View:
FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 or 15 (d) of THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended September 30, 1998 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 of organization) Identification No.) 200 East Jackson Street - Muncie, IN 47305-2814 - ------------------------------------------------------------------------------- (Address of principal executive office) (Zip code) (765) 747-1500 - ------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable - ------------------------------------------------------------------------------- (Former name former address and former fiscal year, if changed since last report.) 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 --- --- As of August 26, 1998, there were outstanding 10,078,994 common shares, without par value, of the registrant. The exhibit index appears on page 2. This report including the cover page contains a total of 21 pages.
FIRST MERCHANTS CORPORATION FORM 10-Q INDEX Page No. PART I. Financial information: -------- Item 1. Financial Statements: Consolidated Condensed Balance Sheet 3 Consolidated Condensed Statement of Income 4 Consolidated Condensed Statement of Comprehensive Income 5 Consolidated Condensed Statement of Changes in Stockholders' Equity 6 Consolidated Condensed Statement of Cash Flows 7 Notes to Consolidated Condensed Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 PART II. Other Information: Item 4. Submission of Matters to a Vote of Security Holders 20 Item 6. Exhibits and Reports of Form 8-K 20 Signatures 21
FIRST MERCHANTS CORPORATION FORM 10-Q PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS CONSOLIDATED CONDENSED BALANCE SHEET (Dollars in thousands, except per share amounts) (Unaudited) September 30, December 31, 1998 1997 ------------- ------------ ASSETS: Cash and due from banks $ 31,960 $ 33,127 Federal funds sold 2,200 9,050 ------------ ----------- Cash and cash equivalents 34,160 42,177 Interest-bearing deposits 289 385 Investment securities available for sale 289,348 212,040 Investment securities held to maturity 23,363 35,332 Mortgage loans held for sale 731 471 Loans 733,659 703,313 Less: Allowance for loan losses (7,202) (6,778) ------------ ----------- Net loans 726,457 696,535 Premises and equipment 17,769 15,382 Federal Reserve and Federal Home Loan Bank stock 3,723 3,373 Interest receivable 9,396 8,968 Core deposit intangibles and goodwill 2,993 1,625 Others assets 5,650 3,848 ------------ ----------- Total assets $1,113,879 $1,020,136 ============ =========== LIABILITIES: Deposits: Noninterest-bearing $ 96,122 $ 115,613 Interest-bearing 764,466 728,199 ------------ ----------- Total deposits 860,588 843,812 Securities sold under repurchase agreements 78,302 15,398 Federal funds purchased and other short-term borrowings 7,405 11,431 Federal Home Loan Bank advances 29,704 20,700 Interest payable 3,876 3,615 Other liabilities 4,177 3,211 ------------ ----------- Total liabilities 984,052 898,167 STOCKHOLDERS' EQUITY: Preferred stock, no-par value: Authorized and unissued -- 500,000 shares Common stock, $.125 stated value: Authorized --- 20,000,000 shares Issued and outstanding -- 10,078,914 and 9,996,658 shares 1,260 1,250 Additional paid-in capital. 24,818 23,723 Retained earnings 101,207 95,449 Accumulated other comprehensive income 2,542 1,547 ------------ ----------- Total stockholders' equity 129,827 121,969 ------------ ----------- Total liabilities and stockholders' equity $1,113,879 $1,020,136 ============ =========== See notes to consolidated condensed financial statements.
FIRST MERCHANTS CORPORATION FORM 10-Q CONSOLIDATED CONDENSED STATEMENT OF INCOME (Dollars in thousands, except per share amounts) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 --------- --------- --------- --------- Interest Income: Loans receivable Taxable $ 16,043 $ 15,288 $ 47,153 $ 44,004 Tax exempt 51 28 155 87 Investment securities: Taxable 2,701 2,588 7,475 8,395 Tax exempt 1,160 1,064 3,378 3,185 Federal funds sold 114 623 27 Deposits with financial institutions 3 6 13 12 Federal Reserve and Federal Home Loan Bank stock 73 68 206 196 --------- ---------- --------- ---------- Total interest income 20,145 19,042 59,003 55,906 --------- ---------- --------- ---------- Interest expense: Deposits 8,531 8,157 25,509 23,487 Securities sold under repurchase agreements 573 419 1,027 1,211 Federal funds purchased and other short-term borrowings 190 271 423 1,051 Federal Home Loan Bank advances 393 285 1,129 627 --------- ---------- --------- ---------- Total interest expense 9,687 9,132 28,088 26,376 --------- ---------- --------- ---------- Net Interest Income 10,458 9,910 30,915 29,530 Provision for loan losses 446 375 1,268 952 --------- ---------- --------- ---------- Net Interest Income After Provision for Loan Losses 10,012 9,535 29,647 28,578 --------- ---------- --------- ---------- Other Income: Net realized gains (losses) on sales of available-for-sale securities 68 (4) 119 (3) Other income 2,889 2,295 8,266 6,758 --------- ---------- --------- ---------- Total other income 2,957 2,291 8,385 6,755 Total other expenses 6,966 6,486 20,358 19,104 --------- ---------- --------- ---------- Income before income tax 6,003 5,340 17,674 16,229 Income tax expense 2,112 1,804 6,161 5,557 --------- ---------- --------- ---------- Net Income $ 3,891 $ 3,536 $ 11,513 $ 10,672 ========= ========== ========= ========== Per share: Net Income: Basic $ .39 $ .35 $ 1.15 $ 1.07 Diluted .38 .35 1.13 1.06 Dividends .20 .19 .57 .51 See notes to consolidated condensed financial statements.
FIRST MERCHANTS CORPORATION FORM 10-Q CONSOLIDATED CONDENSED STATEMENT OF COMPREHENSIVE INCOME (Dollar amounts in thousands) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 --------- --------- --------- --------- Net Income $ 3,891 $ 3,536 $ 11,513 $ 10,672 --------- ---------- --------- ---------- Other comprehensive income, net of tax: Unrealized gains (losses) on securities available for sale: Unrealized holding gains arising during the period, net of income tax (732), (390), (616), and (291) 1,099 585 924 437 Less: Reclassification adjustment for gains (losses) included in net income, net of income tax (28), 2, (48), and 1 40 (2) 71 (2) --------- ---------- --------- --------- 1,139 583 995 435 --------- ---------- --------- --------- Comprehensive income $ 5,030 $ 4,119 $ 12,508 $ 11,107 ========= ========== ========= =========
FIRST MERCHANTS CORPORATION FORM 10-Q CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Dollar amounts in thousands) (Unaudited) 1998 1997 -------- -------- Balances, January 1 $121,969 $112,687 Net income 11,513 10,672 Cash dividends (5,755) (5,038) Net change in accumulated other comprehensive income 995 435 Stock issued under employee benefit plans 384 292 Stock issued under dividend reinvestment and stock purchase plan 511 539 Stock options exercised 210 127 --------- --------- Balances, September 30 $129,827 $119,714 ========= ========= See notes to consolidated condensed financial statements
FIRST MERCHANTS CORPORATION FORM 10-Q CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (Dollar amounts in thousands) (Unaudited) Nine Months Ended September 30 1998 1997 --------- -------- Cash Flows From Operating Activities: Net income $ 11,513 $ 10,672 Adjustments to reconcile net income to net cash provided by operating activities Provision for loan losses 1,268 952 Depreciation and amortization 1,466 1,312 Securities amortization, net 153 245 Securities losses (gains), net (106) 3 Mortgage loans originated for sale (5,982) (3,849) Proceeds from sales of mortgage loans 5,722 3,661 Change in interest receivable (428) (441) Change in interest payable 261 344 Other adjustments (1,352) (191) --------- --------- Net cash provided by operating activities 12,515 12,708 --------- --------- Cash Flows From Investing Activities: Net change in interest-bearing deposits 96 29 Purchases of Securities available for sale (140,342) (47,126) Securities held to maturity (90) (1,760) Proceeds from maturities of Securities available for sale 58,975 54,667 Securities held to maturity 11,834 12,649 Proceeds from sales of Securities available for sale 5,886 8,551 Net change in loans (31,190) (71,021) Purchases of premises and equipment (4,162) (1,329) Other investing activities (1,547) 310 --------- --------- Net cash provided by investing activities (100,540) (45,030) --------- --------- (continued)
FIRST MERCHANTS CORPORATION FORM 10-Q CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (Dollar amounts in thousands) (Unaudited) Nine Months Ended September 30, 1998 1997 ---------- ---------- Cash Flows From Financing Activities: Net change in Demand and savings deposits $ (19,491) $ (27,487) Certificates of deposit and other time deposits 36,267 22,402 Securities sold under repurchase agreements 62,904 15,322 Federal funds purchased and other short-term borrowings (4,026) 12,443 Federal Home Loan Bank advances 9,062 9,550 Repayment of Federal Home Loan Bank advances (58) Cash dividends (5,755) (5,038) Stock issued under employee benefit plans 384 292 Stock issued under dividend reinvestment and stock purchase plan 511 539 Stock options exercised 210 127 ---------- ---------- Net cash provided by financing activities 80,008 28,150 ---------- ---------- Net Change in Cash and Cash Equivalents (8,017) (4,172) Cash and Cash Equivalents, January 1 42,177 35,032 ---------- ---------- Cash and Cash Equivalents, September 30 $ 34,160 $ 30,860 ========== ========== See notes to consolidated condensed financial statements. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE 1. General The significant accounting policies followed by First Merchants Corporation ("Corporation") and its wholly owned subsidiaries for interim financial reporting are consistent with the accounting policies followed for annual financial reporting, except for the change in method of accounting discussed more fully in Note 2. All adjustments which are of a normal recurring nature and are in the opinion of management necessary for a fair statement of the results for the periods reported have been included in the accompanying consolidated condensed financial statements. NOTE 2. Change in Methods of Accounting REPORTING COMPREHENSIVE INCOME. During 1997, the Financial Accounting Standards Board ("FASB") issued Statement No. 130, REPORTING COMPREHENSIVE INCOME, establishing standards for the reporting of comprehensive income and its components in financial statements. Statement No. 130 is applicable to all entities that provide a full set of financial statements. Enterprises that have no items of other comprehensive income in any period presented are excluded from the scope of this Statement. Statement No. 130 is effective for interim and annual periods beginning after December 15, 1997. The Corporation has adopted Statement No. 130 during fiscal the first quarter of 1998. See the Consolidated Condensed Statement of Comprehensive Income on page 5.
FIRST MERCHANTS CORPORATION FORM 10-Q NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Table dollar amounts in thousands) (Unaudited) NOTE 3. Acquisitions On August 20, 1998, the Corporation signed a definitive agreement to acquire all of the outstanding shares of Jay Financial Corporation, Portland, Indiana. Under terms of the agreement, the Corporation will issue approximately 1,099,000 shares of its common stock. The transaction will be accounted for under the pooling of interests method of accounting and is subject to approval by appropriate regulatory agencies. Although the Corporation anticipates that the merger will be consummated during the first quarter of 1999, there can be no assurance that the acquisition will be completed. At December 31, 1997, Jay Financial Corporation, had total assets and stockholders' equity of $104,977,000 and $13,627,000, respectively. On October 27, 1998, the Corporation signed a definitive agreement to acquire all of the outstanding shares of Anderson Community Bank, Anderson, Indiana. Under terms of the agreement, the Corporation will issue approximately 811,000 shares of its common stock. The transaction will be accounted for under the pooling of interests method of accounting and is subject to approval by appropriate regulatory agencies. Although the Corporation anticipates that the merger will be consummated during the first quarter of 1999, there can be no assurance that the acquisition will be completed. At December 31, 1997, Anderson Community Bank had total assets and stockholders' equity of $62,836,000 and $6,448,000, respectively. The Anderson Community Bank will merge with Pendleton Banking Company, an affiliate bank of First Merchants Corporation, to form The Madison Community Bank. NOTE 4. Investment Securities Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ----------- ---------- --------- Available for sale at September 30, 1998: U.S. Treasury $ 13,842 $ 125 $ $ 13,967 Federal agencies 60,385 832 61,217 State and municipal 81,864 2,666 1 84,529 Mortgage-backed securities 77,881 460 40 78,301 Other asset-backed securities 30,279 17 30,262 Corporate obligations 20,632 192 2 20,822 Marketable equity security 250 250 ---------- ------- ------- --------- Total available for sale 285,133 4,275 60 289,348 ---------- ------- ------- --------- Held to maturity at September 30, 1998: U.S. Treasury 249 5 254 Federal agencies 500 3 503 State and municipal 19,307 358 2 19,663 Mortgage-backed securities 1,017 6 1,023 Other asset-backed securities 2,290 46 2,244 ---------- ------- ------- --------- Total held to maturity 23,363 372 48 23,687 ---------- ------- ------- --------- Total investment securities $ 308,496 $4,647 $ 108 $ 313,035 ========== ======= ======= =========
FIRST MERCHANTS CORPORATION FORM 10-Q NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Table dollar amounts in thousands) (Unaudited) Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ----------- ---------- --------- Available for sale at December 31, 1997: U.S. Treasury $ 19,207 $ 104 $ 11 $ 19,300 Federal agencies 66,783 40 48 67,140 State and municipal 67,842 1,815 28 69,629 Mortgage-backed securities 36,682 362 86 36,958 Other asset-backed securities 487 2 54 435 Corporate obligations 18,219 139 30 18,328 Marketable equity securities 250 250 ---------- ------- ------- --------- Total available for sale 209,470 2,827 257 212,040 ---------- ------- ------- --------- Held to maturity at December 31, 1997: U.S. Treasury 249 2 247 Federal agencies 3,412 6 1 3,417 State and municipal 26,206 252 2 26,456 Mortgage-backed securities 1,255 4 1 1,258 Other asset-backed securities 4,210 7 166 4,051 ---------- ------- ------- --------- Total held to maturity 35,332 269 172 35,429 ---------- ------- ------- --------- Total investment securities $ 244,802 $3,096 $ 429 $ 247,469 ========== ======= ======= =========
FIRST MERCHANTS CORPORATION FORM 10-Q NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Table dollar amounts in thousands) (Unaudited) NOTE 5. Loans and Allowance September 30, December 31, 1998 1997 ------------- ------------ Loans: Commercial and industrial loans $ 155,831 $ 148,281 Bankers' acceptances and loans to financial institutions 900 705 Agricultural production financing and other loans to farmers 19,741 16,764 Real estate loans: Construction 26,544 21,389 Commercial and farmland 95,254 97,503 Residential 306,652 287,072 Individuals' loans for household and other personal expenditures 123,856 125,706 Tax-exempt loans 2,509 2,598 Other loans 2,565 3,782 Unearned interest on loans (193) (487) ------------- ------------ Total $ 733,659 $ 703,313 ============= ============ Nine Months Ended September 30 1998 1997 --------- ---------- Allowance for loan losses: Balances, January 1. $ 6,778 $ 6,622 Provision for losses 1,268 952 Recoveries on loans 286 386 Loans charged off (1,130) (1,175) --------- ---------- Balances, September 30 $ 7,202 $ 6,785 ========= ========== NOTE 6. Net Income Per Share Three Months Ended September 30, 1998 1997 ------------------------------- ------------------------------- Weighted- Weighted- Average Per Share Average Per Share Income Shares Amount Income Shares Amount ------ --------- --------- ------ --------- --------- Basic net income per share: Net income available to common stockholders $3,891 10,071,921 $ .39 $3,536 9,974,990 $ .35 ====== ====== Effect of dilutive stock options 150,955 126,621 ------ ---------- ------ ---------- Diluted net income per share: Net income available to common stockholders and assumed conversions $3,891 10,222,876 $ .38 $3,536 10,101,611 $ .35 ====== ========== ====== ====== ========== ======
FIRST MERCHANTS CORPORATION FORM 10-Q Nine Months Ended September 30, 1998 1997 ------------------------------- ------------------------------- Weighted- Weighted- Average Per Share Average Per Share Income Shares Amount Income Shares Amount ------- --------- --------- ------ --------- --------- Basic net income per share: Net income available to common stockholders $11,513 10,033,964 $ 1.15 $10,672 9,936,864 $ 1.07 ====== ====== Effect of dilutive stock options 163,121 128,181 ------- ---------- ------- ---------- Diluted net income per share: Net income available to common stockholders and assumed conversions $11,513 10,197,085 $ 1.13 $10,672 10,065,045 $ 1.06 ======= ========== ====== ======= ========== ====== Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Congress passed the Private Securities Litigation Report Act of 1995 to encourage corporations to provide investors with information about the company's anticipated future financial performance, goals, and strategies. The act anticipated future financial performance, goals, and strategies. The act provides a safe harbor for such disclosure, or in other words, protection from unwarranted litigation if actual results are not the same as management's expectations. First Merchants Corporation desires to provide its shareholders with sound information about past performance and future trends. Consequently, this Quarterly Report, including Management's Discussion and Analysis of financial Condition and Results of Operations, contains forward-looking statements that are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those contained in or implied by First Merchants Corporation's statements due to a variety of factors including: changes in economic conditions; movements in interest rates; competitive pressures on product pricing and services; success and timing of business strategies; the successful integration of acquired businesses; the nature and extent of governmental actions and reform; and extended disruption of vital infrastructure. The management of First Merchants Corporation encourages readers of this report to understand forward-looking statements to be strategic objectives rather than absolute targets of future performance. RESULTS OF OPERATIONS Net income for the three months ended September 30, 1998, was $3,891,000, compared to $3,536,000 earned in the same period of 1997, an increase of 10.0 percent. Diluted net income per share was $.38 for the three months ended September 30, 1998, compared to $.35 for the three months ended September 30, 1997, an increase of 8.6 percent. Net income for the first nine months of 1998 was $11,513,000 compared to $10,672,000 earned in the same period of 1997, an increase of 7.9 percent. Diluted net income per share was $1.13 and $1.06 for the nine months ended September 30, 1998 and 1997, respectively, an increase of 6.6 percent. The increase in earnings was primarily due to growth in earning assets and non-interest income. Net interest income increased $1,385,000 or 4.7 percent over the first nine months of 1997 due to growth in earning assets of 9.3 percent. Noninterest income increased $1,630,000 or 24.1 percent over the first nine months of 1997 due primarily to increased revenues from fiduciary activities and commission income. Annualized returns on average assets and average shareholder's equity for quarter ended September 30, 1998 were 1.45 percent and 12.16 percent, respectively, compared with 1.42 percent and 11.96 percent for the same period of 1997. For the nine months ended September 30, 1998, annualized returns on average assets and shareholder's equity were 1.47 percent and 12.23 percent, respectively, compared to 1.44 percent and 12.29 percent for the same nine month period in 1997.
FIRST MERCHANTS CORPORATION FORM 10-Q CAPITAL The Corporation's capital strength continues to exceed regulatory minimums and peer group averages. Management believes that strong capital is a distinct advantage in the competitive environment in which the Corporation operates and will provide a solid foundation for continued growth. The Corporation's Tier I capital to average assets ratio was 11.9 percent at year-end 1997 and 11.9 percent at September 30, 1998. At September 30, 1998, the Corporation had a Tier I risk-based capital ratio of 16.3 percent, total risk-based capital ratio of 17.2 percent, and a leverage ratio of 11.9 percent. Regulatory capital guidelines require a Tier I risk-based capital ratio of 4.0 percent and a total risk-based capital ratio of 8.0 percent. Banks with Tier I risk-based capital ratios of 6.0 percent and total risk-based capital ratios of 10.0 percent are considered "well capitalized." ASSET QUALITY/PROVISION FOR LOAN LOSSES The Corporation's asset quality and loan loss experience have consistently been superior to that of its peer group, as summarized on the following page. Asset quality has been a major factor in the Corporation's ability to generate consistent profit improvement. 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 provided by an outside accounting firm. The evaluation takes into consideration identified credit problems, as well as the possibility of losses inherent in the loan portfolio that cannot be specifically identified. The following table summarizes the risk elements for the Corporation. - ----------------------------------------------------------------------------------- (Dollars in Thousands) September 30, December 31, December 31, 1998 1997 1996 - ----------------------------------------------------------------------------------- Non-accrual loans $ 1,377 $ 1,410 $ 2,777 Loans contractually past due 90 days or more other than nonaccruing 2,229 1,972 1,699 Restructured loans 418 282 1,540 ------- ------- ------- Total $ 4,024 $ 3,664 $ 6,016 ======= ======= ======= - ----------------------------------------------------------------------------------- Impaired loans included in the table above, totaled $2,551,000 at December 31, 1997. An allowance for losses at December 31, 1997, was not deemed necessary for impaired loans totaling $1,075,000, but an allowance of $407,000 was recorded for the remaining balance of impaired loans of $1,476,000. The average balance of impaired loans for 1997 was $3,414,000. Impaired loans totaled $2,562,000 at September 30, 1998. The average balance of impaired loans as of September 30, 1998 totaled $2,658,000. At September 30, 1998, the allowance for loan losses increased by $424,000, to $7,202,000, up slightly from year end 1997. As a percent of loans, the allowance was .98 percent, up from .96 percent at year end 1997. The third quarter 1998 provision of $446,000 was up from $375,000 for the same quarter in 1997. Net charge-offs amounted to $285,000 during the quarter. The provision of $1,268,000 for the nine months ended September 30, 1998 was up $316,000 from the same period in 1997. Net charge offs amounted to $844,000 during the first nine months of 1998.
FIRST MERCHANTS CORPORATION FORM 10-Q The table below presents loan loss experience for the periods indicated and compares the Corporation's loss experience to that of its peer group, consisting of bank holding companies with assets between $1 billion and $3 billion. Nine Months Ended Year Ended September 30, December 31, ----------------- ------------------ 1998 1997 1997 1996 1995 ---- ---- ---- ---- ---- (Dollars in Thousands) Allowance for loan losses: Balance at beginning of period $6,778 $6,622 $6,622 $6,696 $6,603 ------ ------ ------ ------ ------ Chargeoffs 1,130 1,175 1,609 1,636 1,554 Recoveries 286 386 468 309 259 ------ ------ ------ ------ ------ Net chargeoffs 844 789 1,141 1,327 1,295 Provision for loan losses 1,268 952 1,297 1,253 1,388 ------ ------ ------ ------ ------ Balance at end of period $7,202 $6,785 $6,778 $6,622 $6,696 ====== ====== ====== ====== ====== Ratio of net chargeoffs during the period to average loans outstanding during the period .16%(1) .15%(1) .17% .23% .24% Peer Group N/A N/A .29% .26% .27% (1) First nine months annualized LIQUIDITY, 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 ensure that changes in interest rates will not adversely affect earnings. Decisions regarding investment and the pricing of loan and deposit products are made after analysis of reports designed to measure liquidity, rate sensitivity, the Corporation's exposure to changes in net interest income given various rate scenarios, and the economic and competitive environments. It is the objective of the Corporation to monitor and manage risk exposure to net interest income caused by changes in interest rates. It is the goal of the Corporation's Asset Liability function to provide optimum and stable net interest income. To accomplish this, management uses two asset liability tools. GAP/Interest Rate Sensitivity Reports and Net Interest Income Simulation Modeling are both constructed, presented, and monitored quarterly. The Corporation's liquidity and interest sensitivity position at September 30, 1998, remained adequate to meet the Corporation's primary goal of achieving optimum interest margins while avoiding undue interest rate risk. The Corporation had a cumulative negative gap of $28,227,000 in the six month horizon at September 30, 1998, or just over 2.5 percent of total assets. Net interest income at a financial institution with a negative gap tends to decrease when rates rise and generally increase as interest rates decline. The GAP/Interest Rate Sensitive Report is a tool which displays repricing timing differences between interest sensitive assets and liabilities. The 0-180 day Sensitivity Gap Ratio depicts the institution is liability sensitive 92.9 percent.
FIRST MERCHANTS CORPORATION FORM 10-Q The Corporation places its greatest credence in net interest income simulation modeling. The GAP/Interest Rate Sensitivity Report is known 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. The Corporation's asset liability process monitors simulated net interest income under three separate interest rate scenarios; rising (rate shock), falling (rate shock) and flat. Net Interest income is simulated over an 18 month horizon. By policy, the difference between the best performing and the worst performing rate scenarios are not allowed to show a variance greater than 5 percent. Assumed interest rate changes are simulated to move incrementally over 18 months. The total rate movement (beginning point less ending point) to noteworthy interest rate indexes are as follows: Rising Falling ---------------------- ------------------------ Prime 300 Basis Points (300) Basis Points Federal Funds 300 (300) 90 Day T-Bill 310 (275) One Year T-Bill 290 (270) Three Year T-Note 290 (265) Five Year T-Note 290 (255) Ten Year T-Note 290 (245) Interest Checking 100 ( 67) MMIA Savings 150 (100) Money Market Index 269 (266) Regular Savings 100 ( 67) Results for the flat, rising (rate shock), and falling (rate shock) interest rate scenarios are listed below. The net interest income shown represents cumulative net interest income over an 18 month time horizon. Balance sheet assumptions are the same under both scenarios: Flat/Base Rising Falling ---------------------------------- Net Interest Income (Dollars in Thousands) $61,385 $62,220 $58,912 Change vs. Flat/Base Scenario 385 (2,473) Percent Change 1.36% (4.03%)
FIRST MERCHANTS CORPORATION FORM 10-Q EARNING ASSETS The following table presents the earning asset mix as of September 30, 1998, and December 31, 1997, and December 31, 1996. Loans grew by nearly $31 million from December 31, 1997, to September 30, 1998, while investment securities grew by more than $65 million during the same period. - -------------------------------------------------------------------------------------------------- EARNING ASSETS (Dollars in Millions) September 30, December 31, December 31, 1998 1997 1996 ------------- ------------ ------------ Federal funds sold and interest-bearing deposits $ 2.5 $ 9.4 $ 1.4 Investment securities available for sale 289.3 212.0 228.4 Investment securities held to maturity 23.4 35.3 47.2 Mortgage loans held for sale .7 0.5 0.3 Loans 733.7 703.3 631.4 Federal Reserve and Federal Home Loan Bank stock 3.7 3.4 3.1 ------------ ----------- ----------- Total $ 1,053.3 $ 963.9 $ 911.8 ============ =========== =========== - -------------------------------------------------------------------------------------------------- DEPOSITS, SECURITIES SOLD UNDER REPURCHASE AGREEMENTS, FEDERAL FUNDS SOLD AND OTHER SHORT-TERM BORROWING The following table presents the level of deposits and borrowed funds (Federal funds purchased, repurchase agreements with customers, U.S. Treasury demand notes and Federal Home Loan Bank advances) for the years ended 1997 and 1996 and at September 30, 1998. - -------------------------------------------------------------------------------------------------- (Dollars in Millions) September 30, December 31, December 31, 1998 1997 1996 ------------- ------------ ------------ Deposits $ 860.6 $ 843.8 $ 794.5 Securities sold under repurchase agreements 78.3 15.4 20.0 Federal funds purchased and other short-term borrowings 7.4 11.4 25.0 Federal Home Loan Bank advances 29.7 20.7 9.2 The Corporation, in an attempt to leverage its large capital position, borrowed $51,000,000 in the form of repurchase agreements and pledged the acquired investment securities as collateral against the borrowings. The interest rate risk is included as part of the Corporation's interest simulation discussed in Management's Discussion and Analysis under the heading Liquidity, Interest Sensitivity, and Disclosures about Market Risk. The effect on the Corporation's capital ratios is minimal as the Corporation remains adequately capitalized.
FIRST MERCHANTS CORPORATION FORM 10-Q 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 table below presents the Corporation's asset yields, interest expense, and net interest income as a percent of average earning assets for the three months and nine months ended September 30, 1998 and 1997. Net interest income (FTE) for the three months ended September 30, 1998 increased by $611,000, or 5.8 percent over the same period in 1997, due to an increase in earning assets of over $77 million. For the same period interest income and interest expense, as a percent of average earning assets, declined by .17 and .07 percent, respectively, due to a decline in interest rates and margin compression. Net interest income for the nine months ended September 30, 1998 increased $1,524,000, or 4.9 percent over the same period in 1997, due to an increase in earning assets of $57 million. Net interest income (FTE), as a percent of average earning assets, during the same period declined .05 percent due primarily to declining interest rates and increased non-deposit funds. - -------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Interest Income Interest Expense Net Interest Income Net Interest Income (FTE) as a Percent as a Percent (FTE) as a Percent Average on a of Average of Average of Average Earning Fully Taxable Earning Assets Earning Assets Earning Assets Assets Equivalent Basis - -------------------------------------------------------------------------------------------------------------------------- For the three months ended September 30, 1998 8.18% 3.81% 4.37% $1,017,322 $ 11,110 1997 8.35 3.88 4.47 940,102 10,499 For the nine months ended September 30, 1998 8.19 3.78 4.41 992,050 32,817 1997 8.22 3.76 4.46 935,023 31,293 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. - -------------------------------------------------------------------------------------------------------------------------- OTHER INCOME The Corporation has placed emphasis on the growth of non-interest income in recent years by offering 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.
FIRST MERCHANTS CORPORATION FORM 10-Q OTHER INCOME Other income in the third quarter of 1998 exceeded the same quarter in the prior year by $666,000, or 29.1 percent. Two major areas account for most of the increase: 1. Revenues from fiduciary activities grew $284,000, or 34.6 percent, due to strong new business activity and markets. 2. Commission income increased $274,000, due primarily to the acquisition of First Merchants Insurance Services, Inc., on April 1, 1998. Other income for the nine months ended September 30, 1998 exceeded the same period in the prior year by $1,630,000, or 24.1 percent. Two major areas account for most of the increase: 1. Revenues from fiduciary activities grew $670,000, or 27.7 percent, due to strong new business activity and markets. 2. Commission income increased $492,000, due to the acquisition of First Merchants Insurance Services, Inc., on April 1, 1998. 3. Other customer fees as a whole increased $265,000, or 18.4 percent, due to an increased ATM network, increased sales volume of personal money order agent fees, and increased pricing. OTHER EXPENSE Total "other expenses" represent non-interest operating expenses of the Corporation. Third quarter other expense in 1998 exceeded the same quarter of the prior year by $480,000, or 7.4 percent. Two major areas account for most of the increase: 1. Salaries and benefit expense grew $394,000, or 11.0 percent, due to normal salary increases and staff additions. 2. Net occupancy expense grew $123,000, or 31.7 percent, due to increasing branch network. Total "other expenses" represent non-interest operating expenses of the Corporation. Other expenses for the nine month period ended September 30, 1998 exceeded the same period of the prior year by $1,254,000, or 6.6 percent. Two major areas account for most of the increase: 1. Salaries and benefit expense grew $803,000, or 7.6 percent, due to normal salary increases and staff additions. 2. Equipment expense increased $247,000, or 14.4 percent, reflecting the Corporation's efforts to improve efficiency and provide electronic service delivery to its customers. Both the three months and nine months ended September 30, 1998 expenses are offset by a change from cash basis accounting for inventory to GAAP accounting. First Merchants Corporation reclassified approximately $200,000 of expenses into inventory.
FIRST MERCHANTS CORPORATION FORM 10-Q INCOME TAXES Income tax expense, for the three months ended September 30, 1998, increased by $308,000 over the same period in 1997, due to a $663,000 increase in pre-tax net income, mitigated somewhat by a $119,000 increase in tax-exempt income. Likewise, the increase of $604,000 for the nine months ended September 30, 1998, as compared to the same period in 1997, results from a $1,445,000 increase in pre-tax net income, mitigated somewhat by a $261,000 increase in tax exempt income. YEAR 2000 The Corporation has conducted a comprehensive review of its computer systems to identify the systems that could be affected by the Year 2000 Issue and has developed an implementation plan to resolve the issue. The Year 2000 Issue is the result of the computer programs being written using two digits rather than four to define the applicable year. Any of the Corporation's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations. The Corporation is utilizing both internal and external resources to identify, correct or reprogram and test the systems for the Year 2000 compliance. The corporation began the testing phase during the third quarter of 1998. The target date for the completion of core application testing is December 31, 1998. The Corporation has contacted the companies that supply or service our material operations to certify that their respective computer systems are Year 2000 compliant. We have established a December 31, 1998 deadline for these companies to provide this certification, which should provide our service providers with adequate time to make their systems Year 2000 compliant. This deadline should also provide us sufficient time to identify and contract with alternative service providers to replace those providers who cannot certify that they are, or soon will be Year 2000 compliant. We do not expect the expense of such changes in suppliers or servicers to be material to our operations, financial condition, or results. In addition to possible expenses related to our own systems and those of our service providers, we could incur losses if Year 2000 problems affect any of our depositors or borrowers. Such problems could include delayed loan payments due to Year 2000 problems affecting any of our significant borrowers or impairing the payroll systems of large employers in our market area. Because our loan portfolio to corporate and individual borrowers is diversified and our market area does not depend significantly upon one employer or industry, we do not expect any such Year 2000 related difficulties that may affect our depositors and borrowers to significantly affect our net earnings or cash flow. Our Board of Directors review on a quarterly basis our progress in addressing Year 2000 issues. We believe that our costs related to upgrading our systems and software for Year 2000 compliance will not exceed $900,000. As of September 30, 1998, we have spent approximately $600,000 in connection with Year 2000 compliance, of the $600,000 approximately $550,000 has been capitalized as the Corporation replaces non-compliant systems. Although we believe we are taking the necessary steps to address the Year 2000 compliance issue, no assurances can be given that some problems will not occur or that we will not incur significant additional expenses in future periods. OTHER The Securities and Exchange Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission, including the Corporation, and that address is (http://www.sec.gov). ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required under this item is included as part of Management's Discussion and Analysis under the heading Liquidity, Interest Sensitivity, and Disclosures About Market Risk.
FIRST MERCHANTS CORPORATION FORM 10-Q PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS NONE ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: Form 10-Q Page Exhibit No.: Description of Exhibit: Number ------------ ----------------------- ------ 27 Financial Data Schedule, Period Ending September 30, 1998 . . . . . . 21 (b) Reports on Form 8-K: A report on Form 8-K, dated August 11, 1998, was filed under report item number 5, concerning First Merchants Corporation's declaration of a 3-for-2 stock split effective October 23, 1998.
FIRST MERCHANTS CORPORATION FORM 10-Q SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST MERCHANTS CORPORATION (Registrant) Date November 11, 1998 by /s/ Michael L. Cox ----------------------- ------------------------------- Michael L. Cox President and Director Date November 10, 1998 by /s/ James L. Thrash ----------------------- ------------------------------- James L. Thrash Chief Financial & Principal Accounting Officer
9 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 31,960 289 2,200 0 289,348 23,363 23,687 733,659 7,202 1,113,879 860,588 68,867 8,053 46,544 0 0 1,260 128,567 1,113,879 47,308 10,853 842 59,003 25,509 28,088 30,915 1,268 119 20,358 17,674 11,513 0 0 11,513 1.15 1.13 4.47 1,377 2,229 418 0 6,778 1,130 286 7,202 7,202 0 0