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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, 1997 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 $253,638,448 as of March 2, 1998. As of March 2, 1998 there were outstanding 6,674,696 common shares, without par value, of the registrant. DOCUMENTS INCORPORATED BY REFERENCE Part of Form 10-K Documents Into Which Incorporated --------- ----------------------- 1997 Annual Report to Stockholders Part II (Items 5, 6, 7, and 8) Definitive Proxy Statement for Annual Meeting of Shareholders to be held April 7, 1998 Part III (Items 10 through 13) Exhibit Index: Page 28
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. . . . . . . . . . 22 Item 9 - Changes In and Disagreements With Accountants on Accounting and Financial Disclosures . . . . . . . . . . . . . 22 Part III Item 10 - Directors and Executive Officers of the Registrant . . . . . . 23 Item 11 - Executive Compensation . . . . . . . . . . . . . . . . . . . . 23 Item 12 - Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . . . 23 Item 13 - Certain Relationships and Related Transactions . . . . . . . . 23 Part IV Item 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . 24 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 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 National"), 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. 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, 1997, the Corporation had consolidated assets of $1.020 billion, consolidated deposits of $843.8 million and stockholders' equity of $122.0 million. The Corporation is headquartered in Muncie, Indiana, and is presently engaged in conducting commercial banking business through the 24 offices of its five banking subsidiaries. As of December 31, 1997, the Corporation and its subsidiaries had 462 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 is not actively engaged in discussions or negotiations with other financial institutions regarding their affiliation with the Corporation. Page 3
- ------------------------------------------------------------------------------- COMPETITION The Corporation's banking subsidiaries are located in Delaware, Madison, Fayette, Wayne, Union, Randolph and Henry counties, Indiana. 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 National 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 National, 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, 1997, 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, 1997, 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, 1997: Corporation's Regulatory Consolidated Minimum Ratio Requirement ----- ----------- Tier 1 Capital to Risk-Weighted Assets Ratio . . . . . . . . . . . . . . . . . . 16.9% 4.0% Total Capital to Risk-Weighted Assets Ratio . . . . . . . . . . . . . . . . . . 17.9% 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. 1997 1996 1995 -------------------------- --------------------------- -------------------------- 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 . . . . . . . . . . . . . $ 3,127 $ 172 5.5% $ 9,359 $ 498 5.3% $ 18,409 $ 1,028 5.6% Interest-bearing deposits. . . . . . . . . . 693 34 4.9 346 16 4.6 250 9 3.6 Federal Reserve and Federal Home Loan Bank stock. . . . . . . . 3,144 242 7.7 2,800 212 7.6 2,692 209 7.8 Securities:(1) Taxable. . . . . . . . . . . . . . . . . . . 172,993 10,818 6.3 204,323 12,752 6.2 206,724 12,419 6.0 Tax-exempt . . . . . . . . . . . . . . . . . 86,568 6,647 7.7 77,996 5,892 7.6 72,666 5,542 7.6 -------- ------ -------- ------ -------- ------- Total Securities . . . . . . . . . . . . . 259,561 17,465 6.7 282,319 18,644 6.6 279,390 17,961 6.4 Mortgage loans held for sale . . . . . . . . . 406 47 11.6 262 21 8.0 281 22 7.8 Loans:(2) Commercial . . . . . . . . . . . . . . . . . 272,483 25,125 9.2 230,848 21,232 9.2 211,998 20,347 9.6 Bankers' acceptance and commercial paper purchased . . . . . . . . . . . . . . . . . 1,193 68 5.7 20 1 5.5 2,590 149 5.8 Real estate mortgage . . . . . . . . . . . . 258,499 21,430 8.3 233,830 19,543 8.4 218,607 18,566 8.5 Installment. . . . . . . . . . . . . . . . . 141,290 13,103 9.3 119,379 11,300 9.5 109,917 9,997 9.1 Tax-exempt . . . . . . . . . . . . . . . . . 2,021 178 8.8 1,566 140 8.9 1,064 112 10.5 -------- ------ -------- ------ -------- ------- Total loans. . . . . . . . . . . . . . . . 675,486 59,904 8.9 585,643 52,216 8.9 544,176 49,171 9.0 -------- ------ -------- ------ -------- ------- Total earning assets . . . . . . . . . . . 942,417 77,864 8.3 880,729 71,607 8.1 845,198 68,400 8.1 ------ ------- Net unrealized loss on securities available for sale . . . . . . . . . . . . . 1,273 961 1,483 Allowance for loan losses. . . . . . . . . . . (6,761) (6,672) (6,654) Cash and due from banks. . . . . . . . . . . . 30,647 28,341 26,359 Premises and equipment . . . . . . . . . . . . 14,950 14,879 14,225 Other assets . . . . . . . . . . . . . . . . . 10,812 13,906 10,384 -------- -------- -------- Total assets . . . . . . . . . . . . . . . $993,338 $932,144 $890,995 ======== ======== ======== Liabilities: Interest-bearing deposits: NOW accounts. . . . . . . . . . . . . . . . $104,620 $ 2,450 2.3 $109,792 $ 2,503 2.3 $103,015 $ 2,643 2.6 Money market deposit accounts . . . . . . . 105,628 4,188 4.0 100,897 3,701 3.7 107,735 4,147 3.8 Savings deposits. . . . . . . . . . . . . . 69,633 1,740 2.5 70,875 1,898 2.7 74,293 2,125 2.9 Certificates and other time deposits. . . . 425,478 23,542 5.5 381,378 21,037 5.5 355,448 19,312 5.4 -------- ------ -------- ------ -------- ------- Total interest-bearing deposits. . . . . . 705,359 31,920 4.5 662,942 29,139 4.4 640,491 28,227 4.4 Short-term borrowings . . . . . . . . . . . . 53,185 2,856 5.4 51,768 2,687 5.2 47,345 2,628 5.6 Federal Home Loan Bank advances . . . . . . . 15,455 949 6.1 9,192 523 5.7 9,000 496 5.5 -------- ------ -------- ------ -------- ------- Total interest-bearing liabilities . . . . 773,999 35,725 4.6 723,902 32,349 4.5 696,836 31,351 4.5 Noninterest-bearing deposits. . . . . . . . . 94,759 90,719 88,335 Other liabilities . . . . . . . . . . . . . . 7,566 9,429 6,791 -------- -------- -------- Total liabilities. . . . . . . . . . . . . 876,324 824,050 791,962 Stockholders' equity. . . . . . . . . . . . . 117,014 108,094 99,033 -------- -------- -------- Total liabilities and stockholders' equity $993,338 35,725 3.8(3) $932,144 32,349 3.6(3) $890,995 31,351 3.7(3) ======== ------- ======== ------- ======== ------- Net interest income. . . . . . . . . . . . $42,139 4.5 $39,258 4.5 $37,049 4.4 ======= ======= ======= (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 1995, 1996, and 1997. . . . . . . . . .. . . . . . . . . . $ 2,389 $ 2,111 $ 1,952 ======= ======= ======= 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. 1997 Compared to 1996 1996 Compared to 1995 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 . . . . . . . . . . $( 343) $ 17 $ (326) $ (478) $ ( 52) $ (530) Interest-bearing deposits. . . . . . . 17 1 18 4 3 7 Federal Reserve and Federal Home Loan Bank stock . . . . . . . . 26 4 30 8 ( 5) 3 Securities . . . . . . . . . . . . . . (1,461) 282 (1,179) 171 512 683 Mortgage loans held for sale . . . . . 14 12 26 ( 2) 1 ( 1) Loans. . . . . . . . . . . . . . . . . 7,966 (278) 7,688 3,607 (562) 3,045 ------- ------ ------ ------ ------ ----- Totals . . . . . . . . . . . . . . . 6,219 38 6,257 3,310 (103) 3,207 ------- ------ ------ ------ ------ ----- Interest expense: NOW accounts . . . . . . . . . . . . . ( 126) 73 ( 53) 173 (313) (140) Money market deposit accounts . . . . . . . . . . . . . . 179 308 487 (315) (131) (446) Savings deposits . . . . . . . . . . . ( 33) (125) (158) ( 91) (136) (227) Certificates and other time deposits. . . . . . . . . . . . 2,440 65 2,505 1,376 349 1,725 Short-term borrowings. . . . . . . . . ( 3) 172 169 248 (189) 59 Federal Home Loan Bank advances. . . . 382 44 426 10 17 27 ------- ------ ------ ------ ------ ----- Totals . . . . . . . . . . . . . . . 2,839 537 3,376 1,401 (403) 998 ------- ------ ------ ------ ------ ----- Change in net interest income (fully taxable equivalent basis). . . . . . . . . . . $ 3,380 $ (499) 2,881 $1,909 $ 300 2,209 ======= ====== ====== ====== Tax equivalent adjustment using marginal rate of 35% for 1995, 1996, and 1997 . . . . . . . . . . . . . . . (278) (159) ------ ------ Change in net interest income . . . . . . . . . . . . . . . . $2,603 $2,050 ====== ====== 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, 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 ========= ====== ===== ========= 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 ========= ====== ===== ========= Page 9
- ------------------------------------------------------------------------------- STATISTICAL DATA (continued) Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- Available for sale at December 31, 1995: U.S. Treasury. . . . . . . . . . . . . . . . $ 16,239 $ 184 $ 11 $ 16,412 Federal agencies . . . . . . . . . . . . . . 84,047 1,529 93 85,483 State and municipal. . . . . . . . . . . . . 40,391 1,257 68 41,580 Mortgage-backed securities . . . . . . . . . 47,012 411 282 47,141 Other asset-backed securities. . . . . . . . 433 1 432 Corporate obligations. . . . . . . . . . . . 34,114 289 106 34,297 Marketable equity securities . . . . . . . . 562 31 593 --------- ------ ----- --------- Total available for sale . . . . . . . . . 222,798 3,701 561 225,938 --------- ------ ----- --------- Held to maturity at December 31, 1995: U.S. Treasury. . . . . . . . . . . . . . . . 3,103 8 2 3,109 Federal agencies . . . . . . . . . . . . . . 11,645 69 21 11,693 State and municipal. . . . . . . . . . . . . 40,393 574 57 40,910 Mortgage-backed securities . . . . . . . . . 4,563 9 21 4,551 Other asset-backed securities. . . . . . . . 474 8 482 Corporate obligations. . . . . . . . . . . . 500 1 499 --------- ------ ----- --------- Total held to maturity . . . . . . . . . . 60,678 668 102 61,244 --------- ------ ----- --------- Total investment securities. . . . . . . . $ 283,476 $4,369 $ 663 $ 287,182 ========= ====== ===== ========= Cost ----------------------------- 1997 1996 1995 ------- ------- ------- Federal Reserve and Federal Home Loan Bank stock at December 31: Federal Reserve Bank stock . . . . . . . . $ 397 $ 397 $ 397 Federal Home Loan Bank stock . . . . . . . 2,976 2,693 2,305 ------- ------- ------- Total. . . . . . . . . . . . . . . . . $ 3,373 $ 3,090 $ 2,702 ======= ======= ======= 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, 1997 were: Securities available for sale December 31, 1997: Within 1 Year 1-5 Years 5 - 10 Years ------------- --------- ------------ Amount Yield* Amount Yield* Amount Yield* ------ ------ ------ ------ ------ ------ U.S. Treasury. . . . . . . . . . $ 3,242 5.77% $ 15,965 6.00% Federal Agencies . . . . . . . . 15,327 6.62 51,456 6.27 State and Municipal. . . . . . . 6,461 4.07 26,900 4.65 $ 33,590 4.64% Corporate Obligations. . . . . . 9,596 5.90 8,623 6.13 -------- --------- -------- Total . . . . . . . . . . . . $ 34,626 5.88% $ 102,944 5.79% $ 33,590 4.64% ======== ========= ======== Page 10
- ------------------------------------------------------------------------------- STATISTICAL DATA (continued) Marketable Equity, Mortgage and Other Asset-Backed Due After Ten Years Securities Total ------------------- ---------- ----- Amount Yield* Amount Yield* Amount Yield* ------ ------ ------ ------ ------ ------ U.S. Treasury. . . . . . . . . . $ 19,207 5.96% Federal Agencies . . . . . . . . 66,783 6.35 State and Municipal. . . . . . . $ 891 6.14% 67,842 4.61 Corporate Obligations. . . . . . 18,219 6.01 Marketable Equity Security . . . 250 7.90% 250 7.90 Mortgage-backed securities . . . $ 36,682 6.37 36,682 6.37 Other asset-backed securities. . 487 7.00 487 7.00 ------ --------- --------- Total. . . . . . . . . . . . . $ 891 6.14% $ 37,419 6.39% $ 209,470 5.73% ====== ========= ========= Securities held to maturity at December 31, 1997: Within 1 Year 1-5 Years 5 - 10 Years ------------- --------- ------------ Amount Yield* Amount Yield* Amount Yield* ------ ------ ------ ------ ------ ------ U.S. Treasury. . . . . . . . . . $ 249 5.36% Federal Agencies . . . . . . . . $ 2,912 6.42% 500 6.17 State and Municipal. . . . . . . 8,588 4.88 14,824 4.72 $ 2,264 4.99% --------- -------- -------- Total . . . . . . . . . . . . $ 11,500 5.27% $ 15,573 4.77% $ 2,264 4.99% ========= ======== ======== Mortgage and other Due After Ten Years asset-backed Total ------------------- ------------ ----- Amount Yield* Amount Yield* Amount Yield* ------ ------ ------ ------ ------ ------ U.S. Treasury. . . . . . . . . . $ 249 5.36% Federal Agencies . . . . . . . . 3,412 6.38 State and Municipal. . . . . . . 26,206 4.82 Mortgage-backed securities . . . $ 1,255 6.59% 1,255 6.59 Other asset-backed securities. . $ 530 5.86% 4,210 7.05 4,210 7.05 ------ -------- -------- Total. . . . . . . . . . . . $ 530 5.86% $ 5,465 6.95% $ 35,332 5.30% ====== ======== ======== *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, 1997: Amount Yield ------- ----- Federal Reserve Bank stock . . . . . $ 397 6.00% Federal Home Loan Bank stock . . . . 2,976 8.00 ------- Total. . . . . . . . . . . . . . . $ 3,373 7.76% ======= Page 11
- ------------------------------------------------------------------------------- STATISTICAL DATA (continued) LOAN PORTFOLIO TYPES OF LOANS The loan portfolio at the dates indicated is presented below: 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (Dollars in Thousands) Loans at December 31: Commercial and industrial loans . . . . . . . . . $ 148,281 $ 132,134 $ 98,880 $ 89,696 $ 90,192 Bankers acceptances and loans to financial institutions. . . . . 705 625 2,925 3,293 Agricultural production financing and other loans to farmers . . . . . . . . . . . . 16,764 18,906 17,203 17,255 16,470 Real estate loans: Construction . . . . . . . . . . . 21,389 13,167 9,913 8,126 8,127 Commercial and farmland. . . . . . 97,503 97,596 104,731 95,092 85,992 Residential. . . . . . . . . . . . 287,072 253,530 215,738 217,148 196,570 Individuals' loans for household and other personal expenditures. . . . . . . 125,706 113,507 102,313 99,812 91,277 Tax-exempt loans . . . . . . . . . . 2,598 1,643 1,204 1,514 2,029 Other loans. . . . . . . . . . . . . 3,782 1,672 949 1,608 3,350 -------- -------- -------- -------- -------- 703,800 632,780 553,856 530,251 497,300 Unearned interest on loans . . . . . (487) (1,364) (1,518) (1,610) (1,597) -------- -------- -------- -------- -------- Total loans. . . . . . . . . . $ 703,313 $ 631,416 $ 552,338 $ 528,641 $ 495,703 ========= ========= ========= ========= ========= Residential Real Estate Loans Held for Sale at December 31, 1997, 1996, and 1995 were $471,400, $284,020, and $735,522. MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES Presented in the table below are the maturities of loans (excluding commercial real estate, farmland, residential real estate and individuals' loans) outstanding as of December 31, 1997. 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 . . . . . $ 61,858 $ 42,869 $ 43,554 $148,281 Agricultural production financing and other loans to farmers. . . . . . . 13,498 2,711 555 16,764 Real estate - Construction. . . . . . . . 9,122 3,742 8,525 21,389 Tax-exempt loans. . . . . . . . . . . . . 477 438 1,683 2,598 Other loans . . . . . . . . . . . . . . . 3,504 184 94 3,782 --------- --------- --------- -------- Total. . . . . . . . . . . . . . . . $ 88,459 $ 49,944 $ 54,411 $192,814 ========= ========= ========= ======== Page 12
- ------------------------------------------------------------------------------- STATISTICAL DATA (continued) Maturing ---------------------- 1 - 5 Over Years 5 Years ----- ------- (Dollars in Thousands) Loans maturing after one year with: Fixed rates . . . . . . . . . . $ 13,677 $ 26,736 Variable rate . . . . . . . . . 36,267 27,675 -------- -------- Total . . . . . . . . . . . . $ 49,944 $ 54,411 ======== ======== RISK ELEMENTS December 31 --------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (Dollars in Thousands) Nonaccruing loans . . . . . . . . . . . . $ 1,410 $ 2,777 $ 576 $ 398 $ 1,649 Loans contractually past due 90 days or more other than nonaccruing. . . . . . . . . . . . . . . 1,972 1,699 1,119 1,322 936 Restructured loans. . . . . . . . . . . . 282 1,540 1,075 1,242 1,509 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 $180,280 for the year ended December 31, 1997, was recognized on the nonaccruing and restructured loans listed in the table above, whereas interest income of $296,759 would have been recognized under their original loan terms. Potential problem loans: Management has identified certain other loans totaling $7,880,846 as of December 31, 1997, not included in the risk elements table, which are current as to principal and interest, 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. 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (Dollars in Thousands) Allowance for loan losses: Balance at January 1 . . . . . . . . . $ 6,622 $ 6,696 $ 6,603 $ 6,467 $ 5,811 Chargeoffs: Commercial . . . . . . . . . . . . . 443 767 794 973 675 Real estate mortgage . . . . . . . . 31 14 1 53 129 Installment. . . . . . . . . . . . . 1,135 855 759 462 571 ------- ------- ------- ------- ------- Total chargeoffs. . . . . . . . . . 1,609 1,636 1,554 1,488 1,375 ------- ------- ------- ------- ------- Recoveries: Commercial . . . . . . . . . . . . . 264 106 127 269 248 Real estate mortgage . . . . . . . . 1 7 4 30 5 Installment. . . . . . . . . . . . . 203 196 128 123 124 ------- ------- ------- ------- ------- Total recoveries. . . . . . . . . . 468 309 259 422 377 ------- ------- ------- ------- ------- Net chargeoffs . . . . . . . . . . . . 1,141 1,327 1,295 1,066 998 ------- ------- ------- ------- ------- Provisions for loan losses . . . . . . 1,297 1,253 1,388 1,202 1,654 ------- ------- ------- ------- ------- Balance at December 31 . . . . . . . . $ 6,778 $ 6,622 $ 6,696 $ 6,603 $ 6,467 ======= ======= ======= ======= ======= Ratio of net chargeoffs during the period to average loans outstanding during the period. . . . . .17% .23% .24% .21% .21% Peer Group . . . . . . . . . . . . . . . N/A .26% .26% .25% .49% 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: 1997 1996 ------------------ ------------------- Amount Per Cent Amount Per Cent ------ -------- ------ -------- (Dollars in Thousands) Balance at December 31: Commercial, financial and agricultural . . . . . . . . . . $ 2,594 23.6% $ 2,924 24.2% Real estate - construction . . . . 3 3.0 3 2.1 Real estate - mortgage . . . . . . 1,061 54.7 1,041 55.6 Installment. . . . . . . . . . . . 1,702 18.3 1,576 17.8 Tax-exempt loans . . . . . . . . . 4 .4 16 .3 Unallocated. . . . . . . . . . . . 1,414 N/A 1,062 N/A ------- ----- ------- ---- Totals . . . . . . . . . . . . . . $ 6,778 100.0% $ 6,622 100.0% ======== ====== ======= ====== 1995 1994 ------------------ ------------------- Amount Per Cent Amount Per Cent ------ -------- ------ -------- (Dollars in Thousands) Balance at December 31: Commercial, financial and agricultural . . . . . . . . . . $ 3,105 21.8% $ 3,080 20.5% Real estate - construction . . . . 1 1.8 4 1.5 Real estate - mortgage . . . . . . 1,121 58.0 1,048 59.1 Installment. . . . . . . . . . . . 1,506 18.2 1,550 18.6 Tax-exempt loans . . . . . . . . . 4 .2 4 .3 Unallocated. . . . . . . . . . . . 959 N/A 917 N/A -------- ---- ------- ----- Totals . . . . . . . . . . . . . . $ 6,696 100.0% $ 6,603 100.0% ======== ====== ======= ====== 1993 ------------------ Amount Per Cent ------ -------- (Dollars in Thousands) Balance at December 31: Commercial, financial and agricultural . . . . . . . . . . $ 3,021 22.9% Real estate - construction . . . . 6 1.6 Real estate - mortgage . . . . . . 870 57.0 Installment. . . . . . . . . . . . 1,589 18.1 Tax-exempt loans . . . . . . . . . 7 .4 Unallocated. . . . . . . . . . . . 974 N/A -------- ---- Totals . . . . . . . . . . . . . . $ 6,467 100.0% ======== ====== 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: 1997 1996 1995 ---- ---- ---- (Dollars in Thousands) For the year ending December 31: Impaired loans with an allowance . . . . . . . . $ 1,476 $ 3,124 $ 2,314 Impaired loans for which the discounted cash flows or collateral value exceeds the carrying value of the loan . . . . . . . . . . 1,075 868 2,498 ------- ------- ------- Total impaired loans . . . . . . . . . . . . $ 2,551 $ 3,992 $ 4,812 ======= ======= ======= Allowance for impaired loans (included in the Corporation's allowance for loan losses) . . . $ 407 $ 1,092 $ 1,177 Average balance of impaired loans. . . . . . . . 3,414 5,213 4,650 Interest income recognized on impaired loans . . 180 311 153 Cash basis interest included above . . . . . . . 162 291 93 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. 1997 1996 1995 --------------- --------------- ---------------- Amount Rate Amount Rate Amount Rate ------ ---- ------ ---- ------ ---- (Dollars in Thousands) Balance at December 31: Noninterest bearing deposits . . . . . $ 94,759 $ 90,719 $ 88,335 NOW accounts . . . . . . . . . . . . . 104,620 2.3% 109,792 2.3% 103,015 2.6% Money market deposit accounts. . . . . 105,628 4.0 100,897 3.7 107,735 3.8 Savings deposits . . . . . . . . . . . 69,633 2.5 70,875 2.7 74,293 2.9 Certificates of deposit and other time deposits. . . . . . . . . 425,478 5.5 381,378 5.5 355,448 5.4 -------- -------- -------- --- Total deposits. . . . . . . . . . . $800,118 4.0 $753,661 3.9 $728,826 3.9 ======== ======== ======== --- As of December 31, 1997, 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 . . . . . . . . $51,373 $11,708 $19,766 $21,255 $104,102 Per cent. . . . . . . . . . . . . . . 49% 11% 19% 21% 100% RETURN ON EQUITY AND ASSETS 1997 1996 1995 ---- ---- ---- Return on assets (net income divided by average total assets) . . . . . . . . . . . . 1.45% 1.41% 1.35% Return on equity (net income divided by average equity). . . . . . . . . . . . . . . 12.28 12.16 12.17 Dividend payout ratio (dividends per share divided by net income per share) . . . 47.93 40.85 39.49 Equity to assets ratio (average equity divided by average total assets) . . . . . . 11.78 11.60 11.11 Page 17
- ------------------------------------------------------------------------------- STATISTICAL DATA (continued) SHORT-TERM BORROWINGS 1997 1996 1995 ---- ---- ---- (Dollars in Thousands) Balance at December 31: Federal funds purchased . . . . . . . . . . $ 4,070 $ 20,725 $ 1,700 Securities sold under repurchase agreements . . . . . . . . . . . . . . . . 15,398 20,054 28,887 U.S. Treasury demand notes. . . . . . . . . 7,361 4,258 6,790 -------- -------- -------- Total short-term borrowings . . . . . . . $ 26,829 $ 45,037 $ 37,377 ======== ======== ======== 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: 1997 1996 1995 ---- ---- ---- (Dollars in Thousands) Weighted average interest rate on outstanding balance at December 31: Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . 5.13% 4.92% 5.26% Total short-term borrowings . . . . . . . . . . 5.38 5.78 5.28 Weighted average interest rate during the year: Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . 4.99 5.07 5.52 Total short-term borrowings . . . . . . . . . . 5.36 5.19 5.55 Highest amount outstanding at any month end during the year: Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . $49,750 $52,221 $58,097 Total short-term borrowings . . . . . . . . . . 84,860 83,678 65,514 Average amount outstanding during the year: Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . 31,327 42,140 35,436 Total short-term borrowings . . . . . . . . . . 53,185 51,768 47,345 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 National 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, 1997 was $15,382,400. 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 1997 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, 63 President and Chief Executive of the Corporation and Officer, Corporation; First Merchants since Chairman of the Board and 1987; President and Chief Executive Officer, Chief Executive Officer First Merchants Bank, N.A. of the Corporation since 1982, and Chief Executive Officer of First Merchants Bank since 1979 Michael L. Cox Executive Vice President, Executive Vice President 53 Chief Operating Officer and Chief Operating and Director, Corporation; Officer, Corporation since President, Chief Operating May, 1994; President and Officer and Director, First Chief Operating Officer, Merchants Bank, N.A. 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, 57 General Counsel and Corporation since 1982; Secretary, Corporation; General Counsel, Senior Vice President, First Corporation since 1990 Merchants Bank, N.A.; and Secretary since Director of First United January 1, 1997; Senior Bank; Director of Pendleton Vice President, First Banking Company Merchants 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 58 Director, Corporation; and Director, Corporation President, Chief Executive since August 1996; Officer and Director, The President, Union County Union County National Bank National Bank since 1983 of Liberty and Director since 1981 James L. Thrash Senior Vice President and Senior Vice President and 48 Chief Financial Officer, Chief Financial Officer Corporation; Senior Vice of 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 49 of the Corporation's 1997 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 21 of the Corporation's 1997 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 22 through 27 of the Corporation's 1997 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 - ------------------------------------------------------------------------------- It is the objective of First Merchants 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 on a quarterly basis. The GAP/Interest Rate Sensitive Report is a tool which displays repricing timing differences between interest sensitive assets and liabilities. The Corporation elects to categorize its non-maturity deposits as all to reprice in 13 months. The FMC 181-365 day Sensitivity Gap Ratio depicts the institution is asset sensitive (107.8%). See Interest-Rate Sensitivity Analysis below: INTEREST-RATE SENSITIVITY ANALYSIS (Dollars in Thousands) At December 31, 1997 ----------------------------------------------------------------- 1-180 DAYS 181-365 DAYS 1-5 YEARS BEYOND 5 YEARS TOTAL ----------------------------------------------------------------- Rate-Sensitive Assets: Federal funds sold and interest bearing deposits . . . . . . . $ 9,435 $ 9,435 Investment Securities. . . . . . . . . . 52,680 $ 34,688 $122,966 $ 37,038 247,372 Loans. . . . . . . . . . . . . . . . . . 302,943 71,869 263,440 65,532 703,784 Federal Reserve and Federal Home Loan Bank stock. . . . . . 2,976 397 3,373 -------- -------- -------- -------- -------- Total rate-sensitive assets . . . . . 368,034 106,557 386,406 102,967 963,964 -------- -------- -------- -------- -------- Rate-Sensitive Liabilities: Interest-bearing deposits. . . . . . . . 304,651 102,033 320,727 788 728,199 Borrowed funds . . . . . . . . . . . . . 26,829 26,829 Federal Home Loan Bank advances. . . . . 2,294 4,294 9,278 4,834 20,700 -------- -------- -------- -------- -------- Total rate-sensitive liabilities. . . . 333,774 106,327 330,005 5,622 775,728 -------- -------- -------- -------- -------- Interest rate sensitivity gap by period . $ 34,260 $ 230 $ 56,401 $ 97,345 Cumulative rate sensitivity gap . . . . . 34,260 34,490 90,891 188,236 Cumulative rate sensitivity gap ratio at December 31, 1997. . . . . . . . . . 110.3% 107.8% 111.8% 124.3% The Corporation had a cumulative positive gap of $34,490,000 in the one year horizon at December 31, 1997, or just over 3 percent of total assets. Net interest income at financial institutions with positive gaps tends to increase when rates increase and decrease as interest rates decline. Page 21
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 simulation modeling product used by the Corporation is a personal computer based system known as Asset Liability Model System (ALMS) supported by Alltel, Inc., of Little Rock, AK. The system provides software sophisticated enough to measure; basis risk, yield curve risk, option risk, and interest rate risk. More specifically the software considers yield curve changes, prepayment speeds, caps, floors and allows the user to tie different products to different interest rate drivers which can be assumed to change at different speeds and magnitudes. 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 10%. Assumed interest rate changes are simulated to move incrementally over 18 months. The total rate movement (beginning point less ending point) to noteworthy interest rate indexes are as follows: Rising Falling ----------------- --------------- Prime 300 Basis Points (300) Basis Points Federal Funds 300 (300) 90 Day T-Bill 320 (275) One Year T-Bill 290 (255) Three Year T-Note 275 (235) Five Year T-Note 265 (215) Ten Year T-Note 260 (195) Interest Checking 100 ( 60) MMIA Savings 140 (100) Money Market Index 300 (300) Regular Savings 100 ( 60) 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) $ 60,359 $ 59,423 $ 60,130 Change vs. Flat/Base Scenario (936) (229) % Change (1.58)% (0.38)% ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ------------------------------------------------------------------------------- The financial statements and supplementary data required under this item are incorporated herein by reference to page 20 and pages 28 through 46 of the Corporation's 1997 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, 1997, 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. Page 22
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 1998 Proxy Statement furnished to its stockholders in connection with an annual meeting to be held April 7, 1998 (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 1998 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 1998 Proxy Statement, under the caption, "Security Ownership of Certain Beneficial Owners and Management," which Proxy Statement has been filed with the Commission. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - ------------------------------------------------------------------------------- The information required under this item is incorporated by reference to the Corporation's 1998 Proxy Statement, under the caption "Interest of Management in Certain Transactions," which Proxy Statement has been filed with the Commission. Page 23
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 . . . . . . . . . . . . . . . 20 Consolidated balance sheet at December 31, 1997 and 1996 . . . . . . . . . . . . . . . 28 Consolidated statement of income, years ended December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . 29 Consolidated statement of changes in stockholders' equity, years ended December 31, 1997, 1996 and 1995 . . . . . . . . . . . . 30 Consolidated statement of cash flows, years ended December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . 31 Notes to consolidated financial statements . . . . . . . . . . . . . . . . . . . . . . . 32-46 (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. 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. Page 24
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (continued) - ------------------------------------------------------------------------------- EXHIBIT NO: DESCRIPTION OF EXHIBIT: - ---------- ---------------------- 13 1997 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, 1997 99.1 Financial statements and independent auditor's report for First Merchants Corporation Employee Stock Purchase Plan (b) Reports on Form 8-K: None were filed during 1997. Page 25
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 19th day of March, 1998. 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 19, 1998 Stefan S. Anderson Principal Executive Officer /s/ James L. Thrash - ------------------------------ Principal Financial and March 19, 1998 James L. Thrash Principal Accounting Officer /s/ Michael L. Cox - ------------------------------ Director March 19, 1998 Michael L. Cox - ------------------------------ Director Frank A. Bracken /s/ Thomas B. Clark - ------------------------------ Director March 19, 1998 Thomas B. Clark - ------------------------------ Director David A. Galliher - ------------------------------ Director Norman M. Johnson /s/ Ted J. Montgomery - ------------------------------ Director March 19, 1998 Ted J. Montgomery /s/ George A. Sissel - ------------------------------ Director March 19, 1998 George A. Sissel Page 26
Signature Capacity Date - ------------------------------ ------------------------------ ------ - ------------------------------ Director Robert M. Smitson - ------------------------------ Director Michael D. Wickersham /s/ John E. Worthen - ------------------------------ Director March 19, 1998 John E. Worthen Page 27
INDEX TO EXHIBITS - ------------------------------------------------------------------------------- (a)3. Exhibits: EXHIBIT NO: DESCRIPTION OF EXHIBIT: - ---------- ---------------------- 10.7 First Merchants Corporation Supplemental Executive Retirement Plan and Amendments thereto 13 1997 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, 1997 99.1 Financial statements and independent auditor's report for First Merchants Corporation Employee Stock Purchase Plan Page 28
FIRST MERCHANTS CORPORATION SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN SECTION 1. ESTABLISHMENT AND PURPOSE A. Establishment. First Merchants Corporation (the "Employer"), hereby establishes a non-qualified supplemental executive retirement plan for certain executives, as designated and described herein, which shall be known as the FIRST MERCHANTS CORPORATION SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN (the "Plan"). B. Purpose. The purpose of the Plan is to enable the Employer to attract, retain, and motivate key executive employees of high caliber, and to provide equitable retirement and survivor benefits for certain key executive employees, their surviving spouses and designated beneficiaries. SECTION 2. DEFINITIONS For purposes of this Plan, certain words or phrases used herein will have the following meanings: A. "Board of Directors" means the Board of Directors of First Merchants Corporation. B. "Code" means the Internal Revenue Code of 1986, as amended from time to time. C. "Compensation Committee" means the Employer's Compensation and Human Resources Committee. D. "Executive" means a key executive Employee that is designated to participate in the Plan under Section 3 below. E. "Non-qualified SERP Benefit" means the difference between (1) and (2), where (1) is the Retirement Benefit that would have been paid the Executive from the Pension Plan at the Executive's Normal, Late or Disability Retirement Date (whichever is applicable) if there were no compensation limit imposed under Code Section 401(a)(17) and if Final Average Monthly Plan Compensation did not exclude bonuses for purposes of determining the Standard Benefit Formula, and (2) is the Retirement Benefit payable to the Executive under the Pension Plan at the Executive's Normal, Late or Disability Retirement Date (whichever is applicable). F. "Pension Plan" means the First Merchants Corporation Retirement Pension Plan, as amended, a qualified pension plan under Section 401(a) of the Internal Revenue Code of 1986, as amended. G. "Term Certain Expiration Date" means the 15th anniversary of the event, retirement or death, 1
which causes payment of benefits under this Plan to commence, unless the Compensation Committee establishes a different Term Certain Expiration Date for a covered Executive at the time it designates such Executive to participate in the Plan. H. The following terms will have the same meanings as they have under the Pension Plan: "Employee," "Employer," "Final Average Monthly Plan Compensation," "Normal, Early, Late, or Disability Retirement Date," "Retirement Benefit," "Normal, Early, Late, or Disability Retirement Benefit," and "Standard Benefit Formula." SECTION 3. DESIGNATION OF EXECUTIVES PARTICIPATING IN PLAN The Compensation Committee shall have the sole discretion, from time to time, to designate Employees to participate in the Plan as covered Executives. This designation shall be by resolution of the Compensation Committee and shall be limited to management or highly compensated Employees. The Compensation Committee shall notify each Employee so designated in writing. Covered Executives, their spouses and designated beneficiaries shall become entitled to benefits under this Plan if the Executive is employed by the Employer on his or her 65th birthday (unless the Compensation Committee, at the time it designates a covered Executive to participate in the Plan, establishes a different minimum age as of which such Executive shall become entitled to such benefits), Disability Retirement Date or death, whichever occurs earliest. SECTION 4. RETIREMENT BENEFIT If an Executive retires on his or her Normal, Late or Disability Retirement Date, the Executive shall receive each year thereafter (unless the Compensation Committee provides for a different benefit commencement date for a covered Executive at the time it designates such Executive to participate in the Plan), in the manner described in Section 6, an amount equal to the Non-qualified SERP Benefit for the Executive's lifetime. If the Executive's Retirement Benefit under the Pension Plan commences at a time other than his or her Normal Retirement Date, the amount of the Non-qualified SERP Benefit shall be adjusted using the same actuarial factors and assumptions (except as otherwise provided in Section 7 of this Plan) used to calculate the Retirement Benefit payable to the Executive under the Pension Plan. SECTION 5. PRE-RETIREMENT SURVIVOR BENEFIT If a covered Executive dies while still actively employed by the Employer, and if the Executive is survived by the Executive's spouse, the Executive's spouse shall receive each year until the Term Certain Expiration Date, in the manner described in Section 6, the Non-qualified SERP Benefit otherwise payable to the Executive under this Plan, determined as if the Executive had retired on the date immediately preceding the date of the Executive's death. In determining this Benefit, the Executive shall be deemed to be vested under the Pension Plan and not to have waived the death benefit coverage under the Pension Plan (whether or not that is actually true). If the Executive is not survived by the Executive's spouse, or if the spouse does not live until the Term Certain Expiration 2
Date, the person(s) designated under Section 8 shall receive each year, in the manner described in Section 6, an amount equal to such Benefit. SECTION 6. MANNER OF PAYING BENEFITS Within 30 days following the retirement of the Executive, or, if Section 5 applies, within 30 days following the death of the Executive, payment of a monthly benefit shall commence to the covered Executive, or to the Executive's spouse or designated beneficiary, equal to the benefit described in Section 4 or 5 of this Plan, whichever applies. SECTION 7. TERM CERTAIN Benefits on behalf of a covered Executive, whether payable as a Normal, Late, or Disability Retirement Benefit, or as a survivor benefit or other death benefit payable to a spouse or designated beneficiary, shall be made at least through the Term Certain Expiration Date, without any actuarial reduction on account of such guaranteed payment. At any time, in the discretion of the Compensation Committee, the computed value of the future benefits payable under the Plan to a surviving spouse or designated beneficiary as a guaranteed Term Certain payment, or as a survivor benefit or other death benefit may be computed and paid in one lump sum. SECTION 8. DESIGNATION OF BENEFICIARY An Executive, or subsequent to the Executive's death, the Executive's spouse, may designate the person(s) to receive the benefits payable under this Plan if the Executive and the Executive's spouse do not live to receive the benefits through the Term Certain Expiration Date. If such designation is not made, or if no designated beneficiary is then living, such benefit shall be paid to the Executive's spouse, if then living, or if not, to the Executive's descendants, PER STIRPES, who are then living, or if there are no such descendants then living, to the Executive's estate. SECTION 9. EARLY, LATE OR DISABILITY RETIREMENT The Compensation Committee may grant to a covered Executive, while in the employ of the Employer, early, late or disability retirement under this Plan, if such Executive is eligible for and elects an Early, Late or Disability Retirement Benefit under the Pension Plan. The Compensation Committee, in its sole discretion, may provide that retirement benefits under this Plan shall begin at any time after the granting of early, late or disability retirement, rather than at the Executive's Normal Retirement Date, and the Term Certain Expiration Date shall terminate on the 15th anniversary of the commencement of retirement benefits (or, if the Compensation Committee established a different Term Certain Expiration Date for the covered Executive at the time it designated such Executive to participate in the Plan, such anniversary which corresponds to the number of years for which payment is guaranteed). 3
SECTION 10. TERMINATION OF EMPLOYMENT If an Executive's employment with the Employer is terminated prior to his or her 65th birthday (or such other minimum age established by the Compensation Committee at the time it designates such Executive to participate in the Plan, as of which such Executive shall become entitled to benefits hereunder), either by the Employer or by the Executive, and either with or without cause, no benefits shall be paid under any provision of this Plan, unless the Compensation Committee, in its sole discretion, shall provide that the benefits will be paid regardless of the termination of the Executive's employment. However, disability retirement or death shall not be deemed to be a termination of employment for purposes of this Section. SECTION 11. PROHIBITION OF COMPETITIVE EMPLOYMENT If, during the period of an Executive's employment with the Employer or while the Executive is receiving benefits under this Plan, a covered Executive engages in competitive activities without the Employer's written consent, no further benefits shall be payable under any provision of this Plan. For purposes of this Section, "competitive activities" shall mean engaging, directly or indirectly (including providing consulting services), in a business similar to any business of the Employer or any of its subsidiaries, or owning, managing, operating, controlling, being employed by, participating in, having any financial interest in, or being connected in any manner with the ownership, management, operation or conduct of, any such similar business. SECTION 12. TITLE TO LIFE INSURANCE If life insurance is purchased to provide the Employer with funds to make benefit payments under this Plan to or on behalf of a covered Executive, the owner and beneficiary of such life insurance contract shall at all times be the Employer or, if the Employer establishes a "rabbi trust" in connection with this Plan, the trustee of such trust. If the Employer is the owner and beneficiary of the life insurance contract, it shall have the unrestricted right to use all amounts and to exercise all options and privileges thereunder without the knowledge or consent of the Executive, his or her designated beneficiary, or any other person, it being expressly agreed that neither the Executive nor any such beneficiary or other person shall have any right, title or interest whatsoever in or to any such contract. If the trustee of a "rabbi trust" is the owner and beneficiary of the life insurance contract, the respective rights and interests of the Employer, the trustee, the Executive, his or her designated beneficiary, and other persons, shall be governed by the terms of the trust agreement and the life insurance contract. SECTION 13. PAYMENTS ARE NOT SECURED Except as provided in the "rabbi trust" agreement, if any, established by the Employer in connection with this Plan, (a) the Executive, his or her designated beneficiary and any other person or persons having or claiming a right to payment of benefits hereunder, or to any interest under this Plan, shall rely solely on the unsecured promise of the Employer, and (b) nothing herein shall be construed to 4
give the Executive, his or her designated beneficiary or any other person or persons any right, title, interest or claim in or to any specific asset, fund, reserve, account or property of any kind whatsoever owned by the Employer or in which it may have any right, title or interest now or in the future, but the Executive shall have the right to enforce his or her claim against the Employer in the same manner as any unsecured creditor. SECTION 14. NON-ASSIGNABILITY OF BENEFITS Neither the Executive, nor his or her designated beneficiary, nor any other person entitled to any payment hereunder, shall have power to transfer, assign, anticipate, mortgage or otherwise encumber any right to receive a payment in advance of the time such payment is due under the provisions of this Plan, and any attempted transfer, assignment, anticipation, mortgage or encumbrance shall be void. No payment hereunder shall be subject to seizure for the payment of public or private debts, judgments, alimony or separate maintenance, or be transferable by operation of law in the event of bankruptcy, insolvency or otherwise. SECTION 15. ADMINISTRATION OF THE PLAN The Plan shall be administered by the Compensation Committee, which shall have sole authority to construe and interpret the Plan and issue such rules and regulations as it deems appropriate. The Compensation Committee shall have the duty and responsibility of deciding questions of eligibility, determining the amount, manner and time of payment of any benefits hereunder, and distributing the benefits to covered Executives, their spouses and/or beneficiaries; provided, however, the Compensation Committee may appoint or employ individuals to assist in the administration of the Plan and any other agents it deems advisable, including legal and actuarial counsel. The Compensation Committee's interpretations, determinations, rules and regulations, and calculations shall be final and binding on all persons and parties concerned. If a covered Executive, spouse or beneficiary desires a review of any benefit determination made by the Compensation Committee, he or she shall follow the claims review procedure described in Section 6.06 of the Pension Plan (except that such appeal shall be to the Compensation Committee rather than to the committee responsible for administering the Pension Plan, if different). SECTION 16. AMENDMENT This Plan may be amended at any time or from time to time by the Board of Directors of the Employer. Any amendment shall not reduce the benefit of any covered Executive, or any person receiving benefits under this Plan, without the written consent of the affected person. The failure of either the Employer or any covered Executive to enforce any of the provisions hereof shall not be deemed a waiver thereof. No provision of this Plan shall be deemed to have been waived or modified unless such waiver or modification shall be in writing and signed by the party or parties affected by such waiver or modification. The Employer reserves the right to terminate the Plan at any time by action of the Board of Directors. The termination of this Plan shall not affect the benefits of any Executive, Executive's spouse or designated beneficiary covered by the Plan, prior to termination. 5
SECTION 17. NON-GUARANTEE OF EMPLOYMENT This Plan shall not be construed as giving any Executive the right to be retained as an Employee of the Employer for any period. SECTION 18. BINDING EFFECT AND GOVERNING LAW This Plan shall be binding upon the Executive and the Executive's spouse, beneficiaries, heirs, executors, administrators, personal representatives, successors and assigns, and upon the Employer and its successors and assigns. Except as preempted by ERISA or any other applicable federal law, the Plan shall be construed, enforced and administered, and the validity thereof shall be determined, in accordance with the laws of the State of Indiana. This Plan was adopted by the Board of Directors of First Merchants Corporation on February 11, 1997, effective as of March 1, 1997. It was amended by the Executive Committee of the Board of Directors, acting on the Board's behalf under authority granted in the Bylaws of the Corporation, on December ___, 1997, retroactively to the effective date of the Plan. First Merchants Corporation By /s/ Stefan S. Anderson -------------------------------------- Stefan S. Anderson, Chairman 6
Exhibit 13 Annual Report Financial Review - ------------------------------------------------------------------- - ------------------------------------------------------------------- TABLE OF CONTENTS INDEPENDENT AUDITOR'S REPORT . . . . . . . . . . . . . . . 20 FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA . . . . . . . 21 MANAGEMENT'S DISCUSSION & ANALYSIS . . . . . . . . . . . . 22 CONSOLIDATED FINANCIAL STATEMENTS. . . . . . . . . . . . . 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS . . . . . . . . 32 - ------------------------------------------------------------------- - ------------------------------------------------------------------- 19
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, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997 (pages 28-46). 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, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. GEO. S. OLIVE & CO. LLC Indianapolis, Indiana January 23, 1998 20
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA (In Thousands, Except Share Data) 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------- OPERATIONS Net Interest Income Fully Taxable Equivalent Basis. . . . . . $ 42,139 $ 39,258 $ 37,049 $ 35,909 $ 34,536 Less Tax Equivalent Adjustment. . . . . . . . 2,389 2,111 1,952 1,971 2,011 --------- --------- --------- --------- --------- Net Interest Income . . . . . . . . . . . . . 39,750 37,147 35,097 33,938 32,525 Provision for Loan Losses . . . . . . . . . . 1,297 1,253 1,388 1,202 1,654 --------- --------- --------- --------- --------- Net Interest Income After Provision for Loan Losses . . . . . 38,453 35,894 33,709 32,736 30,871 Total Other Income. . . . . . . . . . . . . . 9,229 8,342 7,592 6,919 7,350 Total Other Expenses. . . . . . . . . . . . . 25,748 24,135 22,992 22,632 22,108 --------- --------- --------- --------- --------- Income Before Income Tax Expense. . . . . 21,934 20,101 18,309 17,023 16,113 Income Tax Expense. . . . . . . . . . . . . . 7,561 6,959 6,261 5,660 5,250 --------- --------- --------- --------- --------- Income Before Change in Accounting Method . . 14,373 13,142 12,048 11,363 10,863 Change in Accounting Method for Income Taxes. 260 --------- --------- --------- --------- --------- Net Income. . . . . . . . . . . . . . . . . . $ 14,373 $ 13,142 $ 12,048 $ 11,363 $ 11,123 ========= ========= ========= ========= ========= PER SHARE DATA (1) Income Before Change in Accounting Method . . $ 2.17 $ 2.00 $ 1.84 $ 1.73 $ 1.64 Basic Net Income. . . . . . . . . . . . . . . 2.17 2.00 1.84 1.73 1.68 Diluted Net Income. . . . . . . . . . . . . . 2.14 1.98 1.82 1.72 1.67 Cash Dividends Paid (2) . . . . . . . . . . . 1.04 .88 .77 .71 .63 December 31 Book Value. . . . . . . . . . . . 18.30 17.07 15.99 14.08 13.46 December 31 Market Value (Bid Price). . . . . 36.50 25.25 25.75 20.83 19.33 AVERAGE BALANCES Total Assets . . . . . . . . . . . . . . . . . $ 993,338 $932,144 $890,995 $853,257 $832,756 Total Loans. . . . . . . . . . . . . . . . . . 675,892 585,905 544,457 513,784 469,782 Total Deposits 800,118 753,661 728,826 698,644 694,453 Total Federal Home Loan Bank Advances. . . . . 15,455 9,192 9,000 7,692 5,833 Total Stockholders' Equity . . . . . . . . . . 117,014 108,094 99,033 91,466 86,311 YEAR-END BALANCES Total Assets . . . . . . . . . . . . . . . . . $1,020,136 $967,993 $942,156 $868,153 $842,681 Total Loans. . . . . . . . . . . . . . . . . . 703,784 631,700 553,074 528,641 495,703 Total Deposits . . . . . . . . . . . . . . . . 843,812 794,451 783,936 720,009 688,644 Total Federal Home Loan Bank Advances. . . . . 20,700 9,150 9,000 8,000 6,000 Total Stockholders' Equity . . . . . . . . . . 121,969 112,687 104,967 92,754 89,257 FINANCIAL RATIOS Return on Average Assets . . . . . . . . . . . 1.45% 1.41% 1.35% 1.33% 1.34% Return on Average Stockholders' Equity . . . . 12.28 12.16 12.17 12.42 12.89 Average Earning Assets to Total Assets . . . . 94.77 94.48 94.86 94.46 94.27 Allowance for Loan Losses as % of Total Loans. .96 1.05 1.21 1.25 1.30 Dividend Payout Ratio. . . . . . . . . . . . . 47.93 40.85 39.49 39.44 37.06 Average Stockholders' Equity to Average Assets 11.78 11.60 11.11 10.72 10.36 Tax Equivalent Yield on Earning Assets (3) . . 8.27 8.13 8.09 7.41 7.46 Cost of Supporting Liabilities . . . . . . . . 3.79 3.67 3.71 2.95 3.06 Net Interest Margin on Earning Assets. . . . . 4.48 4.46 4.38 4.46 4.40 (1) Restated for 3- for- 2 stock splits distributed January, 1993, and October, 1995. (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. 21
MANAGEMENT'S DISCUSSION & ANALYSIS - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ The Corporation's financial data for periods prior to mergers accounted for as pooling of interests has been restated. [Graphic; Bar Chart; Return on Average Assets] [Graphic; Bar Chart; Return on Average Equity] RESULTS of OPERATIONS Net income amounted to $14,373,000 or $2.17 per share, an 8.5 percent increase over 1996 at $2.00 per share. Diluted net income per share amounted to $2.14, an 8.1 percent increase over the 1996 figure of $1.98. Return on assets increased to 1.45 percent, up from 1.41 percent in 1996, and 1.35 percent in 1995. Return on equity was 12.28 percent in 1997, 12.16 percent in 1996, and 12.17 percent in 1995. In 1997, First Merchants Corporation ("Corporation") recorded the twenty-second 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 1997, up from 11.6 percent at December 31, 1996. At December 31, 1997, the Corporation had a Tier I risk-based capital ratio of 16.9 percent, total risk-based capital ratio of 17.9 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) 22
MANAGEMENT'S DISCUSSION & ANALYSIS - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ ASSET QUALITY/PROVISION for LOAN LOSSES (continued) The reduction in non-performing loans is primarily attributable to two loans. One in the amount of $1,000,000 was removed from non-accrual status and one in the amount of $651,000 was removed from restructured status. No material loss is expected on either of these loans. 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 below, totaled $2,551,000 at December 31, 1997. An allowance for losses at December 31, 1997, was not deemed necessary for impaired loans totaling $1,075,000, but an allowance of $407,000 was recorded for the remaining balance of impaired loans of $1,476,000. The average balance of impaired loans for 1997 was $3,414,000. At December 31, 1997, the allowance for loan losses was $6,778,000, up slightly from year end 1996. As a percent of loans, the allowance was .96 percent, down from 1.05 percent at year end 1996. The decline in the allowance ratio is attributable to significant loan growth. The provision for loan losses in 1997 was $1,297,000 compared to $1,253,000 in 1996. December 31, 1997 1996 ------------------------ (Dollars in Thousands) Non-accrual loans. . . . . . . . . . . . . . . . $ 1,410 $ 2,777 Loans contractually past due 90 days or more other than nonaccruing. . . . . . . 1,972 1,699 Restructured loans . . . . . . . . . . . . . . . 282 1,540 -------- -------- Total . . . . . . . . . . . . . . . . . . . $ 3,664 $ 6,016 ======== ======== 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. [Graphic; Bar Chart; Net Loan Losses] The table below presents loan loss experience for the years indicated and compares the Corporation's loss experience to that of its peer group. - ----------------------------------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------- (Dollars in Thousands) Allowance for loan losses: Balance at January 1. . . . . . . . . . $ 6,622 $ 6,696 $ 6,603 ------------ ------------ ------------ Chargeoffs. . . . . . . . . . . . . . . 1,609 1,636 1,554 Recoveries. . . . . . . . . . . . . . . 468 309 259 ------------ ------------ ------------ Net chargeoffs. . . . . . . . . . . . . 1,141 1,327 1,295 Provision for loan losses . . . . . . . 1,297 1,253 1,388 ------------ ------------ ------------- Balance at December 31. . . . . . . . . $ 6,778 $ 6,622 $ 6,696 ============ ============ ============= Ratio of net chargeoffs during the period to average loans outstanding during the period . . . . . .17% .23% .24% Peer Group. . . . . . . . . . . . . . . . . N/A .26% .26% 23
MANAGEMENT'S DISCUSSION & ANALYSIS - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ LIQUIDITY and INTEREST SENSITIVITY 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 investments 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. The Corporation's liquidity and interest sensitivity position at December 31, 1997, 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, 1997. - ----------------------------------------------------------------------------------------------------------------------- INTEREST-RATE SENSITIVITY ANALYSIS (Dollars in Thousands) AT DECEMBER 31, 1997 1-180 DAYS 181-365 DAYS 1-5 YEARS BEYOND TOTAL 5 YEARS - ----------------------------------------------------------------------------------------------------------------------- Rate-Sensitive Assets: Federal funds sold and interest-bearing deposits. . . . . $ 9,435 $ 9,435 Investment securities. . . . . . . . 52,680 $ 34,688 $ 122,966 $ 37,038 247,372 Loans. . . . . . . . . . . . . . . . 302,943 71,869 263,440 65,532 703,784 Federal Reserve and Federal Home Loan Bank stock . . . 2,976 397 3,373 ----------- ----------- ---------- ---------- -------- Total rate-sensitive assets . . . 368,034 106,557 386,406 102,967 963,964 ----------- ----------- ---------- ---------- -------- Rate-Sensitive Liabilities: Interest-bearing deposits. . . . . . 304,651 102,033 320,727 788 728,199 Borrowed funds . . . . . . . . . . . 26,829 26,829 Federal Home Loan Bank advances. . . 2,294 4,294 9,278 4,834 20,700 ----------- ----------- ---------- ---------- -------- Total rate-sensitive liabilities. 333,774 106,327 330,005 5,622 775,728 ----------- ----------- ---------- ---------- -------- Interest rate sensitivity gap by period . $ 34,260 $ 230 $ 56,401 $ 97,345 Cumulative rate sensitivity gap . . . . . 34,260 34,490 90,891 188,236 Cumulative rate sensitivity gap ratio at December 31, 1997. . . . . . . . . . 110.3% 107.8% 111.8% 124.3% The Corporation had a cumulative positive gap of $34,490,000 in the one year horizon at December 31, 1997, or just over 3 percent of total assets. Net interest income at financial institutions with positive gaps tends to increase when rates increase and generally decrease as interest rates decline. 24
MANAGEMENT'S DISCUSSION & ANALYSIS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- EARNING ASSETS Earning assets increased $52 million during 1997. The following table presents the earning asset mix for the years 1997 and 1996 (at December 31). Loans grew by $72 million while investment securities declined. This reflects the Corporation's strategy to change the balance sheet mix to emphasize loans which generally carry higher yields than investment securities, and often provide collateral business. - ------------------------------------------------------------------------------- EARNING ASSETS (Dollars in Millions) DECEMBER 31 1997 1996 -------- -------- Federal funds sold and interest-bearing time deposits. . $ 9.4 $ 1.4 Securities available for sale. . . . . . . . . . . . . . 212.0 228.4 Securities held to maturity. . . . . . . . . . . . . . . 35.3 47.2 Mortgage loans held for sale . . . . . . . . . . . . . . 0.5 0.3 Loans. . . . . . . . . . . . . . . . . . . . . . . . . . 703.3 631.4 Federal Reserve and Federal Home Loan Bank stock . . . . 3.4 3.1 -------- -------- Total. . . . . . . . . . . . . . . . . . . . . . . . $ 963.9 $ 911.8 ======== ======== DEPOSITS, SHORT-TERM BORROWINGS and FEDERAL HOME LOAN BANK ADVANCES The following table presents the level of deposits and borrowed funds (Federal funds purchased, repurchase agreements with customers, U.S. Treasury demand notes and Federal Home Loan Bank advances) based on year-end levels at December 31, 1997 and 1996. AS OF DECEMBER 31 (Dollars in Millions) - ------------------------------------------------------------------------------- SHORT-TERM FEDERAL HOME LOAN DEPOSITS BORROWINGS BANK ADVANCES 1997 . . . . . . . . . . . . . . . $ 843.8 $ 26.8 $ 20.7 1996 . . . . . . . . . . . . . . . 794.5 45.0 9.2 - ------------------------------------------------------------------------------- NET INTEREST INCOME Net interest income is the primary source of the Corporation's earnings. It is a function of net interest margin and the level of average earning assets. The table below presents the Corporation's asset yields, interest expense, and net interest income as a percent of average earning assets for the three-year period ending in 1997. Asset yields improved .14 percent (FTE) in 1997, due primarily to a shift in the Corporation's asset mix (a larger percentage in higher-yielding loans, and a smaller percentage in investments.) Interest costs rose by a similar amount (.12 percent) resulting in a .02 percent increase in net interest income (FTE) as a percent of average earning assets. This "spread" increase accounted for only a small portion of the growth in net interest income. Most of the $2.9 million increase is attributable to growth in earning assets which exceeded $60 million. (Dollars in Thousands) - ------------------------------------------------------------------------------------------------- INTEREST INCOME INTEREST EXPENSE NET INTEREST INCOME NET INTEREST INCOME (FTE) AS A PERCENT AS A PERCENT (FTE) AS A PERCENT AVERAGE ON A OF AVERAGE OF AVERAGE 0F AVERAGE EARNINGS FULLY TAXABLE EARNING ASSETS EARNING ASSETS EARNING ASSETS ASSETS EQUIVALENT BASIS -------------- -------------- -------------- -------- ---------------- 1997 8.27% 3.79% 4.48% $941,351 $ 42,139 1996 8.13 3.67 4.46 880,729 39,258 1995 8.09 3.71 4.38 845,198 37,049 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. - ------------------------------------------------------------------------------ 25
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 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. Personal money order agent fees increased $71,000, or 14.6 percent, due to Increased sales volume. Other income in 1996 amounted to $8,342,000 or 9.9 percent higher than in 1995. The increase of $750,000 is primarily attributable to the following five factors: 1. Revenues from fiduciary activities increased $166,000, or 5.9 percent, due to stronger business activity and markets. 2. Deposit service charges increased $195,000, or 6.9 percent, primarily due to changes in pricing. 3. Interchange fees for the Corporation's credit and debit card programs grew by $169,000, or 142 percent, due to increased product offerings. 4. The Corporation recorded securities gains of $148,000 compared to losses of $30,000 in 1995, an increase of $178,000 as shorter maturity, available for sale securities were sold at gains and longer maturity, higher yielding investments were purchased. 5. Personal money order agent fees increased $79,000, or 19.4 percent, due to an increased client base. OTHER EXPENSE Total "other expenses" represent non-interest operating expenses of the Corporation. Those expenses amounted to $25,748,000 in 1997, 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. 1996 expenses amounted to $24,135,000, an increase of 5.0 percent from the prior year, or $1,142,000. Including an $813,000 reduction in deposit insurance premiums, remaining operating expenses grew by $1,955,000. Four major areas account for most of this increase: 1. Salary and benefit expenses increased by $640,000, or 5.0 percent, due to normal salary increases. 2. Equipment expense rose $223,000, again reflecting the Corporation's investment in technology to increase productivity. 3. Expenses related to mergers with Union National Bancorp and Randolph County Bancorp amounted to $258,000. 4. The previous year included a $238,000 refund from the State of Indiana for Intangibles taxes paid in 1988 and 1989. 26
MANAGEMENT'S DISCUSSION & ANALYSIS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- INCOME TAXES The increase in 1997 tax expense of $602,000 is attributable primarily to a $1,833,000 increase in net pre-tax income, mitigated somewhat by a $514,000 increase in tax-exempt income. Likewise, the $698,000 increase in 1996 resulted primarily from a $1,792,000 increase in pre-tax net income. ACCOUNTING MATTERS REPORTING COMPREHENSIVE INCOME During 1997, the Financial Accounting Standards Board ("FASB") issued Statement No. 130, REPORTING COMPREHENSIVE INCOME, establishing standards for the reporting of comprehensive income and its components in financial statements. Statement No. 130 is applicable to all entities that provide a full set of financial statements. Enterprises that have no items of other comprehensive income in any period presented are excluded from the scope of this Statement. Statement No. 130 is effective for interim and annual periods beginning after December 15, 1997. Earlier application is permitted. The Corporation will adopt Statement No. 130 during fiscal year 1998. DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE Also in 1997, the FASB issued Statement No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, which supersedes Statement No. 14, FINANCIAL REPORTING FOR SEGMENTS OF A BUSINESS ENTERPRISE. It establishes standards for the way that public enterprises report information about operating segments in annual financial statements and requires reporting of selected information about operating segments in interim financial statements issued to the public. It also establishes standards for disclosures regarding products and services, geographic areas and major customers. Statement No. 131 defines operating segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. This standard is effective for financial statement periods beginning after December 15, 1997, and requires comparative information for earlier years to be restated. Due to recent issuance of this standard, management has been unable to fully evaluate the impact, if any, it may have on the Corporation's future financial statement disclosures. 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 employees' 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 the computer programs being written using two digits rather than four to define the applicable year. Any of the Corporation's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations. The Corporation is utilizing both internal and external resources to identify, correct or reprogram and test the systems for the Year 2000 compliance. It is anticipated that all reprogramming efforts will be complete by December 31, 1998, allowing adequate time for testing. OTHER The Securities and Exchange Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission, including the Corporation; that address is http://www.sec.gov 27
CONSOLIDATED BALANCE SHEET December 31 (In Thousands, Except Share Data) 1997 1996 --------- --------- ASSETS Cash and due from banks . . . . . . . . . . . . $ 33,127 $ 33,882 Federal funds sold . . . . . . . . . . . . . . 9,050 1,150 --------- --------- Cash and cash equivalents . . . . . . . . . . 42,177 35,032 Interest-bearing time deposits. . . . . . . . . 385 290 Investment securities Available for sale. . . . . . . . . . . . . . 212,040 228,379 Held to maturity. . . . . . . . . . . . . . . 35,332 47,227 --------- --------- Total investment securities. . . . . . . . 247,372 275,606 Mortgage loans held for sale. . . . . . . . . . 471 284 Loans . . . . . . . . . . . . . . . . . . . . . 703,313 631,416 Less: Allowance for loan losses (6,778) (6,622) --------- --------- Net loans . . . . . . . . . . . . . . . . . 696,535 624,794 Premises and equipment. . . . . . . . . . . . . 15,382 15,303 Federal Reserve and Federal Home Loan Bank stock 3,373 3,090 Interest receivable . . . . . . . . . . . . . . 8,968 8,643 Core deposit intangibles and goodwill . . . . . 1,625 1,714 Other assets. . . . . . . . . . . . . . . . . . 3,848 3,237 --------- --------- Total assets . . . . . . . . . . . . . . . $ 1,020,136 $ 967,993 ============ ========== LIABILITIES Deposits Noninterest-bearing . . . . . . . . . . . . . $ 115,613 $ 110,175 Interest-bearing. . . . . . . . . . . . . . . 728,199 684,276 --------- --------- Total deposits. . . . . . . . . . . . . . . 843,812 794,451 Short-term borrowings . . . . . . . . . . . . . 26,829 45,037 Federal Home Loan Bank advances . . . . . . . . 20,700 9,150 Interest payable. . . . . . . . . . . . . . . . 3,615 3,376 Other liabilities . . . . . . . . . . . . . . . 3,211 3,292 --------- --------- Total liabilities . . . . . . . . . . . . . 898,167 855,306 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--6,664,439 and 6,603,319 shares . . . . . . . . . . . . . . 833 825 Additional paid-in capital. . . . . . . . . . . 24,140 22,968 Retained earnings . . . . . . . . . . . . . . . 95,449 87,978 Net unrealized gain on securities available for sale . . . . . . . . . . . . . . 1,547 916 --------- --------- Total stockholders' equity. . . . . . . . . 121,969 112,687 --------- --------- Total liabilities and stockholders' equity. $ 1,020,136 $ 967,993 ============ ========== See Notes to Consolidated Financial Statements. 28
CONSOLIDATED STATEMENT of INCOME (In Thousands, Except Share Data) Year Ended December 31, 1997 1996 1995 ---- ---- ---- INTEREST INCOME Loans receivable Taxable $ 59,773 $ 52,096 $ 49,060 Tax exempt 116 90 81 Investment securities Taxable 10,818 12,832 12,479 Tax exempt 4,320 3,832 3,642 Federal funds sold 172 498 1,028 Deposits with financial institutions 34 16 9 Federal Reserve and Federal Home Loan Bank stock 242 132 149 --------- --------- --------- Total interest income 75,475 69,496 66,448 --------- --------- --------- INTEREST EXPENSE Deposits 31,920 29,139 28,227 Short-term borrowings 2,856 2,687 2,628 Federal Home Loan Bank advances 949 523 496 --------- --------- --------- Total interest expense 35,725 32,349 31,351 --------- --------- --------- NET INTEREST INCOME 39,750 37,147 35,097 Provision for loan losses 1,297 1,253 1,388 --------- --------- --------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 38,453 35,894 33,709 --------- --------- --------- OTHER INCOME Fiduciary activities 3,355 2,967 2,801 Service charges on deposit accounts 3,365 3,024 2,829 Other customer fees 1,912 1,659 1,270 Net realized gains (losses)on sales of available-for-sale securities (14) 148 (30) Other income 611 544 722 --------- --------- --------- Total other income 9,229 8,342 7,592 --------- --------- --------- OTHER EXPENSES Salaries and employee benefits 14,322 13,433 12,792 Net occupancy expenses 1,620 1,537 1,555 Equipment expenses 2,345 2,152 1,929 Marketing expense 851 706 654 Deposit insurance expense 97 12 825 Outside data processing fees 1,077 901 739 Printing and office supplies 1,021 923 1,094 Other expenses 4,415 4,471 3,404 --------- --------- --------- Total other expenses 25,748 24,135 22,992 --------- --------- --------- INCOME BEFORE INCOME TAX 21,934 20,101 18,309 Income tax expense 7,561 6,959 6,261 --------- --------- --------- NET INCOME $ 14,373 $ 13,142 $ 12,048 ========= ========= ========= NET INCOME PER SHARE: Basic $2.17 $2.00 $1.84 Diluted 2.14 1.98 1.82 See Notes to Consolidated Financial Statements. 29
CONSOLIDATED STATEMENT of CHANGES in STOCKHOLDERS' EQUITY (In Thousands, Except Share Data) Net Unrealized Gain (Loss) On Common Stock Additional Securities ------------ Paid-In Retained Available Shares Amount Capital Earnings for Sale Total ------ ------ ------- -------- ---------- ----- BALANCES, JANUARY 1, 1995 4,876,654 $ 610 $ 22,461 $ 72,615 $(2,932) $ 92,754 Net income for 1995 12,048 12,048 Cash dividends ($.77 per share) (4,456) (4,456) Net change in unrealized gain (loss) on securities available for sale 4,818 4,818 Stock issued under employee benefit plans 11,175 1 276 277 Stock issued under dividend reinvestment and stock purchase plan 13,928 2 454 456 Stock options exercised 9,267 1 191 192 Stock redeemed (31,918) (4) (1,113) (2) (1,119) Three-for-two stock split 1,683,344 210 (210) Cash paid in lieu of issuing fractional shares (160) (4) (4) --------- ----- -------- -------- ------- -------- BALANCES, DECEMBER 31, 1995 6,562,290 820 22,055 80,205 1,886 104,966 Net income for 1996 13,142 13,142 Cash dividends ($.88 per share) (5,369) (5,369) Net change in unrealized gain (loss) on securities available for sale (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 ($1.04 per share) (6,902) (6,902) Net change in unrealized gain (loss) on securities available for sale 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 ========= ===== ======== ======== ======= ======== See Notes to Consolidated Financial Statements. 30
CONSOLIDATED STATEMENT of CASH FLOWS (In Thousands, Except Share Data) Year Ended December 31 1997 1996 1995 ---- ---- ---- OPERATING ACTIVITIES: Net income $ 14,373 $ 13,142 $ 12,048 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,297 1,253 1,388 Depreciation and amortization 1,810 1,626 1,482 Amortization of goodwill and intangibles 89 131 131 Deferred income tax (35) 401 377 Securities amortization, net 236 188 693 Securities losses (gains), net 14 (148) 30 Mortgage loans originated for sale (7,139) (2,501) (4,491) Proceeds from sales of mortgage loans 6,952 2,952 3,785 Net change in Interest receivable (325) 357 (706) Interest payable 239 (40) 979 Other adjustments (1,050) (593) 67 --------- --------- --------- Net cash provided by operating activities 16,461 16,768 15,783 --------- --------- --------- INVESTING ACTIVITIES: Net change in interest-bearing deposits (95) (31) (236) Purchases of Securities available for sale (68,524) (113,473) (91,178) Securities held to maturity (2,652) (22,450) (41,575) Proceeds from maturities of Securities available for sale 73,786 96,441 35,716 Securities held to maturity 15,878 35,715 62,053 Proceeds from sales of Securities available for sale 10,552 13,120 14,165 Net change in loans (73,038) (80,404) (25,629) Purchase of Federal Home Loan Bank stock (283) (389) Purchases of premises and equipment (2,157) (2,083) (2,187) Other investing activities 236 71 367 --------- --------- --------- Net cash used by investing activities (46,297) (73,483) (48,504) --------- --------- --------- FINANCING ACTIVITIES: Net change in Demand and savings deposits 5,438 (19,168) 2,604 Certificates of deposit and other time deposits 43,923 29,683 61,323 Short-term borrowings (18,208) 7,659 (3,254) Federal Home Loan Bank advances 11,550 7,150 1,000 Repayment of Federal Home Loan Bank advances (7,000) Cash dividends (6,902) (5,369) (4,456) Stock issued under employee benefit plans 292 298 277 Stock issued under dividend reinvestment and stock purchase plan 669 558 456 Stock options exercised 219 64 192 Stock redeemed (1,119) Cash paid in lieu of issuing fractional shares (2) (4) --------- --------- --------- Net cash provided by financing activities 36,981 13,873 57,019 --------- --------- --------- NET CHANGE in CASH and CASH EQUIVALENTS 7,145 (42,842) 24,298 CASH and CASH EQUIVALENTS, BEGINNING of YEAR 35,032 77,874 53,576 --------- --------- --------- CASH and CASH EQUIVALENTS, END of YEAR $ 42,177 $ 35,032 $ 77,874 ========= ========= ========= ADDITIONAL CASH FLOWS INFORMATION: Interest paid $ 35,486 $ 32,388 $ 30,372 Income tax paid 7,602 6,203 5,641 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"), First United Bank ("First United"), The Randolph County Bank ("Randolph County"), and Union County National Bank ("Union National"), (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 National operate under national bank charters and provide full banking services, including trust services. As national banks, First Merchants and Union National 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. Certain prior year amounts have been reclassified to conform with current classifications. INVESTMENT SECURITIES - Debt securities are classified as held to maturity when the Corporation has the positive intent and ability to hold the securities to maturity. Securities held to maturity are carried at amortized cost. Debt securities not classified as held to maturity are classified as available for sale. Securities available for sale are carried at fair value with unrealized gains and losses reported separately in 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. MORTGAGE LOANS HELD FOR SALE are carried at the lower of aggregate cost or market. Net unrealized losses are recognized through a valuation allowance by charges to income. LOANS are carried at the principal amount outstanding. 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. Payments with insignificant delays not exceeding 60 days outstanding are not considered impaired. Certain nonaccrual and substantially delinquent loans may be considered to be impaired. 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, 1997, 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. (continued) 32
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts In Thousands, Except Share Data) NOTE 1 NATURE of OPERATIONS and SUMMARY of SIGNIFICANT ACCOUNT 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 27, 1995. NOTE 2 BUSINESS COMBINATIONS On August 1, 1996, the Corporation issued 942,685 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 565,705 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, 1995. Separate operating results of Union National Bancorp and Randolph County Bancorp for the periods prior to the merger were as follows: 1996 1995 ---- ---- Net interest income: First Merchants Corporation $ 33,060 $ 27,881 Union National Bancorp 2,961 4,562 Randolph County Bancorp 1,126 2,654 --------- --------- Combined $ 37,147 $ 35,097 ========= ========= Net income: First Merchants Corporation $ 11,556 $ 9,858 Union National Bancorp 974 1,523 Randolph County Bancorp 612 667 --------- --------- Combined $ 13,142 $ 12,048 ========= ========= Net income per share: Basic: First Merchants Corporation $ 1.76 $ 1.50 Union National Bancorp .15 .23 Randolph County Bancorp .09 .11 --------- --------- Combined $ 2.00 $ 1.84 ========= ========= Diluted: First Merchants Corporation $ 1.74 $ 1.49 Union National Bancorp .15 .23 Randolph County Bancorp .09 .10 --------- --------- Combined $ 1.98 $ 1.82 ========= ========= 33
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts In Thousands, Except Share Data) 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, 1997, was $10,973,000. NOTE 4 INVESTMENT SECURITIES Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---- ----- ------ ----- Available for sale at December 31, 1997 U.S. Treasury $ 19,207 $ 104 $ 11 $ 19,300 Federal agencies 66,783 405 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 ========= ====== ===== ========= 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 ========= ====== ===== ========= The amortized cost and fair value of securities held to maturity and available for sale at December 31, 1997, 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) 34
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 Fair Amortized Fair Cost Value Cost Value ---- ----- ---- ----- Maturity distribution at December 31, 1997: Due in one year or less $ 34,626 $ 34,681 $ 11,500 $ 11,529 Due after one through five years 102,944 103,712 15,573 15,742 Due after five through ten years 33,590 35,079 2,264 2,319 Due after ten years 891 925 530 530 --------- --------- --------- --------- 172,051 174,397 29,867 30,120 Mortgage-backed securities 36,682 36,958 1,255 1,258 Other asset-backed securities 487 435 4,210 4,051 Marketable equity securities 250 250 --------- --------- --------- --------- Totals $ 209,470 $ 212,040 $ 35,332 $ 35,429 ========= ========= ========= ========= Securities with a carrying value of approximately $92,991,000 and $102,787,000 were pledged at December 31, 1997 and 1996, to secure certain deposits, Federal Home Loan Bank advances and for other purposes as permitted or required by law. Proceeds from sales of securities available for sale during 1997, 1996 and 1995 were $10,552,000, $13,120,000 and $14,165,000. Gross gains of $0, $148,000 and $57,800 and gross losses of $14,000, $0 and $113,900 were realized on those sales. In December, 1995, the Corporation transferred certain securities from held to maturity to available for sale in accordance with a transition reclassification allowed by the Financial Accounting Standards Board. Such securities had a carrying value of $52,119,000 and a fair value of $52,811,000. NOTE 5 LOANS and ALLOWANCE 1997 1996 ---- ---- Loans at December 31: Commercial and industrial loans $ 148,281 $ 132,134 Bankers' acceptances and loans to financial institutions 705 625 Agricultural production financing and other loans to farmers 16,764 18,906 Real estate loans: Construction 21,389 13,167 Commercial and farmland 97,503 97,596 Residential 287,072 253,530 Individuals' loans for household and other personal expenditures 125,706 113,507 Tax-exempt loans 2,598 1,643 Other loans 3,782 1,672 ---------- ---------- 703,800 632,780 Unearned interest on loans (487) (1,364) ---------- ---------- Total loans $ 703,313 $ 631,416 ========== ========== 1997 1996 1995 ---- ---- ---- Allowance for loan losses: Balance, January 1 $ 6,622 $ 6,696 $ 6,603 Provision for losses 1,297 1,253 1,388 Recoveries on loans 468 309 259 Loans charged off (1,609) (1,636) (1,554) -------- -------- -------- Balance, December 31 $ 6,778 $ 6,622 $ 6,696 ======== ======== ======== (continued) 35
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: 1997 1996 1995 ---- ---- ---- As of, and for, the year ending December 31: Impaired loans with an allowance $ 1,476 $ 3,124 $ 2,314 Impaired loans for which the discounted cash flows or collateral value exceeds the carrying value of the loan 1,075 868 2,498 -------- -------- -------- Total impaired loans $ 2,551 $ 3,992 $ 4,812 ======== ======== ======== Allowance for impaired loans (included in the Corporation's allowance for loan losses) $ 407 $ 1,092 $ 1,177 Average balance of impaired loans 3,414 5,213 4,650 Interest income recognized on impaired loans 180 311 153 Cash basis interest included above 162 291 93 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 were as shown below: Balances, January 1, 1997 $ 9,063 New loans, including renewals 5,547 Payments, etc., including renewals (2,177) -------- Balances, December 31, 1997 $ 12,433 ======== NOTE 6 PREMISES and EQUIPMENT 1997 1996 ---- ---- Cost at December 31: Land $ 2,826 $ 2,829 Buildings and leasehold improvements 13,723 13,863 Equipment 15,320 13,559 -------- -------- Total cost 31,869 30,251 Accumulated depreciation (16,487) (14,948) -------- -------- Net $ 15,382 $ 15,303 ======== ======== The Corporation is committed under various noncancelable lease contracts for certain subsidiary office facilities. Total lease expense for 1997, 1996 and 1995 was $141,000, $134,000 and $127,000, respectively. The future minimum rental commitments required under the operating leases in effect at December 31, 1997, expiring at various dates through the year 2016, follow on the right for the years ending December 31: 1998 $ 135 1999 123 2000 106 2001 71 2002 62 After 2002 4 ------ Total future minimum obligations $ 501 ====== 36
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts In Thousands, Except Share Data) NOTE 7 DEPOSITS 1997 1996 ---- ---- Deposits at December 31: Demand deposits $ 234,905 $ 225,437 Savings deposits 176,953 170,179 Certificates and other time deposits of $100,000 or more 104,100 82,802 Other certificates and time deposits 327,854 316,033 ---------- ---------- Total deposits $ 843,812 $ 794,451 ========== ========== Certificates and other time deposits maturing in years ending December 31: 1998 $ 298,311 1999 87,074 2000 27,407 2001 10,340 2002 8,034 After 2002 788 ---------- $ 431,954 ========== NOTE 8 SHORT-TERM BORROWINGS 1997 1996 ---- ---- Short-term borrowings at December 31: Federal funds purchased $ 4,070 $ 20,725 Securities sold under repurchase agreements 15,398 20,054 U.S. Treasury demand notes 7,361 4,258 -------- --------- Total short-term borrowings $ 26,829 $ 45,037 ======== ========= Securities sold under repurchase agreements consist of obligations of the Banks to other parties. The obligations are secured by U.S. Treasury and Federal agency obligations and generally mature within one to 185 days from the transaction date. The maximum amount of outstanding agreements at any month-end during 1997 and 1996 totaled $33,802,000 and $52,221,000, and the daily average of such agreements totaled $31,327,000 and $42,140,000. NOTE 9 FEDERAL HOME LOAN BANK ADVANCES Advances from FHLB at December 31: 1997 1996 --------------------- -------------------- Weighted Weighted Average Average Interest Interest Amount Rate Amount Rate ------ ---- ------ ---- Maturities in years ending December 31: 1997 $ 2,000 4.76% 1998 $ 5,000 5.60% 5,000 5.61 1999 7,150 6.02 2,150 5.81 2000 1,850 6.36 2002 150 7.07 Thereafter 6,550 6.65 -------- -------- Total advances $ 20,700 6.16 $ 9,150 5.48 ======== ======== The terms of a security agreement with the FHLB require the Corporation to pledge as collateral for advances qualifying first mortgage loans in an amount equal to at least 160 percent of these advances. Advances are subject to restrictions or penalties in the event of prepayment. 37
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts In Thousands, Except Share Data) NOTE 10 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 $11,877,000 and $5,997,000 at December 31, 1997 and 1996. In 1996, the Corporation 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. NOTE 11 INCOME TAX 1997 1996 1995 ---- ---- ---- Income tax expense, for the year ended December 31: Currently payable: Federal $ 5,702 $ 4,903 $ 4,400 State 1,894 1,655 1,484 Deferred: Federal (21) 336 299 State (14) 65 78 -------- -------- -------- Total income tax expense $ 7,561 $ 6,959 $ 6,261 ======== ======== ======== Reconciliation of federal statutory to actual tax expense: Federal statutory income tax at 34% $ 7,458 $ 6,834 $ 6,225 Tax-exempt interest (1,257) (1,140) (1,087) Effect of state income taxes 1,241 1,135 1,031 Other 119 130 92 -------- -------- -------- Actual tax expense $ 7,561 $ 6,959 $ 6,261 ======== ======== ======== Tax expense (benefit) applicable to security gains and losses for the years ended December 31, 1997, 1996 and 1995, was ($5,700), $60,000 and ($12,200), respectively. A cumulative net deferred tax asset is included in other assets. The components of the asset are as follows: 1997 1996 ---- ---- Deferred tax asset at December 31: Assets Differences in accounting for loan fees $ 157 Differences in accounting for loan losses $ 2,692 2,571 Deferred compensation 313 285 Differences in accounting for pensions and other employee benefits 183 118 -------- ------ Total assets 3,188 3,131 -------- ------ Liabilities Differences in depreciation methods 1,012 983 Differences in accounting for loans and securities 125 78 Differences in accounting for loan fees 28 Net unrealized gain on securities available for sale 1,023 607 State income tax 146 152 Other 69 75 -------- ------- Total liabilities $ 2,403 $ 1,895 -------- ------- Net deferred tax asset $ 785 $ 1,236 ======== ======= 38
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts In Thousands, Except Share Data) NOTE 12 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. Financial instruments whose contract amount represents credit risk as of December 31, were as follows: 1997 1996 ---- ---- Commitments to extend credit $138,828 $137,653 Standby letters of credit 4,649 2,874 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 Banks 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 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, 1997, available for 1998 dividends to the Corporation is $22,736,000. 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, 1997, was $118,792,000, of which $96,056,000 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, 1997, there were 342,924 shares of common stock reserved for purchase under the plan. On August 8, 1995, 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 27, 1995, to holders of record on October 20, 1995. 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, 1997, 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 (continued) 39
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts In Thousands, Except Share Data) NOTE 14 REGULATORY CAPITAL (continued) framework for prompt corrective action. To be categorized as well capitalized, the Corporation and Banks must maintain a minimum total capital, 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: 1997 1996 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 ............................ $125,762 17.9% $56,166 8.0% $116,693 18.0% $51,884 8.0% First Merchants ............................ 75,539 17.4 34,756 8.0 69,651 17.8 31,300 8.0 Pendleton ............................ 12,256 17.4 5,628 8.0 11,383 17.9 5,074 8.0 First United ............................ 7,570 18.2 3,332 8.0 7,091 17.2 3,302 8.0 Randolph County ............................ 10,278 15.1 5,448 8.0 9,985 14.9 5,364 8.0 Union National ............................ 18,075 17.0 8,498 8.0 17,672 17.9 7,914 8.0 Tier I Capital (1) (to risk-weighted assets) Consolidated ............................ $118,984 16.9% $28,083 4.0% $110,072 17.0% $25,942 4.0% First Merchants ............................ 71,900 16.6 17,378 4.0 66,143 16.9 15,650 4.0 Pendleton ............................ 11,506 16.4 2,814 4.0 10,629 16.8 2,537 4.0 First United ............................ 7,133 17.1 1,666 4.0 6,663 16.1 1,651 4.0 Randolph County ............................ 9,548 14.0 2,724 4.0 9,234 13.8 2,682 4.0 Union National ............................ 16,852 15.9 4,249 4.0 16,492 16.7 3,957 4.0 Tier I Capital (1) (to average assets) Consolidated ............................ $118,984 11.9% $40,010 4.0% $110,072 11.6% $38,012 4.0% First Merchants ............................ 71,900 11.7 24,548 4.0 66,143 11.6 22,849 4.0 Pendleton ............................ 11,506 11.8 3,897 4.0 10,629 12.3 3,462 4.0 First United ............................ 7,133 11.5 2,481 4.0 6,663 11.3 2,351 4.0 Randolph County ............................ 9,548 14.0 2,733 4.0 9,234 12.9 2,863 4.0 Union National ............................ 16,852 9.1 7,438 4.0 16,492 9.5 6,954 4.0 (1) As defined by regulatory agencies 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. Pension expense was $139,000 for 1997, $191,000 for 1996 and $253,000 for 1995. The table on the next page sets forth the plans' funded status and amounts recognized in the consolidated balance sheet at December 31: 40
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts In Thousands, Except Share Data) NOTE 15 EMPLOYEE BENEFIT PLANS (continued) 1997 1996 ----------- --------- Actuarial present value of: Accumulated benefit obligation including vested benefits of $12,020 and $10,885............................ $ 12,322 $ 11,133 ----------- --------- ----------- --------- Projected benefit obligation for service rendered to date.... $(14,454) $ (13,060) Plan assets at fair value, primarily interest-bearing deposits and corporate bonds and securities........................... 18,865 15,188 ----------- --------- ----------- --------- Plan assets in excess of projected benefit obligation........... 4,411 2,128 Unrecognized net gain from experience different than that assumed ............................. ( 4,169) ( 1,615) Unrecognized prior service cost ............................. ( 156) ( 169) Unrecognized net transition asset ............................. ( 519) ( 638) ----------- --------- Accrued pension cost included in the balance sheet.............. $( 433) $( 294) ----------- --------- ----------- --------- 1997 1996 1995 -------- -------- --------- Pension expense includes the following components: Service cost-benefits earned during the year................ $ 624 $ 537 $ 462 Interest cost on projected benefit obligation............... 956 921 845 Actual return on plan assets................................ (4,251) (1,966) (2,633) Net amortization and deferral............................... 2,810 699 1,579 -------- -------- --------- $ 139 $ 191 $ 253 -------- -------- --------- -------- -------- --------- 1997 1996 1995 -------- -------- --------- Assumptions used in the accounting as of December 31 were: Discount rate................................................ 7.40% 7.50% 7.50% Rate of increase in compensation............................. 4.50% 4.50% 4.50% Expected long-term rate of return on assets.................. 9.00% 8.75% 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 112,500 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, 1997. On March 31, 1994, stockholders approved the 1994 Stock Option Plan, reserving 315,000 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 80,525 shares available for grant at December 31, 1997. The table on the following page 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, 1997, 1996 and 1995. The number of shares and prices have been restated to give effect to the Corporation's 1995 stock split. (continued) 41
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (Table Dollar Amounts In Thousands, Except Share Data) NOTE 15 EMPLOYEE BENEFIT PLANS (continued) Year Ended December 31 1997 1996 1995 ---- ---- ----- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Shares Price Shares Price Shares Price ------ --------- ------- -------- ------- ------ Outstanding, beginning of year.... 272,122 $ 19.37 223,059 $18.07 179,807 $15.81 Granted........................... 64,250 31.36 53,300 24.27 57,150 24.16 Exercised......................... ( 37,953) 14.99 ( 4,237) 15.23 ( 13,898) 13.26 --------- -------- -------- ------ -------- Outstanding, end of year.......... 298,419 $ 22.47 272,122 $19.37 223,059 $18.07 --------- -------- -------- --------- -------- -------- Options exercisable at year end.... 234,169 218,822 165,909 Weighted-average fair value of options granted during the year.. $ 6.32 $ 5.09 $4.90 As of December 31, 1997, other information by exercise price range for options outstanding and exercisable is as follows: Outstanding Exercisable - ------------------------------------------------------------------- --------------------------- Weighted-Average Exercise Price Number Weighted-Average Remaining Number Weighted-Average Range Of Shares Exercise Price Contractual Life Of Shares Exercise Price - ---------------- --------- ---------------- ---------------- --------- ----------------- $ 9.11 - $11.33 36,956 $10.51 2.5 years 36,956 $10.51 17.22 - 25.00 197,213 21.82 7.0 years 197,213 21.82 31.25 - 31.38 64,250 31.36 9.5 years --------- ------- 298,419 $22.47 7.0 years 234,169 $20.04 --------- ------- --------- ------- 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: 1997 1996 ------- ------ Risk-free interest rates................................ 6.54% 6.66% Dividend yields......................................... 3.37% 3.41% Volatility factors of expected market price common stock 11.20% 12.00% Weighted-average expected life of the options........... 8.50 years 8.50 years (Continued) 42
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 below: 1997 1996 Net income As reported............ $14,373 $13,142 Pro forma.............. 13,948 12,852 Earnings per share Basic: As reported............ $ 2.17 $ 2.00 Pro forma.............. 2.10 1.95 Diluted: As reported............ $ 2.14 $ 1.98 Pro forma.............. 2.07 1.93 In 1994, the stockholders approved the 1994 Employee Stock Purchase Plan, enabling eligible employees to purchase the Corporation's common stock. A total of 168,750 shares of the Corporation's common stock are reserved for issuance pursuant to the plan. The price of the stock to be paid by the employees is determined by the Corporation's compensation committee, but may not be less than 85 percent of the lesser of the fair market value of the Corporation's common stock at the beginning or at the end of the offering period. Common stock purchases are made annually and are paid through advance payroll deductions of up to 20 percent of eligible compensation. Participants under the plan purchased 13,690 shares in 1997 at $21.25 per share. The fair market value per share on the purchase date was $31.25. At December 31, 1997, there were 123,122 shares of Corporation common stock reserved for purchase under the plan, and $191,000 has been withheld from compensation, plus interest, toward the purchase of shares after June 30, 1998, 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 1997 and 1996, respectively: dividend yield of 3.37 and 3.41 percent; an expected life of one year for both years; expected volatility of 11.20 and 12.00 percent; and risk-free interest rates of 6.54 and 6.66 percent. The fair value of those purchase rights granted in 1997 and 1996 was $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 percent (30 percent at Union National) for the first 5 percent (6 percent at Union National) of base salary contributed by participants. The Banks' expense for the plans was $110,000 for 1997, $92,000 for 1996 and $81,000 for 1995. Union National's plan was merged with the Corporation's plan as of December 31, 1996. Union National had an Employee Stock Ownership Plan covering substantially all of its employees. The plan was terminated in 1997. The cost of the plan was borne by Union National through contributions to an Employee Stock Ownership Trust in amounts determined by its Board of Directors. The contributions to the plan in 1997, 1996 and 1995 were $0, $91,700 and $79,000, respectively. NOTE 16 Net Income Per Share Year Ended December 31, 1997 1996 1995 ----------------------------- --------------------------- ----------------------------- Weighted- Weighted- Weighted- Average Per Share Average Per Share Average Per Share Income Shares Amount Income Shares Amount Income Shares Amount ------ --------- --------- ------ --------- ---------- ------ --------- --------- Basic net income per share: Net income available to common stockholders....... $14,373 6,633,535 $2.17 $13,142 6,581,167 $2.00 $12,048 6,563,559 $1.84 ===== ===== ===== Effect of dilutive stock options 90,105 66,371 57,254 Diluted net income per share: --------- --------- --------- Net income available to common stockholders and assumed conversions $14,373 6,723,640 $2.14 $13,142 6,647,538 $1.98 $12,048 6,620,813 $1.82 ======= ========= ===== ======= ========= ===== ======= ========= ===== 43
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, SECURITIES SOLD UNDER REPURCHASE AGREEMENTS and U.S. TREASURY DEMAND NOTES--These financial instruments are short-term borrowing arrangements. The rates at December 31, 1997 and 1996, approximate market rates, thus the fair value approximates carrying value. FEDERAL HOME LOAN BANK ADVANCES--The fair value of 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: 1997 1996 ------------------------- ------------------------- Carrying Fair Carrying Fair Amount Value Amount Value --------- ------ --------- ------ Assets at December 31: Cash and cash equivalents........................ $ 42,177 $ 42,177 $ 35,032 $ 35,032 Interest-bearing deposits........................ 385 385 290 290 Investment securities available for sale......... 212,040 212,040 228,379 228,379 Investment securities held to maturity........... 35,332 35,429 47,227 47,494 Mortgage loans held for sale..................... 471 471 284 284 Loans............................................ 703,313 704,335 631,416 632,151 FRB and FHLB stock............................... 3,373 3,373 3,090 3,090 Interest receivable.............................. 8,968 8,968 8,643 8,643 Liabilities at December 31: Deposits......................................... 843,812 845,277 794,451 795,369 Short-term borrowings: Federal funds purchased........................ 4,070 4,070 20,725 20,725 Securities sold under repurchase agreements 15,398 15,398 20,054 20,054 U.S. Treasury demand notes..................... 7,361 7,361 4,258 4,258 FHLB advances.................................... 20,700 21,114 9,150 9,340 Interest payable................................. 3,615 3,615 3,376 3,376 44
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 -------------------------- 1997 1996 ----------- ----------- ASSETS Cash............................................ $ 318 $ 413 Security purchased with agreement to resell to an affiliate...................... 2,000 1,000 Investment securities available for sale........ 250 258 Investment in subsidiaries...................... 118,732 110,349 Goodwill........................................ 553 570 Other assets.................................... 230 195 ---------- ---------- Total assets.................................. $ 122,083 $ 112,785 ========== ========== LIABILITIES $ 114 $ 98 STOCKHOLDERS' EQUITY 121,969 112,687 ---------- ---------- Total liabilities and stockholders' equity $ 122,083 $ 112,785 ========== ========== CONDENSED STATEMENT OF INCOME Year Ended December 31 --------------------------------------- 1997 1996 1995 -------- --------- -------- INCOME Dividends from subsidiaries.................... $ 6,903 $ 5,420 $ 5,378 Other income................................... 101 25 51 -------- --------- -------- Total income............................... 7,004 5,445 5,429 -------- --------- -------- EXPENSES Amortization of core deposit intangibles, goodwill, and fair value adjustments......... 45 43 38 Business combination expenses.................. 258 Other expenses................................. 591 269 189 -------- --------- -------- Total expenses............................. 636 570 227 -------- --------- -------- INCOME BEFORE INCOME TAX BENEFIT and EQUITY in UNDISTRIBUTED INCOME of SUBSIDIARIES......... 6,368 4,875 5,202 Income tax benefit........................... (193) (100) (72) -------- --------- -------- INCOME BEFORE EQUITY in UNDISTRIBUTED INCOME of SUBSIDIARIES 6,561 4,975 5,274 Equity in undistributed income of subsidiaries 7,812 8,167 6,774 -------- --------- -------- NET INCOME........................................ $ 14,373 $ 13,142 $ 12,048 ======== ========= ======== (continued) 45
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 --------------------------------------- 1997 1996 1995 ---- ---- ---- OPERATING ACTIVITIES: Net income $ 14,373 $ 13,142 $ 12,048 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 17 20 47 Equity in undistributed income of subsidiaries (7,812) (8,167) (6,774) Security gains (19) (20) Net change in: Other assets 25 567 (57) Other liabilities 16 (337) 81 -------- -------- ------ Net cash provided by operating activities 6,619 5,206 5,325 -------- -------- ------ INVESTING ACTIVITIES: Purchase of a security with an agreement to resell (1,000) (1,000) Purchase of securities available for sale (309) Proceeds from sales of securities available for sale 8 103 113 Other investing activities (78) -------- -------- ------ Net cash used by investing activities (992) (975) (196) -------- -------- ------ FINANCING ACTIVITIES: Cash dividends (6,902) (5,369) (4,456) Stock issued under employee benefit plans 291 298 277 Stock issued under dividend reinvestment and stock purchase plan 726 558 456 Stock options exercised 163 64 192 Stock redeemed (1,119) Cash paid in lieu of issuing fractional shares (2) (4) -------- -------- ------ Net cash used by financing activities (5,722) (4,451) (4,654) -------- -------- ------ Net change in cash on deposit (95) (220) 475 Cash on deposit, beginning of year 413 633 158 -------- -------- ------ Cash on deposit, end of year $ 318 $ 413 $ 633 ======== ======== ====== NOTE 19 QUARTERLY RESULTS of OPERATIONS (Unaudited) The following table sets forth certain quarterly results for the years ended December 31, 1997 and 1996: PROVISION AVERAGE NET FOR SHARES NET INCOME QUARTER ENDED INTEREST INTEREST INTEREST LOAN NET OUTSTANDING PER SHARE INCOME EXPENSE INCOME LOSSES INCOME BASIC DILUTED BASIC DILUTED 1997: March . . . . . . $ 17,884 $ 8,343 $ 9,541 $ 287 $ 3,429 6,605,012 6,692,974 $ .52 $ .51 June . . . . . . 18,980 8,901 10,079 290 3,707 6,618,723 6,702,709 .56 .55 Sept. . . . . . . 19,042 9,132 9,910 375 3,536 6,649,993 6,743,407 .53 .53 Dec. . . . . . . 19,569 9,349 10,220 345 3,701 6,660,414 6,764,472 .56 .55 --------- -------- -------- ------ ------- ------ ------- $ 75,475 $ 35,725 $ 39,750 $1,297 $14,373 6,633,535 6,723,640 $ 2.17 $ 2.14 ========= ======== ======== ====== ======= ====== ======= 1996: March . . . . . . $ 17,010 $ 8,037 $ 8,973 $ 280 $ 3,187 6,564,529 6,633,789 $ .49 $ .48 June . . . . . . 16,992 7,856 9,136 300 3,273 6,570,648 6,640,592 .50 .49 Sept. . . . . . . 17,511 8,201 9,310 295 3,221 6,591,219 6,649,897 .49 .49 Dec. . . . . . . 17,982 8,255 9,727 378 3,461 6,598,271 6,665,873 .52 .52 --------- -------- -------- ------ ------- ------ ------- $ 69,495 $ 32,349 $ 37,146 $1,253 $ 13,142 6,581,167 6,647,538 $ 2.00 $ 1.98 ========= ======== ======== ====== ======= ====== ======= 46
[GRAPHIC:MAP;FIRST MERCHANTS CORPORATION MARKET AREA] First Merchants Corporation Market Area STOCKHOLDER INFORMATION Corporate Office 200 East Jackson Street Muncie, IN 47305 765-747-1500 http://firstmerchants.com First Merchants Corporation currently provides services through 24 offices located in Delaware, Madison, Henry, Fayette, Wayne, Union and Randolph counties in Indiana. 47
ANNUAL MEETING The Annual Meeting of Stockholders of First Merchants Corporation will be held ... Tuesday, April 7, 1998 3:30 p.m. Horizon Convention Center 401 South High Street Muncie, Indiana First Merchants Corporation of Muncie, Indiana, was organized in September 1982, as the bank holding company for The Merchants National Bank of Muncie, 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, established in 1882. In August, 1996, First Merchants Corporation acquired Union County National Bank of Liberty, Indiana, established in 1872. In October, 1996, the Corporation acquired The Randolph County Bank of Winchester, Indiana, which was founded in 1865. 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. 48
STOCK PRICE AND DIVIDEND INFORMATION PRICE PER SHARE - ------------------------------------------------------------------------------------------------------ QUARTER HIGH LOW DIVIDENDS DECLARED - ------------------------------------------------------------------------------------------------------ 1997 1996 1997 1996 1997 1996 ------ ------ ------ ------ ------ ------ First Quarter $30.00 $27.50 $25.25 $25.00 $ .24 $ .20 Second Quarter 30.75 27.50 27.75 24.50 .24 .20 Third Quarter 32.38 26.00 30.00 23.25 .28 .24 Fourth Quarter 38.00 26.75 32.13 24.06 .28 .24 Prices are as reported by the National Association of Securities Dealers Automated Quotation - National Market System. Numbers rounded to nearest cent when applicable. STOCK INFORMATION COMMON STOCK LISTING First Merchants Corporation common stock is trader over-the-counter on the NASDAQ National Market System. Quotations are carried in many daily papers. The NASDAQ symbol is FMRE (Cusip #320817-10-9). At the close of business on December 31, 1997, the number of shares outstanding was 6,664,439. There were 1,473 stockholders of record on that date. GENERAL STOCKHOLDER INQUIRIES Stockholders and interested investors may obtain information about the Corporation upon written request or by calling: Mr. 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 MARKET MAKERS The following firms make a market in First Merchants Corporation stock: Robert W. Baird & Co., Inc. City Securities Corporation Herzog, Heine, Geduld, Inc. Howe, Barnes & Johnson, Inc. McDonald and Company NatCity Investments, Inc. David A. Noyes and Company 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 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 49
ANNUAL REPORT APPENDIX - GRAPHIC & IMAGE INFORMATION (Continued) - ------------------------------------------------------------------------------ Bar Chart: RETURN on AVERAGE ASSETS A bar graph with the following plot points for the respective years. RETURN ON AVERAGE ASSETS (per cent) 1995 1996 1997 ------ ------ ------ Return on Average Assets 1.35% 1.41% 1.45% A narrative discussion of this data is provided in the Management's Discussion & Analysis, under the caption "Results of Operations." - ------------------------------------------------------------------------------ Bar Chart: RETURN on AVERAGE EQUITY A bar graph with the following plot points for the respective years. RETURN ON AVERAGE EQUITY (per cent) 1995 1996 1997 ------ ------ ------ Return on Average Equity 12.17% 12.16% 12.28% A narrative discussion of this data is provided in the Management's Discussion & Analysis, under the caption "Results of Operations." - ------------------------------------------------------------------------------ Bar Chart: NET LOAN LOSSES A bar graph with the following plot points for the respective years. NET LOAN LOSSES (as a per cent of average loans) 1995 1996 1997 ------ ------ ------ First Merchants Corporation .24% .23% .17% Peer Group .26% .26% N/A A narrative discussion of this data is provided in the Management's Discussion & Analysis, under the caption "Asset Quality/Provision for Loan Losses." - ------------------------------------------------------------------------------
ANNUAL REPORT APPENDIX - GRAPHIC & IMAGE INFORMATION MAP: FIRST MERCHANTS CORPORATION MARKET AREA This graphic is a map of Indiana showing the market area for First Merchants Corporation ("Corporation"). The map illustrates the location of Delaware, Madison, Henry, Randolph, Union, Fayette, and Wayne counties, Indiana. The map identifies the communities with Corporation offices. The following table summarizes the Corporation's office locations: LOCATION COUNTY Muncie Delaware Albany Delaware Daleville Delaware Eaton Delaware Pendleton Madison Edgewood Madison Ingalls Madison Lapel Madison Markleville Madison Middletown Henry Sulphur Springs Henry Mooreland Henry Winchester Randolph Connersville Fayette Liberty Union Richmond Wayne - ------------------------------------------------------------------------------
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 23, 1998, 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/ Geo. S. Olive & Co. LLC Indianapolis, Indiana March 22, 1998
9 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 33,127 385 9,050 0 212,040 35,332 35,429 703,784 6,778 1,020,136 843,812 26,829 6,826 20,700 0 0 833 121,136 1,020,136 59,889 15,138 448 75,475 31,920 35,725 39,750 1,297 (14) 25,748 21,934 14,373 0 0 14,373 2.17 2.14 4.48 1,410 1,972 282 7,881 6,622 1,609 468 6,778 5,364 0 1,414
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, 1998, will be filed as an amendment to the 1997 Annual Report on Form 10-K no later than October 28, 1998.