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SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 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 or organization) Identification No.) 200 East Jackson Muncie, Indiana 47305-2814 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (317) 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 whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] 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 $231,676,424 as of March 5, 1999. As of March 5, 1999 there were outstanding 10,072,888 common shares, without par value, of the registrant. DOCUMENTS INCORPORATED BY REFERENCE Part of Form 10-K Documents Into Which Incorporated --------- ----------------------- 1998 Annual Report to Stockholders Part II (Items 5, 6, 7, 7A, and 8) Definitive Proxy Statement for Annual Meeting of Shareholders to be held April 14, 1999 Part III (Items 10 through 13) Exhibit Index: Page 26
FORM 10-K TABLE OF CONTENTS - -------------------------------------------------------------------------------- Form 10-K Page Number Part I Item 1 - Business.........................................................3 Item 2 - Properties......................................................19 Item 3 - Legal Proceedings...............................................19 Item 4 - Submission of Matters to a Vote of Security Holders.............19 Supplemental Information - Executive Officers of the Registrant...........20 Part II Item 5 - Market For the Registrant's Common Equity and Related Stockholder Matters.....................................21 Item 6 - Selected Financial Data.........................................21 Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations.............................21 Item 7A - Quantitative and Qualitative Disclosures about Market Risk......21 Item 8 - Financial Statements and Supplementary Data.....................21 Item 9 - Changes In and Disagreements With Accountants on Accounting and Financial Disclosures............................21 Part III Item 10 - Directors and Executive Officers of the Registrant.............21 Item 11 - Executive Compensation.........................................21 Item 12 - Security Ownership of Certain Beneficial Owners and Management..........................................21 Item 13 - Certain Relationships and Related Transactions.................22 Part IV Item 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................................22 Signatures..................................................................24 Page 2
PART I ITEM 1. BUSINESS. - -------------------------------------------------------------------------------- GENERAL First Merchants Corporation (the "Corporation") was incorporated under Indiana law on September 20, 1982, as the bank holding company for First Merchants Bank, National Association ("First Merchants"), a national banking association incorporated in 1893. Prior to December 16, 1991, First Merchants' name was The Merchants National Bank of Muncie. On November 30, 1988, the Corporation acquired Pendleton Banking Company ("Pendleton"), a state chartered commercial bank organized in 1872. On July 31, 1991, the Corporation acquired First United Bank ("First United"), a state chartered commercial bank organized in 1882. On August 1, 1996, the Corporation acquired The Union County National Bank of Liberty ("Union County"), a national banking association incorporated in 1872. On October 2, 1996, the Corporation acquired The Randolph County Bank ("Randolph County"), a state chartered commercial bank founded in 1865. On April 1, 1998, Pendleton acquired the Muncie office of Insurance and Risk Management, Inc., which was renamed, on April 1, 1998, First Merchants Insurance Services, Inc. After the holding company was formed in 1982, the Corporation's practice was to appoint each of the outside directors of First Merchants as a director of the Corporation. However, as the Corporation grew through acquisition of four other financial institutions, it became apparent that increased separation of the operation and direction of the Corporation and First Merchants would be desirable, and that this objective was hindered by the substantial overlap in the composition of the two Boards of Directors. Therefore, the Corporation's Board appointed an ad hoc Committee on Board Structure to review the structure and makeup of the two Boards. The Committee's report and recommendations, including a plan to restructure the respective Boards effective as of January 1, 1997, were unanimously adopted by the Boards of both the Corporation and First Merchants on December 10, 1996. As a result of the restructuring, six of the directors who were serving on both Boards became directors of First Merchants only, and five of the directors who were serving on both Boards became directors of the Corporation only. The size of the Corporation's Board was reduced from eighteen to twelve members, and the size of the First Merchants' Board was reduced from fifteen to ten members. As of December 31, 1998, the Corporation had consolidated assets of $1.177 billion, consolidated deposits of $926.8 million and stockholders' equity of $131.5 million. The Corporation is headquartered in Muncie, Indiana, and is presently engaged in conducting commercial banking business through the 27 offices of its five banking subsidiaries. As of December 31, 1998, the Corporation and its subsidiaries had 492 full-time equivalent employees. Through its subsidiaries, the Corporation offers a broad range of financial services, including: accepting time and transaction deposits; making consumer, commercial, agri-business and real estate mortgage loans; issuing credit cards; renting safe deposit facilities; providing personal and corporate trust services; and providing other corporate services, letters of credit and repurchase agreements. ACQUISITION POLICY AND PENDING TRANSACTIONS The Corporation anticipates that it will continue its policy of geographic expansion through consideration of acquisitions of additional financial institutions. Management of the Corporation periodically engages in reviewing and analyzing potential acquisitions. At the present time, management of the Corporation has signed definitive agreements with both Jay Financial Corporation and Anderson Community Bank regarding their affiliation with the Corporation. Page 3
- -------------------------------------------------------------------------------- COMPETITION The Corporation's banking subsidiaries are located in Delaware, Fayette, Hamilton, Henry, Madison, Wayne, Randolph, and Union counties in Indiana and Butler county in Ohio. 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. SUPERVISION AND REGULATION The Corporation is a bank holding company ("BHC") subject to regulation under the Bank Holding Company Act of 1956, as amended (the "Act"). The Act generally requires a BHC to obtain prior approval of the Federal Reserve Board (the "FRB") to acquire or hold more than a 5% voting interest in any bank. The Act restricts the non-banking activities of BHCs to those which are closely related to banking activities. As a result of the provisions in the Financial Institutional Reform, Recovery and Enforcement Act of 1989, BHCs may now own and operate savings and loan associations or savings banks which, in the past, was prohibited. First Merchants and Union County are national banks and are supervised, regulated and examined by the Comptroller of the Currency. Pendleton, First United, and Randolph County are state banks and are supervised, regulated and examined by the Indiana Department of Financial Institutions (the "DFI"). In addition, First Merchants, as a member of the Federal Reserve System, is supervised and regulated by the Federal Reserve. In addition, Pendleton, First United, and Randolph County, which are not members of the Federal Reserve System, are supervised and regulated by the Federal Deposit Insurance Corporation ("FDIC"). The deposits of First Merchants, Union County, Pendleton, First United, and Randolph County (the "Banks") are insured by the FDIC. Each regulator has the authority to issue cease-and-desist orders if it determines their activities represent an unsafe and unsound practice or violation of law. Under the Act and under regulations of the FRB, the Corporation and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit and are subject to limitations as to certain intercompany transactions. Subject to certain limitations, an Indiana bank may establish branches de novo and may establish branches by acquisition in any location or locations within Indiana. Indiana law permits intrastate bank holding company acquisitions, subject to certain limitations. Effective July 1, 1992, Indiana bank holding companies were permitted to acquire banks, and banks and bank holding companies in Indiana were permitted to be acquired by bank holding companies, located in any state in the United States which permits reciprocal entry by Indiana bank holding companies. Prior to July 1, 1992, such interestate bank holding company acquisitions were permitted only on a regional, as opposed to national, basis. Neither the Corporation nor its subsidiaries presently contemplate engaging in any non-banking related business activities. During 1991, Congress passed the Federal Deposit Insurance Corporation Improvement Act ("FDICIA"). In addition to addressing the insurance fund's financial needs, FDICIA expanded the power of the federal banking regulators. FDICIA introduced a new system of classifying financial institutions with respect to their capitalization. Effective in 1993, FDICIA also requires certain financial institutions, such as First Merchants, to have annual audits and requires management to issue supplemental reports attesting to an institution's compliance with laws and regulations and to the adequacy of its internal controls and procedures. Page 4
- -------------------------------------------------------------------------------- SUPERVISION AND REGULATION (continued) The Riegle Community Development and Regulatory Improvement Act of 1994 ("Act") was signed into law in 1994. The Act contains seven titles pertaining to community development and home ownership protection, small business capital formation, paperwork reduction and regulatory improvement, money laundering and flood insurance. The Act grants the authority to several agencies to promulgate regulations under the Act. No regulations have yet been promulgated. The Corporation cannot predict with certainty the impact of the Act on the banking industry. In September, 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("Interstate Act") was enacted into law. The Interstate Act authorized interstate acquisitions, mergers and bank branching and agency banking with affiliates in different states. The Interstate Act amends the Bank Holding Company Act to allow adequately capitalized and managed bank holding companies to acquire a bank located in another state beginning in September, 1995. The new act permits full interstate branching after June 1, 1997. After that date, BHCs may merge existing bank subsidiaries into one bank, with banks also permitted to merge unaffiliated banks across state lines. States may permit interstate branching earlier than June 1, 1997, where both states involved with a bank merger expressly permit it by statute. The Interstate Act permits states to enact a law expressly prohibiting interstate mergers. Such laws must apply equally to all out-of-state banks and be passed before June 1, 1997. The monetary policies of regulatory authorities, including the Federal Reserve Board, have a significant effect on the operating results of banks and bank holding companies. The nature of future monetary policies and the effect of such policies on the future business and earnings of the Corporation and its subsidiary banks cannot be predicted. The Corporation is under the jurisdiction of the Securities and Exchange Commission and state securities commission for matters relating to the offering and sale of its securities and is subject to the Securities and Exchange Commission's rules and regulations relating to periodic reporting, reporting to stockholders, proxy solicitation, and insider trading. The Corporation's income is principally derived from dividends paid on the common stock of its subsidiaries. The payment of these dividends are subject to certain regulatory restrictions. CAPITAL REQUIREMENTS The Corporation and its subsidiary banks must meet certain minimum capital requirements mandated by the FRB, the FDIC and DFI. These regulatory agencies require BHCs and banks to maintain certain minimum ratios of primary capital to total assets and total capital to total assets. As of January 1, 1991, the FRB required bank holding companies to maintain a minimum Tier 1 leverage ratio to 3 per cent capital to total assets; however, for all but the most highly rated institutions which do not anticipate significant growth, the minimum Tier 1 ratio is 3 per cent plus an additional cushion of 100 to 200 basis points. As of December 31, 1998, the Corporation's leverage ratio of capital to total assets was 11.9 per cent. The FRB and FDIC each have approved the imposition of "risk-adjusted" capital ratios on BHCs and financial institutions. The Corporation and its subsidiaries had capital to assets ratios and risk-adjusted capital ratios at December 31, 1998, in excess of the applicable regulatory minimum requirements. Page 5
- -------------------------------------------------------------------------------- CAPITAL REQUIREMENTS (continued) The following table summarizes the Corporation's risk-adjusted capital ratios under FRB guidelines at December 31, 1998: Corporation's Regulatory Consolidated Minimum Ratio Requirement ------------- ----------- Tier 1 Capital to Risk-Weighted Assets Ratio.................. 16.0% 4.0% Total Capital to Risk-Weighted Assets Ratio.................. 16.9% 8.0% Page 6
- -------------------------------------------------------------------------------- STATISTICAL DATA The following tables set forth statistical data relating 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. 1998 1997 1996 -------------------------- -------------------------- -------------------------- Interest Interest Interest Average Income/ Average Average Income/ Average Average Income/ Average Balance Expense Rate Balance Expense Rate Balance Expense Rate ------- ------- ------- ------- ------- ------- ------- ------- ------- (Dollars in Thousands on Fully Taxable Equivalent Basis) Assets: Federal funds sold..........................$ 15,172 $ 720 4.7% $ 3,127 $ 172 5.5% $ 9,359 $ 498 5.3% Interest-bearing deposits................ 598 27 4.5 693 34 4.9 346 16 4.6 Federal Reserve and Federal Home Loan Bank stock............ 3,590 278 7.7 3,144 242 7.7 2,800 212 7.6 Securities:(1) Taxable.................................. 175,281 10,858 6.2 172,993 10,818 6.3 204,323 12,752 6.2 Tax-exempt............................... 93,438 7,049 7.5 86,568 6,647 7.7 77,996 5,892 7.6 --------- ------- -------- ------- -------- ------- Total Securities....................... 268,719 17,907 6.7 259,561 17,465 6.7 282,319 18,644 6.6 Mortgage loans held for sale............... 773 98 12.7 406 47 11.6 262 21 8.0 Loans:(2) Commercial............................... 296,329 26,737 9.0 272,483 25,125 9.2 230,848 21,232 9.2 Bankers' acceptance and commercial paper purchased............................... 1,366 67 4.9 1,193 68 5.7 20 1 5.5 Real estate mortgage..................... 274,573 22,786 8.3 258,499 21,430 8.3 233,830 19,543 8.4 Installment.............................. 145,379 13,374 9.2 141,290 13,103 9.3 119,379 11,300 9.5 Tax-exempt............................... 3,511 309 8.8 2,021 178 8.8 1,566 140 8.9 --------- ------- -------- ------- -------- ------- Total loans............................ 721,158 63,273 8.8 675,486 59,904 8.9 585,643 52,216 8.9 --------- ------- -------- ------- -------- ------- Total earning assets................... 1,010,010 82,303 8.1 942,417 77,864 8.3 880,729 71,607 8.1 --------- ------- -------- ------- -------- ------- Net unrealized gain on securities available for sale....................... 2,897 1,273 961 Allowance for loan losses.................. (7,020) (6,761) (6,672) Cash and due from banks.................... 29,249 30,647 28,341 Premises and equipment..................... 16,608 14,950 14,879 Other assets............................... 12,970 10,812 13,906 ---------- -------- -------- Total assets........................... $1,064,714 $993,338 $932,144 ========== ======== ======== Liabilities: Interest-bearing deposits: NOW accounts............................ $ 116,026 $ 2,329 2.0 $104,620 $ 2,450 2.3 $109,792 $ 2,503 2.3 Money market deposit accounts........... 140,015 5,810 4.1 105,628 4,188 4.0 100,897 3,701 3.7 Savings deposits........................ 68,016 1,653 2.4 69,633 1,740 2.5 70,875 1,898 2.7 Certificates and other time deposits.... 434,897 23,960 5.5 425,478 23,542 5.5 381,378 21,037 5.5 ---------- ------- -------- ------- -------- ------- Total interest-bearing deposits........ 758,954 33,752 4.4 705,359 31,920 4.5 662,942 29,139 4.4 Borrowings................................ 77,508 4,298 5.5 68,640 3,805 5.5 60,960 3,210 5.3 ---------- ------- -------- ------- -------- ------- Total interest-bearing liabilities..... 836,462 38,050 4.6 773,999 35,725 4.6 723,902 32,349 4.5 Noninterest-bearing deposits.............. 97,771 94,759 90,719 Other liabilities......................... 3,769 7,566 9,429 ---------- -------- -------- Total liabilities...................... 938,002 876,324 824,050 Stockholders' equity...................... 126,712 117,014 108,094 ---------- -------- -------- Total liabilities and stockholders'equity $1,064,714 38,050 3.8(3) $993,338 35,725 3.8(3) $932,144 32,349 3.6(3) ========== ------- ======== -------- ======== -------- Net interest income...................... $44,254 4.3 $ 42,139 4.5 $ 39,258 4.5 ======= ======== ======== (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) Nonaccruing loans have been included in the average balances. (3) Total interest expense divided by total earning assets Adjustment to convert tax exempt investment securities to fully taxable equivalent basis, using marginal rate of 35% for 1996, 1997, and 1998................................ $ 2,575 $ 2,389 $ 2,111 ======= ======== ======== Page 7
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) 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. 1998 Compared to 1997 1997 Compared to 1996 Increase (Decrease) Due To Increase (Decrease) Due To -------------------------- -------------------------- Volume Rate Total Volume Rate Total ------ ---- ----- ------ ---- ----- (Dollars in Thousands on Fully Taxable Equivalent Basis) Interest income: Federal funds sold................... $ 575 $ ( 27) $ 548 $( 343) $ 17 $( 326) Interest-bearing deposits............ ( 4) ( 3) ( 7) 17 1 18 Federal Reserve and Federal Home Loan Bank stock............... 35 1 36 26 4 30 Securities........................... 612 (170) 442 (1,461) 282 (1,179) Mortgage loans held for sale......... 46 5 51 14 12 26 Loans................................ 4,013 (644) 3,369 7,966 (278) 7,688 ------- -------- ------- -------- ------- -------- Totals............................. 5,277 (838) 4,439 6,219 38 6,257 ------- -------- ------- -------- ------- -------- Interest expense: NOW accounts......................... 251 (372) (121) ( 126) 73 ( 53) Money market deposit accounts........................... 1,419 203 1,622 179 308 487 Savings deposits..................... (40) ( 47) ( 87) ( 33) (125) ( 158) Certificates and other time deposits...................... 519 (101) 418 2,440 65 2,505 Borrowings........................... 492 1 493 382 44 426 ------- -------- ------- -------- ------- -------- Totals............................. 2,641 (316) 2,325 2,839 537 3,376 ------- -------- ------- -------- ------- -------- Change in net interest income (fully taxable equivalent basis).................... $2,636 $ (522) $2,114 $ 3,380 $ (449) $ 2,881 ======= ======== ======== ======= Tax equivalent adjustment using marginal rate of 35% for 1996, 1997, and 1998............................. (186) (278) ------- ------- Change in net interest income............................... $1,928 $2,603 ======= ======= Page 8
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) INVESTMENT SECURITIES The amortized cost, gross unrealized gains, gross unrealized losses and approximate market value of the investment securities at the dates indicated were: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- (Dollars in Thousands) Available for sale at December 31, 1998: U.S. Treasury.............................. $ 20,269 $ 95 $ $ 20,364 Federal agencies........................... 52,598 577 19 53,156 State and municipal........................ 86,537 2,620 4 89,153 Mortgage-backed securities................. 126,329 424 183 126,570 Other asset-backed securities.............. 265 1 11 255 Corporate obligations...................... 18,624 143 8 18,759 Marketable equity securities............... 250 250 --------- ------ ------ --------- Total available for sale................. 304,872 3,860 225 308,507 --------- ------ ------ --------- Held to maturity at December 31, 1998: U.S. Treasury.............................. 249 4 253 Federal agencies........................... 500 1 501 State and municipal........................ 17,480 348 1 17,827 Mortgage-backed securities................. 864 3 867 Other asset-backed securities.............. 1,761 2 27 1,736 --------- ------ ------ --------- Total held to maturity................... 20,854 358 28 21,184 --------- ------ ------ --------- Total investment securities.............. $ 325,726 $4,218 $ 253 $ 329,691 ========= ====== ====== ========= Available for sale at December 31, 1997: U.S. Treasury.............................. $ 19,207 $ 104 $ 11 $ 19,300 Federal agencies........................... 66,783 405 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 ========= ====== ====== ========= Page 9
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- (Dollars in Thousands) Available for sale at December 31, 1996: U.S. Treasury.............................. $ 21,570 $ 92 $ 46 $ 21,616 Federal agencies........................... 79,130 540 180 79,490 State and municipal........................ 52,026 1,173 106 53,093 Mortgage-backed securities................. 35,946 297 145 36,098 Other asset-backed securities.............. 6,204 130 6,074 Corporate obligations...................... 31,470 156 128 31,498 Marketable equity securities............... 510 510 --------- ------ ------ --------- Total available for sale.................. 226,856 2,258 735 228,379 --------- ------ ------ --------- Held to maturity at December 31, 1996: U.S. Treasury.............................. 249 7 242 Federal agencies........................... 5,729 23 5 5,747 State and municipal........................ 36,405 381 21 36,765 Mortgage-backed securities................. 1,053 1,053 Other asset-backed securities.............. 3,791 17 121 3,687 --------- ------ ------ --------- Total held to maturity................... 47,227 421 154 47,494 --------- ------ ------ --------- Total investment securities.............. $ 274,083 $2,679 $ 889 $ 275,873 ========= ====== ====== ========= Cost ---------------------------------- 1998 1997 1996 ------ ------ ------ Federal Reserve and Federal Home Loan Bank stock at December 31: Federal Reserve Bank stock . . . . . . . . $ 397 $ 397 $ 397 Federal Home Loan Bank stock . . . . . . . 3,326 2,976 2,693 ------ ------ ------ Total. . . . . . . . . . . . . . . . . $3,723 $3,373 $3,090 ====== ====== ====== The Fair value of Federal Reserve and Federal Home Loan Bank stock approximates cost. The maturity distribution (dollars in thousands) and average yields for the securities portfolio at December 31, 1998 were: Securities available for sale December 31, 1998: Within 1 Year 1-5 Years 5-10 Years ----------------- ---------------- ---------------- Amount Yield* Amount Yield* Amount Yield* --------- ------ ------- ------ -------- ------ U.S. Treasury............ $ 19,265 5.39% $ 1,004 6.53% Federal Agencies......... 13,313 6.35 38,272 5.99 $ 1,013 5.53% State and Municipal...... 7,547 5.65 47,767 4.53 25,817 5.14 Corporate Obligations.... 12,454 5.50 6,170 6.68 --------- ------- -------- Total................. $ 52,579 5.70% $93,213 5.29% $ 26,830 5.15% ========= ======= ======== Page 10
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) Marketable Equity, Mortgage and Other Due After Ten Years Asset-Backed Securities Total ------------------- ----------------------- -------------------- Amount Yield* Amount Yield* Amount Yield* ------- ------ -------- ------- ------ ------ U.S. Treasury.................. $ 20,269 5.44% Federal Agencies............... 52,598 6.07 State and Municipal............ $ 5,406 5.69% 86,537 4.88 Corporate Obligations.......... 18,624 5.89 Marketable Equity Security..... $ 250 7.90% 250 7.90 Mortgage-backed securities..... 126,329 6.23 126,329 6.23 Other asset-backed securities.. 265 6.93 265 6.93 ------- -------- -------- Total....................... $ 5,406 5.69% $126,844 6.23% $304,872 5.75% ======= ======== ======== Securities held to maturity at December 31, 1998: Within 1 Year 1-5 Years 5-10 Years ---------------- ----------------- ---------------- Amount Yield* Amount Yield* Amount Yield* ------ ------ ------- ------ ------ ------ U.S. Treasury.................. $ 249 5.36% Federal Agencies............... $ 500 6.17% State and Municipal............ 4,870 5.15 10,492 4.74 $ 1,638 5.10% ------- ------- ------- Total....................... $ 5,370 5.24% $10,741 4.75% $ 1,638 5.10% ======= ======= ======= Mortgage and other Due After Ten Years asset-backed Total ------------------- ------------------- ------------------ Amount Yield* Amount Yield* Amount Yield* ------- ------ ------ ------ ------ ------ U.S. Treasury................ $ 249 5.36% Federal Agencies............. 500 6.17 State and Municipal.......... $ 480 5.88% 17,480 4.92 Mortgage-backed securities... $ 864 6.57% 864 6.57 Other asset-backed securities 1,761 7.38 1,761 7.38 ------- ------- ------- Total.................... $ 480 5.88% $ 2,625 7.11% $20,854 5.23 ======= ======= ======= *Interest yields on state and municipal securities are presented on a fully taxable equivalent basis using a 35% rate. Federal Reserve and Federal Home Loan Bank stock at December 31, 1998: Amount Yield ------ ----- Federal Reserve Bank stock........................ $ 397 6.00% Federal Home Loan Bank stock...................... 3,326 8.00 ------ Total........................................... $3,723 7.79% ====== Page 11
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) LOAN PORTFOLIO TYPES OF LOANS The loan portfolio at the dates indicated is presented below: 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (Dollars in Thousands) Loans at December 31: Commercial and industrial loans.................. $ 169,685 $ 148,281 $ 132,134 $ 98,880 $ 89,696 Bankers acceptances and loans to financial institutions......... 900 705 625 2,925 Agricultural production financing and other loans to farmers........................ 16,661 16,764 18,906 17,203 17,255 Real estate loans: Construction...................... 26,426 21,389 13,167 9,913 8,126 Commercial and farmland........... 95,172 97,503 97,596 104,731 95,092 Residential....................... 302,680 287,072 253,530 215,738 217,148 Individuals' loans for household and other personal expenditures............. 128,253 125,706 113,507 102,313 99,812 Tax-exempt loans.................... 2,115 2,598 1,643 1,204 1,514 Other loans......................... 1,217 3,782 1,672 949 1,608 ---------- ---------- ---------- ---------- ---------- 743,109 703,800 632,780 553,856 530,251 Unearned interest on loans.......... (137) (487) (1,364) (1,518) (1,610) ---------- ---------- ---------- ---------- ---------- Total loans................... $ 742,972 $ 703,313 $ 631,416 $ 552,338 $ 528,641 ========== ========== ========== ========== ========== Residential Real Estate Loans Held for Sale at December 31, 1998, 1997, 1996, 1995, and 1994 were $775,800, $471,400, $284,020, 735,522, and $0. MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES Presented in the table below are the maturities of loans (excluding commercial real estate, banker acceptances, farmland, residential real estate and individuals' loans) outstanding as of December 31, 1998. Also presented are the amounts due after one year classified according to the sensitivity to changes in interest rates. Maturing ----------------------------------------------- Within 1-5 Over 5 1 Year Years Years Total -------- -------- -------- -------- (Dollars in Thousands) Commercial and industrial loans............ $ 66,367 $ 53,164 $ 50,154 $169,685 Agricultural production financing and other loans to farmers............... 12,022 3,333 1,306 16,661 Real estate - Construction................. 13,431 5,677 7,318 26,426 Tax-exempt loans........................... 401 367 1,347 2,115 Other loans................................ 978 143 96 1,217 -------- -------- -------- -------- Total ................................ $ 93,199 $ 62,684 $ 60,221 $216,104 ======== ======== ======== ======== Page 12
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) Maturing ---------------------- 1 - 5 Over Years 5 Years ------- -------- (Dollars in Thousands) Loans maturing after one year with: Fixed rates................ $16,407 $26,627 Variable rate.............. 46,277 33,594 ------- ------- Total.................... $62,684 $60,221 ======= ======= RISK ELEMENTS December 31 --------------------------------------------- 1998 1997 1996 1995 1994 ------- ------- -------- ------- ------- (Dollars in Thousands) Nonaccruing loans.................... $ 735 $ 1,410 $ 2,777 $ 576 $ 398 Loans contractually past due 90 days or more other than nonaccruing......................... 2,275 1,972 1,699 1,119 1,322 Restructured loans................... 926 282 1,540 1,075 1,242 Nonaccruing loans are loans which are reclassified to a nonaccruing status when in management's judgment the collateral value and financial condition of the borrower do not justify accruing interest. Interest previously recorded but not deemed collectible is reversed and charged against current income. Interest income on these loans is then recognized when collected. Restructured loans are loans for which the contractual interest rate has been reduced or other concessions are granted to the borrower because of a deterioration in the financial condition of the borrower resulting in the inability of the borrower to meet the original contractual terms of the loans. Interest income of $94,000 for the year ended December 31, 1998, was recognized on the nonaccruing and restructured loans listed in the table above, whereas interest income of $163,000 would have been recognized under their original loan terms. POTENTIAL PROBLEM LOANS: Management has identified certain other loans totaling $7,039,000 as of December 31, 1998, not included in the risk elements table, or impaired loan table, about which there are doubts as to the borrowers' ability to comply with present repayment terms. The Banks generate commercial, mortgage and consumer loans from customers located primarily in central and east central Indiana and Butler County, Ohio. The Banks'loans are generally secured by specific items of collateral, including real property, consumer assets, and business assets. Although the Banks have diversified loan portfolio, a substantial portion of their debtors' ability to honor their contracts is dependent upon economic conditions in the automotive and agricultural industries. Page 13
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) SUMMARY OF LOAN LOSS EXPERIENCE The following table summarizes the loan loss experience for the years indicated. 1998 1997 1996 1995 1994 ------- ------- -------- ------- ------- (Dollars in Thousands) Allowance for loan losses: Balance at January 1.............. $ 6,778 $ 6,622 $ 6,696 $ 6,603 $ 6,467 Chargeoffs: Commercial...................... 694 443 767 794 973 Real estate mortgage............ 44 31 14 1 53 Installment..................... 1,143 1,135 855 759 462 ------- ------- ------- ------- ------- Total chargeoffs............... 1,881 1,609 1,636 1,554 1,488 ------- ------- ------- ------- ------- Recoveries: Commercial...................... 217 264 106 127 269 Real estate mortgage............ 20 1 7 4 30 Installment..................... 294 203 196 128 123 ------- ------- ------- ------- ------- Total recoveries............... 531 468 309 259 422 ------- ------- ------- ------- ------- Net chargeoffs.................... 1,350 1,141 1,327 1,295 1,066 ------- ------- ------- ------- ------- Provisions for loan losses........ 1,984 1,297 1,253 1,388 1,202 ------- ------- ------- ------- ------- Balance at December 31............ $ 7,412 $ 6,778 $ 6,622 $ 6,696 $ 6,603 ======= ======= ======= ======= ======= Ratio of net chargeoffs during the period to average loans outstanding during the period..... .18% .17% .23% .24% .21% Peer Group.......................... N/A .29% .26% .26% .25% Page 14
- -------------------------------------------------------------------------------- STATISTICAL DATA (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 per cent of loans in each category to total loans: 1998 1997 ------------------- ------------------- Amount Per Cent Amount Per Cent ------ -------- ------ -------- (Dollars in Thousands) Balance at December 31: Commercial, financial and agricultural................. $ 2,375 25.2% $ 2,594 23.6% Real estate - construction..... 3 3.6 3 3.0 Real estate - mortgage......... 1,057 53.5 1,061 54.7 Installment.................... 2,824 17.4 1,702 18.3 Tax-exempt loans............... 4 .3 4 .4 Unallocated.................... 1,149 N/A 1,414 N/A ------- ------ ------- ------ Totals......................... $ 7,412 100.0% $ 6,778 100.0% ======= ====== ======= ====== 1996 1995 ------------------- ------------------- Amount Per Cent Amount Per Cent ------ -------- ------ -------- (Dollars in Thousands) Balance at December 31: Commercial, financial and agricultural................. $ 2,924 24.2% $ 3,105 21.8% Real estate - construction..... 3 2.1 1 1.8 Real estate - mortgage......... 1,041 55.6 1,121 58.0 Installment.................... 1,576 17.8 1,506 18.2 Tax-exempt loans............... 16 .3 4 .2 Unallocated.................... 1,062 N/A 959 N/A ------- ------ ------- ------ Totals......................... $ 6,622 100.0% $ 6,696 100.0% ======= ====== ======= ====== 1994 ------------------- Amount Per Cent ------ -------- (Dollars in Thousands) Balance at December 31: Commercial, financial and agricultural................. $ 3,080 20.5% Real estate - construction..... 4 1.5 Real estate - mortgage......... 1,048 59.1 Installment.................... 1,550 18.6 Tax-exempt loans............... 4 .3 Unallocated.................... 917 N/A ------- ------ Totals......................... $ 6,603 100.0% ======= ====== Page 15
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) LOAN LOSS CHARGEOFF PROCEDURES The Banks have weekly meetings at which loan delinquencies, maturities and problems are reviewed. The Board of Directors receive and review reports on loans monthly. The Executive Committee of First Merchants' Board meets bimonthly to approve or disapprove all new loans in excess of $1,000,000 and the Board reviews all commercial loans in excess of $50,000 which were made or renewed during the preceding month. Pendleton's and First United's loan committees, consisting of all loan officers and the president, meet as required to approve or disapprove any loan which is in excess of an individual loan officer's lending limit. The Loan/Discount Committee of Union County's Board meets monthly to approve or disapprove all loans to borrowers with aggregate loans in excess of $300,000. The Loan Committee of Randolph County's Board meets weekly to approve or disapprove any loan which is in excess of an individual loan officer's lending limit. All chargeoffs are approved by the 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 chargeoff 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. Information on impaired loans is summarized below: 1998 1997 1996 ---- ---- ---- (Dollars in Thousands) For the year ending December 31: Impaired loans with an allowance................ $ 1,946 $ 1,476 $ 3,124 Impaired loans for which the discounted cash flows or collateral value exceeds the carrying value of the loan.................... 6,882 1,075 868 ------- ------- ------- Total impaired loans........................ $ 8,828 $ 2,551 $ 3,992 ======= ======= ======= Allowance for impaired loans (included in the Corporation's allowance for loan losses)...... $ 712 $ 407 $ 1,092 Average balance of impaired loans............... 8,318 3,414 5,213 Interest income recognized on impaired loans.... 873 180 311 Cash basis interest included above.............. 745 162 291 Page 16
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) DEPOSITS The following table shows the average amount of deposits and average rate of interest paid thereon for the years indicated. 1998 1997 1996 -------------- -------------- -------------- Amount Rate Amount Rate Amount Rate ------ ---- ------ ---- ------ ---- (Dollars in Thousands) Balance at December 31: Noninterest bearing deposits............ $ 97,771 $ 94,759 $ 90,719 NOW accounts............................ 116,026 2.0% 104,620 2.3% 109,792 2.3% Money market deposit accounts........... 140,015 4.1 105,628 4.0 100,897 3.7 Savings deposits........................ 68,016 2.4 69,633 2.5 70,875 2.7 Certificates of deposit and other time deposits.................... 434,897 5.5 425,478 5.5 381,378 5.5 -------- -------- -------- Total deposits....................... $856,725 3.9 $800,118 4.0 $753,661 3.9 ======== ======== ======== As of December 31, 1998, certificates of deposit and other time deposits of $100,000 or more mature as follows: Maturing ---------------------------------------------- 3 Months 3-6 6-12 Over 12 or less Months Months Months Total -------- ------ ------ ------- ----- (Dollars in Thousands) Certificates of deposit and other time deposits.................. $ 35,033 $14,426 $22,774 $19,346 $91,579 Per cent............................... 38% 16% 25% 21% 100% RETURN ON EQUITY AND ASSETS 1998 1997 1996 ---- ---- ---- Return on assets (net income divided by average total assets)......................... 1.45% 1.45% 1.41% Return on equity (net income divided by average equity).............................. 12.15 12.28 12.16 Dividend payout ratio (dividends per share divided by net income per share)....... 50.47 47.93 40.85 Equity to assets ratio (average equity divided by average total assets)............. 11.90 11.78 11.60 Page 17
- -------------------------------------------------------------------------------- STATISTICAL DATA (continued) SHORT-TERM BORROWINGS 1998 1997 1996 ---- ---- ---- (Dollars in Thousands) Balance at December 31: Securities sold under repurchase agreements(short-term portion)......... $ 20,836 $ 15,398 $ 20,054 Federal funds purchased.................. 17,070 4,070 20,725 U.S. Treasury demand notes............... 2,226 7,361 4,258 -------- -------- -------- Total short-term borrowings......... $ 40,132 $ 26,829 $ 45,037 ======== ======== ======== Securities sold under repurchase agreements are borrowings maturing within one year and are secured by U. S. Treasury and Federal agency obligations. Pertinent information with respect to short-term borrowings is summarized below: 1998 1997 1996 ---- ---- ---- (Dollars in Thousands) Weighted average interest rate on outstanding balance at December 31: Securities sold under repurchase agreements (short-term portion).... 5.07% 5.13% 4.92% Total short-term borrowings ............ 5.27 5.38 5.78 Weighted average interest rate during the year: Securities sold under repurchase agreements (short-term portion).... 5.10 4.99 5.07 Total short-term borrowings ............ 4.99 5.36 5.19 Highest amount outstanding at any month end during the year: Securities sold under repurchase agreements (short-term portion).... $27,002 $49,750 $52,221 Total short-term borrowings ............ 61,355 84,860 83,678 Average amount outstanding during the year: Securities sold under repurchase agreements (short-term portion).... 24,526 31,327 42,140 Total short-term borrowings ............ 37,854 53,185 51,768 Page 18
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. This building and eight branch buildings are owned by First Merchants; four remaining branches of First Merchants are located in leased premises. Twelve automated cash dispensers are located in leased premises. All of the Corporation's and First Merchants' facilities are located in Delaware and Madison Counties of Indiana. The principal offices of Pendleton are located at 100 West State Street, Pendleton, Indiana. Pendleton also operates three branches. All of Pendleton's properties are owned by Pendleton and are located in Madison County, Indiana. Two automated dispensers are located in leased premises. The principal offices of First United are located at 790 West Mill Street, Middletown, Indiana. First United also operates two branches. All of First United's properties are owned by First United and are located in Henry County, Indiana. The principal offices of Union County are located at 107 West Union Street, Liberty, Indiana. This building and two branches are owned by Union National; one branch is located in leased premises. Three automated cash dispensers are located in leased premises. All of Union National's facilities are located in Union, Fayette and Wayne Counties of Indiana. The principal office of Randolph County is located at 122 West Washington Street, Winchester, Indiana. This building is owned by Randolph County and is located in Randolph County, Indiana. None of the properties owned by the banks are subject to any major encumbrances. The net investment of the Corporation and subsidiaries in real estate and equipment at December 31, 1998 was $16,954,400. 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. 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 1998 to a vote of security holders, through the solicitation of proxies or otherwise. Page 19
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 are listed below. Offices with the Corporation Principal Occupation Name and Age And Subsidiary Banks During Past Five Years - ------------ ---------------------------- ---------------------- Stefan S. Anderson Chairman of the Board, Chairman of the Board of 64 Chief Executive Officer, the Corporation and First Corporation; Chairman of the Merchants since 1987; Board and Chief Executive Chief Executive Officer of Officer, First Merchants the Corporation since Bank, N.A. 1982; President of the Corporation from 1982 to August 1998, and Chief Executive Officer of First Merchants Bank since 1979 Michael L. Cox President, Chief Operating President and Chief 54 Officer and Director, Operating Officer, Corporation; President, Corporation since Chief Operating Officer and August 1998 and May, 1994 Director, First Merchants respectively; President Bank, N.A. and Chief Operating Officer, First Merchants since April, 1996; Director, Corporation and First Merchants since December, 1984; President, Information Services Group, Ontario Corporation prior to May 1994 Larry R. Helms Senior Vice President, Senior Vice President, 58 General Counsel and Corporation since 1982; Secretary, Corporation; General Counsel, Senior Vice President, First Corporation since 1990 and Merchants Bank, N.A.; Secretary since January 1, Director of First United 1997; Senior Vice Bank; Director of Pendleton President, First Merchants Banking Company since January 1979; Director of First United Bank since 1991 and Pendleton Banking Company since 1992 Ted J. Montgomery Senior Vice President and Senior Vice President and 59 Director, Corporation; Director, Corporation President, Chief Executive since August 1996; Officer and Director, The President, Union County Union County National Bank of National Bank since 1983 Liberty and Director since 1981 James L. Thrash Senior Vice President and Senior Vice President and 49 Chief Financial Officer, Chief Financial Officer of Corporation; Senior Vice the Corporation since President, First Merchants 1990; Senior Vice Bank, N.A. President, First Merchants since 1990 Page 20
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. - -------------------------------------------------------------------------------- The information required under this item is incorporated by reference to page 50 of the Corporation's 1998 Annual Report to Stockholders under the caption "Stockholder Information," Exhibit 13. ITEM 6. SELECTED FINANCIAL DATA. - -------------------------------------------------------------------------------- The information required under this item is incorporated by reference to page 18 of the Corporation's 1998 Annual Report to Stockholders - Financial Review under the caption "Five-Year Summary of Selected Financial Data," Exhibit 13. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. - -------------------------------------------------------------------------------- The information required under this item is incorporated by reference to page 19 through 27 of the Corporation's 1998 Annual Report to Stockholders - Financial Review under the caption "Management's Discussion and Analysis," Exhibit 13. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - -------------------------------------------------------------------------------- The information required under this item is incorporated by reference to page 21 and 22 of the corporation's 1998 Annual Report to Stockholders - Financial Review under the caption "Management's Discussion and Analysis," Exhibit 13. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - -------------------------------------------------------------------------------- The financial statements and supplementary data required under this item are incorporated herein by reference to page 17 and pages 28 through 47 of the Corporation's 1998 Annual Report to Stockholders - Financial Review, Exhibit 13. 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, 1998, there have been no disagreements with the Corporation's independent certified public accountants on any matter of accounting principles or practices, financial statement disclosure or audit scope or procedure, nor have there been any changes in accountants. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - -------------------------------------------------------------------------------- The information required under this item relating to directors is incorporated by reference to the Corporation's 1999 Proxy Statement furnished to its stockholders in connection with an annual meeting to be held April 14, 1999 (the "1998 Proxy Statement"), under the caption "Election of Directors," which Proxy Statement has been filed with the Commission. The information required under this item relating to executive officers is set forth in Part I, "Supplemental Information - Executive Officers of the Registrant" of this annual report on Form 10-K. ITEM 11. EXECUTIVE COMPENSATION. - -------------------------------------------------------------------------------- The information required under this item is incorporated by reference to the Corporation's 1999 Proxy Statement, under the captions, "Compensation of Directors" and "Compensation of Executive Officers," which Proxy Statement has been filed with the Commission. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. - -------------------------------------------------------------------------------- The information required under this item is incorporated by reference to the Corporation's 1999 Proxy Statement, under the caption, "Security Ownership of Certain Beneficial Owners and Management," which Proxy Statement has been filed with the Commission. Page 21
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - -------------------------------------------------------------------------------- The information required under this item is incorporated by reference to the Corporation's 1999 Proxy Statement, under the caption "Interest of Management in Certain Transactions," which Proxy Statement has been filed with the Commission. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. - -------------------------------------------------------------------------------- Exhibit 13 Page Number ---------- (a)1. Financial Statements: Independent auditor's report.............................. 17 Consolidated balance sheet at December 31, 1998 and 1997.............................. 28 Consolidated statement of income, years ended December 31, 1998, 1997 and 1996........................................... 29 Consolidated statement of comprehensive income, Years ended December 31, 1998, 1997, and 1996........... 30 Consolidated statement of changes in stockholders' equity, years ended December 31, 1998, 1997 and 1996........................ 30 Consolidated statement of cash flows, years ended December 31, 1998, 1997 and 1996........................................... 31 Notes to consolidated financial statements.............................................. 32-47 (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 Exhibit: - ----------- ----------------------- 3.1 First Merchants Corporation Articles of Incorporation and the Articles and amendment thereto is incorporated by reference to registrant's Form 10-Q for quarter ended June 30, 1997. 3.2 First Merchants Corporation Bylaws and amendments thereto (same as above). 10.1 First Merchants Corporation and First Merchants Bank, National Association Management Incentive Plan is incorporated by reference to registrant's Form 10-K for year ended December 31, 1996. 10.2 First Merchants Bank, National Association Unfunded Deferred Compensation Plan, as amended is incorporated by reference to registrant's Form 10-K for year ended December 31, 1996. 10.3 First Merchants Corporation 1989 Stock Option Plan is incorporated by reference to Registrant's Registration Statement on Form S-8 (SEC File No. 33-28901) effective on May 24, 1989. 10.4 First Merchants Corporation 1994 Stock Option Plan is incorporated by reference to Registrant's Form 10-K for year ended December 31, 1993. Page 22
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (continued) - -------------------------------------------------------------------------------- 10.5 First Merchants Corporation Change of Control Agreements are incorporated by reference to registrant's Form 10-K for year ended December 31, 1996. 10.6 First Merchants Corporation Unfunded Deferred Compensation Plan is incorporated by reference to registrant's Form 10-K for year ended December 31, 1996. 10.7 First Merchants Corporation Supplemental Executive Retirement Plan and amendments thereto is incorporated by reference to registrant's Form 10-K for year ended December 31, 1997. 13 1998 Annual Report to Stockholders (except for the Pages and information thereof expressly incorporated by reference in this Form 10-K, the Annual Report to Stockholders is provided solely for the information of the Securities and Exchange Commission and is not deemed "filed" as part of this Form 10-K) 21 Subsidiaries of Registrant 23 Consent of Independent Auditors 27 Financial Data Schedule, year ended December 31, 1998 99.1 Financial statements and independent auditor's report for First Merchants Corporation Employee Stock Purchase Plan (b) Reports on Form 8-K: None Page 23
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 31st day of March, 1999. FIRST MERCHANTS CORPORATION By /s/ Stefan S. Anderson -------------------------------------- Stefan S. Anderson, Chairman 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 and on the dates indicated. Signature Capacity Date - ------------------------------ ------------------------------ ---- /s/ Stefan S. Anderson - ------------------------------ Director, March 31, 1999 Stefan S. Anderson Principal Executive Officer /s/ James L. Thrash - ------------------------------ Principal Financial and March 31, 1999 James L. Thrash Principal Accounting Officer /s/ Michael L. Cox - ------------------------------ Director March 31, 1999 Michael L. Cox /s/ Frank A. Bracken - ------------------------------ *Director March 31, 1999 Frank A. Bracken /s/ Thomas B. Clark - ------------------------------ *Director March 31, 1999 Thomas B. Clark /s/ David A. Galliher - ------------------------------ *Director March 31, 1999 David A. Galliher /s/ Norman M. Johnson - ------------------------------ *Director March 31, 1999 Norman M. Johnson /s/ Ted J. Montgomery - ------------------------------ *Director March 31, 1999 Ted J. Montgomery /s/ George A. Sissel - ------------------------------ *Director March 31, 1999 George A. Sissel Page 24
Signature Capacity Date - ------------------------------ ------------------------------ ---- /s/ Robert M. Smitson - ------------------------------ *Director March 31, 1999 Robert M. Smitson /s/ Michael D. Wickersham - ------------------------------ *Director March 31, 1999 Michael D. Wickersham /s/ John E. Worthen - ------------------------------ *Director March 31, 1999 John E. Worthen * By James L. Thrash as Attorney-in-Fact pursuant to a limited Power of Attorney executed by the directors listed above, which Power of Attorney has been filed with the Securities and Exchange Commission. By /s/ James L. Thrash -------------------------------------- James L. Thrash As Attorney-in-Fact March 31, 1999 Page 25
INDEX TO EXHIBITS - -------------------------------------------------------------------------------- (a)3. Exhibits: Exhibit No: Description of Exhibit: - ----------- ----------------------- 13 1998 Annual Report to Stockholders (Except for the Pages and information thereof expressly incorporated by reference in this Form 10-K, the Annual Report to Stockholders is provided solely for the information of the Securities and Exchange Commission and is not deemed "filed" as part of this Form 10-K.) 21 Subsidiaries of Registrant 23 Consent of Independent Auditors 24 Limited Power of Attorney 27 Financial Data Schedule, year ended December 31, 1998 99.1 Financial statements and independent auditor's report for First Merchants Corporation Employee Stock Purchase Plan Page 26
Financial REVIEW Independent Auditor's Report 17 Five-Year Summary of Selected Financial Data 18 Management's Discussion & Analysis 19 Consolidated Financial Statements 28 Notes to Consolidated Financial Statements 32 - ---------------------------- INDEPENDENT AUDITOR'S REPORT - ---------------------------- To the Stockholders and Board of Directors First Merchants Corporation Muncie, Indiana We have audited the consolidated balance sheet of First Merchants Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998 (pages 28-47). These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements described above present fairly, in all material respects, the consolidated financial position of First Merchants Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. OLIVE llp Indianapolis, Indiana January 15, 1999 17
FIVE-YEAR SUMMARY of SELECTED FINANCIAL DATA (In Thousands, Except Share Data) ==================================================================================================================================== 1998 1997 1996 1995 1994 ==================================================================================================================================== OPERATIONS Net Interest Income Fully Taxable Equivalent Basis ........................ $ 44,253 $ 42,139 $ 39,258 $ 37,049 $ 35,909 Less Tax Equivalent Adjustment .......................... 2,575 2,389 2,111 1,952 1,971 ---------- ---------- ---------- ---------- ---------- Net Interest Income ..................................... 41,678 39,750 37,147 35,097 33,938 Provision for Loan Losses ............................... 1,984 1,297 1,253 1,388 1,202 ---------- ---------- ---------- ---------- ---------- Net Interest Income After Provision for Loan Losses ....................... 39,694 38,453 35,894 33,709 32,736 Total Other Income ...................................... 11,725 9,229 8,342 7,592 6,919 Total Other Expenses .................................... 27,895 25,748 24,135 22,992 22,632 ---------- ---------- ---------- ---------- ---------- Income Before Income Tax Expense ...................... 23,524 21,934 20,101 18,309 17,023 Income Tax Expense ...................................... 8,125 7,561 6,959 6,261 5,660 ---------- ---------- ---------- ---------- ---------- Net Income .............................................. $ 15,399 $ 14,373 $ 13,142 $ 12,048 $ 11,363 ========== ========== ========== ========== ========== PER SHARE DATA (1) Basic Net Income ........................................ $ 1.53 $ 1.44 $ 1.33 $ 1.23 $ 1.15 Diluted Net Income ...................................... 1.51 1.43 1.32 1.21 1.15 Cash Dividends Paid (2) ................................. .77 .69 .59 .51 .47 December 31 Book Value .................................. 13.04 12.20 11.38 10.66 9.39 December 31 Market Value (Bid Price) .................... 26.00 24.33 16.83 17.17 13.89 AVERAGE BALANCES Total Assets ............................................ $1,064,714 $ 993,338 $ 932,144 $ 890,995 $ 853,257 Total Loans ............................................. 721,931 675,892 585,905 544,457 513,784 Total Deposits .......................................... 856,725 800,118 753,661 728,826 698,644 Securities Sold Under Repurchase Agreements (long-term portion) ................................... 16,182 Total Federal Home Loan Bank Advances ................... 26,942 15,455 9,192 9,000 7,692 Total Stockholders' Equity .............................. 126,712 117,014 108,094 99,033 91,466 YEAR-END BALANCES Total Assets ............................................ $1,177,172 $1,020,136 $ 967,993 $ 942,156 $ 868,153 Total Loans ............................................. 743,748 703,784 631,700 553,074 528,641 Total Deposits .......................................... 926,844 843,812 794,451 783,936 720,009 Securities Sold Under Repurchase Agreements (long-term portion) ................................... 28,000 Total Federal Home Loan Bank Advances ................... 43,268 20,700 9,150 9,000 8,000 Total Stockholders' Equity .............................. 131,497 121,969 112,687 104,967 92,754 FINANCIAL RATIOS Return on Average Assets ................................ 1.45% 1.45% 1.41% 1.35% 1.33% Return on Average Stockholders' Equity .................. 12.15 12.28 12.16 12.17 12.42 Average Earning Assets to Total Assets .................. 95.13 94.77 94.48 94.86 94.46 Allowance for Loan Losses as % of Total Loans ........... .99 .96 1.05 1.21 1.25 Dividend Payout Ratio ................................... 50.47 47.93 40.85 39.49 39.44 Average Stockholders' Equity to Average Assets .......... 11.90 11.78 11.60 11.11 10.72 Tax Equivalent Yield on Earning Assets (3) .............. 8.13 8.27 8.13 8.09 7.41 Cost of Supporting Liabilities .......................... 3.76 3.79 3.67 3.71 2.95 Net Interest Margin on Earning Assets ................... 4.37 4.48 4.46 4.38 4.46 (1) Restated for 3-for-2 stock splits distributed October, 1995 and October, 1998. (2) Dividends per share is for First Merchants Corporation only, not restated for pooling transactions. (3) 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. 18
Management's Discussion & ANALYSIS The Corporation's financial data for periods prior to mergers, which were accounted for as pooling of interests, has been restated. o Return on Average Assets (percent) [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] 1996 1.41% 1997 1.45% 1998 1.45% o Return on Average Equity (percent) [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] 1996 12.16% 1997 12.28% 1998 12.15% RESULTS of OPERATIONS Net income amounted to $15,399,000 or $1.53 per share, a 6.2 percent increase over 1997 at $1.44 per share. Diluted net income per share amounted to $1.51, a 5.6 percent increase over the 1997 figure of $1.43. Return on assets was 1.45 percent in 1998 and 1997, up from 1.41 percent in 1996. Return on equity was 12.15 percent in 1998, 12.28 percent in 1997 and 12.16 percent in 1996. In 1998, First Merchants Corporation ("Corporation") recorded the twenty-third consecutive year of improvement in net income on both an aggregate and per share basis. 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 1998, equaling 11.9 percent at December 31, 1997. At December 31, 1998, the Corporation had a Tier I risk-based capital ratio of 16.0 percent, total risk-based capital ratio of 16.9 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. The Corporation has an employee stock purchase plan and an employee stock option plan. Activity under these plans is described in Note 15 to the Consolidated Financial Statements. The transactions under these plans have not had a material effect on the Corporation's capital position. 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. continued 19
- ---------------------------------- MANAGEMENT'S DISCUSSION & ANALYSIS - ---------------------------------- The following table summarizes the risk elements for the Corporation. December 31, ================================================================================ 1998 1997 ================================================================================ (Dollars in Thousands) Non-accrual loans ..................................... $ 735 $1,410 Loans contractually past due 90 days or more other than non-accruing ............................. 2,275 1,972 Restructured loans .................................... 926 282 ------ ------ Total ............................................... $3,936 $3,664 ====== ====== - -------------------------------------------------------------------------------- The Corporation's asset quality and loan loss experience have consistently been superior to that of its peer group. Asset quality has been a major factor in the Corporation's ability to generate consistent profit improvement. ASSET QUALITY/PROVISION for LOAN LOSSES continued At December 31, 1998, non-performing loans totaled $3,936,000, an increase of $272,000, and one non-accrual loan totaling $367,000 was restructured. At December 31, 1998, impaired loans totaled $8,828,000, an increase of $6,277,000, due to the addition of two loans totaling $5,402,000. As of December 31, 1998, the two businesses were experiencing negative cash flows. However, both loans are current, and the Corporation believes that the underlying collateral does not warrant a specific reserve. The Corporation adopted Statement of Financial Accounting Standards ("SFAS") No. 114 and No. 118, Accounting by Creditors for Impairment of a Loan and Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures, on January 1, 1995. Impaired loans included in the table at left totaled $2,222,000 at December 31, 1998. An allowance for losses at December 31, 1998, was not deemed necessary for impaired loans totaling $6,882,000, but an allowance of $712,000 was recorded for the remaining balance of impaired loans of $1,946,000. The average balance of impaired loans for 1998 was $8,318,000. At December 31, 1998, the allowance for loan losses was $7,412,000, up $634,000 from year end 1997. As a percent of loans, the allowance was .99 percent, up from .96 percent at year-end 1997. The provision for loan losses in 1998 was $1,984,000 compared to $1,297,000 in 1997. o Net Loan Losses (as a percent of average loans) [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] First Merchants Corporation Peer Group --------------------------- ---------- 1996 .23 .26 1997 .17 .29 1998 .18 NA The table below presents loan loss experience for the years indicated and compares the Corporation's loss experience to that of its peer group. ================================================================================ 1998 1997 1996 ================================================================================ (Dollars in Thousands) Allowance for loan losses: Balance at January 1 ........................... $6,778 $6,622 $6,696 ------ ------ ------ Chargeoffs ................................... 1,881 1,609 1,636 Recoveries ................................... 531 468 309 ------ ------ ------ Net chargeoffs ............................... 1,350 1,141 1,327 Provision for loan losses .................... 1,984 1,297 1,253 ------ ------ ------ Balance at December 31 ....................... $7,412 $6,778 $6,622 ====== ====== ====== Ratio of net chargeoffs during the period to average loans outstanding during the period .... .18% .17% .23% Peer Group ....................................... NA .29% .26% 20
---------------------------------- MANAGEMENT'S DISCUSSION & ANALYSIS ---------------------------------- 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 December 31, 1998, remained adequate to meet the Corporation's primary goal of achieving optimum interest margins while avoiding undue interest rate risk. The table below presents the Corporation's interest rate sensitivity analysis as of December 31, 1998. Asset/Liability Management has been an important factor in the Corporation's ability to record consistent earnings growth through periods of interest rate volatility. INTEREST RATE SENSITIVITY ANALYSIS (Dollars in Thousands) At December 31, 1998 - ------------------------------------------------------------------------------------------------------------------------------------ 1-180 Days 181-365 Days 1-5 Years Beyond 5 Years Total - ------------------------------------------------------------------------------------------------------------------------------------ Rate-Sensitive Assets: Federal funds sold and interest-bearing deposits .......................... $ 38,170 $ 38,170 Investment securities ................................ 67,950 $ 44,812 $ 154,855 $ 61,744 329,361 Loans ................................................ 319,806 75,404 249,283 99,255 743,748 Federal Reserve and Federal Home Loan Bank stock ......................... 3,723 3,723 ---------- ---------- ---------- ---------- ---------- Total rate-sensitive assets ........................ 429,649 120,216 404,138 160,999 $1,115,002 ---------- ---------- ---------- ---------- ---------- Rate-Sensitive Liabilities: Interest-bearing deposits ............................ 363,969 179,739 258,564 1,275 803,547 Securities sold under repurchase agreements .......... 10,936 9,900 28,000 48,836 Other short-term borrowings .......................... 19,296 19,296 Federal Home Loan Bank advances ...................... 1,387 17,763 12,000 12,118 43,268 ---------- ---------- ---------- ---------- ---------- Total rate-sensitive liabilities ................... 395,588 207,402 298,564 13,393 914,947 ---------- ---------- ---------- ---------- ---------- Interest rate sensitivity gap by period ................ $ 34,061 $ (87,186) $ 105,574 $ 147,606 Cumulative rate sensitivity gap ........................ 34,061 (53,125) 52,449 200,055 Cumulative rate sensitivity gap ratio at December 31, 1998 ................................. 108.6% 91.2% 105.8% 121.9% The Corporation had a cumulative negative gap of $53,125,000 in the one-year horizon at December 31, 1998, just over 4.5 percent of total assets. Net interest income at financial institutions with negative gaps tends to increase when rates decrease and decrease as interest rates increase. 21
- ---------------------------------- MANAGEMENT'S DISCUSSION & ANALYSIS - ---------------------------------- LIQUIDITY, INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued 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 minus 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-Bill 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 292 (243) Regular Savings 100 (267) - -------------------------------------------------------------------------------- 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) $ 64,520 $ 63,838 $ 62,713 Change vs. Flat/Base Scenario $ (682) $ (1,807) Percent Change (1.06%) (2.80%) - -------------------------------------------------------------------------------- 22
---------------------------------- MANAGEMENT'S DISCUSSION & ANALYSIS ---------------------------------- EARNING ASSETS Earning assets increased $151.2 million during 1998. The table at right reflects the earning asset mix for the years 1998 and 1997 (at December 31). Loans grew by $39.7 million while investment securities increased by $81.8 million, reflecting the Corporation's strategy to leverage its strong capital position. Earning Assets (Dollars in Millions) ================================================================================ December 31, 1998 1997 ================================================================================ Federal funds sold and interest-bearing time deposits .... $ 38.2 $ 9.4 Securities available for sale ............................ 308.5 212.0 Securities held to maturity .............................. 20.9 35.3 Mortgage loans held for sale ............................. 0.8 0.5 Loans .................................................... 743.0 703.3 Federal Reserve and Federal Home Loan Bank stock ............................................... 3.7 3.4 -------- ------ Total .................................................. $1,115.1 $963.9 ======== ====== - -------------------------------------------------------------------------------- DEPOSITS, SECURITIES SOLD UNDER REPURCHASE AGREEMENTS, OTHER SHORT-TERM BORROWINGS AND FEDERAL HOME LOAN BANK ADVANCES The table at right reflects the level of deposits and borrowed funds (Federal funds purchased, repurchase agreements, U.S. Treasury demand notes and Federal Home Loan Bank advances) based on year-end levels at December 31, 1998 and 1997. As of December 31 (Dollars in Millions) - -------------------------------------------------------------------------------- SECURITIES SOLD UNDER OTHER SHORT-TERM FEDERAL HOME LOAN DEPOSITS REPURCHASE AGREEMENTS BORROWINGS BANK ADVANCES - -------------------------------------------------------------------------------- 1998 $926.8 $48.8 $19.3 $43.3 1997 $843.8 $15.4 $11.4 $20.7 - -------------------------------------------------------------------------------- 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 reflects the Corporation's asset yields, interest expense, and net interest income as a percent of average earning assets for the three-year period ending in 1998. Asset yields declined .14 percent (FTE) in 1998, due primarily to a decline in interest rates. Interest costs declined by .03 percent resulting in a .11 percent decrease in net interest income (FTE) as a percent of average earning assets. Despite this "spread" decrease, net interest income increased by $2.1 million, due to the growth in average earning assets of $71.6 million. (Dollars in Thousands) - ------------------------------------------------------------------------------------------------------------------------------------ INTEREST INCOME INTEREST EXPENSE NET INTEREST INCOME NET INTEREST INCOME (FTE) as a Percent of as a Percent of (FTE) as a Percent of AVERAGE on a fully Taxable Average Earning Assets Average Earning Assets Average Earning Assets EARNING ASSETS Equivalent Basis - ------------------------------------------------------------------------------------------------------------------------------------ 1998 8.13% 3.76% 4.37% $1,012,907 $44,253 1997 8.27 3.79 4.48 941,351 42,139 1996 8.13 3.67 4.46 880,729 39,258 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. - ------------------------------------------------------------------------------------------------------------------------------------ 23
- ---------------------------------- MANAGEMENT'S DISCUSSION & ANALYSIS - ---------------------------------- 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. Other income in 1998 amounted to $11,725,000, or 27 percent higher than in 1997. The increase of $2,496,000 is primarily attributable to the following factors: 1. Revenues from fiduciary activity grew $778,000, or 23.2 percent, due to strong new business activity and markets. 2. Commission income increased $711,000, or 230.1 percent, due to the acquisition of the Muncie office of Insurance & Risk Management, Inc., renamed First Merchants Insurance Services, on April 1, 1998. 3. Other customer fees increased $453,000, or 23.7 percent, due to increased electronic delivery methods and some minor price adjustments. 4. Other income increased $483,000, or 159.9 percent, due primarily to a $442,000 gain on sale of a Bank building. Other income in 1997 amounted to $9,229,000, or 10.6 percent higher than in 1996. The increase of $887,000 is primarily attributable to the following factors: 1. Revenues from fiduciary activity grew $388,000, or 13.1 percent, due to strong new business activity and markets. 2. Service charges on deposit accounts increased $341,000, or 11.3 percent, due to account growth and some minor price adjustments. 3. Purchase money order agent fees increased $71,000, or 14.6 percent, due to increased sales volume. OTHER EXPENSES Total "other expenses" represent non-interest operating expenses of the Corporation. Those expenses amounted to $27,895,000 in 1998, an increase of 8.3 percent from the prior year, or $2,147,000. Four major areas account for most of the increase: 1. Salary and benefit expenses, which account for over one-half of the Corporation's non-interest operating expenses, grew by $1,319,000, or 9.2 percent, due to normal salary increases and staff additions. 2. Equipment expenses increased $375,000, or 16.0 percent, reflecting the Corporation's efforts to improve efficiency and provide electronic service delivery to its customers. 3. Net occupancy expense increased $212,000, or 13.1 percent, due primarily to increased branch expansion into new markets. Operating costs in 1998 included start-up expenses for three banking centers opened in new markets. These banking centers helped implement our strategy of enlarging our presence in rapidly growing areas and should have a positive effect on earnings in 1999 and succeeding years. 24
---------------------------------- MANAGEMENT'S DISCUSSION & ANALYSIS ---------------------------------- OTHER EXPENSES continued Expenses for 1997 amounted to $25,748,000, an increase of 6.7 percent from the prior year, or $1,613,000. Four major areas account for most of the increase: 1. Salary and benefit expenses, which account for over one-half of the Corporation's non-interest operating expenses, grew by $889,000, or 6.6 percent, due to normal salary increases and staff additions. 2. Equipment expenses increased $193,000, or 9.0 percent, reflecting the Corporation's efforts to improve efficiency and provide electronic service delivery to its customers. 3. Marketing expenses rose $145,000, or 20.5 percent, due to more aggressive product promotion. 4. Outside data processing fees grew by $176,000, or 19.5 percent, due to increased debit card, credit card and trust activity. INCOME TAXES The increase in 1998 tax expense of $564,000 is attributable primarily to a $1,590,000 increase in net pre-tax income, mitigated somewhat by a $347,000 increase in tax-exempt income. Likewise, the $602,000 increase in 1997 resulted primarily from a $1,833,000 increase in pre-tax net income, mitigated somewhat by a $514,000 increase in tax-exempt income. ACCOUNTING MATTERS Accounting for Derivative Instruments and Hedging Activities During 1998, the Financial Accounting Standards Board (FASB) issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement requires companies to record derivatives on the balance sheet at their fair value. Statement No. 133 also acknowledges that the method of recording a gain or loss depends on the use of the derivative. The new Statement applies to all entities. If hedge accounting is elected by the entity, the method of assessing the effectiveness of the hedging derivative and the measurement approach of determining the hedge's ineffectiveness must be established at the inception of the hedge. Statement No. 133 amends Statement No. 52 and supersedes Statements No. 80, 105 and 119. Statement No. 107 is amended to include the disclosure provisions about the concentrations of credit risk from Statement No. 105. Several Emerging Issues Task Force consensuses are also changed or nullified by the provisions of Statement No. 133. Statement No. 133 will be effective for all fiscal years beginning after June 15, 1999. The Statement may not be applied retroactively to financial statements of prior periods. The adoption of this Statement will have no material impact on the Corporation's financial condition or result of operations. 25
- ---------------------------------- MANAGEMENT'S DISCUSSION & ANALYSIS - ---------------------------------- ACCOUNTING MATTERS continued Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise Also in 1998, the FASB issued Statement No. 134, Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. It establishes accounting standards for certain activities of mortgage banking enterprises and for other enterprises with similar mortgage operations. This Statement amends Statement No. 65. Statement No. 134, as previously amended by Statements No. 115 and 125, required a mortgage banking enterprise to classify a mortgage-backed security as a trading security following the securitization of the mortgage loan held for sale. This Statement further amends Statement No. 65 to require that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities must classify the resulting mortgage-backed security or other retained interests based on the entity's ability and intent to sell or hold those investments. The determination of the appropriate classification for securities retained after the securitization of mortgage loans by a mortgage banking enterprise now conforms to Statement No. 115. The only new requirement is that if an entity has a sales commitment in place, the security must be classified into trading. This Statement is effective for the first fiscal quarter beginning after December 15, 1998. On the date this Statement is initially applied, an entity may reclassify mortgage-backed securities and other beneficial interests retained after the securitization of mortgage loans held for sale from the trading category, except for those with sales commitments in place. Those securities and other interests shall be classified based on the entity's present ability and intent to hold the investments. The adoption of this Statement will have no material impact on the Corporation's financial condition and result of operations. Reporting on the Costs of Start-Up Activities During 1998, the Accounting Standards Executive Committee (AcSEC) issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities. Statement of Position 98-5 will affect all non-governmental entities, including not-for-profits, reporting start-up costs in their financial statements. Some existing industry practices result in the capitalization and amortization of start-up costs. This Statement of Position requires that start-up costs be expensed when incurred. The Statement of Position applies to start-up activities and organizational costs associated with both development stage and established operating entities. According to Statement of Position 98-5, start-up activities are "those one-time activities related to opening a new facility, introducing a new product or service, conducting business in a new territory, conducting business with a new class of customer or beneficiary, initiating a new process in an existing facility, or commencing some new operation. Start-up activities include activities related to organizing a new entity (commonly referred to as organizational costs)." Statement of Position 98-5 is effective for fiscal years beginning on or after December 15, 1998. Earlier application is encouraged in fiscal years during which annual financial statements have not yet been issued. The adoption of this Statement will not have a material impact on the Corporation's financial condition or result of operations. 26
---------------------------------- MANAGEMENT'S DISCUSSION & ANALYSIS ---------------------------------- INFLATION Changing prices of goods, services and capital affect the financial position of every business enterprise. The level of market interest rates and the price of funds loaned or borrowed fluctuate due to changes in the rate of inflation and various other factors, including government monetary policy. Fluctuating interest rates affect the Corporation's net interest income, loan volume and other operating expenses, such as employee salaries and benefits, reflecting the effects of escalating prices, as well as increased levels of operations and other factors. As the inflation rate increases, the purchasing power of the dollar decreases. Those holding fixed-rate monetary assets incur a loss, while those holding fixed-rate monetary liabilities enjoy a gain. The nature of a bank holding company's operations is such that there will be an excess of monetary assets over monetary liabilities, and, thus, a bank holding company will tend to suffer from an increase in the rate of inflation and benefit from a decrease. 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 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 and test the systems for the Year 2000 compliance. The Corporation began the testing phase during the third quarter of 1998. Core application testing should be completed by March 31, 1999. The Corporation has contacted the companies that supply or service its material operations to certify that their respective computer systems are Year 2000 compliant. In addition to possible expenses related to the Corporation's systems and those of the Corporation's service providers, the Corporation could incur losses if Year 2000 problems affect any of its depositors or borrowers. Such problems could include delayed loan payments, due to Year 2000 problems affecting any of its significant borrowers or impairing the payroll systems of large employers in its market area. Because the Corporation's loan portfolio to corporate and individual borrowers is diversified and its market area does not depend significantly upon one employer or industry, the Corporation does not expect any such Year 2000 related difficulties that may affect its depositors and borrowers to significantly affect its net earnings or cash flows. The Board of Directors reviews, on a quarterly basis, the progress in addressing Year 2000 issues. The Corporation believes that its costs related to upgrading systems and software for Year 2000 compliance will not exceed $900,000. As of December 31, 1998, the Corporation has spent approximately $625,000 in connection with Year 2000 compliance. Of the $625,000 approximately $550,000 has been capitalized as the Corporation replaced and upgraded non-compliant systems. Although the Corporation believes it is taking the necessary steps to address the Year 2000 compliance issue, no assurances can be given that some problems will not occur or that the Corporation will not incur significant additional expenses in future periods. WEB SITE The Securities and Exchange Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants with the commission, including the Corporation; http://www.sec.gov is that address. 27
CONSOLIDATED BALANCE SHEET (In Thousands, Except Share Data) December 31, =================================================================================================================== 1998 1997 =================================================================================================================== ASSETS Cash and due from banks .............................................. $ 33,908 $ 33,127 Federal funds sold ................................................... 37,315 9,050 ----------- ----------- Cash and cash equivalents .......................................... 71,223 42,177 Interest-bearing time deposits ....................................... 855 385 Investment securities Available for sale ................................................. 308,507 212,040 Held to maturity (fair value of $21,184 and $35,429) ............... 20,854 35,332 ----------- ----------- Total investment securities ...................................... 329,361 247,372 Mortgage loans held for sale ......................................... 776 471 Loans ................................................................ 742,972 703,313 Less: Allowance for loan losses .................................... (7,412) (6,778) ----------- ----------- Net loans ........................................................ 735,560 696,535 Premises and equipment ............................................... 16,954 15,382 Federal Reserve and Federal Home Loan Bank stock ..................... 3,723 3,373 Interest receivable .................................................. 9,173 8,968 Core deposit intangibles and goodwill ................................ 3,117 1,625 Other assets ......................................................... 6,430 3,848 ----------- ----------- Total assets ....................................................... $ 1,177,172 $ 1,020,136 =========== =========== LIABILITIES Deposits Noninterest-bearing ................................................ $ 123,297 $ 115,613 Interest-bearing ................................................... 803,547 728,199 ----------- ----------- Total deposits ................................................... 926,844 843,812 Borrowings ............................................................. 111,400 47,529 Interest payable ....................................................... 3,614 3,615 Other liabilities ...................................................... 3,817 3,211 ----------- ----------- Total liabilities ................................................ 1,045,675 898,167 COMMITMENTS AND CONTINGENT LIABILITIES 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 - 10,086,083 and 6,664,439 shares ........... 1,261 833 Additional paid-in capital ........................................... 24,969 24,140 Retained earnings .................................................... 103,076 95,449 Accumulated other comprehensive income ............................... 2,191 1,547 ----------- ----------- Total stockholders' equity ......................................... 131,497 121,969 ----------- ----------- Total liabilities and stockholders' equity ......................... $ 1,177,172 $ 1,020,136 =========== =========== See Notes to Consolidated Financial Statements. 28
CONSOLIDATED STATEMENT OF INCOME (In Thousands, Except Share Data) Year Ended December 31, ================================================================================================================== 1998 1997 1996 ================================================================================================================== Interest Income Loans receivable Taxable .............................................. $ 63,062 $ 59,773 $ 52,096 Tax exempt ........................................... 201 116 90 Investment securities Taxable .............................................. 10,858 10,818 12,832 Tax exempt ........................................... 4,582 4,320 3,832 Federal funds sold ..................................... 720 172 498 Deposits with financial institutions ................... 27 34 16 Federal Reserve and Federal Home Loan Bank stock ....... 278 242 132 -------- -------- -------- Total interest income .............................. 79,728 75,475 69,496 -------- -------- -------- Interest Expense Deposits ............................................... 33,752 31,920 29,139 Securities sold under repurchase agreements ............ 2,015 1,563 2,137 Federal Home Loan Bank advances ........................ 1,645 949 523 Other borrowings ....................................... 638 1,293 550 -------- -------- -------- Total interest expense ............................. 38,050 35,725 32,349 -------- -------- -------- Net Interest Incomei ..................................... 41,678 39,750 37,147 Provision for loan losses .............................. 1,984 1,297 1,253 -------- -------- -------- Net Interest Income After Provision for Loan Losses ................................ 39,694 38,453 35,894 -------- -------- -------- Other Income Fiduciary activities ................................... 4,133 3,355 2,967 Service charges on deposit accounts .................... 3,303 3,365 3,024 Other customer fees .................................... 2,365 1,912 1,659 Net realized gains (losses) on sales of available-for-sale securities ............... 119 (14) 148 Commission income ...................................... 1,020 309 344 Other income ........................................... 785 302 200 -------- -------- -------- Total other income ................................. 11,725 9,229 8,342 -------- -------- -------- Other Expenses Salaries and employee benefits ......................... 15,641 14,322 13,433 Net occupancy expenses ................................. 1,832 1,620 1,537 Equipment expenses ..................................... 2,720 2,345 2,152 Marketing expense ...................................... 817 851 706 Deposit insurance expense .............................. 100 97 12 Outside data processing fees ........................... 1,061 1,077 901 Printing and office supplies ........................... 893 1,021 923 Other expenses ......................................... 4,831 4,415 4,471 -------- -------- -------- Total other expenses ............................... 27,895 25,748 24,135 -------- -------- -------- Income Before Income Tax ................................. 23,524 21,934 20,101 Income tax expense ..................................... 8,125 7,561 6,959 -------- -------- -------- Net Income ............................................... $ 15,399 $ 14,373 $ 13,142 ======== ======== ======== Net Income Per Share: Basic .................................................. $ 1.53 $ 1.44 $ 1.33 Diluted ................................................ 1.51 1.43 1.32 See Notes to Consolidated Financial Statements. 29
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (Dollar Amounts In Thousands) Year Ended December 31, =========================================================================================================================== 1998 1997 1996 =========================================================================================================================== Net income ................................................................ $ 15,399 $ 14,373 $ 13,142 -------- -------- -------- Other comprehensive income, net of tax: Unrealized gains (losses) on securities available for sale: Unrealized holding gains (losses) arising during the period, net of income tax of $(487), $(424) and $601 .......................... 715 623 (882) Less: Reclassification adjustment for (gains) losses included in net income, net of income tax of $48, ($6) and $60 ........ (71) 8 (88) -------- -------- -------- 644 631 (970) -------- -------- -------- Comprehensive income ...................................................... $ 16,043 $ 15,004 $ 12,172 ======== ======== ======== CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (In Thousands, Except Share Data) - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCK ACCUMULATED ---------------------- OTHER ADDITIONAL RETAINED COMPREHENSIVE SHARES AMOUNT PAID-IN CAPITAL EARNINGS INCOME TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Balances, January 1, 1996 ...................... 6,562,290 $ 820 $22,055 $ 80,205 $1,886 $104,966 Net income for 1996 .......................... 13,142 13,142 Cash dividends ($.59 per share) .............. (5,369) (5,369) Other comprehensive income, net of tax ....... (970) (970) Stock issued under employee benefit plans .... 15,175 2 296 298 Stock issued under dividend reinvestment and stock purchase plan .................... 21,712 3 555 558 Stock options exercised ...................... 4,237 64 64 Cash paid in lieu of issuing fractional shares (95) (2) (2) ----------- ------- ------- --------- ------ -------- Balances, December 31, 1996 .................... 6,603,319 825 22,968 87,978 916 112,687 Net income for 1997 .......................... 14,373 14,373 Cash dividends ($.69 per share) .............. (6,902) (6,902) Other comprehensive income, net of tax ....... 631 631 Stock issued under employee benefit plans .... 13,690 2 289 291 Stock issued under dividend reinvestment and stock purchase plan .................... 23,276 3 723 726 Stock options exercised ...................... 24,154 3 160 163 ----------- ------- ------- --------- ------ -------- Balances, December 31, 1997 .................... 6,664,439 833 24,140 95,449 1,547 121,969 Net income for 1998 .......................... 15,399 15,399 Cash dividends ($.77 per share) .............. (7,772) (7,772) Other comprehensive income, net of tax ....... 644 644 Stock issued under employee benefit plans .... 14,471 2 383 385 Stock issued under dividend reinvestment and stock purchase plan .................... 19,092 2 677 679 Stock options exercised ...................... 31,606 4 267 271 Stock redeemed ............................... (2,000) (72) (72) Three-for-two stock split .................... 3,358,760 420 (420) Cash paid in lieu of issuing fractional shares (285) (6) (6) ----------- ------- ------- --------- ------ -------- Balances, December 31, 1998 .................... 10,086,083 $ 1,261 $24,969 $(103,076 $2,191 $131,497 =========== ======= ======= ========= ====== ======== See Notes to Consolidated Financial Statements. 30
CONSOLIDATED STATEMENT OF CASH FLOWS (In Thousands, Except Share Data) Year Ended December 31, ==================================================================================================================================== 1998 1997 1996 ==================================================================================================================================== Operating Activities: Net income ........................................................... $ 15,399 $ 14,373 $ 13,142 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses .......................................... 1,984 1,297 1,253 Depreciation and amortization ...................................... 1,970 1,810 1,626 Amortization of goodwill and intangibles ........................... 184 89 131 Deferred income tax ................................................ 28 (35) 401 Securities amortization, net ....................................... 179 236 188 Securities losses (gains), net ..................................... (119) 14 (148) Gain on sale of premises and equipment ............................. (442) Mortgage loans originated for sale ................................. (10,251) (7,139) (2,501) Proceeds from sales of mortgage loans .............................. 9,946 6,952 2,952 Net change in Interest receivable .............................................. (205) (325) 357 Interest payable ....................................................... (1) 239 (40) Other adjustments ...................................................... (2,426) (1,050) (593) --------- --------- --------- Net cash provided by operating activities .............................. 16,246 16,461 16,768 --------- --------- --------- Investing Activities: Net change in interest-bearing deposits ............................. (470) (95) (31) Purchases of Securities available for sale ..................................... (184,585) (68,524) (113,473) Securities held to maturity ............................................ (90) (2,652) (22,450) Proceeds from maturities of Securities available for sale ..................................... 83,556 73,786 96,441 Securities held to maturity ....................................... 14,250 15,878 35,715 Proceeds from sales of Securities available for sale ..................................... 5,886 10,552 13,120 Net change in loans ................................................. (41,009) (73,038) (80,404) Acquisition of insurance subsidiary ................................. (1,254) Purchase of Federal Home Loan Bank stock ............................ (350) (283) (389) Purchases of premises and equipment .................................... (4,447) (2,157) (2,083) Proceeds from sale of fixed assets .................................. 1,029 Other investing activities .......................................... (104) 236 71 --------- --------- --------- Net cash used by investing activities ............................... (127,588) (46,297) (73,483) --------- --------- --------- Financing Activities: Net change in Demand and savings deposits ....................................... 77,474 16,242 (19,168) Certificates of deposit and other time deposits ................... 5,558 33,119 29,683 Repurchase agreements and other borrowings ............................. 41,303 (18,208) 7,659 Federal Home Loan Bank advances ..................................... 27,657 11,550 7,150 Repayment of Federal Home Loan Bank advances ........................ (5,089) (7,000) Cash dividends ...................................................... (7,772) (6,902) (5,369) Stock issued under employee benefit plans .............................. 385 291 298 Stock issued under dividend reinvestment and stock purchase plan ........................................... 679 726 558 Stock options exercised ............................................. 271 163 64 Stock redeemed ...................................................... (72) Cash paid in lieu of issuing fractional shares ...................... (6) (2) --------- --------- --------- Net cash provided by financing activities .............................. 140,388 36,981 13,873 --------- --------- --------- Net Change in Cash and Cash Equivalents ................................ 29,046 7,145 (42,842) Cash and Cash Equivalents, Beginning of Year ........................... 42,177 35,032 77,874 --------- --------- --------- Cash and Cash Equivalents, End of Year ................................. $ 71,223 $ 42,177 $ 35,032 ========= ========= ========= Additional Cash Flows Information: Interest paid ....................................................... $ 38,051 $ 35,486 $ 32,388 Income tax paid ........................................................ 8,252 7,602 6,203 See Notes to Consolidated Financial Statements. 31
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 1 ================================================================================ Nature of Operations and Summary of Significant Accounting Policies The accounting and reporting policies of First Merchants Corporation ("Corporation"), and its wholly owned subsidiaries, First Merchants Bank, N.A. ("First Merchants"), Pendleton Banking Company ("Pendleton"), and its subsidiary First Merchants Insurance Services, Inc., First United Bank ("First United"), The Randolph County Bank ("Randolph County"), and Union County National Bank ("Union County"), (collectively "the Banks"), conform to generally accepted accounting principles and reporting practices followed by the banking industry. The more significant of the policies are described below. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Corporation is a bank holding company whose principal activity is the ownership and management of the Banks. First Merchants and Union County operate under national bank charters and provide full banking services, including trust services. As national banks, First Merchants and Union County are subject to the regulation of the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation ("FDIC"). Pendleton, First United and Randolph County operate under state bank charters and provide full banking services, including trust services. As state banks, Pendleton, First United and Randolph County are subject to the regulation of the Department of Financial Institutions, State of Indiana, and the FDIC. The Banks generate commercial, mortgage, and consumer loans and receive deposits from customers located primarily in central and east central Indiana and Butler County, Ohio. The Banks' loans are generally secured by specific items of collateral, including real property, consumer assets, and business assets. Although the Banks have a diversified loan portfolio, a substantial portion of their debtors' ability to honor their contracts is dependent upon economic conditions in the automotive and agricultural industries. Consolidation The consolidated financial statements include the accounts of the Corporation and the Banks, after elimination of all material intercompany transactions. Investment Securities Debt securities are classified as held to maturity when the Corporation has the positive intent and ability to hold the securities to maturity. Securities held to maturity are carried at amortized cost. Debt securities not classified as held to maturity are classified as available for sale. Securities available for sale are carried at fair value with unrealized gains and losses reported as accumulated other comprehensive income in stockholders' equity, net of tax. Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses on sales of securities are determined on the specific-identification method. Loans Held for Sale are carried at the lower of aggregate cost or market. Market is determined using the aggregate method. Net unrealized losses are recognized through a valuation allowance by charges to income. Loans are carried at the principal amount outstanding. Certain nonaccrual and substantially delinquent loans may be considered to be impaired. A loan is impaired when, based on current information or events, it is probable that the Banks will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. In applying the provisions of Statement of Financial Accounting Standards ("SFAS") No. 114, the Corporation considers its investment in one-to-four family residential loans and consumer installment loans to be homogeneous and therefore excluded from separate identification for evaluation of impairment. Interest income is accrued on the principal balances of loans, except for installment loans with add-on interest, for which a method that approximates the level yield method is used. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed when considered uncollectible. Interest income is subsequently recognized only to the extent cash payments are received. Certain loan fees and direct costs are being deferred and amortized as an adjustment of yield on the loans. Allowance for Loan Losses is maintained to absorb potential loan losses based on management's continuing review and evaluation of the loan portfolio and its judgment as to the impact of economic conditions on the portfolio. The evaluation by management includes consideration of past loan loss experience, changes in the composition of the loan portfolio, the current condition and amount of loans outstanding, and the probability of collecting all amounts due. 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. The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that, as of December 31, 1998, the allowance for loan losses is adequate based on information currently available. A worsening or protracted economic decline in the area within which the Corporation operates would increase the likelihood of additional losses due to credit and market risks and could create the need for additional loss reserves. 32 continued
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data)s ================================================================================ NOTE 1 ================================================================================ Nature of Operations and Summary of Significant Accounting Policies continued Premises and Equipment are carried at cost net of accumulated depreciation. Depreciation is computed using the straight-line and declining balance methods based on the estimated useful lives of the assets. Maintenance and repairs are expensed as incurred, while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations. Federal Reserve and Federal Home Loan Bank Stock are required investments for institutions that are members of the Federal Reserve Bank ("FRB") and Federal Home Loan Bank ("FHLB") systems. The required investment in the common stock is based on a predetermined formula. Intangible Assets are being amortized on the straight-line basis over periods ranging from 7 to 25 years. Such assets are periodically evaluated as to the recoverability of their carrying value. Income Tax in the consolidated statement of income includes deferred income tax provisions or benefits for all significant temporary differences in recognizing income and expenses for financial reporting and income tax purposes. The Corporation files consolidated income tax returns with its subsidiaries. Stock Options are granted for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Corporation accounts for and will continue to account for stock option grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and accordingly, recognizes no compensation expense for the stock option grants. Earnings Per Share have been computed based upon the weighted average common and common equivalent shares outstanding during each year and have been restated to give effect to a three-for-two stock split distributed to stockholders on October 23, 1998. Reclassifications of certain amounts in the prior years consolidated financial statements have been made to conform to the 1998 presentation. ================================================================================ NOTE 2 ================================================================================ Business Combinations 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 second 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 second 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 to form the Madison Community Bank. On August 1, 1996, the Corporation issued 1,414,028 shares of its common stock in exchange for all of the outstanding shares of Union National Bancorp, Liberty, Indiana. On October 2, 1996, the Corporation issued 848,558 shares of its common stock in exchange for all of the outstanding shares of Randolph County Bancorp, Winchester, Indiana. These transactions were accounted for under the pooling-of-interests method of accounting. The financial information contained herein reflects the mergers and reports the financial condition and results of operations as though the Corporation had been combined as of January 1, 1996. Separate operating results of Union National Bancorp and Randolph County Bancorp for the periods prior to the merger were as follows on page 34: 33
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 2 ================================================================================ Business Combinations continued ================================================================================ 1996 ================================================================================ Net interest income: First Merchants Corporation ............................ $33,060 Union National Bancorp ................................. 2,961 Randolph County Bancorp ................................ 1,126 ------- Combined ......................................... $37,147 ======= Net income: First Merchants Corporation ............................ $11,556 Union National Bancorp ................................. 974 Randolph County Bancorp ................................ 612 ------- Combined ......................................... $13,142 ======= Net income per share: Basic: First Merchants Corporation ......................... $ 1.17 Union National Bancorp .............................. .10 Randolph County Bancorp ............................. .06 ------- Combined ......................................... $ 1.33 ======= Diluted: First Merchants Corporation ......................... $ 1.16 Union National Bancorp .............................. .10 Randolph County Bancorp ............................. .06 ------- Combined ......................................... $ 1.32 ======= ================================================================================ 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, 1998, was $12,229,000. 34
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ==================================================================================================================================== NOTE 4 ==================================================================================================================================== Investment Securities - ------------------------------------------------------------------------------------------------------------------------------------ GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------------------------------ Available for sale at December 31, 1998 U.S. Treasury ........................................... $ 20,269 $ 95 $ 20,364 Federal agencies ........................................ 52,598 577 $ 19 53,156 State and municipal ..................................... 86,537 2,620 4 89,153 Mortgage-backed securities .............................. 126,329 424 183 126,570 Other asset-backed securities ........................... 265 1 11 255 Corporate obligations ................................... 18,624 143 8 18,759 Marketable equity securities ............................ 250 250 -------- -------- -------- -------- Total available for sale ............................. 304,872 3,860 225 308,507 -------- -------- -------- -------- Held to maturity at December 31, 1998 U.S. Treasury ........................................... 249 4 253 Federal agencies ........................................ 500 1 501 State and municipal ..................................... 17,480 348 1 17,827 Mortgage-backed securities .............................. 864 3 867 Other asset-backed securities ........................... 1,761 2 27 1,736 -------- -------- -------- -------- Total held to maturity ............................... 20,854 358 28 21,184 -------- -------- -------- -------- Total investment securities .......................... $325,726 $ 4,218 $ 253 $329,691 ======== ======== ======== ======== Available for sale at December 31, 1997 U.S. Treasury ........................................... $ 19,207 $ 104 $ 11 $ 19,300 Federal agencies ........................................ 66,783 405 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 ======== ======== ======== ======== The amortized cost and fair value of securities held to maturity and available for sale at December 31, 1998, by contractual maturity, are shown on the following page. 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. continued 35
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 4 ================================================================================ Investment Securities continued - ------------------------------------------------------------------------------------------------------------ AVAILABLE FOR SALE HELD TO MATURITY AMORTIZED COST FAIR VALUE AMORTIZED COST FAIR VALUE - ------------------------------------------------------------------------------------------------------------ Maturity distribution at December 31, 1998: Due in one year or less .............. $ 52,579 $ 52,837 $ 5,370 $ 5,397 Due after one through five years ..... 93,213 94,927 10,741 11,003 Due after five through ten years ..... 26,830 28,047 1,638 1,701 Due after ten years .................. 5,406 5,621 480 480 -------- -------- -------- -------- 178,028 181,432 18,229 18,581 Mortgage-backed securities ........... 126,329 126,570 864 867 Other asset-backed securities ........ 265 255 1,761 1,736 Marketable equity securities ......... 250 250 -------- -------- -------- -------- Totals ............................. $304,872 $308,507 $ 20,854 $ 21,184 ======== ======== ======== ======== Securities with a carrying value of approximately $144,863,000 and $92,991,000 were pledged at December 31, 1998 and 1997, to secure certain deposits and securities sold under repurchase agreements, and for other purposes as permitted or required by law. In addition, all otherwise unpledged securities are pledged as collateral for Federal Home Loan Bank advances with qualified first mortgage loans. Proceeds from sales of securities available for sale during 1998, 1997 and 1996 were $5,886,000, $10,552,000, and $13,120,000. Gross gains of $119,000 and $148,000 in 1998 and 1996 and gross losses of $14,000 in 1997 were realized on those sales. ================================================================================ NOTE 5 ================================================================================ Loans and Allowance ============================================================================================ 1998 1997 ============================================================================================ Loans at December 31: Commercial and industrial loans ................................ $ 169,685 $ 148,281 Bankers' acceptances and loans to financial institutions ....... 900 705 Agricultural production financing and other loans to farmers ... 16,661 16,764 Real estate loans: Construction ............................................... 26,426 21,389 Commercial and farmland .................................... 95,172 97,503 Residential ................................................ 302,680 287,072 Individuals' loans for household and other personal expenditures 128,253 125,706 Tax-exempt loans ............................................... 2,115 2,598 Other loans .................................................... 1,217 3,782 --------- --------- 743,109 703,800 Unearned interest on loans ..................................... (137) (487) --------- --------- Total loans ................................................ $ 742,972 $ 703,313 ========= ========= ============================================================================================ 1998 1997 1996 ============================================================================================ Allowance for loan losses: Balance, January 1............................... $ 6,778 $ 6,622 $(6,696) Provision for losses............................. 1,984 1,297 1,253 Recoveries on loans.............................. 531 468 309 Loans charged off................................ (1,881) (1,609) (1,636) ------- ------- ------- Balance, December 31............................. $ 7,412 $ 6,778 $6,622 ======= ======= ====== continued 36
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 5 ================================================================================ Loans and Allowance continued Information on impaired loans is summarized below: ================================================================================ 1998 1997 1996 ================================================================================ As of, and for, the year ending December 31: Impaired loans with an allowance ................. $1,946 $1,476 $3,124 Impaired loans for which the discounted cash flows or collateral value exceeds the carrying value of the loan ................... 6,882 1,075 868 ------ ------ ------ Total impaired loans ....................... $8,828 $2,551 $3,992 ====== ====== ====== Allowance for impaired loans (included in the Corporation's allowance for loan losses) ..... $ 712 $ 407 $1,092 Average balance of impaired loans ................ 8,318 3,414 5,213 Interest income recognized on impaired loans ..... 873 180 311 Cash basis interest included above ............... 745 162 291 The Banks have entered into transactions with certain directors, executive officers, significant stockholders, and their affiliates or associates ("related parties"). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The aggregate amount of loans, as defined, to such related parties is as shown on the right: ================================================================================ ================================================================================ Balances, January 1, 1998 ... $ 12,433 New loans, including renewals ....... 5,440 Payments, etc., including renewals ....... (5,432) -------- Balances, December 31, 1998 . $ 12,441 ======== ================================================================================ NOTE 6 ================================================================================ Premises and Equipment ================================================================================ 1998 1997 ================================================================================ Cost at December 31: Land .......................................... $ 2,991 $ 2,826 Buildings and leasehold improvements .......... 15,660 13,723 Equipment ..................................... 16,385 15,320 -------- -------- Total cost .............................. 35,036 31,869 Accumulated depreciation ......................... (18,082) (16,487) -------- -------- Net ..................................... $ 16,954 $ 15,382 ======== ======== The Corporation is committed under various noncancelable lease contracts for certain subsidiary office facilities. Total lease expense for 1998, 1997 and 1996 was $204,000, $141,000, and $134,000, respectively. The future minimum rental commitments required under the operating leases in effect at December 31, 1998, expiring at various dates through the year 2016, follow on the right for the years ending December 31: ================================================================================ ================================================================================ 1999 ........................................................... $180 2000 ........................................................... 159 2001 ........................................................... 116 2002 ........................................................... 99 2003 ........................................................... 48 After 2003 ..................................................... 177 ---- Total future minimum obligations ............................ $779 ==== 37
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 7 ================================================================================ Deposits ================================================================================ 1998 1997 ================================================================================ Deposits at December 31: Demand deposits .................................. $261,708 $234,905 Savings deposits ................................. 227,624 176,953 Certificates and other time deposits of $100,000 or more ............................ 91,579 104,100 Other certificates and time deposits ............. 345,933 327,854 -------- -------- Total deposits ............................... $926,844 $843,812 ======== ======== ================================================================================ ================================================================================ Certificates and other time deposits maturing in years ending December 31: 1999............... $302,973 2000............... 87,437 2001............... 26,694 2002 .............. 13,270 2003............... 5,863 After 2003 ........ 1,275 -------- $437,512 ======== ================================================================================ NOTE 8 ================================================================================ Borrowings ================================================================================ 1998 1997 ================================================================================ Borrowings at December 31: Securities sold under repurchase agreements ....... $ 48,836 $ 15,398 Federal funds purchased ........................... 17,070 4,070 U. S. Treasury demand notes ....................... 2,226 7,361 Federal Home Loan Bank advances ................... 43,268 20,700 -------- -------- Total borrowings .............................. $111,400 $ 47,529 ======== ======== Securities sold under repurchase agreements consist of obligations of the Banks to other parties. The obligations are secured by U.S. Treasury, Federal agency obligations and corporate asset-backed securities. The maximum amount of outstanding agreements at any month-end during 1998 and 1997 totaled $78,302,000 and $33,802,000, and the average of such agreements totaled $36,506,000 and $31,327,000. Maturities of Federal Home Loan Bank advances and securities sold under repurchase agreements as of December 31, 1998 are as follows: Federal Home Loan Securities Sold Under Bank Advances Repurchase Agreements - -------------------------------------------------------------------------------------------------------- WEIGHTED-AVERAGE WEIGHTED-AVERAGE AMOUNT INTEREST RATE AMOUNT INTEREST RATE - -------------------------------------------------------------------------------------------------------- Maturities in years ending December 31 1999 ................................. $19,150 5.45% $20,836 5.07% 2000 ................................. 2,850 5.84 11,700 5.69 2001 ................................. 6,000 5.44 2,500 5.73 2002 ................................. 150 7.07 2003 ................................. 3,000 5.26 13,800 5.80 After 2003............................. 12,118 6.26 ------- ---- ------- ---- Total ............................... $43,268 5.69 $48,836 5.46 ======= ==== ======= ==== The terms of a security agreement with the FHLB require the Corporation to pledge, as collateral for advances, qualifying first mortgage loans and all otherwise unpledged investment securities in an amount equal to at least 160 percent of these advances. Advances are subject to restrictions or penalties in the event of prepayment. 38
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 9 ================================================================================ Loan Servicing Mortgage loans serviced for others are not included in the accompanying consolidated balance sheet. The loans are serviced primarily for the Federal Home Loan Mortgage Corporation and the unpaid balances totaled $15,541,000 and $11,877,000 at December 31, 1998 and 1997. The Corporation has adopted SFAS No. 122, Accounting for Mortgage Servicing Rights. The adoption of this statement has had no material impact on the Corporation's financial condition and results of operations for all years presented. ================================================================================ NOTE 10 ================================================================================ Income Tax ================================================================================================== 1998 1997 1996 ================================================================================================== Income tax expense, for the year ended December 31: Currently payable: Federal ..................................... $ 6,090 $ 5,702 $ 4,903 State ....................................... 2,007 1,894 1,655 Deferred: Federal ..................................... 38 (21) 336 State ....................................... (10) (14) 65 ------- ------- ------- Total income tax expense ................. $ 8,125 $ 7,561 $ 6,959 ======= ======= ======= Reconciliation of federal statutory to actual tax expense: Federal statutory income tax at 34% ............ $ 7,998 $ 7,458 $ 6,834 Tax-exempt interest ............................ (1,311) (1,257) (1,140) Graduated tax rates ............................ 173 Effect of state income taxes ................... 1,318 1,241 1,135 Other .......................................... (53) 119 130 ------- ------- ------- Actual tax expense ....................... $ 8,125 $ 7,561 $ 6,959 ======= ======= ======= Tax expense (benefit) applicable to security gains and losses for the years ended December 31, 1998, 1997 and 1996, was $47,600, $(5,700) and $60,000, respectively. A cumulative net deferred tax asset is included in other assets. The components of the asset are as follows: ================================================================================ 1998 1997 ================================================================================ Deferred tax asset at December 31: Assets: Differences in accounting for loan losses ............... $3,042 $2,692 Deferred compensation ................................... 344 313 Differences in accounting for pensions and other employee benefits .......................... 84 183 ------ ------ Total assets ...................................... 3,470 3,188 ------ ------ Liabilities: Differences in depreciation methods ..................... 968 1,012 Differences in accounting for loans and securities ...... 206 125 Differences in accounting for loan fees ................. 228 28 Net unrealized gain on securities available for sale .... 1,444 1,023 State income tax ........................................ 141 146 Other ................................................... 91 69 ------ ------ Total liabilities ................................. 3,078 2,403 ------ ------ Net deferred tax asset ............................ $ 392 $ 785 ====== ====== 39
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 11 ================================================================================ 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 Banks' 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 sheet. ============================================= 1998 1997 ============================================= Commitments to extend credit $185,879 $138,828 Standby letters of credit 4,310 4,649 - --------------------------------------------- Financial instruments whose contract amount represents credit risk as of December 31, were as follows: Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit, is based on management's credit evaluation. Collateral held varies, but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. The Corporation and subsidiaries are also subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Corporation. ================================================================================ NOTE 12 ================================================================================ Year 2000 Like all entities, the Corporation and subsidiaries are exposed to risks associated with the Year 2000 Issue, which affects computer software and hardware; transactions with customers, vendors and entities; and equipment dependent upon microchips. The Company has begun, but not yet completed, the process of remediating potential Year 2000 problems. It is not possible for any entity to guarantee the results of its own remediation efforts or to accurately predict the impact of the Year 2000 Issue on third parties with which the Company and subsidiaries do business. If remediation efforts of the Company or third parties with which the Company and subsidiaries do business are not successful, the Year 2000 Issue could have negative effects on the Company's financial condition and results of operations in the near term. ================================================================================ NOTE 13 ================================================================================ Stockholders' Equity National and state banking laws restrict the maximum amount of dividends that a bank may pay in any calendar year. National and state 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, 1998, available for 1999 dividends to the Corporation is $23,878,000. The subsidiaries restrict dividends to a lesser amount because of the need to maintain an adequate capital structure. Total stockholders' equity for all subsidiaries at December 31, 1998, was $129,067,000, of which $105,189,000 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. At December 31, 1998, there were 543,913 shares of common stock reserved for purchase under the plan. On August 11, 1998, the Board of Directors of the Corporation declared a three-for-two stock split on its common shares. The new shares were distributed on October 23, 1998, to holders of record on October 16, 1998. 40
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 14 ================================================================================ 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, 1998, the management of the Corporation believes that it meets all capital adequacy requirements to which it is subject. The most recent notifications from the regulatory agencies categorized the Corporation and Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Corporation and Banks must maintain a minimum total capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier I capital to average assets of 10 percent, 6 percent and 5 percent, respectively. There have been no conditions or events since that notification that management believes have changed this categorization. Actual and required capital amounts and ratios are as follows: ==================================================================================================================================== 1998 1997 ==================================================================================================================================== 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............................... $133,762 16.9% $ 63,206 8.0% $125,762 17.9% $ 56,166 8.0% First Merchants ........................... 79,685 15.7 40,678 8.0 75,539 17.4 34,756 8.0 Pendleton ................................. 13,486 18.5 5,844 8.0 12,256 17.4 5,628 8.0 First United .............................. 8,069 18.5 3,484 8.0 7,570 18.2 3,332 8.0 Randolph County ........................... 10,574 18.2 4,640 8.0 10,278 15.1 5,448 8.0 Union County .............................. 19,375 16.4 9,451 8.0 18,075 17.0 8,498 8.0 Tier I Capital (1) (to risk-weighted assets) Consolidated............................... $126,350 16.0% $ 31,603 4.0% $118,984 16.9% $ 28,083 4.0% First Merchants ........................... 75,752 14.9 20,338 4.0 71,900 16.6 17,378 4.0 Pendleton ................................. 12,701 17.4 2,922 4.0 11,506 16.4 2,814 4.0 First United .............................. 7,599 17.5 1,742 4.0 7,133 17.1 1,666 4.0 Randolph County ........................... 9,848 17.0 2,320 4.0 9,548 14.0 2,724 4.0 Union County .............................. 17,966 15.2 4,726 4.0 16,852 15.9 4,249 4.0 Tier I Capital (1) (to average assets) Consolidated............................... $126,350 11.9% $ 42,464 4.0% $118,984 11.9% $ 40,010 4.0% First Merchants ........................... 75,752 10.8 27,981 4.0 71,900 11.7 24,548 4.0 Pendleton ................................. 12,701 12.4 4,092 4.0 11,506 11.8 3,897 4.0 First United .............................. 7,599 11.5 2,646 4.0 7,133 11.5 2,481 4.0 Randolph County ........................... 9,848 13.0 3,042 4.0 9,548 14.0 2,733 4.0 Union County .............................. 17,966 8.6 8,362 4.0 16,852 9.1 7,438 4.0 (1) As defined by regulatory agencies continued 41
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 15 ================================================================================ Employee Benefit Plans The Corporation's defined-benefit pension plans cover substantially all of the Banks' employees. The benefits are based primarily on years of service and employees' pay near retirement. Contributions are intended to provide not only for benefits attributed to service-to-date, but also for those expected to be earned in the future. The table below sets forth the plans' funded status and amounts recognized in the consolidated balance sheet at December 31: December 31 ================================================================================ 1998 1997 ================================================================================ Change in benefit obligation Benefit obligation at beginning of year ........... $ 14,454 $ 13,060 Service cost ...................................... 688 624 Interest cost ..................................... 1,044 956 Actuarial gain .................................... 793 388 Benefits paid ..................................... (660) (574) -------- -------- Benefit obligation at end of year ................. 16,319 14,454 -------- -------- Change in plan assets Fair value of plan assets at beginning of year .... 18,865 15,188 Actual return of plan assets ...................... 1,038 4,251 Benefits paid ..................................... (660) (574) -------- -------- Fair value of plan assets at end of year .......... 19,243 18,865 -------- -------- Funded status ..................................... 2,924 4,411 Unrecognized net actuarial gain ................... (2,579) (4,169) Unrecognized prior service cost ................... (144) (156) Unrecognized transition asset ..................... (480) (617) -------- -------- Accrued benefit cost .............................. $ (279) $ (531) ======== ======== ============================================================================================== 1998 1997 1996 ============================================================================================== Pension expense (benefit) includes the following components: Service cost-benefits earned during the year ............ $ 688 $ 624 $ (537 Interest cost on projected benefit obligation ........... 1,044 956 921 Actual return on plan assets ............................ (1,038) (4,251) (1,966) Net amortization and deferral ........................... (946) 2,810 699 ------- ------- ------- Total pension expense (benefit) ...................... $ (252) $ 139 $ 191 ======= ======= ======= ============================================================================================== 1998 1997 1996 ============================================================================================== Assumptions used in the accounting as of December 31 were: Discount rate ........................................... 6.77% 7.40% 7.50% Rate of increase in compensation ........................ 4.00% 4.50% 4.50% Expected long-term rate of return on assets ............. 9.00% 9.00% 8.75% Randolph County employees participated in a defined-benefit pension plan, which is included in the above disclosures. This plan was merged with the Corporation's plan as of December 31, 1996. Randolph County's plan assumptions used in the accounting were different than the Corporation's plan assumptions. However, the differences do not have a material impact on the disclosures presented. In 1989, stockholders approved the 1989 Stock Option Plan, reserving 253,125 shares of Corporation common stock for the granting of options to certain employees. The exercise price of the shares may not be less than the fair market value of the shares upon grant of the option. Options become 100 percent vested when granted and are fully exercisable generally six months after the date of grant, for a period of ten years. There were no shares available for grant at December 31, 1998. 42 continued
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 15 ================================================================================ Employee Benefit Plans continued On March 31, 1994, stockholders approved the 1994 Stock Option Plan, reserving 472,500 shares of Corporation common stock for the granting of options to certain employees and non-employee directors. The exercise price of the shares may not be less than the fair market value of the shares upon the grant of the option. Options become 100 percent vested when granted and are fully exercisable generally six months after the date of the grant, for a period of ten years. There were 34,829 shares available for grant at December 31, 1998. The table below is a summary of the status of the Corporation's stock option plans and changes in those plans as of and for the years ended December 31, 1998, 1997 and 1996. The number of shares and prices have been restated to give effect to the Corporation's 1998 stock split. Year Ended December 31, ============================================================================================================================== 1998 1997 1996 ============================================================================================================================== WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE - ------------------------------------------------------------------------------------------------------------------------------ Outstanding, beginning of year ... 447,577 $14.98 408,127 $12.89 334,532 $12.05 Granted .......................... 97,645 28.64 96,375 20.91 79,950 16.18 Exercised ........................ (67,628) 12.99 (56,925) 9.99 (6,355) 10.11 Cancelled ........................ (862) 28.71 ------- ------- ------- Outstanding, end of year ......... 476,732 $18.04 447,577 $14.98 408,127 $12.89 ======= ======= ======= Options exercisable at year end .. 376,949 348,652 324,925 Weighted-average fair value of options granted during the year $ 5.95 $ 4.21 $ 3.39 As of December 31, 1998, other information by exercise price range for options outstanding and exercisable is as follows: OUTSTANDING EXERCISABLE - ---------------------------------------------------------------------------- ------------------------------ EXERCISE PRICE NUMBER WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE RANGE OF SHARES EXERCISE PRICE REMAINING CONTRACTURAL LIFE OF SHARES EXERCISE PRICE - ---------------------------------------------------------------------------- ------------------------------ $ 6.07 - $14.39 166,589 $11.72 4.4 years 166,589 $11.72 15.39 - 20.92 213,360 18.16 7.7 years 207,360 18.17 24.67 - 30.44 96,783 28.63 9.6 years 3,000 26.13 ------- ------- 476,732 $18.04 6.9 years 376,949 $15.38 ======= ======= - ------------------------------------------------------------------------------------------------------------------ The Corporation's stock option plans are accounted for in accordance with Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and related interpretations. The exercise price of each option was equal to the market price of the Corporation's stock on the date of grant; therefore, no compensation expense was recognized. Although the Corporation has elected to follow APB No. 25, SFAS No. 123 requires pro forma disclosures of net income and earnings per share as if the Corporation had accounted for its employee stock options under that Statement. The fair value of each option grant was estimated on the grant date using an option-pricing model with the following assumptions: ================================================================================ 1998 1997 1996 ================================================================================ Risk-free interest rates ............ 5.45% 6.54% 6.66% Dividend yields ..................... 3.25% 3.37% 3.41% Volatility factors of expected market price common stock ....... 17.19% 11.20% 12.00% Weighted-average expected life of the options ............. 8.50 years 8.50 years 8.50 years - -------------------------------------------------------------------------------- continued 43
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 15 ================================================================================ Employee Benefit Plans continued Under SFAS No. 123, compensation cost is recognized in the amount of the estimated fair value of the options and amortized to expense over the options' vesting period. The pro forma effect on net income and earnings per share of this statement are shown on the right: ================================================================================ 1998 1997 1996 ================================================================================ Net Income As reported ............. $15,399 $14,373 $13,142 Pro Forma ............... 14,650 13,948 12,852 Earnings per share Basic: As reported ............. $ 1.53 $ 1.44 $ 1.33 Pro forma ............... 1.46 1.40 1.30 Diluted: As reported ............. $ 1.51 $ 1.43 $ 1.32 Pro forma ............... 1.44 1.38 1.29 In 1994, the stockholders approved the 1994 Employee Stock Purchase Plan, enabling eligible employees to purchase the Corporation's common stock. A total of 253,125 shares of the Corporation's common stock are reserved for issuance persuant to the plan. The price of the stock to be paid by the employees is determined by the Corporation's compensation committee, but may not be less than 85 percent of the lesser of the fair market value of the Corporation's common stock at the beginning or at the end of the offering period. Common stock purchases are made annually and are paid through advance payroll deductions of up to 20 percent of eligible compensation. Participants under the plan purchased 21,706 shares in 1998 at $17.71 per share. The fair market value per share on the purchase date was $30.44. At December 31, 1998, there were 162,977 shares of Corporation common stock reserved for purchase under the plan, and $444,000 has been withheld from compensation, plus interest, toward the purchase of shares after June 30, 1999, the end of the annual offering period. The Corporation's Employee Stock Purchase Plan is accounted for in accordance with APB No. 25. Although the Corporation has elected to follow APB No. 25, SFAS No. 123 requires pro forma disclosures of net income and earnings per share as if the Corporation had accounted for the purchased shares under that statement. The pro forma disclosures are included in the table above and were estimated using an option pricing model with the following assumptions for 1998, 1997 and 1996, respectively: dividend yield of 3.25, 3.37 and 3.41 percent; an expected life of one year for all years; expected volatility of 17.19, 11.20 and 12.00 percent; and risk-free interest rates of 5.41, 6.54 and 6.66 percent. The fair value of those purchase rights granted in 1998, 1997 and 1996 was $12.69, $5.03 and $4.68, respectively. The Banks have retirement savings 401(k) plans in which substantially all employees may participate. The Banks match employees' contributions at the rate of 25-50 percent for the first 5-6 percent of base salary contributed by participants. The Banks' expense for the plans was $108,000 for 1998, $110,000 for 1997, and $92,000 for 1996. ================================================================================ NOTE 16 ================================================================================ Net Income Per Share Year Ended December 31, ============================================================================================================ 1998 1997 ============================================================================================================ WEIGHTED-AVERAGE PER SHARE WEIGHTED-AVERAGE PER SHARE INCOME SHARES AMOUNT INCOME SHARES AMOUNT - ------------------------------------------------------------------------------------------------------------ Basic net income per share: Net income available to common stockholders .......... $15,399 10,045,502 $ 1.53 $14,373 9,950,303 $ 1.44 ====== ====== Effect of dilutive stock options . 155,568 135,157 ------- ---------- ------- ---------- Diluted net income per share: Net income available to common stockholders and assumed conversions ...... $15,399 10,201,070 $ 1.51 $14,373 10,085,460 $ 1.43 ======= ========== ====== ======= ========== ====== ===================================================================== 1996 ===================================================================== WEIGHTED-AVERAGE PER SHARE INCOME SHARES AMOUNT - --------------------------------------------------------------------- Basic net income per share: Net income available to common stockholders .......... $13,142 9,871,751 $ 1.33 ====== Effect of dilutive stock options . 99,556 ------- --------- Diluted net income per share: Net income available to common stockholders and assumed conversions ...... $13,142 9,971,307 $ 1.32 ======= ========= ====== 44
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 17 ================================================================================ Fair Values of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument: Cash and Cash Equivalents The fair value of cash and cash equivalents approximates carrying value. Interest-Bearing Time Deposits The fair value of interest-bearing time deposits approximates carrying value. Investment Securities Fair values are based on quoted market prices. Mortgage Loans Held for Sale The fair value of mortgages held for sale approximates carrying values. Loans For both short-term loans and variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value for other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Interest Receivable/Payable The fair values of interest receivable/payable approximate carrying values. 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. 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. Federal Funds Purchased and U.S. Treasury Demand Notes These financial instruments are short-term borrowing arrangements. The rates at December 31, 1998 and 1997, approximate market rates, thus the fair value approximates carrying value. Securities Sold Under Repurchase Agreements and Federal Home Loan Bank Advances The fair value of the these borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt. Off-Balance Sheet Commitments Loan commitments and letters-of-credit generally have short-term, variable-rate features and contain clauses which limit the Banks' exposure to changes in customer credit quality. Accordingly, their carrying values, which are immaterial at the respective balance sheet dates, are reasonable estimates of fair value. The estimated fair values of the Corporation's financial instruments are as follows: ==================================================================================================================================== 1998 1997 ==================================================================================================================================== CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE - ------------------------------------------------------------------------------------------------------------------------------------ Assets at December 31: Cash and cash equivalents ....................................... $ 71,223 $ 71,223 $ 42,177 $ 42,177 Interest-bearing time deposits .................................. 855 855 385 385 Investment securities available for sale ........................ 308,507 308,507 212,040 212,040 Investment securities held to maturity .......................... 20,854 21,184 35,332 35,429 Mortgage loans held for sale .................................... 776 776 471 471 Loans ........................................................... 742,972 751,589 703,313 704,335 FRB and FHLB stock .............................................. 3,723 3,723 3,373 3,373 Interest receivable ............................................. 9,173 9,173 8,968 8,968 Liabilities at December 31: Deposits ........................................................ 926,844 928,712 843,812 845,277 Borrowings: Securities sold under repurchase agreements .................. 48,836 43,903 15,398 15,398 Federal funds purchased ...................................... 17,070 17,070 4,070 4,070 U.S. Treasury demand notes ...................................... 2,226 2,226 7,361 7,361 FHLB advances ................................................ 43,268 43,425 20,700 21,114 Interest payable ................................................ 3,614 3,614 3,615 3,615 45
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 18 ================================================================================ 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 SHEET December 31, ================================================================================ 1998 1997 ================================================================================ Assets Cash .............................................. $ 84 $ 318 Loans to affiliates ............................... 1,500 Security purchased with agreement to resell to an affiliate ...................... 2,000 Investment securities available for sale .......... 250 250 Investment in subsidiaries ........................ 129,067 118,732 Goodwill .......................................... 535 553 Other assets ...................................... 329 230 -------- -------- Total assets ................................... $131,765 $122,083 ======== ======== Liabilities' ......................................... $ 268 $ 114 Stockholders' Equityi ................................ 131,497 121,969 -------- -------- Total liabilities and stockholders' equity ..... $131,765 $122,083 ======== ======== CONDENSED STATEMENT OF INCOME Year Ended December 31, =============================================================================================================== 1998 1997 1996 =============================================================================================================== Income Dividends from subsidiaries ............................... $ 7,772 $ 6,903 $ 5,420 Other income .............................................. 105 101 25 -------- -------- -------- Total income ........................................... 7,877 7,004 5,445 -------- -------- -------- Expenses Amortization of core deposit intangibles, goodwill, and fair value adjustments .................... 45 45 43 Business combination expenses ............................. 36 258 Other expenses ............................................ 500 591 269 -------- -------- -------- Total expenses ......................................... 581 636 570 -------- -------- -------- Income Before Income Tax Benefit and Equity in Undistributed Income of Subsidiariesi ....................... 7,296 6,368 4,875 Income tax benefit ........................................ (201) (193) (100) -------- -------- -------- Income Before Equity in Undistributed Income of Subsidiaries. 7,497 6,561 4,975 Equity in undistributed income of subsidiaries ........... 7,902 7,812 8,167 -------- -------- -------- Net Income ................................................. $ 15,399 $ 14,373 $ 13,142 ======== ======== ======== continued 46
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts in Thousands, Except Share Data) ================================================================================ NOTE 18 ================================================================================ Condensed Financial Information (Parent Company Only) continued CONDENSED STATEMENT OF CASH FLOWS Year Ended December 31, =================================================================================================================================== 1998 1997 1996 =================================================================================================================================== Operating Activities: Net income .......................................................... $ 15,399 $ 14,373 $ 13,142 Adjustments to reconcile net income to net cash provided by operating activities: Amortization ...................................................... 18 17 20 Equity in undistributed income of subsidiaries .................... (7,902) (7,812) (8,167) Security gains .................................................... (19) Net change in: Other assets ................................................... (131) 25 567 Other liabilities .............................................. 126 16 (337) -------- -------- -------- Net cash provided by operating activities ................... 7,510 6,619 5,206 -------- -------- -------- Investing Activities: Security purchased with an agreement to resell to an affiliate ...... 2,000 (1,000) (1,000) Net change in loans ................................................. (1,500) Proceeds from sales of securities available for sale ................ 8 103 Investment in subsidiary ............................................ (1,729) Other investing activities .......................................... (78) -------- -------- -------- Net cash used by investing activities ....................... (1,229) (992) (975) -------- -------- -------- Financing Activities: Cash dividends ...................................................... (7,772) (6,902) (5,369) Stock issued under employee benefit plans ........................... 385 291 298 Stock issued under dividend reinvestment and stock purchase plan ........................................... 679 726 558 Stock options exercised ............................................. 271 163 64 Stock redeemed ...................................................... (72) Cash paid in lieu of issuing fractional shares ...................... (6) (2) -------- -------- -------- Net cash used by financing activities ....................... (6,515) (5,722) (4,451) -------- -------- -------- Net change in cash .................................................. (234) (95) (220) Cash, beginning of year ................................................ 318 413 633 -------- -------- -------- Cash, end of year ................................................... $ 84 $ 318 $ 413 ======== ======== ======== ================================================================================ NOTE 19 ================================================================================ Quarterly Results of Operations (Unaudited) The following table sets forth certain quarterly results for the years ended December 31, 1998 and 1997: - ------------------------------------------------------------------------------------------------------------------------------------ QUARTER INTEREST INTEREST NET INTEREST PROVISION FOR NET AVERAGE SHARES OUTSTANDING NET INCOME PER SHARE ENDED INCOME EXPENSE INCOME LOAN LOSSES INCOME BASIC DILUTED BASIC DILUTED - ------------------------------------------------------------------------------------------------------------------------------------ 1998: March ........ $19,122 $8,970 $10,152 $411 $3,824 10,005,041 10,186,400 $.38 $.38 June ......... 19,736 9,431 10,305 411 3,798 10,024,931 10,210,374 .38 .37 Sept ......... 20,145 9,687 10,458 446 3,891 10,071,921 10,222,876 .39 .38 Dec .......... 20,725 9,962 10,763 716 3,886 10,080,117 10,217,407 .38 .38 ------- ------- ------- ------ ------- ----- ----- $79,728 $38,050 $41,678 $1,984 $15,399 10,045,502 10,201,070 $1.53 $1.51 ======= ======= ======= ====== ======= ===== ===== 1997: March ........ $17,884 $8,343 $9,541 $287 $3,429 9,907,518 10,039,461 $.35 $.34 June ......... 18,980 8,901 10,079 290 3,707 9,928,085 10,054,069 .37 .37 Sept ......... 19,042 9,132 9,910 375 3,536 9,974,990 10,101,611 .35 .35 Dec .......... 19,569 9,349 10,220 345 3,701 9,990,621 10,146,708 .37 .37 ------- ------- ------- ------ ------- ----- ----- $75,475 $35,725 $39,750 $1,297 $14,373 9,950,303 10,085,460 $1.44 $1.43 ======= ======= ======= ====== ======= ===== ===== 47
Stockholder INFORMATION [GRAPHIC] First Merchants Corporation currently provides services through offices located in Delaware, Fayette, Hamilton, Henry, Madison, Wayne, Randolph and Union counties in Indiana and Butler county in Ohio. [LOGO] First Merchants Corporation Corporate Office 200 East Jackson Street Muncie, Indiana 47305-2814 765-747-1500 http://firstmerchants.com 48
First Merchants Corporation of Muncie, Indiana, was organized in September, 1982, as the bank holding company for The Merchants National Bank, now First Merchants Bank, N.A., an institution which has served Muncie and the surrounding communities since 1893. In November 1988, First Merchants acquired Pendleton Banking Company of Pendleton, Indiana, a commercial bank which was organized in 1872. In July 1991, the Corporation acquired First United Bank of Middletown, Indiana, which was established in 1882. In August 1996, First Merchants Corporation acquired Union County National Bank, established in 1872 and based in Liberty, Indiana. In October 1996, the Corporation acquired The Randolph County Bank of Winchester, Indiana, which was founded in 1865. In April 1998, the Corporation acquired the Muncie office of Insurance & Risk Management, Inc., renamed First Merchants Insurance Services, Inc. Subsidiaries of First Merchants Corporation conduct a full range of banking operations, including commercial, industrial, consumer and real estate lending, deposit and investment services, and other banking services. First Merchants Bank, with more than one billion dollars in fiduciary assets at market value, operates one of the ten largest trust departments in Indiana. First Merchants Corporation is committed to the sound management of its subsidiaries and to leading its east central Indiana marketplace in meeting customer banking needs and expectations. [PHOTO] Annual MEETING The Annual Meeting of Stockholders of First Merchants Corporation will be held... Wednesday, April 14, 1999 o 3:30 p.m. Horizon Convention Center 401 South High Street Muncie, Indiana 47305 49
======================= STOCKHOLDER INFORMATION ======================= Stock PRICE & Dividend INFORMATION ================================================================================ PRICE PER SHARE ================================================================================ QUARTER HIGH LOW DIVIDENDS DECLARED 1998 1997 1998 1997 1998 1997 --------------- ---------------- -------------- First Quarter ........ $27.67 $20.00 $24.50 $16.83 $.187 $.160 Second Quarter ....... 31.83 20.50 25.67 18.50 .187 .160 Third Quarter ........ 30.83 21.58 24.00 20.00 .200 .187 Fourth Quarter ....... 28.75 25.33 21.50 21.42 .200 .187 The table above lists per share prices and dividend payments during 1998 and 1997. Prices are as reported by the National Association of Securities Dealers. Automated Quotation - National Market System. Numbers rounded to nearest cent when applicable. Restated for 3-for-2 stock split distributed October, 1998. - -------------------------------------------------------------------------------- ================== STOCK INFORMATION ================== Common Stock Listing First Merchants Corporation common stock is traded over-the-counter on the NASDAQ National Market System. Quotations are carried in many daily papers. The NASDAQ symbol is FRME (Cusip #320817-10-9). At the close of business on December 31, 1998, the number of shares outstanding was 10,086,083. There were 1,555 stockholders of record on that date. ============== Market Makers ============== The following firms make a market in First Merchants Corporation stock: Robert W. Baird & Co., Inc. Keefe, Bruyette & Woods, Inc. Knight Securities, L.P. Herzog, Heine, Geduld, Inc. Howe, Barnes & Johnson, Inc. McDonald Investments Inc. NatCity Investments, Inc. Troster Securities, L.P. General Stockholder Inquiries Stockholders and interested investors may obtain information about the Corporation upon written request or by calling: Mr. Douglas B. Harris Vice President Investor Services & Bank Investments First Merchants Corporation P. O. Box 792 Muncie, Indiana 47308-0792 765-741-7278 1-800-262-4261 Ext. 7278 Stock Transfer Agent and Registrar First Merchants Bank, N.A. Corporate Trust Department P. O. Box 792 Muncie, Indiana 47308-0792 Form 10-k and Financial Information First Merchants Corporation, upon request and without charge, will furnish stockholders, security analysts and investors a copy of Form 10-k filed with the Securities and Exchange Commission. Please contact: Mr. James L. Thrash Senior Vice President and Chief Financial Officer First Merchants Corporation P. O. Box 792 Muncie, Indiana 47308-0792 765-747-1390 1-800-262-4261 Ext. 1390
EXHIBIT 21--SUBSIDIARIES OF THE REGISTRANT
- --------------------------------------------------------------------------------
State of
Name Incorporation
---- -------------
First Merchants Bank, National Association........................U.S.
Pendleton Banking Company.......................................Indiana
First United Bank...............................................Indiana
The Union County National Bank of Liberty.........................U.S.
The Randolph County Bank........................................Indiana
EXHIBIT 23--CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS - -------------------------------------------------------------------------------- We hereby consent to the incorporation by reference to Registration Statements on Form S-8, File Number 33-28900 and 33-28901, of our report dated January 15, 1999, on the consolidated financial statements of First Merchants Corporation, which report is incorporated by reference in the Annual Report on Form 10-K of First Merchants Corporation. /s/ Olive LLP Indianapolis, Indiana March 22, 1999
EXHIBIT 24 -- FORM 10-K, 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 James L. Thrash, 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: February 9, 1999
/s/ Stefan S. Anderson /s/ Stefan S. Anderson
- -------------------------------------- ---------------------------------------
Stefan S. Anderson Officer Stefan S. Anderson Director
/s/ James L. Thrash /s/ Frank A. Bracken
- -------------------------------------- ---------------------------------------
James L. Thrash Frank A. Bracken Director
/s/ Thomas B. Clark
---------------------------------------
Thomas B. Clark Director
/s/ Michael L. Cox
---------------------------------------
Michael L. Cox Director
/s/ David A. Galliher
---------------------------------------
David A. Galliher Director
/s/ Norman M. Johnson
---------------------------------------
Norman M. Johnson Director
/s/ Ted J. Montgomery
---------------------------------------
Ted J. Montgomery Director
/s/ George A. Sissel
---------------------------------------
George A. Sissel Director
/s/ Robert M. Smitson
---------------------------------------
Robert M. Smitson Director
/s/ Michael D. Wickersham
---------------------------------------
Michael D. Wickersham Director
/s/ Dr. John E. Worthen
---------------------------------------
Dr. John E. Worthen Director
9 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 33,908 855 37,315 0 308,507 20,854 21,184 743,748 7,412 1,177,172 926,844 59,282 7,431 52,118 0 0 1,261 130,236 1,177,172 63,263 15,440 1,025 79,728 33,752 38,050 41,678 1,984 119 27,895 23,524 15,399 0 0 15,399 1.53 1.51 4.37 735 2,275 926 7,309 6,778 1,881 531 7,412 5,763 0 1,649
EXHIBIT 99.1--FINANCIAL STATEMENTS AND INDEPENDENT AUDITOR'S REPORT FOR
FIRST MERCHANTS CORPORATION EMPLOYEE STOCK PURCHASE PLAN
- --------------------------------------------------------------------------------
The annual financial statements and independent auditor's report thereon for
First Merchants Corporation Employee Stock Purchase Plan for the year ending
June 30, 1999, will be filed as an amendment to the 1998 Annual Report on Form
10-K no later than October 28, 1999.