December 31, 2008 were as follows:
Weighted-
Average
Weighted- Remaining
Number Average Contractual Aggregate
of Exercise Term Intrinsic
Shares Price (in Years) Value
---------- ------------ ----------- ----------
Outstanding at January 1, 2008 .................. 1,054,430 $ 24.30
Granted ......................................... 82,713 26.76
Exercised ....................................... (124,896) 22.70
Cancelled ....................................... (60,925) 24.77
----------
Outstanding at December 31, 2008 ................ 951,322 $ 24.70 5.30 $533,634
==========
Vested and Expected to Vest at December 31, 2008. 951,322 $ 24.70 5.30 $533,634
Exercisable at December 31, 2008 ................ 809,159 $ 24.36 4.70 $496,772
The weighted-average grant date fair value was $6.08, $5.85 and $6.22 for stock
options granted during the year ended December 31, 2008, 2007 and 2006,
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 2008 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
2008. 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, 2008, 2007 and 2006 were $615,000, $250,185 and $665,000,
respectively. Exercise of options during these same periods resulted in cash
receipts of $1,633,000, $496,000 and $1,228,000, respectively. The Corporation
recognized a tax benefit of approximately $156,000 for the year ended December
31, 2008, related to the exercise of employee stock options and has been
recorded as an increase to additional paid-in capital.
The following table summarizes information on unvested restricted stock awards
outstanding as of December 31, 2008:
Number of Grant-Date
Shares Fair Value
---------- ----------
Unvested RSAs at January 1, 2008 ........... 98,027 $ 27.12
Granted .................................... 69,899 26.94
Forfeited .................................. (2,719) 24.54
Vested ..................................... (2,713) 24.82
------- --------
Unvested RSAs at December 31, 2008 ......... 162,494 $ 26.20
======= ========
The grant date fair value of ESPP options was estimated at the beginning of the
July 1, 2008 offering period and approximates $240,000. The ESPP options vest
during the twelve-month period ending June 30, 2009. At December 31, 2008, total
unrecognized compensation expense related to unvested ESPP options was $120,000,
which is expected to be recognized over a six-month period ending June 30, 2009.
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 Corporation also 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.
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
69
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 17
PENSION AND OTHER POST RETIREMENT BENEFIT PLANS continued
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, "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 table below sets forth the plans' funded status and amounts recognized in
the consolidated balance sheet at December 31, using measurement dates of
December 31, 2008 and September 30, 2007.
December 31
2008 2007
===================================================================================
Change in benefit obligation
Benefit obligation at beginning of year ............ $ 57,500 $ 58,078
Service cost ....................................... 1,852 671
Interest cost....................................... 2,032 3,146
Actuarial (gain)/loss .............................. 493 (1,640)
Adjustment due to measurement date change .......... 546
Benefits paid....................................... (3,548) (2,755)
-------- --------
Benefit obligation at end of year .................. 58,875 57,500
-------- --------
Change in plan assets
Fair value of plan assets at beginning of year...... 46,252 41,591
Actual return on plan assets........................ (13,768) 6,563
Expected return on plan assets ..................... 2,134
Employer Contributions.............................. 15,911 853
Adjustment due to measurement date change .......... 533
Benefits Paid....................................... (3,548) (2,755)
-------- --------
End of Year ........................................ 47,514 46,252
-------- --------
Unfunded Status at End of Year........................... $ 11,361 $ 11,248
======== ========
Assets and Liabilities Recognized in the Balance Sheets:
Deferred Tax Assets................................. $ 9,107 $ 2,804
Liabilities ........................................ $ 11,361 $ 11,248
Amounts Recognized in Accumulated Other Comprehensive Income Not Yet
Recognized as Components of Net Periodic Benefit Cost Consist of:
Accumulated loss.................................... $ 13,559 $ 4,089
Prior Service (Cost) Credit......................... (101) 118
-------- --------
$ 13,660 $ 4,207
======== ========
The accumulated benefit obligation for all defined benefit plans was $58,437,000
and $56,739,000 at December 31, 2008 and 2007, respectively.
Information for pension plans with an accumulated benefit obligation in excess
of plan assets:
December 31
2008 2007
===================================================================================
Projected Benefit Obligation........................ $ 58,875 $ 57,500
======== ========
Accumulated Benefit Obligation ..................... $ 58,437 $ 51,770
======== ========
Fair Value of Plan Assets........................... $ 47,514 $ 46,252
======== ========
The following table shows the components of net periodic pension costs. The 2008
column includes gross for the 15-month period due to the measurement date
change:
December 31
2008 2007
===================================================================================
Service Cost ....................................... $ 537 $ 671
Interest Cost....................................... 3,084 3,146
Expected Return on Plan Assets...................... (3,506) (3,164)
Amortization of Prior Service Costs ................ 25 25
Amortization of Net Loss ............. ............. 167 527
-------- --------
Net Periodic Pension Cost........................... $ 307 $ 1,205
======== ========
70
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 17
PENSION AND OTHER POST RETIREMENT BENEFIT PLANS continued
Other changes in plan assets and benefit obligations recognized in other
comprehensive income:
December 31
2008 2007
==============================================================================================
Net Periodic Pension Cost .............................................. $ 307 $ 1,205
Net gain (loss)...................................................... (10,056) 2,725
Prior service cost arising during period ............................ 30
Amortization of prior service (cost) credit.......................... (15) (15)
------- -------
Total Recognized in Other Comprehensive Income....................... (10,071) 2,740
------- -------
Total Recognized in NPPC and OCI ....................................... $(9,764) $ 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:
December 31
2008 2007
================================================================================================
Amortization of Net Loss ................................ $ 1,203 $ 152
Amortization of Prior Service Cost ...................... 25 16
--------- ---------
Total ............................................... $ 1,228 $ 168
========= =========
Significant assumptions include:
December 31
2008 2007
==============================================================================================
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% 7.75%
Rate of Compensation Increase ...................... 3.50% 3.52%
At December 31, 2008 and September 30, 2007, the Corporation based its estimate
of the expected long-term rate of return on analysis of the historical returns
of the plans and current market information available. The plans' investment
strategies are to provide for preservation of capital with an emphasis on
long-term growth without undue exposure to risk. The assets of the plans' are
invested in accordance with the plans' Investment Policy Statement, subject to
strict compliance with ERISA and any other applicable statutes.
The plans' risk management practices include quarterly evaluations of investment
managers, including reviews of compliance with investment manager guidelines and
restrictions; ability to exceed performance objectives; adherence to the
investment philosophy and style; and ability to exceed the performance of other
investment managers. The evaluations are reviewed by management with appropriate
follow-up and actions taken, as deemed necessary. The Investment Policy
Statement generally allows investments in cash and cash equivalents, real
estate, fixed income debt securities and equity securities, and specifically
prohibits investments in derivatives, options, futures, private placements,
short selling, non-marketable securities and purchases of non-investment grade
bonds.
At December 31, 2008, the maturities of the plans' debt securities ranged from
96 days to 9.7 years, with a weighted average maturity of 3.4 years. 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.
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid as of December 31, 2008. The minimum
contribution required in 2009 will likely be zero but the Corporation may decide
to make a discretionary contribution during the year.
===================================================
2009................................ $ 3,078
2010................................ 3,231
2011................................ 3,463
2012................................ 3,663
2013................................ 3,798
2014 and After...................... 19,898
71
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 17
PENSION AND OTHER POST RETIREMENT BENEFIT PLANS continued
Plan assets are re-balanced quarterly. At December 31, 2008 and 2007, plan
assets by category are as follows:
December 31
2008 2007
===========================================================================
Equity Securities ................................ 30% 65%
Debt Securities .................................. 31% 32%
Other ............................................ 39% 3%
-------- --------
100% 100%
======== ========
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 $2,615,000 for 2008, $2,454,000 for 2007 and $2,026,000
for 2006.
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 $4,792,000 and $1,317,000 at December 31, 2008
and 2007, respectively. Post-retirement plan expense totaled $225,000, $171,000
and $127,000 for the years ending December 31, 2008, 2007 and 2006,
respectively.
NOTE 18
NET INCOME PER SHARE
==================================================================================================================================
Year Ended December 31, 2008 2007 2006
- ----------------------------------------------------------------------------------------------------------------------------------
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 .......... $20,638 18,066,404 $1.14 $31,639 18,249,919 $1.73 $30,198 18,383,074 $1.64
===== ===== =====
Effect of Dilutive Stock Options.. 95,477 64,045 83,679
------- ---------- ------- ---------- ------- ----------
Diluted Net Income Per Share:
Net Income Available to
Common Stockholders
and Assumed Conversions ...... $20,638 18,161,881 $1.14 $31,639 18,313,964 $1.73 $30,198 18,466,753 $1.64
======= ========== ===== ======= ========== ===== ======= ========== =====
Options to purchase 797,595, 831,795 and 590,736 shares of common stock with
weighted average exercise prices of $24.70, $25.67 and $26.21 at December 31,
2008, 2007 and 2006, 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
Effective January 1, 2008, the Corporation adopted Statement of Financial
Accounting Standards No. 157, Fair Value Measurements ("FAS 157"). FAS 157
defines fair value, establishes a framework for measuring fair value and expands
disclosures about fair value measurements. FAS 157 has been applied
prospectively as of the beginning of the year.
FAS 157 defines fair value as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. FAS 157 also establishes a fair value
hierarchy which requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value. The standard
describes three levels of inputs that may be used to measure fair value:
72
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 19
FAIR VALUES OF FINANCIAL INSTRUMENTS continued
Level 1 Quoted prices in active markets for identical assets or liabilities
Level 2 Observable inputs other than Level 1 prices, such as quoted prices for
similar assets or liabilities; quoted prices in active markets that are
not active; or other inputs that are observable or can be corroborated
by observable market data for substantially the full term of the assets
or liabilities
Level 3 Unobservable inputs that are supported by little or no market activity
and that are significant to the fair value of the assets or liabilities
Following is a description of the valuation methodologies used for instruments
measured at fair value on a recurring basis and recognized in the accompanying
balance sheet, as well as the general classification of such instruments
pursuant to the valuation hierarchy.
Available-For-Sale Securities: Where quoted market prices are available in an
active market, securities are classified within Level 1 of the valuation
hierarchy. There are no securities classified within Level 1 of the hierarchy.
If quoted market prices are not available, then fair values are estimated by
using pricing models, quoted prices of securities with similar characteristics
or discounted cash flows. Level 2 securities include treasury securities,
agencies, mortgage backs, state and municipal, corporate obligations, and
marketable equity securities. In certain cases where Level 1 or Level 2 inputs
are not available, securities are classified within Level 3 of the hierarchy and
include mortgage-backed securities and corporate obligations.
Interest Rate Swap Agreements: The fair value is estimated by a third party
using inputs that are primarily unobservable and cannot be corroborated by
observable market data and, therefore, are classified within Level 3 of the
valuation hierarchy.
The following table presents the fair value measurements of assets and
liabilities recognized in the accompanying balance sheet measured at fair value
on a recurring basis and the level within the FAS 157 fair value hierarchy in
which the fair value measurements fall at December 31, 2008.
Fair Value Measurements Using
-----------------------------------------------------------------
Quoted Prices in Significant
Active Markets Other Significant
for Identical Observable Unobservable
Assets Inputs Inputs
Fair Value (Level 1) (Level 2) (Level 3)
--------------------------------------------------------------------------------
Available for sale securities........ $ 459,636 $ 451,707 $ 7,929
Hedged loans......................... 57,970 57,970
Interest rate swap agreements........ (4,224) (4,224)
The following is a reconciliation of the beginning and ending balances of
recurring fair value measurements recognized in the accompanying balance sheet
using significant unobservable Level 3 inputs for year ended December 31, 2008.
Year Ended
December 31, 2008
---------------------------------------------------------
Available for Sale Hedged Interest
Securities Loans Rate Swaps
---------------------------------------------------------
Beginning balance......................... $ 12,023
Total realized and unrealized gains and losses
Included in net income.................. (2,682) $ 4,094 $ (4,224)
Included in other comprehensive income.. (7,002)
Purchases, issuances, and settlements..... 54,657
Transfers in/(out) of Level 3............. 5,710
Principal payments........................ (120) (781)
---------------------------------------------------------
Ending balance $ 7,929 $ 57,970 $ (4,224)
=========================================================
At January 1, 2008, Level 2 securities include pooled trust preferred
securities. The fair value of these securities was priced using third-party
servicer quotations. At December 31, 2008, trading of these types of securities
was only conducted on a distress sale or forced liquidation basis. Given that a
quoted market price was not readily available, the fair value on the trust
preferred securities is now calculated using discounted cash flow projections.
The Corporation has included the pooled trust preferred securities in Level 3 at
December 31, 2008.
73
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 19
FAIR VALUES OF FINANCIAL INSTRUMENTS continued
Following is a description of valuation methodologies used for instruments
measured at fair value on a non-recurring basis and recognized in the
accompanying balance sheet, as well as the general classification of such
instruments pursuant to the valuation hierarchy.
Fair Value Measurements Using
-----------------------------------------------------------------
Quoted Prices in Significant
Active Markets Other Significant
for Identical Observable Unobservable
Assets Inputs Inputs
Fair Value (Level 1) (Level 2) (Level 3)
--------------------------------------------------------------------------------
Impaired Loans................................. $ 21,847 $21,847
Assets acquired on December 31, 2008:
Loans...................................... 626,058 626,058
Deposits................................... 655,370 655,370
Securities sold under repurchase agreements 15,300 15,300
FHLB Advances.............................. 121,367 121,367
IMPAIRED LOANS are reported when scheduled payments under contractual terms are
deemed uncollectible. Impaired loans are carried at the present value of
estimated future cash flows using the loan's existing rate, or the fair value of
collateral if the loan is collateral dependent. A portion of the allowance for
loan losses is allocated to impaired loans if the value of such loans is deemed
to be less than the unpaid balance. If these allocations cause the allowance for
loan losses to increase, such increase is reported as a component of the
provision for loan losses. Loan losses are charged against the allowance when
management believes the uncollectability of the loan is confirmed. The valuation
of impaired loans would be considered Level 3, consisting of appraisals of
underlying collateral and discounted cash flow analysis.
LOANS acquired at December 31, 2008 with the Lincoln acquisition are estimated
using discounted cash flows at the current rates at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities. Loans with similar characteristics were aggregated for purposes of
the calculations. The carrying amount of accrued interest approximates fair
value.
DEPOSITS include demand deposits, NOW accounts, savings accounts and certain
money market accounts. The carrying amount approximates fair value. The fair
value of fixed-maturity time deposits is estimated using a discounted cash flow
calculation that applied the rates currently offered for deposits of similar
remaining maturities.
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS AND FHLB ADVANCES are reported using
quoted market prices or a discounted cash flow method to estimate the fair value
of these instruments. Discounting was based on the contractual cash flows and
the current rate at which debt with similar terms could be issued.
74
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 19
FAIR VALUES OF FINANCIAL INSTRUMENTS continued
The estimated fair values of the Corporation's financial instruments are as
follows:
2008 2007
====================================================================================================================================
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
====================================================================================================================================
Assets at December 31:
Cash and Due from Banks .................................... $ 150,486 $ 150,486 $ 134,683 $134,683
Interest-bearing Time Deposits ............................. 38,823 38,823 24,931 24,931
Investment Securities Available for Sale ................... 459,636 459,636 440,836 440,836
Investment Securities Held to Maturity ..................... 22,348 22,176 10,331 10,270
Mortgage Loans Held for Sale ............................... 4,295 4,295 3,735 3,735
Loans ...................................................... 3,672,409 3,660,499 2,848,615 2,846,625
FRB and FHLB Stock ......................................... 34,319 34,319 25,250 25,250
Interest Receivable ........................................ 23,976 23,976 23,402 23,402
Interest Rate Floors ....................................... 2,001 2,001
Liabilities at December 31:
Deposits ................................................... $3,718,811 $3,617,980 $2,844,121 $2,731,895
Borrowings:
Federal Funds Purchased ................................ 52,350 52,350
Securities Sold Under Repurchase Agreements ............ 122,311 122,311 106,497 106,497
FHLB Advances .......................................... 360,217 370,418 294,101 298,574
Subordinated Debentures, Revolving Credit
Lines and Term Loans ................................. 135,826 144,891 115,826 121,177
Interest Payable ........................................... 8,844 8,844 8,325 8,325
Cash and Due from Banks: 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: See Fair Value of Financial Instruments above.
Mortgage Loans Held for Sale: The fair value of mortgage loans held for sale
approximates carrying value.
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
analysis, using interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality. See Impaired Loans above.
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.
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 and Interest Payable: The fair values of interest
receivable/payable 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 floors are based on an expectation of future interest rates
derived from observed market interest rate curves and volatilities.
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.
75
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
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,
2008 2007
================================================================================
Assets
Cash .............................................. $ 19,365 $ 8,192
Investment in Subsidiaries ........................ 527,166 445,104
Goodwill .......................................... 448 448
Other Assets ...................................... 14,992 12,282
-------- --------
Total Assets ................................... $561,971 $466,026
======== ========
Liabilities
Borrowings ........................................ $135,826 $115,826
Other Liabilities ................................. 30,242 10,264
-------- --------
Total Liabilities .............................. 166,068 126,090
Stockholders' Equity ................................. 395,903 339,936
-------- --------
Total Liabilities and Stockholders' Equity ..... $561,971 $466,026
======== ========
CONDENSED STATEMENTS OF INCOME
December 31,
2008 2007 2006
=================================================================================================================================
Income
Dividends from Subsidiaries ................................................ $ 24,528 $ 20,979 $ 33,919
Administrative Services Fees from Subsidiaries.............................. 18,252 17,670 15,104
Other Income ............................................................... 3,316 102 240
-------- -------- --------
Total Income ............................................................ 46,096 38,750 49,263
-------- -------- --------
Expenses
Amortization of Fair Value Adjustments...................................... 11 11
Interest Expense............................................................ 6,870 7,750 8,124
Salaries and Employee Benefits.............................................. 18,325 16,111 13,934
Net Occupancy Expenses...................................................... 1,286 1,198 1,232
Equipment Expenses.......................................................... 3,895 3,772 4,210
Telephone Expenses.......................................................... 910 915 1,108
Postage and Courier Expenses................................................ 1,807 1,797 1,658
Other Expenses.............................................................. 3,656 5,898 2,548
-------- -------- --------
Total Expenses .......................................................... 36,749 37,452 32,825
-------- -------- --------
Income Before Income Tax Benefit and Equity in
Undistributed Income of Subsidiaries ....................................... 9,347 1,298 16,438
Income Tax Benefit ...................................................... 5,436 7,355 6,771
-------- -------- --------
Income Before Equity in Undistributed Income of Subsidiaries ................. 14,783 8,653 23,209
Equity in Undistributed (Distributions in Excess of)
Income of Subsidiaries ................................................... 5,855 22,986 6,989
-------- -------- --------
Net Income ................................................................... $ 20,638 $ 31,639 $ 30,198
======== ======== ========
76
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 20
CONDENSED FINANCIAL INFORMATION (parent company only)
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
=====================================================================================================================
2008 2007 2006
=====================================================================================================================
Operating Activities:
Net Income ........................................................ $ 20,638 $ 31,639 $ 30,198
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Amortization .................................................... 11 11
Share-based Compensation ........................................ 848 723 41
Distributions in Excess of (Equity in Undistributed)
Income of Subsidiaries ............... ........................ (5,855) (22,986) (6,989)
Net Change in:
Other Assets ................................................. (2,307) 3,143 (3,166)
Other Liabilities ............................................ (539) (2,237) 5,923
Investment in Subsidiaries - Operating Activities..... ....... .. (6,460)
-------- -------- --------
Net Cash Provided by Operating Activities ................. 6,325 10,293 26,018
-------- -------- --------
Investing Activities - Investment in Subsidiaries 388 2,559 840
-------- -------- --------
Net Cash Provided (Used) by Investing Activities .......... 388 2,559 840
-------- -------- --------
Financing Activities:
Cash Dividends .................................................... (16,775) (16,854) (16,951)
Borrowings......................................................... 45,000 73,202 3,750
Repayment of Borrowings ........................................... (25,000) (56,832) (8,250)
Stock Issued Under Employee Benefit Plans ......................... 773 787 857
Stock Issued Under Dividend Reinvestment
and Stock Purchase Plan ......................................... 1,021 1,170 1,190
Stock Options Exercised ........................................... 1,633 496 1,228
Stock Redeemed .................................................... (2,188) (12,751) (5,690)
Other ............................................................. (4) 381
-------- -------- --------
Net Cash Used by Financing Activities ..................... 4,460 (10,782) (23,485)
-------- -------- --------
Net Change in Cash ................................................... 11,173 2,070 3,373
Cash, Beginning of Year .............................................. 8,192 6,122 2,749
-------- -------- --------
Cash, End of Year .................................................... $ 19,365 $ 8,192 $ 6,122
======== ======== ========
NOTE 21
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth certain quarterly results for the years ended
December 31, 2008 and 2007:
NET REALIZED
AND UNREALIZED
GAINS/(LOSSES)
PROVISION AVAILABLE AVERAGE SHARES OUTSTANDING NET INCOME PER SHARE
QUARTER INTEREST INTEREST NET INTEREST FOR LOAN FOR SALE NET -------------------------- --------------------
ENDED INCOME EXPENSE INCOME LOSSES SECURITIES INCOME BASIC DILUTED BASIC DILUTED
2008:
March ........ $ 56,653 $ 25,844 $ 30,809 $ 3,823 $ 73 $ 8,126 17,938,442 18,054,967 $ .45 $ .45
June ......... 54,106 21,933 32,173 7,070 13 6,542 18,050,956 18,159,207 .36 .36
September..... 54,978 21,724 33,254 7,094 (1,255) 5,749 18,114,916 18,196,453 .32 .32
December...... 53,736 20,588 33,148 10,251 (914) 221 18,159,745 18,256,843 .01 .01
---------- ---------- ----------- -------- ------- -------- ----- -----
$ 219,473 $ 90,089 $ 129,384 $ 28,238 $(2,083) $ 20,638 18,066,404 18,161,881 $1.14 $1.14
========== ========== =========== ======== ======= ======== ===== =====
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 $ 0 $ 31,639 18,249,919 18,313,964 $1.73 $1.73
========== ========== =========== ======== ======= ======== ===== =====
77
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 22
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, SFAS
No. 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 No. 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. 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.
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 has used interest rate floors to protect against
movements in interest rates below the floors' strike rates over the life of the
agreements. On August 1, 2006, the Corporation purchased three prime-based
interest rate floor agreements with an aggregate notional amount of $250 million
and strike rates ranging from 6 to 7 percent. The combined purchase price of
approximately $550,000 was to be amortized on an allocated fair value basis over
the three-year term of the agreements. On March 19, 2008, the Corporation
received $5,216,000 in connection with the termination of the three interest
rate floor agreements. The contractual maturity of the floors was August 1,
2009. During the life of the floors, pre-tax gains of approximately $4,662,500
were deferred in accumulated other comprehensive income (AOCI) in accordance
with cash flow hedge accounting rules established by SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities (as amended). The amounts
deferred in AOCI will be reclassified out of equity into earnings over the
remaining contractual term of the original contract. SFAS No. 133 requires that
amounts deferred in AOCI be reclassified into earnings in the same periods
during which the originally hedged cash flows (prime-based interest payments on
loan assets) affects earnings, as long as the originally hedged cash flows
remain probable of occurring (i.e. the principal amount of designated
prime-based loans match or exceed the notional amount of the terminated floor
through August 1, 2009). If the principal amount of the originally hedged loans
falls below the notional amount of the terminate floors, then amounts in AOCI
could be accelerated. The Corporation decided to terminate the interest rate
floor agreements only after considering the impact of the transaction on its
risk management objectives and after alternative strategies were in place to
mitigate the adverse impact of falling interest rates on its net interest
margin. At December 31, 2008, the remaining pre-tax gains are approximately $1.4
million.
The Corporation offers interest rate derivative products (e.g. interest rate
swaps) to certain of its high-quality commercial borrowers. This product allows
customers to enter into an agreement with the Corporation to swap their variable
rate loan to a fixed rate. These derivative products are designed to reduce,
eliminate or modify the risk of changes in the borrower's interest rate or
market price risk. The extension of credit incurred through the execution of
these derivative products is subject to the same approvals and rigorous
underwriting standards as the related traditional credit product. The
Corporation limits its risk exposure to these products by entering into a
mirror-image, offsetting swap agreement with a separate, well-capitalized and
rated counterparty previously approved by the Credit and Asset Liability
78
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
Note 22
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES continued
Committee. By using these interest rate swap arrangements, the Corporation is
also better insulated from the interest rate risk associated with underwriting
fixed-rate loans. These derivative contracts are not designated against specific
assets or liabilities under SFAS No. 133 and, therefore, do not qualify for
hedge accounting. The derivatives are recorded on the balance sheet at fair
value and changes in fair value of both the customer and the offsetting swaps
agreements are recorded (and essentially offset) in non-interest income. The
fair value of the derivative instruments incorporates a consideration of credit
risk (in accordance with SFAS No. 157), resulting in some volatility in earnings
each period. As of December 31, 2008, the notional amount of customer-facing
swaps is approximately $53,876,000. This amount is offset with third-party
counterparties, as described above, in the same amount. As of December 31, the
fair value of derivative assets in this program is approximately $4,094,000; the
fair value of derivative liabilities is approximately $4,224,000.
NOTE 23
SUBSEQUENT EVENTS
On February 20, 2009, the Corporation completed the sale to the U.S. Treasury of
$116.0 million of newly issued First Merchants non-voting preferred shares with
a liquidation value of $1,000 as part of the Capital Purchase Program. All of
the proceeds from this sale of the Series A Preferred Shares and the Warrant by
the Corporation to the Treasury will qualify as Tier 1 capital for regulatory
purposes. In addition to the preferred shares, the Treasury received a warrant
to purchase up to 991,453 shares of the Corporation at an initial exercise price
of $17.55 per share. The warrant provides for the adjustment of the exercise
price and has a term of 10 years. The additional capital would have increased
Tier 1 capital ratio to 10.9 percent at December 31, 2008, and increased its
total capital ratio to 12.8 percent at December 31, 2008. The Corporation
continues to evaluate the manner in which it intends to deploy the proceeds of
this sale of the Series A Preferred Shares and Warrant.
On February 27, 2009, the FDIC announced the adoption of an interim rule to
impose a 20 basis point emergency special assessment under 12 U.S.C. 1817(b)(5)
on June 30, 2009. The interim rule also provides that, after June 30, 2009, if
the reserve ratio of the Deposit Insurance Fund is estimated to fall to a level
that the Board believes would adversely affect public confidence or to a level
which shall be close to zero or negative at the end of a calendar quarter, an
emergency special assessment of up to 10 basis points may be imposed by a vote
of the Board on all insured depository institutions based on each institution's
assessment base calculated pursuant to 12 CFR section 327.5 for the
corresponding assessment period. There has been further discussion on the
possibility of the special assessment being reduced to 10 basis points but the
final decision has not yet been made.
NOTE 24
ACCOUNTING MATTERS
Statement of Financial Accounting Standards No. 157, Fair Value measurements
("SFAS 157"). Effective January 1, 2008, the Corporation adopted SFAS 157 for
existing fair value measurement requirements related to financial and
nonfinancial assets and liabilities. SFAS 157 establishes a hierarchy to be used
in performing measurements of fair value. Additionally, SFAS 157 emphasizes that
fair value should be determined from the perspective of a market participant
while also indicating that valuation methodologies should first reference
available market data before using internally developed assumptions. SFAS 157
also provides expanded disclosure requirements regarding the effects of fair
value measurements on the financial statements. The adoption of SFAS 157 did not
have a material impact on the consolidated financial condition or results of
operations, or liquidity.
On October 10, 2008 the Financial Accounting Standards Board ("FASB") issues FSP
FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market For
That Asset Is Not Active" ("FSP FAS 157-3"). FSP FAS 157-3 clarifies the
application of SFAS 157 in a market that is not active and provides an example
to illustrate key consideration in determining the fair value of a financial
asset when the market for that financial asset is not active. FSP FAS 157-3 is
effective upon issuance, including prior periods for which financial statements
have not been issued. The Corporation adopted FSP FAS 157-3 for the period ended
September 30, 2008 and the adoption did not have any significant impact on
consolidated statements of financial position, consolidated statement of
operations, or disclosures.
Statement of Financial Accounting Standards No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities ("SFAS 159"). In February 2007, the
FASB issued SFAS 159 which permits companies to elect to measure certain
eligible items at fair value. Subsequent unrealized gains and losses on those
items will be reported in earnings. Upfront costs and fees related to those
items will be reported in earnings as incurred and not deferred. SFAS 159 is
effective for fiscal years beginning after November 15,
79
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
Note 24
ACCOUNTING MATTERS continued
2007. The Corporation does not expect the adoption of SFAS 159 to have a
material impact on the operations of the Corporation.
Statement of Financial Accounting Standards No. 141 (Revised 2007), Business
Combinations ("SFAS 141(R)". During December 2007, the FASB issues SFAS 141(R).
This Statement replaces SFAS 141 "Business Combinations" ("Statement 141"). SFAS
141(R) retains the fundamental requirements in Statement 141 that the
acquisition method of accounting (called the 'purchase method') be used for all
business combinations and for an acquirer to be identified for each business
combination. This Statement defines the acquirer as the entity that obtains
control of one or more businesses, including those sometimes referred to as
"true mergers" or "mergers of equals" and combinations achieved without the
transfer of consideration, for example, by contract alone or through the lapse
of minority veto rights. This is broader than in Statement 141 which applied
only to business combinations in which control was obtained by transferring
consideration. This Statement requires an acquirer to recognize the assets
acquired, liabilities assumed and any noncontrolling interest in the acquiree at
the acquisition date, measured at their fair values as of that date. SFAS 141(R)
recognized and measures the goodwill acquired in the business combination and
defines a bargain purchase as a business combination in which the total
acquisition-date fair value of the identifiable net assets acquired exceeds the
fair value of the consideration transferred plus any noncontrolling interest in
the acquiree, and it requires the acquirer to recognize that excess as a gain
attributable to the acquirer. In contrast, Statement 141 required the "negative
goodwill" amount to be allocated as a pro rata reduction of the amounts assigned
to assets acquired. SFAS 141(R) applies prospectively to business combinations
for which the acquisition date is on or after December 15, 2008. An entity may
not apply it before that date.
Statement of Financial Accounting Standards No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans ("SFAS 158"). In
September 2006, the FASB issued SFAS 158. Except for the measurement
requirement, the Corporation adopted this accounting guidance as of December 31,
2006. Additional information regarding the adoption of SFAS 158 is included in
Note 17 ("Pension and Other Post Retirement Benefit Plans"). The requirement to
measure plan assets and benefit obligations as of the end of an employer's
fiscal year is effective for years ending December 15, 2008 (December 31, 2008
for the Corporation). Adoption of this guidance did not have a material effect
on the Corporation's financial condition or results of operations.
Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB No. 51 ("SFAS 160").
During December 2007, the FASB issued SFAS 160 to establish accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in
a subsidiary is an ownership interest in the consolidated entity that should be
reported as equity in the consolidated financial statement, but separate from
the parent's equity. Before the Statement was issued these so-called minority
interests were reported in the consolidated statement of financial position as
liabilities or in the mezzanine section between liabilities and equity. The
amount of consolidated net income attributable to the parent and to the
noncontrolling interest must be clearly identified and presented in the
consolidated statement of income. This Statement requires that a parent
recognize a gain or loss within those fiscal years, beginning on or after
December 15, 2008. Earlier adoption is prohibited.
Management does not anticipate that this Statement will have a material impact
on the Corporation's consolidated financial condition or results of operations.
Statement of Financial Accounting Standards No. 161, Disclosures about
Derivative Instruments and Hedging Activities - an amendment of FASB Statement
No. 133 ("SFAS 161"). During March 2008, the FASB issued SFAS 161, SFAS 161
amends and expands the disclosure requirement of SFAS 133 "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133") with the intent to
provide users of financial statements with an enhanced understanding of: (1) how
and why an entity uses derivative instruments; (b) how derivative instruments
and related hedged items are accounted for under SFAS 133 and its related
interpretations; and (c) how derivative instruments and related hedged items
affect an entity's financial position, financial performance, and cash flows. To
meet those objectives, SFAS 161 requires qualitative disclosures about
objectives and strategies for using derivative, quantitative disclosures about
fair value amounts of and gains and losses on derivative instruments, and
disclosures about credit-risk related contingent features in derivative
agreements. SFAS 161 is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008. Early application
is encouraged.
Statement of Financial Accounting Standards, The Hierarchy of Generally Accepted
Accounting Principles ("SFAS 162"). During May 2008, the FASB issued SFAS 162.
This Statement identifies the sources of account principles and the framework
for selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with
generally accepted accounting principles (GAAP) in the United States. This
Statement is effective 60 days following SEC approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present
Fairly in Conformity With Generally Accepted Accounting Principles." Adoption of
SFAS 162 will not be a change in
80
PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLOIDATED
FINANCIALS STATEMENTS (table dollar amounts in thousands, except share data)
NOTE 24
ACCOUNTING MATTERS continued
the Corporation's current accounting practices; therefore, it will not have a
material impact on the Corporation's consolidated financial condition or results
of operations.
FASB Staff Position EITF 03-6-1, Determining Whether Instruments Granted in
Share Based Payment Transactions are Participating Securities ("FSP EITF
03-6-1"). During June 2008, the FASB issued FSP EITF 03-6-1. FSP EITF 03-6-1
clarifies whether instruments, such as restricted stock, granted in share-based
payments are participating securities prior to vesting. Such participating
securities must be included in the computation of earnings per share under the
two-class method as described in SFAS No. 128, "Earnings per Share." FSP EITF
03-6-1 requires companies to treat unvested share based payment awards that have
non-forfeitable rights to dividend or dividend equivalents as a separate class
of securities in calculation earnings per share. FSP EITF 03-6-1 is effective
for financial statements issued for fiscal years and interim periods beginning
after December 15, 2008, and requires a company to retrospectively adjust its
earnings per share data. Early adoption is not permitted. It is not expected
that the adoption of FSP EITF 03-6-1 will have a material effect on consolidated
results of operations or earnings per share.
81
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, 2008, 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, 2008. 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. This assessment excluded internal control over financial
reporting for Lincoln Bancorp, as allowed by the SEC for current year
acquisitions. Lincoln Bancorp was acquired on December 31, 2008 and represented
18% of assets at December 31, 2008. Based on this assessment, management has
determined that the Corporation's internal control over financial reporting as
of December 31, 2008 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.
82
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, 2008, 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.
As permitted, the Corporation excluded the operations of Lincoln Bancorp, a
financial institution acquired on December 31, 2008, from the scope of
management's report on internal control over financial reporting. As such, this
entity has also been excluded from the scope of our audit of internal control
over financial reporting.
In our opinion, First Merchants Corporation maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2008, 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 March 16, 2009,
expressed an unqualified opinion thereon.
Indianapolis, Indiana
March 16, 2009
ITEM 9B. OTHER INFORMATION
None
83
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 27, 2009
furnished to its stockholders in connection with an annual meeting to be held
May 6, 2009 (the "2009 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, the Chief Banking
Officer, the Chief Accounting Officer, the Corporate Controller and the
Corporate 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 2009 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 2009 Proxy Statement, under the captions,
"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 2009 Proxy Statement, under the captions,
"SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT - Securities Ownership
of Certain 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 2009 Proxy Statement, under the caption
"INDEPENDENT AUDITOR", is expressly incorporated herein by reference.
84
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, 2008 and 2007
Consolidated statements of income,
years ended December 31, 2008,
2007 and 2006
Consolidated statements of comprehensive income,
years ended December 31, 2008, 2007 and 2006
Consolidated statements of stockholders' equity,
years ended December 31, 2008, 2007 and 2006
Consolidated statements of cash flows,
years ended December 31, 2008,
2007 and 2006
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:
- ----------- ------------------------
2.1 Agreement of Reorganization and Merger between First Merchants
Corporation and Lincoln Bancorp dated September 2, 2008 (Incorporated
by reference to registrant's Form 8-K filed on September 3, 2008).
Upon request, the registrant agrees to furnish supplementally to the
Commission a copy of the Disclosure Letters referenced in the
Agreement of Reorganization and Merger.
2.2 First Amendment of Agreement of Reorganization and Merger dated
October 29, 2008 (Incorporated by reference to registrant's Form 10-Q
filed on November 5, 2008).
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 28, 2008
(Incorporated by reference to registrant's Form 10-Q for the quarter
ended September 30, 2008)
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)
85
ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS (continued)
- --------------------------------------------------------------------------------
10a First Merchants Corporation Senior Management Incentive Compensation
Program, dated February 24, 2009.(2)
10b First Merchants Corporation Equity Compensation Plan for Non-Employee
Directors, effective April 29, 2008 (Incorporated by reference to the
registrant's Form 10-Q filed on August 11, 2008)
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 First Merchants Corporation Change of Control Agreement with Michael
J. Stewart dated April 28, 2008. (Incorporated by reference to
registrant's Form 8-K filed on May 5, 2008.) (1)
10k Resolution of the Board of Directors of First Merchants Corporation on
director compensation dated December 4, 2007. (Incorporated by
reference to the registrant's Form 10-K for year ended December 31,
2007) (1)
10l 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)
10m 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)
10n 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)
10o 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)
10p 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)
10q First Merchants Corporation 2004 Employee Stock Purchase Plan approved
April 22, 2004 (Incorporated by reference to the registrant's Form
10-Q filed on August 9, 2004)
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.
86
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 16th day of March, 2009.
/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
and Accounting
Officer)
/s/ Thomas B. Clark* /s/ Barry J. Hudson*
- ------------------------------------ ------------------------------------
Thomas B. Clark Director Barry J. Hudson Director
/s/ Michael L. Cox* /s/ Michael C. Rechin*
- ------------------------------------ ------------------------------------
Michael L. Cox Director Michael C. Rechin Director
/s/ Roderick English* /s/ Charles E. Schalliol*
- ------------------------------------ ------------------------------------
Roderick English Director Charles E. Schalliol Director
/s/ Terry L. Walker*
- ------------------------------------ ------------------------------------
Dr. Jo Ann Gora Director Teryy L. Walker Director
/s/ William L. Hoy*
- ------------------------------------ ------------------------------------
William L. Hoy Director Jean L. Wojtowicz 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 16, 2009
87
INDEX TO EXHIBITS
- --------------------------------------------------------------------------------
(a) 3. Exhibits:
Exhibit No: Description of Exhibits:
- ----------- ------------------------
2.1 Agreement of Reorganization and Merger between First Merchants
Corporation and Lincoln Bancorp dated September 2, 2008 (Incorporated
by reference to registrant's Form 8-K filed on September 3, 2008).
Upon request, the registrant agrees to furnish supplementally to the
Commission a copy of the Disclosure Letters referenced in the
Agreement of Reorganization and Merger.
2.2 First Amendment of Agreement of Reorganization and Merger dated
October 29, 2008 (Incorporated by reference to registrant's Form 10-Q
filed on November 5, 2008).
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 28, 2008
(Incorporated by reference to registrant's Form 10-Q for the quarter
ended September 30, 2008)
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)
88
ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS (continued)
- --------------------------------------------------------------------------------
10a First Merchants Corporation Senior Management Incentive Compensation
Program, dated February 24, 2009.(2)
10b First Merchants Corporation Equity Compensation Plan for Non-Employee
Directors, effective April 29, 2008 (Incorporated by reference to the
registrant's Form 10-Q filed on August 11, 2008)
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 First Merchants Corporation Change of Control Agreement with Michael
J. Stewart dated April 28, 2008. (Incorporated by reference to
registrant's Form 8-K filed on May 5, 2008.) (1)
10k Resolution of the Board of Directors of First Merchants Corporation on
director compensation dated December 4, 2007. (Incorporated by
reference to the registrant's Form 10-K for year ended December 31,
2008) (1)
10l 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)
10m 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)
10n 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)
10o 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)
10p 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)
10q First Merchants Corporation 2004 Employee Stock Purchase Plan approved
April 22, 2004 (Incorporated by reference to the registrant's Form
10-Q filed on August 9, 2004)
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.
89
EXHIBIT 10a
First Merchants Corporation
Senior Management Incentive
Compensation Program
Approved February 24, 2009
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." Additional disqualifiers
will be added based on the position, role and level of influence on
results.
Participant lists will be reviewed annually by the Committee.
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.
90
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
o Selected Senior Leadership
- ------------ ----------- ----------- --------------------------- ---------------------------------------
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 FMIS at FMTC at Balanced
(calculated (calculated EPS at 80% Scorecards 70%; 70%; Change Scorecard
on GAAP on GAAP Consolidated Change in in EPS at
basis) basis) Efficiency EPS at 30% 30% Non-Bank
Ratio at Participants:
20% Change in EPS
at 80%;
Consolidated
Efficiency
Ratio at 20%
- ------------ ----------- ----------- --------------------------- ---------------------------------------
- ------------ ---------------------------------------- ----------------------------------------- -----------
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: FMTC: Bank 5 bps
Components: Participants: Change in Change in Change in Change in Participants: of
Balanced FMIS at 70%; FMTC at FMIS at 70%; FMTC at 70%; Balanced subordinate
Scorecard Change in 70%; Change Change in Change in Scorecard mortgage
EPS at 30% Change in EPS at 30% EPS at 30% volume
Non-Bank EPS at 30% Non-Bank
Participants: Particpants:
Change in EPS Change in EPS
at 80%; at 80%;
Consolidated Consolidated
Efficiency Efficiency
Ratio at 20% Ratio at 20%
- ------------ ---------------------------------------- ----------------------------------------- -----------
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 % Change* Payout %
<3% 0%
3% 30%
4% 40%
5% 50%
6% 60%
7% 70%
8% 80%
91
9% 90%
Target 10% 100%
20% 125%
30% 150%
40% 175%
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
C. Schedule Determining Operating Earnings Payouts 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.
92
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.
Lincoln Bank................................................Indiana
First Merchants Capital Trust II............................Delaware
First Merchants Insurance Services, Inc.....................Indiana
First Merchants Reinsurance Co. Ltd.........................Providencials Turkes
and Caicos, Island
FMB Portfolio Management, Inc...............................Delaware
Wabash Valley Investments, Inc..............................Nevada
Wabash Valley, LLC..........................................Nevada
Wabash Valley Holdings, Inc.................................Nevada
LF Portfolio Services, Inc..................................Delaware
First Merchants Trust Company, National Association.........U.S.
CNBC Statutory Trust I......................................Connecticut
LF Service Corporation......................................Indiana
Citizens Loan and Service Corporation.......................Indiana
GS Asset Management, Inc....................................Indiana
Park One/332 Water Utility Co., Inc.........................Indiana
93
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 March
16, 2009 on the consolidated financial statements of the Corporation as of
December 31, 2008 and 2007, and for each of the three years in the period ended
December 31, 2008, and on our audit of internal control over financial reporting
of the Corporation as of December 31, 2008, which reports are included in this
Annual Report on Form 10-K.
/s/ BKD, LLP
Indianapolis, Indiana
March 16, 2009
94
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: March 16, 2009
/s/ Michael C. Rechin
- --------------------------------------
Michael C. Rechin President and
Chief Executive
Officer (Principal
Executive Officer)
/s/ Mark K. Hardwick
- --------------------------------------
Mark K. Hardwick Executive Vice
President and Chief
Financial Officer
(Principal Financial
and Accounting
Officer)
/s/ Thomas B. Clark
------------------------------------
Thomas B. Clark Director
/s/ Michael L. Cox
------------------------------------
Michael L. Cox Director
/s/ Roderick English
------------------------------------
Roderick English Director
------------------------------------
Dr. Jo Ann M. Gora Director
/s/ William L. Hoy
------------------------------------
William L. Hoy Director
/s/ Barry J. Hudson
------------------------------------
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
------------------------------------
Jean L. Wojtowicz Director
95
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 16, 2009 /s/ Michael C. Rechin
----------------------------------------
Michael C. Rechin
President and Chief Executive Officer
(Principal Executive Officer)
96
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 16, 2009 /s/ Mark K. Hardwick
----------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)
97
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, 2008 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 16, 2009 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, 2008 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 16, 2009 by /s/ Mark K. Hardwick
------------------------- -------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting
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.
98
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, 2008, will be filed as an amendment to the
2008 Annual Report on Form 10-K.
99
