UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________to_________
Commission file number 0-17071
FIRST MERCHANTS CORPORATION
(Exact name of registrant as specified in its charter)
Indiana 35-1544218
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 East Jackson
Muncie, Indiana 47305-2814
(Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (765) 747-1500
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.125 stated value per share
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant(1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. Large accelerated filer[ ] Accelerated filer[X] Non-accelerated filer[ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No[X]
The aggregate market value (not necessarily a reliable indication of
the price at which more than a limited number of shares would trade) of the
voting stock held by non-affiliates of the registrant was $457,630,766 as of the
last business day of the registrant's most recently completed second fiscal
quarter (June 30, 2005).
As of March 7, 2006 there were 18,427,098 outstanding common shares,
without par value, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K
Documents Into Which Incorporated
Portions of the Registrant's Annual Part I (Item 1)
Report to Shareholders for the year
ended December 31, 2005 Part II (Items 5, 6, 7, 7A, and 8)
Portions of the Registrant's Part III (Items 10 through 14)
Definitive Proxy Statement for
Annual Meeting of Shareholders
to be held April 13, 2006
FORM 10-K TABLE OF CONTENTS
Form 10-K
Page
Number
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS.................................3
PART I
Item 1 - Business............................................................4
Item 1A- Risk Factors.......................................................23
Item 1B- Unresolved Staff Comments..........................................26
Item 2 - Properties.........................................................27
Item 3 - Legal Proceedings..................................................27
Item 4 - Submission of Matters to a Vote of Security Holders................27
Supplemental Information - Executive Officers of the Registrant.............28
PART II
Item 5 - Market For the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities........................................................29
Item 6 - Selected Financial Data...........................................30
Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations...............................30
Item 7A- Quantitative and Qualitative Disclosures About Market Risk........30
Item 8 - Financial Statements and Supplementary Data.......................31
Item 9 - Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure...............................31
Item 9A- Controls and Procedures...........................................31
Item 9B- Other Information.................................................32
PART III
Item 10- Directors and Executive Officers of the Registrant.................33
Item 11- Executive Compensation.............................................33
Item 12- Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters.....................34
Item 13- Certain Relationships and Related Transactions.....................34
Item 14- Principal Accounting Fees and Services.............................34
PART IV
Item 15- Exhibits and Financial Statement Schedules.........................35
Signatures.........................................................37
Exhibit Index......................................................38
Page 2
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The Corporation from time to time includes forward-looking statements in
its oral and written communication. The Corporation may include forward-looking
statements in filings with the Securities and Exchange Commission, such as this
Form 10-K, in other written materials and in oral statements made by senior
management to analysts, investors, representatives of the media and others. The
Corporation intends these forward-looking statements to be covered by the safe
harbor provisions for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995, and the Corporation is including this
statement for purposes of these safe harbor provisions. Forward-looking
statements can often be identified by the use of words like "believe",
"continue", "pattern", "estimate", "project", "intend", "anticipate", "expect"
and similar expressions or future or conditional verbs such as "will", "would",
"should", "could", "might", "can", "may", or similar expressions. These
forward-looking statements include:
* statements of the Corporation's goals, intentions and expectations;
* statements regarding the Corporation's business plan and growth
strategies;
* statements regarding the asset quality of the Corporation's loan and
investment portfolios; and
* estimates of the Corporation's risks and future costs and benefits.
These forward-looking statements are subject to significant risks,
assumptions and uncertainties, including, among other things, the following
important factors which could affect the actual outcome of future events:
* fluctuations in market rates of interest and loan and deposit pricing,
which could negatively affect the Corporation's net interest margin,
asset valuations and expense expectations;
* adverse changes in the economy, which might affect the Corporation's
business prospects and could cause credit-related losses and expenses;
* adverse developments in the Corporation's loan and investment
portfolios;
* competitive factors in the banking industry, such as the trend towards
consolidation in the Corporation's market;
* changes in the banking legislation or the regulatory requirements of
federal and state agencies applicable to bank holding companies and
banks like the Corporation's affiliate banks;
* acquisitions of other businesses by the Corporation and integration of
such acquired businesses;
* changes in market, economic, operational, liquidity, credit and interest
rate risks associated with the Corporation's business; and
* the continued availability of earnings and excess capital sufficient
for the lawful and prudent declaration and payment of cash dividends.
Because of these and other uncertainties, the Corporation's actual future
results may be materially different from the results indicated by these forward-
looking statements. In addition, the Corporation's past results of operations do
not necessarily indicate its future results.
Page 3
PART I
Item 1. BUSINESS
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GENERAL
First Merchants Corporation (the "Corporation") is a financial holding
company headquartered in Muncie, Indiana. The Corporation's Common Stock is
traded on NASDAQ's National Market System under the symbol FRME and was
organized in September 1982. Since its organization, the Corporation has grown
to include nine affiliate banks with over sixty-five locations in seventeen
Indiana and three Ohio counties, a trust company, a multi-line insurance agency,
a reinsurance agency, and a title agency.
The bank subsidiaries of the Corporation include the following:
* First Merchants Bank, National Association in Delaware and Hamilton
counties;
* The Madison Community Bank, National Association in Madison County;
* First United Bank, National Association in Henry County;
* United Communities National Bank with locations in Randolph, Union,
Fayette, Wayne and Butler (OH) counties;
* The First National Bank of Portland in Jay County;
* Decatur Bank & Trust Company, National Association in Adams County;
* Frances Slocum Bank & Trust Company, National Association in Wabash,
Howard, and Miami counties;
* Lafayette Bank and Trust Company, National Association in Tippecanoe,
Carroll, Jasper, and White counties; and
* Commerce National Bank in Franklin and Hamilton counties in Ohio.
Effective January 1, 2006, First United Bank, National Association was
merged into First Merchants Bank, National Association, and the name of the
continuing institution is First Merchants Bank, National Association.
The Corporation also operates First Merchants Insurance Services, Inc. a
full- service property, casualty, personal lines, and health care insurance
agency headquartered in Muncie, Indiana. On September 1, 2005, Trustcorp
Financial Services of Greenville, Inc. merged with and into First Merchants
Insurance Services, Inc. The Corporation is also the majority owner of the
Indiana Title Insurance Company LLC, a full-service title insurance agency;
operates First Merchants Reinsurance Co. Ltd., a reinsurance agency; and
wholly-owns Merchants Trust Company, National Association, a trust and asset
management services company.
As of December 31, 2005, the Corporation had consolidated assets of
$3.2 billion, consolidated deposits of $2.4 billion and stockholders' equity of
$313 million. The Corporation is presently engaged in conducting commercial
banking business through the offices of its nine banking subsidiaries. As of
December 31, 2005, the Corporation and its subsidiaries had 1,109 full-time
equivalent employees.
Through its bank subsidiaries, the Corporation offers a broad range of
financial services, including: accepting time, savings and demand deposits;
making consumer, commercial, agri-business and real estate mortgage loans;
renting safe deposit facilities; providing personal and corporate trust
services; providing full service brokerage; and providing other corporate
services, letters of credit and repurchase agreements. Through various nonbank
subsidiaries, the Corporation also offers personal and commercial lines of
insurance and engages in the title agency business and the reinsurance of credit
life, accident, and health insurance.
The Corporation makes its Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, available on its website at www.firstmerchants.com without
charge, as soon as reasonably practicable after such reports are electronically
filed with, or furnished to, the Securities and Exchange Commission. These
documents can also be read and copied at the Securities and Exchange
Commission's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for
further information on the public reference room. Our SEC filings are also
available to the public at the Securities and Exchange Commission's web site at
http://www.sec.gov. Additionally, the Corporation will also provide without
charge, a copy of its Form 10-K to any shareholder by mail. Requests should be
sent to Mr. Brian Edwards, Shareholder Relations Officer, First Merchants
Corporation, P.O. Box 792, Muncie, IN 47308-0792.
Page 4
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ACQUISITION POLICY
The Corporation anticipates that it will continue its policy of geographic
expansion of its banking business through the acquisition of banks whose
operations are consistent with its community banking philosophy. Management
routinely explores opportunities to acquire financial institutions and other
financial services-related businesses and to enter into strategic alliances to
expand the scope of its services and its customer base.
COMPETITION
The Corporation's banking subsidiaries are located in Indiana and Ohio
counties where other financial services companies provide similar banking
services. In addition to the competition provided by the lending and deposit
gathering subsidiaries of national manufacturers, retailers, insurance companies
and investment brokers, the banking subsidiaries compete vigorously with other
banks, thrift institutions, credit unions and finance companies located within
their service areas.
REGULATION AND SUPERVISION
OF FIRST MERCHANTS CORPORATION AND SUBSIDIARIES
BANK HOLDING COMPANY REGULATION
The Corporation is registered as a bank holding company and has elected to
be a financial holding company. It is subject to the supervision of, and
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve") under the Bank Holding Company Act of 1956, as amended (the "BHC
Act"). Bank holding companies are required to file periodic reports with and are
subject to periodic examination by the Federal Reserve. The Federal Reserve has
issued regulations under the BHC Act requiring a bank holding company to serve
as a source of financial and managerial strength to its subsidiary banks. Thus,
it is the policy of the Federal Reserve that a bank holding company should
stand ready to use its resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity. Additionally,
under the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), a bank holding company is required to guarantee the compliance of
any subsidiary bank that may become "undercapitalized" (as defined in the FDICIA
section of this Form 10-K) with the terms of any capital restoration plan filed
by such subsidiary with its appropriate federal banking agency. Under the BHC
Act, the Federal Reserve has the authority to require a bank holding company to
terminate any activity or relinquish control of a nonbank subsidiary (other than
a nonbank subsidiary of a bank) upon the determination that such activity
constitutes a serious risk to the financial stability of any bank subsidiary.
The BHC Act requires the Corporation to obtain the prior approval of the
Federal Reserve before:
1. Acquiring direct or indirect control or ownership of any voting shares of
any bank or bank holding company if, after such acquisition, the bank
holding company will directly or indirectly own or control more than 5% of
the voting shares of the bank or bank holding company.
2. Merging or consolidating with another bank holding company; or
3. Acquiring substantially all of the assets of any bank.
The BHC Act generally prohibits bank holding companies that have not become
financial holding companies from (i) engaging in activities other than banking
or managing or controlling banks or other permissible subsidiaries, and (ii)
acquiring or retaining direct or indirect control of any company engaged in the
activities other than those activities determined by the Federal Reserve to be
closely related to banking or managing or controlling banks.
The BHC Act does not place territorial restrictions on such nonbanking-
related activities.
Page 5
CAPITAL ADEQUACY GUIDELINES FOR BANK HOLDING COMPANIES
The Corporation is required to comply with the Federal Reserve's
risk-based capital guidelines. These guidelines require a minimum ratio of
capital to risk-weighted assets of 8% (including certain off-balance sheet
activities such as standby letters of credit). At least half of the total
required capital must be "Tier 1 capital," consisting principally of
stockholders' equity, noncumulative perpetual preferred stock, a limited amount
of cumulative perpetual preferred stock and minority interest in the equity
accounts of consolidated subsidiaries, less certain goodwill items. The
remainder may consist of a limited amount of subordinate debt and
intermediate-term preferred stock, certain hybrid capital instruments and other
debt securities, cumulative perpetual preferred stock, and a limited amount of
the general loan loss allowance.
In addition to the risk-based capital guidelines, the Federal Reserve has
adopted a Tier 1 (leverage) capital ratio under which the Corporation must
maintain a minimum level of Tier 1 capital to average total consolidated assets.
The ratio is 3% in the case of bank holding companies which have the highest
regulatory examination ratings and are not contemplating significant growth or
expansion. All other bank holding companies are expected to maintain a ratio of
at least 1% to 2% above the stated minimum.
The following are the Corporation's regulatory capital ratios as of
December 31, 2005:
Regulatory Minimum
Corporation Requirement
Tier 1 Capital: 9.7% 4.0%
(to risk-weighted assets)
Total Capital: 11.7% 8.0%
BANK REGULATION
Each of the Corporation's bank subsidiaries are national banks and are
supervised, regulated and examined by the Office of the Comptroller of the
Currency (the "OCC"). The OCC has the authority to issue cease-and-desist orders
if it determines that activities of the bank regularly represent an unsafe and
unsound banking practice or a violation of law. Federal law extensively
regulates various aspects of the banking business such as reserve requirements,
truth-in-lending and truth-in-savings disclosures, equal credit opportunity,
fair credit reporting, trading in securities and other aspects of banking
operations. Current federal law also requires banks, among other things, to make
deposited funds available within specified time periods.
Page 6
BANK CAPITAL REQUIREMENTS
The OCC has adopted risk-based capital ratio guidelines to which national
banks are subject. The guidelines establish a framework that makes regulatory
capital requirements more sensitive to differences in risk profiles. Risk-based
capital ratios are determined by allocating assets and specified off-balance
sheet commitments to four risk-weighted categories, with higher levels of
capital being required for the categories perceived as representing greater
risk.
Like the capital guidelines established by the Federal Reserve, these
guidelines divide a bank's capital into tiers. Banks are required to maintain a
total risk-based capital ratio of 8%. The OCC may, however, set higher capital
requirements when a bank's particular circumstances warrant. Banks experiencing
or anticipating significant growth are expected to maintain capital ratios,
including tangible capital positions, well above the minimum levels.
In addition, the OCC established guidelines prescribing a minimum Tier 1
leverage ratio (Tier 1 capital to adjusted total assets as specified in the
guidelines). These guidelines provide for a minimum Tier 1 leverage ratio of 3%
for banks that meet specified criteria, including that they have the highest
regulatory rating and are not experiencing or anticipating significant growth.
All other banks are required to maintain a Tier 1 leverage ratio of 3% plus an
additional 100 to 200 basis points.
All of the Corporation's affiliate banks exceed the risk-based capital
guidelines of the OCC as of December 31, 2005.
The Federal Reserve and the OCC have adopted rules to incorporate
market and interest rate risk components into their risk-based capital
standards. Amendments to the risk-based capital requirements, incorporating
market risk, became effective January 1, 1998. Under the new market risk
requirements, capital will be allocated to support the amount of market risk
related to a financial institution's ongoing trading activities.
FDIC IMPROVEMENT ACT OF 1991
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires, among other things, federal bank regulatory authorities to
take "prompt corrective action" with respect to banks which do not meet minimum
capital requirements. For these purposes, FDICIA establishes five capital tiers:
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized. The FDIC has adopted
regulations to implement the prompt corrective action provisions of FDICIA.
"Undercapitalized" banks are subject to growth limitations and are
required to submit a capital restoration plan. A bank's compliance with such
plan is required to be guaranteed by the bank's parent holding company. If an
"undercapitalized" bank fails to submit an acceptable plan, it is treated as if
it is significantly undercapitalized. "Significantly undercapitalized" banks are
subject to one or more restrictions, including an order by the FDIC to sell
sufficient voting stock to become adequately capitalized, requirements to reduce
total assets and cease receipt of deposits from correspondent banks, and
restrictions on compensation of executive officers. "Critically
undercapitalized" institutions may not, beginning 60 days after becoming
"critically undercapitalized," make any payment of principal or interest on
certain subordinated debt or extend credit for a highly leveraged transaction or
enter into any transaction outside the ordinary course of business. In addition,
"critically undercapitalized" institutions are subject to appointment of a
receiver or conservator.
Page 7
FDICIA continued
As of December 31, 2005, each bank subsidiary of First Merchants is
"well capitalized" based on the "prompt corrective action" ratios and deadlines
described above. It should be noted, however, that a bank's capital category is
determined solely for the purpose of applying the OCC's "prompt corrective
action" regulations and that the capital category may not constitute an accurate
representation of the bank's overall financial condition or prospects.
DEPOSIT INSURANCE
The Corporation's affiliated banks are insured up to regulatory limits by
the FDIC and, accordingly, are subject to deposit insurance assessments to
maintain the Bank Insurance Fund (the "BIF") and the Savings Association
Insurance Fund ("SAIF") administered by the FDIC. The FDIC has adopted
regulations establishing a permanent risk-related deposit insurance assessment
system. Under this system, the FDIC places each insured bank in one of nine risk
categories based on (i) the bank's capitalization, and (ii) supervisory
evaluations provided to the FDIC by the institution's primary federal regulator.
Each insured bank's insurance assessment rate is then determined by the risk
category in which it is classified by the FDIC.
The Deposit Insurance Funds Act of 1996 provides for assessments to be
imposed on insured depository institutions with respect to deposits insured by
the BIF and the SAIF (in addition to assessments currently imposed on depository
institutions with respect to BIF- and SAIF-insured deposits) to pay for the cost
of Financing Corporation ("FICO") funding. The FICO assessments do not vary
depending upon a depository institution's capitalization or supervisory
evaluations.
DIVIDEND LIMITATIONS
National banking laws restrict the amount of dividends that an affiliate
bank may declare in a year without obtaining prior regulatory approval. National
banks are limited to the bank's retained net income (as defined) for the current
year plus those for the previous two years. At December 31, 2005, the
Corporation's affiliate banks had a total of $17,060,000 retained net profits
available for 2006 dividends to the Corporation without prior regulatory
approval.
BROKERED DEPOSITS
Under FDIC regulations, no FDIC-insured depository institution can
accept brokered deposits unless it (i) is well capitalized, or (ii) is
adequately capitalized and received a waiver from the FDIC. In addition, these
regulations prohibit any depository institution that is not well capitalized
from (a) paying an interest rate on deposits in excess of 76 basis points over
certain prevailing market rates or (b) offering "pass through" deposit insurance
on certain employee benefit plan accounts unless it provides certain notice to
affected depositors.
INTERSTATE BANKING AND BRANCHING
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994 ("Riegle-Neal") subject to certain concentration limits, required
regulatory approvals and other requirements, (i) financial holding companies
such as the Corporation are permitted to acquire banks and bank holding
companies located in any state; (ii) any bank that is a subsidiary of a bank
holding company is permitted to receive deposits, renew time deposits, close
loans, service loans and receive loan payments as an agent for any other bank
subsidiary of that holding company; and (iii) banks are permitted to acquire
branch offices outside their home states by merging with out-of-state banks,
purchasing branches in other states, and establishing de novo branch offices in
other states.
Page 8
FINANCIAL SERVICES MODERNIZATION ACT
The Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization
Act") establishes a comprehensive framework to permit affiliations among
commercial banks, insurance companies, securities firms, and other financial
service providers by revising and expanding the existing BHC Act. Under this
legislation, bank holding companies would be permitted to conduct essentially
unlimited securities and insurance activities as well as other activities
determined by the Federal Reserve Board to be financial in nature or related to
financial services. As a result, the Corporation is able to provide securities
and insurance services. Furthermore, under this legislation, the Corporation is
able to acquire, or be acquired by, brokerage and securities firms and insurance
underwriters. In addition, the Financial Services Modernization Act broadens the
activities that may be conducted by national banks through the formation of
financial subsidiaries. Finally, the Financial Services Modernization Act
modifies the laws governing the implementation of the Community Reinvestment Act
and addresses a variety of other legal and regulatory issues affecting both
day-to-day operations and long-term activities of financial institutions.
A bank holding company may become a financial holding company if each of
its subsidiary banks is well capitalized, is well managed and has at least a
satisfactory rating under the Community Reinvestment Act, by filing a
declaration that the bank holding company wishes to become a financial holding
company. Also effective March 11, 2000, no regulatory approval is required for a
financial holding company to acquire a company, other than a bank or savings
association, engaged in activities that are financial in nature or incidental to
activities that are financial in nature, as determined by the Federal Reserve
Board. The Federal Reserve Bank of Chicago approved the Corporation's
application to become a Financial Holding Company effective September 13, 2000.
USA PATRIOT ACT
As part of the USA Patriot Act, signed into law on October 26, 2001,
Congress adopted the International Money Laundering Abatement and Financial
Anti-Terrorism Act of 2001 (the "Act"). The Act authorizes the Secretary of the
Treasury, in consultation with the heads of other government agencies, to adopt
special measures applicable to financial institutions such as banks, bank
holding companies, broker-dealers and insurance companies. Among its other
provisions, the Act requires each financial institution: (i) to establish an
anti-money laundering program; (ii) to establish due diligence policies,
procedures and controls that are reasonably designed to detect and report
instances of money laundering in United States private banking accounts and
correspondent accounts maintained for non-United States persons or their
representatives; and (iii) to avoid establishing, maintaining, administering, or
managing correspondent accounts in the United States for, or on behalf of, a
foreign shell bank that does not have a physical presence in any country. In
addition, the Act expands the circumstances under which funds in a bank account
may be forfeited and requires covered financial institutions to respond under
certain circumstances to requests for information from federal banking agencies
within 120 hours.
Treasury regulations implementing the due diligence requirements were
issued in 2002. These regulations required minimum standards to verify customer
identity, encouraged cooperation among financial institutions, federal banking
agencies, and law enforcement authorities regarding possible money laundering or
terrorist activities, prohibited the anonymous use of "concentration accounts,"
and required all covered financial institutions to have in place an anti-money
laundering compliance program.
The Act also amended the Bank Holding Company Act and the Bank Merger Act
to require the federal banking agencies to consider the effectiveness of a
financial institution's anti-money laundering activities when reviewing an
application under these acts.
Page 9
THE SARBANES-OXLEY ACT
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"), which became law on
July 30, 2002, added new legal requirements for public companies affecting
corporate governance, accounting and corporate reporting. The Sarbanes-Oxley Act
provides for, among other things:
* a prohibition on personal loans made or arranged by the issuer to its
directors and executive officers (except for loans made by a bank
subject to Regulation O);
* independence requirements for audit committee members;
* independence requirements for company auditors;
* certification of financial statements on Forms 10-K and 10-Q reports by
the chief executive officer and the chief financial officer;
* the forfeiture by the chief executive officer and chief financial
officer of bonuses or other incentive-based compensation and profits
from the sale of an issuer's securities by such officers in the
twelve month period following initial publication of any financial
statements that later require restatement due to corporate misconduct;
* disclosure of off-balance sheet transactions;
* two-business day filing requirements for insiders filing Form 4s;
* disclosure of a code of ethics for financial officers and filing a
Form 8-K for a change in or waiver of such code;
* the reporting of securities violations "up the ladder" by both in-house
and outside attorneys;
* restrictions on the use of non-GAAP financial measures in press releases
and SEC filings;
* the formation of a public accounting oversight board; and
* various increased criminal penalties for violations of securities laws.
The Sarbanes-Oxley Act contains provisions which became effective upon
enactment on July 30, 2002,including provisions which became effective from
within 30 days to one year from enactment. The SEC has been delegated the task
of enacting rules to implement various provisions. In addition, each of the
national stock exchanges developed new corporate governance rules, including
rules strengthening director independence requirements for boards, the adoption
of corporate governance codes and charters for the nominating, corporate
governance and audit committees.
ADDITIONAL MATTERS
The Corporation and its affiliate banks are subject to the Federal Reserve
Act, which restricts financial transactions between banks and affiliated
companies. The statute limits credit transactions between banks, affiliated
companies and its executive officers and its affiliates. The statute prescribes
terms and conditions for bank affiliate transactions deemed to be consistent
with safe and sound banking practices, and restricts the types of collateral
security permitted in connection with the bank's extension of credit to an
affiliate. Additionally, all transactions with an affiliate must be on terms
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated parties.
In addition to the matters discussed above, the Corporation's affiliate
banks are subject to additional regulation of their activities, including a
variety of consumer protection regulations affecting their lending, deposit and
collection activities and regulations affecting secondary mortgage market
activities.
The earnings of financial institutions are also affected by general
economic conditions and prevailing interest rates, both domestic and foreign,
and by the monetary and fiscal policies of the United States Government and its
various agencies, particularly the Federal Reserve. The Federal Reserve
regulates the supply of credit in order to influence general economic
conditions, primarily through open market operations in United States government
obligations, varying the discount rate on financial institution borrowings,
varying reserve requirements against financial institution deposits, and
restricting certain borrowings by financial institutions and their subsidiaries.
The monetary policies of the Federal Reserve have had a significant effect on
the operating results of the bank subsidiaries in the past and are expected to
continue to do so in the future.
Additional legislation and administrative actions affecting the banking
industry may be considered by the United States Congress, state legislatures and
various regulatory agencies, including those referred to above. It cannot be
predicted with certainty whether such legislation or administrative action will
be enacted or the extent to which the banking industry in general or the
Corporation and its affiliate banks in particular would be affected.
Page 10
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.
(Dollars in Thousands)
2005 2004 2003
------------------------------ ------------------------------ ------------------------------
Interest Interest Interest
Average Income/ Average Average Income/ Average Average Income/ Average
Balance Balance Rate Balance Balance Rate Balance Balance Rate
--------- --------- -------- --------- --------- -------- --------- --------- --------
Assets:
Federal funds sold ............ $ 8,385 $ 264 3.1% $ 7,759 $ 165 2.1% $ 44,243 $ 485 1.1%
Interest-bearing deposits...... 16,683 695 4.2 17,500 555 3.2 6,655 76 1.1
Federal Reserve and
Federal Home Loan Bank stock. 23,019 1,185 5.1 22,655 1,250 5.5 13,615 649 4.8
Securities: (1)
Taxable ....................... 263,435 9,612 3.6 247,930 8,371 3.4 181,698 6,105 3.4
Tax-exempt (3)................. 162,965 9,807 6.0 141,205 9,382 6.6 136,028 9,648 7.1
---------- -------- ---------- -------- ---------- --------
Total Securities............. 426,400 19,419 4.6 389,135 17,753 4.6 317,726 15,753 5.0
Mortgage loans held for sale..... 2,746 113 4.1 4,205 240 5.7 12,294 725 5.9
Loans: (2)
Commercial .................... 1,569,270 105,740 6.7 1,495,195 89,108 6.0 1,387,704 82,183 5.9
Bankers' acceptance and
Commercial paper purchased... 4,660 61 1.3
Real estate mortgage........... 464,426 27,334 5.9 486,377 27,969 5.8 517,376 32,100 6.2
Installment ................... 385,097 25,248 6.6 372,817 22,636 6.1 345,084 26,167 7.6
Tax-exempt (3)................. 12,595 989 7.9 10,423 894 8.6 14,496 1,088 7.5
---------- -------- ---------- -------- ---------- --------
Total loans ................. 2,434,134 159,424 6.5 2,369,017 140,847 5.9 2,281,614 142,324 6.2
---------- -------- ---------- -------- ---------- --------
Total earning assets......... 2,908,621 180,987 6.3 2,806,066 160,570 5.7 2,663,853 159,287 6.0
---------- -------- ---------- -------- ---------- --------
Net unrealized gain (loss) on securities
available for sale........... (1,217) 4,676 7,553
Allowance for loan losses........ (24,889) (26,093) (28,906)
Cash and due from banks.......... 53,037 63,420 75,801
Premises and equipment .......... 38,284 38,397 39,069
Other assets .................... 205,628 222,638 202,825
--------- --------- ---------
Total assets ................ $3,179,464 $3,109,104 $2,960,195
========== ========== ==========
Liabilities:
Interest-bearing deposits:
NOW accounts ................ $ 395,356 2,058 0.5% $ 346,525 1,779 0.5% $ 344,933 2,015 0.6%
Money market deposit accounts 280,508 4,899 1.7 359,359 3,219 0.9 336,669 3,360 1.0
Savings deposits ............ 319,552 2,583 0.8 297,364 992 0.3 293,119 1,376 0.5
Certificates and other
time deposits ............. 1,149,679 36,581 3.2 1,051,092 27,854 2.7 988,957 28,107 2.8
---------- -------- ---------- -------- ---------- --------
Total interest-bearing
deposits..................... 2,145,095 46,121 2.2 2,054,340 33,844 1.6 1,963,678 34,858 1.8
Borrowings ...................... 412,091 19,959 4.8 402,776 17,741 4.4 381,178 17,530 4.6
---------- -------- ---------- -------- ---------- --------
Total interest-bearing
liabilities................. 2,557,186 66,080 2.6 2,457,116 51,585 2.1 2,344,856 52,388 2.2
Noninterest-bearing deposits..... 273,657 310,966 293,397
Other liabilities ............... 33,096 31,018 28,339
---------- ---------- ----------
Total liabilities............ 2,863,939 2,799,100 2,666,592
Stockholders' equity ............ 315,525 310,004 293,603
---------- ---------- ----------
Total liabilities and
stockholders' equity........ $3,179,464 66,080 2.3 $3,109,104 51,585 1.8 $2,960,195 52,388 2.0
========== -------- ========== -------- ========== --------
Net interest income ......... $114,907 $108,985 $106,899
======== ======== ========
Net interest margin.......... 4.0 3.9 4.0
(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) Tax exempt securities and loans are presented on a fully taxable
equivalent basis, using a marginal tax rate of 35% for 2005, 2004,
and 2003..........................
$3,778 $3,597 $3,757
====== ====== ======
Page 11
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.
2005 Compared to 2004 2004 Compared to 2003
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 ............... $ 14 $ 85 $ 99 $ (577) $ 257 $ (320)
Interest-bearing deposits ........ (27) 167 140 229 250 479
Federal Reserve and Federal
Home Loan Bank stock ........... 36 (101) (65) 474 127 601
Securities ....................... 1,697 (31) 1,666 3,332 (1,332) 2,000
Mortgage loans held for sale ..... (70) (57) (127) (462) (23) (485)
Loans ............................ 4,027 14,677 18,704 5,843 (6,835) (992)
-------- --------- --------- -------- --------- ---------
Totals ........................... 5,677 14,740 20,417 8,839 (7,556) 1,283
-------- --------- --------- -------- --------- ---------
Interest expense:
NOW accounts ..................... 254 25 279 9 (245) (236)
Money market deposit
accounts........................ (832) 2,512 1,680 217 (358) (141)
Savings deposits.................. 79 1,512 1,591 20 (404) (384)
Certificates and other
time deposits................... 2,780 5,947 8,727 1,708 (1,961) (253)
Borrowings........................ 418 1,800 2,218 969 (758) 211
-------- --------- --------- -------- --------- ---------
Totals.......................... 2,699 11,796 14,495 2,923 (3,726) (803)
-------- --------- --------- -------- --------- ---------
Change in net interest
income (fully taxable
equivalent basis)................ $ 2,978 $ 2,944 5,922 $ 5,916 $ (3,830) 2,086
======== ========= ======== =========
Tax equivalent adjustment
using marginal rate
of 35% for 2005, 2004,
and 2003.......................... (182) 161
---------- ----------
Change in net interest
income........................... $ 5,740 $ 2,247
========== ==========
Page 12
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, 2005
U.S. Treasury ............................... $ 1,586 $ 1 $ 1,585
U.S. Government-sponsored agency securities.. 83,026 $ 1 1,836 81,191
State and municipal ......................... 167,095 2,159 1,131 168,123
Mortgage-backed securities .................. 168,019 139 5,656 162,502
Other asset-backed securities ............... 1 1
Marketable equity securities ................ 9,660 435 9,225
-------- -------- -------- --------
Total available for sale ................. 429,387 2,299 9,059 422,627
-------- -------- -------- --------
Held to maturity at December 31, 2005
State and municipal ......................... 11,609 283 412 11,480
Mortgage-backed securities .................. 30 30
-------- -------- -------- --------
Total held to maturity ................... 11,639 283 412 11,510
-------- -------- -------- --------
Total investment securities .............. $441,026 $ 2,582 $ 9,471 $434,137
======== ======== ======== ========
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- --------------- -------------- --------------
(Dollars in Thousands)
Available for sale at December 31, 2004
U.S. Treasury ............................... $ 1,745 $ 1 $ 1,744
U.S. Government-sponsored agency securities.. 65,325 $ 73 332 65,066
State and municipal ......................... 150,284 5,243 82 155,445
Mortgage-backed securities .................. 183,200 485 1,980 181,705
Other asset-backed securities ............... 18 18
Marketable equity securities ................ 12,191 8 12,199
-------- -------- -------- --------
Total available for sale ................. 412,763 5,809 2,395 416,177
-------- -------- -------- --------
Held to maturity at December 31, 2004
State and municipal ......................... 5,306 162 5,468
Mortgage-backed securities .................. 52 52
-------- -------- -------- --------
Total held to maturity ................... 5,358 162 5,520
-------- -------- -------- --------
Total investment securities .............. $418,121 $ 5,971 $ 2,395 $421,697
======== ======== ======== ========
Page 13
--------------------------------------------------------------------------------
STATISTICAL DATA (continued)
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- --------------- -------------- --------------
(Dollars in Thousands)
Available for sale at December 31, 2003
U.S. Treasury ............................... $ 1,498 $ 1,498
U.S. Government-sponsored agency securities.. 38,290 $ 523 $ 52 38,761
State and municipal ......................... 118,794 6,932 86 125,640
Mortgage-backed securities .................. 174,208 813 1,817 173,204
Corporate obligations ....................... 500 16 516
Marketable equity securities ................ 9,237 4 9,241
-------- -------- -------- --------
Total available for sale ................. 342,527 8,288 1,955 348,860
-------- -------- -------- --------
Held to maturity at December 31, 2003
State and municipal ......................... 7,860 389 8,249
Mortgage-backed securities .................. 77 77
-------- -------- -------- --------
Total held to maturity ................... 7,937 389 8,326
-------- -------- -------- --------
Total investment securities .............. $350,464 $ 8,677 $ 1,955 $357,186
======== ======== ======== ========
Cost
----------------------------------------------------------
2005 2004 2003
---- ---- ----
(Dollars in Thousands)
Federal Reserve and Federal Home Loan
Bank stock at December 31:
Federal Reserve Bank stock .................... $ 8,913 $ 8,814 $ 2,320
Federal Home Loan Bank stock .................. 14,287 14,044 13,182
------- ------- -------
Total ..................................... $23,200 $22,858 $15,502
======= ======= =======
The fair value of Federal Reserve and Federal Home Loan Bank stock approximates
cost.
There were no issuers included in our investment security portfolio at December
31, 2005, 2004 or 2003 where the aggregate carrying value of any one issuer
exceeded 10 percent of the Corporation's stockholders' equity at those dates.
The term "issuer" excludes the U.S. Government and its sponsored agencies and
corporations.
The maturity distribution (Dollars in Thousands) and average yields for the
securities portfolio at December 31, 2005 were:
Securities available for sale December 31, 2005:
Within 1 Year 1-5 Years 5-10 Years
------------- --------- ----------
Amount Yield* Amount Yield* Amount Yield*
------ ------ ------ ------ ------ ------
U.S. Treasury................................ $ 1,585 4.2%
U.S. Government-sponsored agency securities.. 3,093 2.5 $ 78,098 3.9%
State and Municipal.......................... 8,167 5.1 90,109 4.6 $53,734 6.3%
------- -------- -------
Total.................................... $12,845 4.4% $168,207 4.3% $53,734 6.3%
======= ======== =======
Page 14
--------------------------------------------------------------------------------
STATISTICAL DATA (continued)
Marketable Equity
and Mortgage -
Due After Ten Years Backed Securities Total
------------------- ----------------------- -----
Amount Yield* Amount Yield* Amount Yield*
------ ------ ------ ------ ------ ------
U.S. Treasury........................ $ 1,585 4.2%
U.S. Government-sponsored
agency securities................. 81,191 3.8
State and Municipal.................. $ 16,112 7.8% 168,122 5.5
Marketable equity securities......... $ 9,225 5.6% 9,225 5.6
Mortgage-backed securities........... 162,503 4.0 162,503 4.0
Other asset-backed securities........ 1 7.0 1 7.0
-------- --------- --------
Total............................ $ 16,112 7.8% $ 171,729 4.1% $422,627 4.6%
======== ========= ========
Securities held to maturity at December 31, 2005:
Within 1 Year 1-5 Years 5-10 Years
------------- --------- ----------
Amount Yield* Amount Yield* Amount Yield*
------ ------ ------ ------ ------ ------
State and municipal.................. $ 733 7.9% $ 1,943 8.1% $ 960 6.3%
Mortgage-Backed
Due After Ten Years Securities Total
------------------- ------------ -----
Amount Yield* Amount Yield* Amount Yield*
------ ------ ------ ------ ------ ------
State and municipal.................. $ 7,973 7.0% $11,609 7.2%
Other asset-backed securities........ $ 30 8.4% 30 8.4
------- ------- -------
Total............................ $ 7,973 7.0% $ 30 8.4% $11,639 7.2%
======= ======= =======
*Interest yields on state and municipal securities are presented on a fully
taxable equivalent basis using a 35% rate.
Page 15
STATISTICAL DATA (continued)
Federal Reserve and Federal Home Loan Bank stock at December 31, 2005:
(Dollars in Thousands)
Amount Yield
Federal Reserve Bank Stock........... $ 8,913 6.0%
Federal Home Loan Bank stock......... 14,287 4.3
-------
Total............................ $23,200 4.9%
=======
The following tables show the Corporation's gross unrealized losses and fair
value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2005 and 2004:
Less than 12 12 Months or Total
Months Longer
---------------------------------------------------------------------------
GROSS GROSS GROSS
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
---------------------------------------------------------------------------
(Dollars in Thousands)
Temporarily impaired investment
securities at December 31, 2005:
U.S. Treasury ........................................ $ 1,487 $ (1) $ 1,487 $ (1)
U.S. Government-sponsored agency securities........... 31,692 (581) $ 45,466 $ (1,255) 77,158 (1,836)
State and municipal .................................. 90,905 (1,501) 2,124 (42) 93,029 (1,543)
Mortgage-backed securities ........................... 59,595 (1,511) 96,120 (4,141) 155,715 (5,652)
Marketable equity securities.......................... 27 (8) 1,072 (431) 1,099 (439)
---------- ---------- ---------- ---------- ---------- ----------
Total temporarily impaired investment securities .. $ 183,706 $ (3,602) $ 144,782 $ (5,869) $328,488 $ (9,471)
========== ========== ========== ========== ========== ==========
Less than 12 12 Months or Total
Months Longer
---------------------------------------------------------------------------
GROSS GROSS GROSS
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
---------------------------------------------------------------------------
(Dollars in Thousands)
Temporarily impaired investment
securities at December 31, 2004:
U.S. Treasury ........................................ $ 1,496 $ (1) $ 1,496 $ (1)
U.S. Government-sponsored agency securities........... 46,227 (303) $ 1,472 $ (29) 47,699 (332)
State and municipal .................................. 2,976 (20) 1,094 (62) 4,070 (82)
Mortgage-backed securities ........................... 109,213 (1,129) 27,493 (851) 136,706 (1,980)
---------- ---------- ---------- ---------- ---------- ----------
Total temporarily impaired investment securities .. $ 159,912 $ (1,453) $ 30,059 $ (942) $189,971 $ (2,395)
========== ========== ========== ========== ========== ==========
Page 16
STATISTICAL DATA (continued)
LOAN PORTFOLIO
TYPES OF LOANS
The loan portfolio at the dates indicated is presented below:
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(Dollars in Thousands)
Loans at December 31:
Commercial and industrial loans.............. $ 461,102 $ 451,227 $ 435,221 $ 401,395 $ 301,962
Agricultural production
financing and other loans to farmers....... 95,130 98,902 95,048 85,059 29,645
Real estate loans:
Construction............................... 174,783 164,738 149,865 133,896 58,316
Commercial and farmland.................... 734,865 709,163 564,578 401,561 230,233
Residential................................ 751,217 761,163 866,477 746,349 544,028
Individuals' loans for
household and other personal expenditures.. 200,139 198,532 196,093 206,083 179,325
Tax-exempt loans............................. 8,263 8,203 16,363 12,615 7,277
Lease financing receivibles,
net of unearned income .................... 8,713 11,311 7,919 5,249
Other loans.................................. 23,215 24,812 21,939 12,170 8,800
---------- ---------- ---------- ---------- ----------
Total loans........................ $2,457,427 $2,428,051 $2,353,503 $2,004,377 $1,359,586
========== ========== ========== ========== ==========
Residential Real Estate Loans Held for Sale at December 31, 2005, 2004, 2003,
2002 and 2001 were $4,910,000, $3,367,000, $3,043,000, $21,545,000, and
$307,000.
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
Presented in the table below are the maturities of loans (excluding residential
real estate, individuals' loans for household and other personal expenditures
and lease financing) outstanding as of December 31, 2005. Also presented are the
amounts due after one year classified according to the sensitivity to changes in
interest rates.
Maturing
Within 1-5 Over
1 Year Years 5 Years Total
-------------- --------------- -------------- ------------
(Dollars in Thousands)
Commercial and industrial loans................ $ 296,921 $ 100,558 $ 63,623 $ 461,102
Agricultural production financing
and other loans to farmers................... 79,693 11,343 4,094 95,130
Real estate - Construction..................... 135,165 33,906 5,712 174,783
Real estate - Commercial and farmland.......... 358,951 314,272 61,642 734,865
Tax-exempt loans............................... 1,539 1,788 4,936 8,263
Other loans.................................... 12,384 10,551 280 23,215
---------- --------- --------- ----------
Total.................................... $ 884,653 $ 472,418 $140,287 $1,497,358
========== ========= ========= ==========
Page 17
STATISTICAL DATA (continued)
Maturing
---------------------------------------------------
1 - 5 Over
Years 5 Years
----- -------
(Dollars in Thousands)
Loans maturing after one year with:
Fixed rate.............................. $ 118,119 $ 94,083
Variable rate........................... 354,299 46,204
------------- ------------
Total................................. $ 472,418 $ 140,287
============= ============
NONACCRUING, CONTRACTUALLY PAST DUE 90 DAYS OR MORE
OTHER THAN NONACCRUING AND RESTRUCTURED LOANS
December 31
---------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(Dollars in Thousands)
Nonaccruing loans......................... $10,030 $15,355 $19,453 $14,134 $6,327
Loans contractually past due 90
days or more other than
nonaccruing............................. 3,965 1,907 6,530 6,676 4,828
Restructured loans........................ 310 2,019 641 2,508 3,511
------- ------- ------- ------- -------
$14,305 $19,281 $26,624 $23,318 $14,666
======= ======= ======= ======= =======
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 $788,000 for the year ended December 31, 2005, was recognized
on the nonaccruing and restructured loans listed in the table above, whereas
interest income of $1,074,000 would have been recognized under their original
loan terms.
Potential problem loans:
Management has identified certain other loans totaling $64,494,000 as of
December 31, 2005, not included in the table above, or the impaired loan table
in the footnotes to the consolidated financial statements, about which there are
doubts as to the borrowers' ability to comply with present repayment terms.
The Corporation's affiliate banks generate commercial, mortgage and consumer
loans from customers located primarily in north-central and east-central Indiana
and Butler, Franklin and Hamilton counties in Ohio. The Banks' loans are
generally secured by specific items of collateral, including real property,
consumer assets, and business assets.
Page 18
STATISTICAL DATA (continued)
----------------
SUMMARY OF LOAN LOSS EXPERIENCE
The following table summarizes the loan loss experience for the years indicated.
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(Dollars in Thousands)
Allowance for loan losses:
Balance at January 1.................... $ 22,548 $ 25,493 $ 22,417 $ 15,141 $ 12,454
Chargeoffs:
Commercial and industrial(1)........... 3,763 7,455 5,023 4,711 1,688
Real estate mortgage(3)................ 2,117 1,588 2,111 800 227
Individuals' loans for household and
other personal expenditures,
including other loans................ 1,864 1,858 5,005 2,602 1,632
-------- -------- -------- -------- --------
Total chargeoffs..................... 7,744 10,901 12,139 8,113 3,547
-------- -------- -------- -------- --------
Recoveries:
Commercial and industrial(2)........... 1,283 1,629 1,002 549 176
Real estate mortgage(4)................ 122 161 421 92 32
Individuals' loans for household and
other personal expenditures,
including other loans................ 625 461 588 672 365
-------- -------- -------- -------- --------
Total recoveries..................... 2,030 2,251 2,011 1,313 573
-------- -------- -------- -------- --------
Net chargeoffs........................... 5,714 8,650 10,128 6,800 2,974
-------- -------- -------- -------- --------
Provisions for loan losses............... 8,354 5,705 9,477 7,174 3,576
Allowance acquired in purchase........... 3,727 6,902 2,085
-------- -------- -------- -------- --------
Balance at December 31................... $25,188 $22,548 $25,493 $22,417 $15,141
======== ======== ======== ======== ========
(1)Category also includes the chargeoffs for lease financing, loans to
financial institutions, tax-exempt loans and agricultural production
financing and other loans to farmers.
(2)Category also includes the recoveries for lease financing, loans to
financial institutions, tax-exempt loans and agricultural production
financing and other loans to farmers.
(3)Category includes the chargeoffs for construction, commercial and farmland
and residential real estate loans.
(4)Category includes the recoveries for construction, commercial and farmland
and residential real estate loans.
Ratio of net chargeoffs during the
period to average loans
outstanding during the period.......... .23% .37% .44% .37% .23%
Page 19
STATISTICAL DATA (continued)
----------------
The information regarding the analysis of loan loss experience on pages 9 and 10
of the First Merchants Corporation - Annual Report 2005 under the caption "ASSET
QUALITY/PROVISION FOR LOAN LOSSES" is expressly incorporated herein by
reference.
Allocation of the Allowance for Loan Losses at December 31:
Presented below is an analysis of the composition of the allowance for loan
losses and percent of loans in each category to total loans:
2005 2004
------------------------- -------------------------
Amount Per Cent Amount Per Cent
-------- -------- -------- --------
(Dollars in Thousands)
Balance at December 31:
Commercial and industrial(1)................ $ 7,430 31.0% $ 16,821 30.9%
Real estate mortgage(2)..................... 13,149 60.5 1,916 60.6
Individuals' loans for household and
other personal expenditures,
including other loans..................... 4,509 8.5 3,711 8.5
Unallocated................................. 100 N/A 100 N/A
-------- ------ -------- ------
Totals...................................... $ 25,188 100.0% $ 22,548 100.0%
======== ====== ======== ======
2003 2002
------------------------- -------------------------
Amount Per Cent Amount Per Cent
-------- -------- -------- --------
(Dollars in Thousands)
Balance at December 31:
Commercial and industrial(1)................ $ 17,517 29.9% $ 12,405 31.8%
Real estate mortgage(2)..................... 4,441 60.8 2,875 57.3
Individuals' loans for household and
other personal expenditures,
including other loans..................... 3,435 9.3 7,037 10.9
Unallocated................................. 100 N/A 100 N/A
-------- ------ -------- ------
Totals...................................... $ 25,493 100.0% $ 22,417 100.0%
======== ====== ======== ======
2001
-------------------------
Amount Per Cent
-------- --------
(Dollars in Thousands)
Balance at December 31:
Commercial and industrial(1)................ $ 6,884 29.2%
Real estate mortgage(2)..................... 2,655 56.9
Individuals' loans for household and
other personal expenditures,
including other loans..................... 5,502 13.9
Unallocated. .... .......................... 100 N/A
-------- ------
Totals...................................... $ 15,141 100.0%
======== ======
(1) Category also includes the allowance for loan losses and percent of
loans for lease financing, loans to financial institutions, tax-exempt
loans, agricultural production financing and other loans to farmers and
construction real estate loans.
(2) Category includes the allowance for loan losses and percent of loans for
commercial real estate, farmland and residential real estate loans.
At December 31, 2005, the Corporation had no concentration of loans exceeding 10
percent of total loans, which are not otherwise disclosed. Loan concentrations
are considered to exist when there are amounts loaned to a multiple number of
borrowers engaged in similar activities, which would cause them to be similarly
impacted by economic or other conditions.
Page 20
STATISTICAL DATA (continued)
----------------
Loan Administration and Loan Loss Chargeoff Procedures
Primary responsibility and accountability for day-to-day lending activities
rests with the Corporation's affiliate banks. Loan personnel at each bank have
the authority to extend credit under guidelines approved by the bank's board of
directors. Executive and board loan committees active at each bank serve as
vehicles for communication between the banks and for the pooling of knowledge,
judgment and experience of the Corporation's affiliate banks. These committees
provide valuable input to lending personnel, act as an approval body, and
monitor the overall quality of the banks' loan portfolios. The Corporation also
maintains a loan grading and review program for its affiliate banks, which
includes quarterly reviews of problem loans, delinquencies and charge-offs. The
purpose of this program is to evaluate loan administration, credit quality, loan
documentation and the adequacy of the allowance for loan losses.
The Corporation maintains an allowance for loan losses to cover probable credit
losses identified during its loan review process. The allowance is increased by
the provision for loan losses and decreased by charge-offs less recoveries. All
charge-offs are approved by the bank's 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:
2005 2004 2003
--------------- --------------- ---------------
(Dollars in Thousands)
As of, and for the year ending December 31:
Impaired loans with an allowance............................ $ 7,540 $ 7,728 $ 12,725
Impaired loans for which the discounted
cash flows or collateral value exceeds the
carrying value of the loan................................ 44,840 41,683 32,047
------------ ------------ ------------
Total impaired loans.................................. $ 52,380 $ 49,411 $ 44,772
============ ============ ============
Total impaired loans as a percent of total loans.............. 2.13% 2.03% 1.90%
Allowance for impaired loans (included in the
Corporation's allowance for loan losses).................. $ 2,824 $ 1,673 $ 5,728
Average balance of impaired loans........................... 44,790 59,568 50,245
Interest income recognized on impaired loans................ 3,747 4,166 3,259
Cash basis interest included above.......................... 3,951 3,029 2,714
Page 21
--------------------------------------------------------------------------------
STATISTICAL DATA (continued)
DEPOSITS
The average balances, interest income and expense and average rates on deposits
for the years ended December 2005, 2004 and 2003 are presented within the
"Distribution of Assets, Liabilities and Stockholders' Equity, Interest Rates
and Interest Differential" table on page 11 of this Form 10-K.
As of December 31, 2005, 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.......... $109,317 $ 33,338 $ 41,961 $ 92,063 $276,679
Per cent....................... 40% 12% 15% 33% 100%
RETURN ON EQUITY AND ASSETS
The information regarding return on equity and assets presented on page 2 of the
First Merchants Corporation - Annual Report 2005 under the caption "Five - Year
Summary of Selected Financial Data" is expressly incorporated herein by
reference.
SHORT-TERM BORROWINGS
2005 2004 2003
----------------- ----------------- -----------------
(Dollars in Thousands)
Balance at December 31:
Securities sold under repurchase
agreements (short-term portion)........ $ 106,415 $ 87,472 $ 71,095
Federal funds purchased.................. 50,000 32,550
--------- --------- ---------
Total short-term borrowings...... $ 156,415 $ 120,022 $ 71,095
========= ========= =========
Securities sold under repurchase agreements are borrowings maturing within one
year and are secured by U.S. Treasury and U.S. Government-sponsored agency
securities.
Pertinent information with respect to short-term borrowings is summarized below:
2005 2004 2003
----------------- ----------------- -----------------
(Dollars in Thousands)
Weighted average interest rate on outstanding
balance at December 31:
Securities sold under repurchase
agreements(short-term portion).............. 3.8% 1.8% 1.4%
Total short-term borrowings..................... 4.3 1.9 1.4
Weighted average interest rate during the year:
Securities sold under repurchase
agreements (short-term portion)............. 2.1% .8% .9%
Total short-term borrowings..................... 2.3 1.0 .9
Highest amount outstanding at any month end
during the year:
Securities sold under repurchase
agreements (short-term portion)............. $ 68,198 $ 37,771 $ 69,396
Total short-term borrowings..................... 144,898 120,019 113,618
Average amount outstanding during the year:
Securities sold under repurchase
agreements (short-term portion)............. $ 77,969 $ 62,702 $ 51,780
Total short-term borrowings..................... 95,447 81,194 59,719
Page 22
ITEM 1A. RISK FACTORS
--------------------------------------------------------------------------------
RISK FACTORS
There are a number of factors, including those specified below, that may
adversely affect the Corporation's business, financial results or stock price.
Additional risks that the Corporation currently does not know about or currently
views as immaterial may also impair the Corporation's business or adversely
impact its financial results or stock price.
INDUSTRY RISK FACTORS
* The Corporation's business and financial results are significantly affected
by general business and economic conditions.
The Corporation's business activities and earnings are affected by general
business conditions in the United States and abroad. These conditions include
short-term and long-term interest rates, inflation, monetary supply,
fluctuations in both debt and equity capital markets, and the strength of the
United States economy and the state and local economies in which the Corporation
operates. For example, an economic downturn, an increase in unemployment, or
other events that affect household and/or corporate incomes could result in a
deterioration of credit quality, a change in the allowance for loan losses, or
reduced demand for loan or fee-based products and services. Changes in the
financial performance and condition of the Corporation's borrowers could
negatively affect repayment of those borrowers' loans. In addition, changes in
securities market conditions and monetary fluctuations could adversely affect
the availability and terms of funding necessary to meet the Corporation's
liquidity needs.
* Changes in the domestic interest rate environment could reduce the
Corporation's net interest income.
The operations of financial institutions such as the Corporation are dependent
to a large degree on net interest income, which is the difference between
interest income from loans and investments and interest expense on deposits and
borrowings. An institution's net interest income is significantly affected by
market rates of interest, which in turn are affected by prevailing economic
conditions, by the fiscal and monetary policies of the federal government and by
the policies of various regulatory agencies. Like all financial institutions,
the Corporation's balance sheet is affected by fluctuations in interest rates.
Volatility in interest rates can also result in the flow of funds away from
financial institutions into direct investments. Direct investments, such as U.S.
Government and corporate securities and other investment vehicles (including
mutual funds) generally pay higher rates of return than financial institutions,
because of the absence of federal insurance premiums and reserve requirements.
* Changes in the laws, regulations and policies governing banks and financial
services companies could alter the Corporation's business environment and
adversely affect operations.
The Board of Governors of the Federal Reserve System regulates the supply of
money and credit in the United States. Its fiscal and monetary policies
determine in a large part the Corporation's cost of funds for lending and
investing and the return that can be earned on those loans and investments, both
of which affect the Corporation's net interest margin. Federal Reserve Board
policies can also materially affect the value of financial instruments that the
Corporation holds, such as debt securities. The Corporation and its bank
subsidiaries are heavily regulated at the federal and state levels. This
regulation is to protect depositors, federal deposit insurance funds and the
banking system as a whole. Congress and state legislatures and federal and state
agencies continually review banking laws, regulations and policies for possible
changes. Changes in statutes, regulations or policies could affect the
Corporation in substantial and unpredictable ways, including limiting the types
of financial services and products that the Corporation offers and/or increasing
the ability of non-banks to offer competing financial services and products. The
Corporation cannot predict whether any of this potential legislation will be
enacted, and if enacted, the effect that it or any regulations would have on the
Corporation's financial condition or results of operations.
* The banking and financial services industry is highly competitive, and
competitive pressures could intensify and adversely affect the Corporation's
financial results.
The Corporation operates in a highly competitive industry that could become even
more competitive as a result of legislative, regulatory and technological
changes and continued consolidation. The Corporation competes with other banks,
savings and loan associations, mutual savings banks, finance companies, mortgage
banking companies, credit unions and investment companies. In addition,
technology has lowered barriers to entry and made it possible for non-banks to
offer products and services traditionally provided by banks. Many of the
Corporation's competitors have fewer regulatory constraints and some have lower
cost structures. Also, the potential need to adapt to industry changes in
information technology systems, on which the Corporation and financial services
industry are highly dependent, could present operational issues and require
capital spending.
Page 23
* Acts or threats of terrorism and political or military actions taken by the
United States or other governments could adversely affect general economic or
industry conditions.
Geopolitical conditions may also affect the Corporation's earnings. Acts or
threats or terrorism and political or military actions taken by the United
States or other governments in response to terrorism, or similar activity, could
adversely affect general economic or industry conditions.
CORPORATION RISK FACTORS
* The Corporation's allowance for loan losses may not be adequate to cover
actual losses.
The Corporation maintains an allowance for loan losses to provide for loan
defaults and non-performance. The allowance for loan losses represents
management's estimate of probable losses inherent in the Corporation's loan
portfolio. The Corporation's allowance consists of three components: probable
losses estimated from individual reviews of specific loans, probable losses
estimated from historical loss rates, and probable losses resulting from
economic, environmental, qualitative or other deterioration above and beyond
what is reflected in the first two components of the allowance. The process for
determining the adequacy of the allowance for loan losses is critical to our
financial results. It requires management to make difficult, subjective and
complex judgments, as a result of the need to make estimates about the effect of
matters that are uncertain. Therefore, the allowance for loan losses,
considering current factors at the time, including economic conditions and
ongoing internal and external examination processes, will increase or decrease
as deemed necessary to ensure the allowance for loan losses remains adequate. In
addition, the allowance as a percentage of charge-offs and nonperforming loans
will change at different points in time based on credit performance, loan mix
and collateral values.
* The Corporation may suffer losses in its loan portfolio despite its
underwriting practices.
The Corporation seeks to mitigate the risks inherent in its loan portfolio by
adhering to specific underwriting practices. The Corporation's strategy for
credit risk management includes conservative credit policies and underwriting
criteria for all loans, as well as an overall credit limit for each customer
significantly below legal lending limits. The strategy also emphasizes
diversification on a geographic, industry and customer level, regular credit
quality reviews and management reviews of large credit exposures and loans
experiencing deterioration of credit quality. There is a continuous review of
the loan portfolio, including an internally administered loan "watch" list and
an independent loan review. The evaluation takes into consideration identified
credit problems, as well as the possibility of losses inherent in the loan
portfolio that are not specifically identified. Although the Corporation
believes that its underwriting criteria are appropriate for the various kinds of
loans it makes, the Corporation may incur losses on loans due to the factors
previously discussed.
* Because the nature of the financial services business involves a high volume
of transactions, the Corporation faces significant operational risks.
The Corporation operates in diverse markets and relies on the ability of its
employees and systems to process a high number of transactions. Operational risk
is the risk of loss resulting from the Corporation's operations, including, but
not limited to, the risk of fraud by employees or persons outside of the
Corporation, the execution of unauthorized transactions by employees, errors
relating to transaction processing and technology, breaches of the internal
control system and compliance requirements and business continuation and
disaster recovery. This risk of loss also includes the potential legal actions
that could arise as a result of an operational deficiency or as a result of
noncompliance with applicable regulatory standards, adverse business decisions
or their implementation, and customer attrition due to potential negative
publicity. In the event of a breakdown in the internal control system, improper
operation of systems or improper employee actions, the Corporation could suffer
financial loss, face regulatory action and suffer damage to its reputation.
Page 24
* A natural disaster could harm the Corporation's business.
Natural disasters could harm the Corporation's operations directly through
interference with communications, as well as through the destruction of
facilities and operational, financial and management information systems. These
events could prevent the Corporation from gathering deposits, originating loans
and processing and controlling its flow of business.
* The Corporation faces systems failure risks as well as security risks,
including "hacking" and "identity theft."
The computer systems and network infrastructure the Corporation uses could be
vulnerable to unforeseen problems. Our operations are dependent upon our ability
to protect computer equipment against damage from fire, power loss or
telecommunication failure. Any damage or failure that causes an interruption in
our operations could adversely affect our business and financial results. In
addition, our computer systems and network infrastructure present security
risks, and could be susceptible to hacking or identity theft.
* The Corporation relies on dividends from its subsidiaries for its liquidity
needs.
The Corporation is a separate and distinct legal entity from its bank and
non-bank subsidiaries. The Corporation receives substantially all of its cash
from dividends paid by its subsidiaries. These dividends are the principal
source of funds to pay dividends on the Corporation's stock and interest and
principal on its debt. Various federal and state laws and regulations limit the
amount of dividends that our bank subsidiaries may pay to the Corporation.
* The Corporation's reported financial results depend on management's selection
of accounting methods and certain assumptions and estimates.
The Corporation's accounting policies and methods are fundamental to how it
records and reports its financial condition and results of operations. The
Corporation's management must exercise judgment in selecting and applying many
of these accounting policies and methods, so they comply with Generally Accepted
Accounting Principles and reflect management's judgment of the most appropriate
manner to report the Corporation's financial condition and results. In some
cases, management must select the accounting policy or method to apply from two
or more alternatives, any of which might be reasonable under the circumstances
yet might result in the Corporation's reporting materially different results
than would have been reported under a different alternative. Certain accounting
policies are critical to presenting the Corporation's financial condition and
results, and require management to make difficult, subjective or complex
judgments about matters that are uncertain. Materially different amounts could
be reported under different conditions or using different assumptions or
estimates. These critical accounting policies include: the allowance for loan
losses; the valuation of investment securities; the valuation of goodwill and
intangible assets; and pension accounting. Because of the uncertainty of
estimates involved in these matters, the Corporation may be required to do one
or more of the following: significantly increase the allowance for loan losses
and/or sustain loan losses that are significantly higher than the reserve
provided; recognize significant provision for impairment of its investment
securities; recognize significant impairment on its goodwill and intangible
assets; or significantly increase its pension liability. For more information,
refer to pages 3 through 6 of the First Merchants Corporation - Annual Report
2005 under the caption "Critical Accounting Policies."
* Changes in accounting standards could materially impact the Corporation's
financial statements.
From time to time, the Financial Accounting Standards Board changes the
financial accounting and reporting standards that govern the preparation of the
Corporation's financial statements. These changes can be hard to predict and can
materially impact how the Corporation records and reports its financial
condition and results of operations. In some cases, the Corporation could be
required to apply a new or revised standard retroactively, resulting in the
Corporation's restating prior period financial statements.
Page 25
* Significant legal actions could subject the Corporation to substantial
uninsured liabilities.
The Corporation is from time to time subject to claims related to its
operations. These claims and legal actions, including supervisory actions by the
Corporation's regulators, could involve large monetary claims and significant
defense costs. To protect itself from the cost of these claims, the Corporation
maintains insurance coverage in amounts and with deductibles that it believes
are appropriate for its operations. However, the Corporation's insurance
coverage may not cover all claims against the Corporation or continue to be
available to the Corporation at a reasonable cost. As a result, the Corporation
may be exposed to substantial uninsured liabilities, which could adversely
affect the Corporation's results of operations and financial condition.
* Negative publicity could damage the Corporation's reputation and adversely
impact its business and financial results.
Reputation risk, or the risk to the Corporation's earnings and capital from
negative publicity, is inherent in the Corporation's business. Negative
publicity can result from the Corporation's actual or alleged conduct in any
number of activities, including lending practices, corporate governance and
acquisitions, and actions taken by government regulators and community
organizations in response to those activities. Negative publicity can adversely
affect the Corporation's ability to keep and attract customers and can expose
the Corporation to litigation and regulatory action. Although the Corporation
takes steps to minimize reputation risk in dealing with customers and other
constituencies, the Corporation is inherently exposed to this risk.
* Acquisitions may not produce revenue enhancements or cost savings at levels
or within timeframes originally anticipated and may result in unforeseen
integration difficulties.
The Corporation regularly explores opportunities to acquire banks, financial
institutions, or other financial services businesses or assets. The Corporation
cannot predict the number, size or timing of acquisitions. Difficulty in
integrating an acquired business or company may cause the Corporation not to
realize expected revenue increases, cost savings, increases in geographic or
product presence, and/or other projected benefits from the acquisition. The
integration could result in higher than expected deposit attrition (run-off),
loss of key employees, disruption of the Corporation's business or the business
of the acquired company, or otherwise adversely affect the Corporation's ability
to maintain relationships with customers and employees or achieve the
anticipated benefits of the acquisition. Also, the negative effect of any
divestitures required by regulatory authorities in acquisitions or business
combinations may be greater than expected.
* The Corporation's stock price can be volatile.
The Corporation's stock price can fluctuate widely in response to a variety of
factors, including: actual or anticipated variations in the Corporation's
quarterly operating results; recommendations by securities analysts; significant
acquisitions or business combinations; strategic partnerships, joint ventures or
capital commitments; operating and stock price performance of other companies
that investors deem comparable to the Corporation; new technology used or
services offered by the Corporation's competitors; news reports relating to
trends, concerns and other issues in the banking and financial services
industry, and changes in government regulations. General market fluctuations,
industry factors and general economic and political conditions and events,
including terrorist attacks, economic slowdowns or recessions, interest rate
changes, credit loss trends or currency fluctuations, could also cause the
Corporation's stock price to decrease, regardless of the Corporation's operating
results.
ITEM 1B. UNRESOLVED STAFF COMMENTS
--------------------------------------------------------------------------------
None.
Page 26
ITEM 2. PROPERTIES.
--------------------------------------------------------------------------------
The headquarters of the Corporation and First Merchants are located in a
five-story building at 200 East Jackson Street, Muncie, Indiana. The building is
owned by First Merchants.
The Corporation's affiliate banks conduct business through numerous facilities
owned and leased by the respective affiliate banks. Of the 65 banking offices
operated by the Corporation's affiliate banks, 51 are owned by the respective
banks and 14 are leased from non-affiliated third parties.
None of the properties owned by the Corporation's affiliate banks are subject to
any major encumbrances. The net investment of the Corporation and subsidiaries
in real estate and equipment at December 31, 2005 was $39,417,000.
ITEM 3. LEGAL PROCEEDINGS.
--------------------------------------------------------------------------------
There is no pending legal proceeding, other than ordinary routine litigation
incidental to the business of the Corporation or its subsidiaries, of a material
nature to which the Corporation or its subsidiaries is a party or of which any
of their properties are subject. Further, there is no material legal proceeding
in which any director, officer, principal shareholder, or affiliate of the
Corporation, or any associate of any such director, officer or principal
shareholder, is a party, or has a material interest, adverse to the Corporation
or any of its subsidiaries.
None of the routine legal proceedings, individually or in the aggregate, in
which the Corporation or its affiliates are involved are expected to have a
material adverse impact on the financial position or the results of operations
of the Corporation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
--------------------------------------------------------------------------------
No matters were submitted during the fourth quarter of 2005 to a vote of
security holders, through the solicitation of proxies or otherwise.
Page 27
SUPPLEMENTAL INFORMATION - EXECUTIVE OFFICERS OF THE REGISTRANT.
--------------------------------------------------------------------------------
The names, ages, and positions with the Corporation and subsidiary banks of all
executive officers of the Corporation and all persons chosen to become executive
officers are listed below. The officers are elected by the Board of Directors of
the Corporation for a term of one (1) year or until the election of their
successors. There are no arrangements between any officer and any other person
pursuant to which he was selected as an officer.
Offices with the Corporation Principal Occupation
Name and Age And Subsidiary Banks During Past Five Years
------------------------------------------- ---------------------------------------- ----------------------------------------
Michael L. Cox President, Chief Executive Officer, Chief Executive Officer of the Corporation
61 Corporation since April 1999; President First Merchants
from April 1999 to September 2000; President
and Chief Operating Officer, Corporation since
August 1998 and from May 1994 to April 1999
respectively; President and Chief Operating
Officer, First Merchants from April, 1996 to
April 1999; Director, Corporation and First
Merchants since December, 1984.
Michael C. Rechin Executive Vice President and Chief Executive Vice President and Chief Operating
47 Operating Officer, Corporation Officer, Corporation since November 2005;
Executive Vice President, Corporate Banking
National City Bank from 1995 to November 2005.
Mark K. Hardwick Executive Vice President and Chief Executive Vice President and Chief Financial
35 Financial Officer, Corporation Officer of the Corporation since December 2005;
Senior Vice President and Chief Financial
Officer from April 2002 to December 2005;
Corporate Controller, Corporation from November
1997 to April 2002.
Robert R. Connors Senior Vice President, Chief Senior Vice President and Chief Information
56 Information Officer, Corporation Officer of the Corporation and First Merchants
and First Merchants since January 2006; Senior Vice President of
Operations and Technology, Corporation and
First Merchants from August 2002 to January
2006; Senior Vice President of Operations and
Compliance Officer at First Internet Bank of
Indiana from 1999 to 2002.
Shawn R. Blackburn Senior Vice President of Senior Vice President of Administrative
52 Administrative Services, Corporation Services, Corporation since May 2005; Senior
National Bank Examiner, Office of Comptroller
of the Currency from 1978 to 2005.
Kimberly J. Ellington Senior Vice President and Director of Senior Vice President and Director of Human
46 Human Resources, Corporation Resources since 2004; Vice President and
Director of Human Resources, Corporation from
1999 to 2004.
Jeffrey B. Lorentson First Vice President and Corporate First Vice President and Corporate Controller,
42 Controller, Corporation Corporation since March 2003; Vice President
and Corporate Controller, Corporation from
April 2002 to March 2003; Senior Manager, Ernst
& Young, LLP from 1998 to 2002.
Page 28
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
--------------------------------------------------------------------------------
The information on pages 52 and 53 of the First Merchants Corporation - Annual
Report 2005 under the captions "Annual Meeting, Stock Price and Dividend
Information" and "Common Stock Listing", is expressly incorporated herein by
reference.
The following table presents information relating to the Corporation's purchases
of its equity securities during the quarter ended December 31, 2005, as
follows(1):
MAXIMUM NUMBER OF
TOTAL NUMBER OF SHARES THAT MAY YET
TOTAL NUMBER OF AVERAGE PRICE SHARES PURCHASED AS PART BE PURCHASED UNDER
PERIOD SHARES PURCHASED PAID PER SHARE OF BOARD AUTHORIZATION(1) BOARD AUTHORIZATION(1)
------ ---------------- -------------- ------------------------- -----------------------
October 1-31, 2005 0 0 0 0
November 1-30, 2005 105,000(2) 25.60 0 0
December 1-31, 2005 0 0 0 0
(1) On February 8, 2005, the Corporation's Board authorized management to
repurchase up to 250,000 shares of the Corporation's Common Stock. On June 14,
2005 and August 9, 2005, the Corporation's Board authorized management to
repurchase addtional shares of the Corporation's Common Stock, totaling 6,500
and 243,500 shares, respectively. These authorizations were not publicly
announced and expire February 14, 2006. There were 138,500 remaining shares that
may yet be purchased pursuant to such authorizations as of December 31, 2005.
(2) These shares were purchased in open-market transactions pursuant to the
Board's authorization to repurchase shares.
The following table presents information relating to securities authorized under
equity compensation plans.
Equity Compensation Plan Information
Number of securities to Weighted-average Number of securities remaining
be issued upon exercise exercise price of available for future issuance under
of outstanding options, outstanding options, equity compensations plans (excluding
Plan category warrants and rights warrants and rights securities reflected in first column)
------------- ----------------------- -------------------- -------------------------------------
Equity compensation plans approved
by stockholders 1,060,108 $ 23.37 400,000 (1)
Equity compensation plans not
approved by stockholders(2) 44,679 21.18
----------------------- -------------------- -------------------------------------
Total 1,104,787 $ 23.28 400,000 (1)
======================= ==================== =====================================
(1) This number does not include shares remaining available for future issuance
under the 1999 Long-term Equity Incentive Plan, which was approved by the
Corporation's shareholders at the 1999 annual meeting. The aggregate number of
shares that are available for grants under that Plan in any calendar year is
equal to the sum of: (a) 1% of the number of common shares of the Corporation
outstanding as of the last day of the preceding calendar year; plus (b) the
number of shares that were available for grants, but not granted, under the Plan
in any previous year; but in no event will the number of shares available for
grants in any calendar year exceed 1 1/2% of the number of common shares of the
Corporation outstanding as of the last day of the preceding calendar year. The
1999 Long-term Equity Incentive Plan will expire in 2009.
(2) The only plan reflected above that was not approved by the Corporation's
stockholders relates to certain First Merchants Corporation Stock Option
Agreements ("Agreements"). These Agreements provided for non-qualified stock
options of the common stock of the Corporation, awarded between 1995 and 2002
to each director of First Merchants Bank, National Association (the "Bank") who,
on the date of the grants: (a) were serving as a director of the Bank; (b) were
not an employee of the Corporation, the Bank, or any of the Corporation's other
affiliated banks or non-bank subsidiaries; and (c) were not serving as a
director of the Corporation. The exercise price of the shares was equal to the
fair market value of the shares upon the grant of the option. Options became 100
percent vested when granted and are fully exercisable six months after the date
of the grant, for a period of ten years.
Page 29
ITEM 6. SELECTED FINANCIAL DATA.
--------------------------------------------------------------------------------
The information on page 2 of the First Merchants Corporation - Annual Report
2005 under the caption "Five-Year Summary of Selected Financial Data", is
expressly incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
--------------------------------------------------------------------------------
The information on pages 3 through 18 of the First Merchants Corporation -
Annual Report 2005 under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations", is expressly incorporated herein
by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
--------------------------------------------------------------------------------
The information on pages 12 through 14 of the First Merchants Corporation -
Annual Report 2005 under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" within the section "Interest
Sensitivity and Disclosures About Market Risk", is expressly incorporated herein
by reference.
Page 30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
--------------------------------------------------------------------------------
Pages 19 through 51 of the First Merchants Corporation - Annual Report 2005, are
expressly incorporated herein by reference.
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, 2005, there have been no disagreements with the Corporation's
independent registered public accounting firm on any matter of accounting
principles or practices, financial statement disclosure or audit scope or
procedure, nor have there been any changes in accountants.
ITEM 9A. CONTROLS AND PROCEDURES
--------------------------------------------------------------------------------
At the end of the period covered by this report (the "Evaluation Date"), the
Corporation carried out an evaluation, under the supervision and with the
participation of the Corporation's management, including the Corporation's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of it's disclosure controls and procedures pursuant to Rule
13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934 ("Exchange Act").
Based upon that evaluation, the Corporation's Chief Executive Officer and Chief
Financial Officer concluded that, as of the Evaluation Date, the Corporation's
disclosure controls and procedures are effective. Disclosure controls and
procedures are controls and procedures that are designed to ensure that
information required to be disclosed in Corporation reports filed or submitted
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission's rules and
forms.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Corporation is responsible for establishing and maintaining
effective internal control over financial reporting as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934. The Corporation's internal
control over financial reporting is designed to provide reasonable assurance to
the Corporation's management and board of directors regarding the preparation
and fair presentation of published financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Accordingly, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.
Management assessed the effectiveness of the Corporation's internal control over
financial reporting as of December 31, 2005. In making this assessment,
management used the criteria set forth in "Internal Control - Integrated
Framework" issued by the Committee of Sponsoring Organizations (COSO) of the
Treadway Commission. Based on this assessment, management has determined that
the Corporation's internal control over financial reporting as of December 31,
2005 is effective based on the specified criteria.
Management's assessment of the effectiveness of internal control over financial
reporting as of December 31, 2005 has been audited by BKD, LLP, an independent
registered public accounting firm, as stated in their report, which appears
on the next page.
There have been no changes in the Corporation's internal controls over financial
reporting identified in connection with the evaluation referenced above that
occurred during the Corporation's last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Corporation's
internal control over financial reporting.
Page 31
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee, Board of Directors and Stockholders
First Merchants Corporation
Muncie, Indiana
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that First
Merchants Corporation maintained effective internal control over financial
reporting as of December 31, 2005, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Corporation's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Corporation's internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit includes obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control and performing such
other procedures as we consider necessary in the circumstances. We believe that
our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that First Merchants Corporation
maintained effective internal control over financial reporting as of December
31, 2005, is fairly stated, in all material respects, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Also in our
opinion, First Merchants Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2005,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of First Merchants Corporation and our report dated January 27, 2006,
expressed an unqualified opinion thereon.
BKD, LLP
Indianapolis, Indiana
January 27, 2006
ITEM 9B. OTHER INFORMATION
--------------------------------------------------------------------------------
None
Page 32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
--------------------------------------------------------------------------------
The information in the Corporation's Proxy Statement dated March 2, 2006
furnished to its stockholders in connection with an annual meeting to be held
April 13, 2006 (the "2006 Proxy Statement"), under the captions "ELECTION OF
DIRECTORS", "COMMITTEES OF THE BOARD" and "SECTION 16(A) BENEFICIAL OWNERSHIP
REPORTING COMPLIANCE", is expressly incorporated herein by reference. The
information required under this item relating to executive officers is set forth
in Part I, "Supplemental Information - Executive Officers of the Registrant" of
this annual report on Form 10-K and is expressly incorporated herein by
reference.
The Corporation has adopted a Code of Ethics that applies to its Chief Executive
Officer, Chief Operating Officer, Chief Financial Officer, Controller and
Treasurer. It is part of the Corporation's Code of Business Conduct, which
applies to all employees and directors of the Corporation and its affiliates. A
copy of the Code of Ethics may be obtained, free of charge, by writing to First
Merchants Corporation at 200 East Jackson Street, Muncie, IN 47305. In addition,
the Code of Ethics is maintained on the Corporation's web site, which can be
accessed at http://www.firstmerchants.com.
ITEM 11. EXECUTIVE COMPENSATION.
--------------------------------------------------------------------------------
The information in the Corporation's 2006 Proxy Statement, under the captions,
"COMPENSATION OF DIRECTORS", "COMPENSATION OF EXECUTIVE OFFICERS", "COMMITTEES
OF THE BOARD-Compensation and Human Resources Committee Interlocks and Insider
Participation" and "PERFORMANCE GRAPH" is expressly incorporated herein by
reference.
Page 33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
--------------------------------------------------------------------------------
The information in the Corporation's 2006 Proxy Statement, under the caption,
"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" is expressly
incorporated herein by reference. The information required under this item
relating to equity compensation plans is set forth in Part II, Item 5 of this
annual report on Form 10-K under the table entitled "Equity Compensation Plan
Information" and is expressly incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
--------------------------------------------------------------------------------
The information in the Corporation's 2006 Proxy Statement, under the caption
"INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS," is expressly incorporated
herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
--------------------------------------------------------------------------------
The information in the Corporation's 2006 Proxy Statement, under the caption
"INDEPENDENT PUBLIC ACCOUNTANTS", is expressly incorporated herein by reference.
Page 34
PART IV
ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS.
--------------------------------------------------------------------------------
(a) 1. Financial Statements:
Independent accountants' report
Consolidated balance sheets at
December 31, 2005 and 2004
Consolidated statements of income,
years ended December 31, 2005,
2004 and 2003
Consolidated statements of comprehensive income,
years ended December 31, 2005, 2004 and 2003
Consolidated statements of stockholders' equity,
years ended December 31, 2005, 2004 and 2003
Consolidated statements of cash flows,
years ended December 31, 2005,
2004 and 2003
Notes to consolidated financial
statements
(a) 2. Financial statement schedules:
All schedules are omitted because
they are not applicable or not required,
or because the required information is included in the
consolidated financial statements or related notes.
(a) 3. Exhibits:
Exhibit No: Description of Exhibits:
----------- ------------------------
3a First Merchants Corporation Articles of Incorporation.
(Incorporated by reference to registrant's Form 10-Q for quarter
ended June 30, 1999)
3b Bylaws of First Merchants Corporation (Incorporated by reference
to registrant's Form 10-K for year ended December 31, 2004)
4.1 Certificate of Trust of First Merchants Capital Trust I dated
December 12, 2001 (3)
4.2 Amended and Restated Trust Agreement of First Merchants Capital
Trust I dated April 17, 2002 (3)
4.3 Agreement as to Expenses and Liabilities dated April 17, 2002 (3)
4.4 Cumulative Trust Preferred Security Certificate (3)
4.5 Preferred Securities Guarantee Agreement dated April 17, 2002 (3)
4.6 Indenture dated April 17, 2002 (3)
4.7 First Supplemental Indenture dated April 17, 2002 (3)
4.8 8.75% Junior Subordinated Debenture due June 30, 2002 (3)
Page 35
ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS (continued)
--------------------------------------------------------------------------------
10a First Merchants Corporation Senior Management Incentive
Compensation Program, as amended. (Incorporated by reference
to the registrant's Form 10-Q for the quarter ended June 30,
2005)(1)
10b First Merchants Corporation 1994 Stock Option Plan.
(Incorporated by reference to registrant's Form 10-K for year
ended December 31, 1993)(1)
10c First Merchants Corporation Change of Control Agreement, as
amended, with Mark K. Hardwick dated February 14, 2006.
(Incorporated by reference to registrant's Form 8-K filed on
March 9, 2006)(1)
10d First Merchants Corporation Change of Control Agreement with
Michael C. Rechin dated December 13, 2005. (Incorporated by
reference to registrant's Form 8-K filed on December 19,
2005)(1)
10e First Merchants Corporation Change of Control Agreement with
Shawn R. Blackburn dated May 2, 2005. (Incorporated by
reference to registrant's Form 8-K filed on May 4, 2005)(1)
10f First Merchants Corporation Change of Control Agreement with
Robert R. Connors dated August 26, 2002. (Incorporated by
reference to registrant's Form 10-Q for quarter ended
September 30, 2002)(1)
10g First Merchants Corporation Change of Control Agreement with
Michael L. Cox dated February 11, 2003. (Incorporated by
reference to registrant's Form 10-Q for quarter ended March
31, 2003)(1)
10h First Merchants Corporation Change of Control Agreement with
Kimberly J. Ellington dated January 1, 2005.(2)
10i First Merchants Corporation Change of Control Agreement with
Jeffrey B. Lorentson dated January 1, 2004.(2)
10j First Merchants Corporation Supplemental Executive Retirement
Plan and amendments thereto. (Incorporated by reference to
registrant's Form 10-K for year ended December 31, 1997)(1)
10k First Merchants Corporation 1999 Long-Term Equity Incentive
Plan, as amended. (Incorporated by reference to registrant's
Form 10-Q for quarter ended September 30, 2004) (1)
13 First Merchants Corporation - Annual Report 2005 (except
for the pages and information expressly incorporated by
reference in this Form 10-K, the First Merchants Corporation
- Annual Report 2005 is provided solely for the information
of the Securities and Exchange Commission and is not
deemed "filed" as part of this Form 10-K)(2)
21 Subsidiaries of Registrant(2)
23 Consent of Independent Registered Public Accounting Firm(2)
24 Limited Power of Attorney(2)
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes - Oxley Act of 2002(2)
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes - Oxley Act of 2002(2)
32 Certifications Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002(2)
99.1 Financial statements and independent registered public
accounting firm's report for First Merchants Corporation
Employee Stock Purchase Plan (See Exhibit 13 to this Form
10-K)(2)
(1) Management contract or compensatory plan.
(2) Filed here within.
(3) Incorporated by reference to the registrant's Form 8-K filed on
April 19, 2002.
Page 36
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on this 16th day of March,
2006.
FIRST MERCHANTS CORPORATION
By /s/ Michael L.Cox
-----------------------------
Michael L. Cox, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
on Form 10-K has been signed by the following persons on behalf of the
registrant and in the capacities indicated, on this 16th day of March, 2006.
/s/ Michael L. Cox /s/ Mark K. Hardwick
-------------------------------------- --------------------------------------
Michael L. Cox President and Mark K. Hardwick Executive Vice
Chief Executive President and Chief
Officer (Principal Financial Officer
Executive Officer) (Principal Financial
and Principal
Accounting Officer)
/s/ Robert M. Smitson* /s/ Michael L. Cox
------------------------------------ ------------------------------------
Robert M. Smitson Director Michael L. Cox Director
/s/ Michael C. Rechin* /s/ Barry J. Hudson*
------------------------------------ ------------------------------------
Michael C. Rechin Director Barry J. Hudson Director
/s/ James F. Ault* /s/ Robert T. Jeffares*
------------------------------------ ------------------------------------
James F. Ault Director Robert T. Jeffares Director
/s/Richard A. Boehning* /s/ Thomas D. McAuliffe*
------------------------------------ ------------------------------------
Richard A. Boehning Director Thomas D. McAuliffe Director
/s/ Thomas B. Clark* /s/ Charles E. Schalliol*
------------------------------------ ------------------------------------
Thomas B. Clark Director Charles E. Schalliol Director
/s/ Roderick English*
------------------------------------ ------------------------------------
Roderick English Director Jean L. Wojtowicz Director
/s/ Dr. Jo Ann M. Gora*
------------------------------------
Dr. Jo Ann M. Gora Director
* By Mark K. Hardwick as Attorney-in Fact pursuant to a Limited Power of
Attorney executed by the directors listed above, which Power of Attorney is
being filed with the Securities and Exchange Commission as an exhibit hereto.
By /s/ Mark K. Hardwick
------------------------------
Mark K. Hardwick
As Attorney-in-Fact
March 16, 2006
Page 37
INDEX TO EXHIBITS
--------------------------------------------------------------------------------
(a) 3. Exhibits:
Exhibit No: Description of Exhibits:
----------- ------------------------
3a First Merchants Corporation Articles of Incorporation.
(Incorporated by reference to registrant's Form 10-Q for quarter
ended June 30, 1999)
3b Bylaws of First Merchants Corporation (Incorporated by reference
to registrant's Form 10-K for year ended December 31, 2004)
4.1 Certificate of Trust of First Merchants Capital Trust I dated
December 12, 2001 (3)
4.2 Amended and Restated Trust Agreement of First Merchants Capital
Trust I dated April 17, 2002 (3)
4.3 Agreement as to Expenses and Liabilities dated April 17, 2002 (3)
4.4 Cumulative Trust Preferred Security Certificate (3)
4.5 Preferred Securities Guarantee Agreement dated April 17, 2002 (3)
4.6 Indenture dated April 17, 2002 (3)
4.7 First Supplemental Indenture dated April 17, 2002 (3)
4.8 8.75% Junior Subordinated Debenture due June 30, 2002 (3)
10a First Merchants Corporation Senior Management Incentive
Compensation Program, as amended. (Incorporated by reference
to the registrant's Form 10-Q for the quarter ended June 30,
2005)(1)
10b First Merchants Corporation 1994 Stock Option Plan.
(Incorporated by reference to registrant's Form 10-K for year
ended December 31, 1993)(1)
10c First Merchants Corporation Change of Control Agreement, as
amended, with Mark K. Hardwick dated February 14, 2006.
(Incorporated by reference to registrant's Form 8-K filed on
March 9, 2006)(1)
Page 38
10d First Merchants Corporation Change of Control Agreement with
Michael C. Rechin dated December 13, 2005. (Incorporated by
reference to registrant's Form 8-K filed on December 19,
2005)(1)
10e First Merchants Corporation Change of Control Agreement with
Shawn R. Blackburn dated May 2, 2005. (Incorporated by
reference to registrant's Form 8-K filed on May 4, 2005)(1)
10f First Merchants Corporation Change of Control Agreement with
Robert R. Connors dated August 26, 2002. (Incorporated by
reference to registrant's Form 10-Q for quarter ended
September 30, 2002)(1)
10g First Merchants Corporation Change of Control Agreement with
Michael L. Cox dated February 11, 2003. (Incorporated by
reference to registrant's Form 10-Q for quarter ended March
31, 2003)(1)
10h First Merchants Corporation Change of Control Agreement with
Kimberly J. Ellington dated January 1, 2005.(2)
10i First Merchants Corporation Change of Control Agreement with
Jeffrey B. Lorentson dated January 1, 2004.(2)
10j First Merchants Corporation Supplemental Executive Retirement
Plan and amendments thereto. (Incorporated by reference to
registrant's Form 10-K for year ended December 31, 1997)(1)
10k First Merchants Corporation 1999 Long-Term Equity Incentive
Plan, as amended. (Incorporated by reference to registrant's
Form 10-Q for quarter ended September 30, 2004) (1)
13 First Merchants Corporation - Annual Report 2005 (except
for the pages and information expressly incorporated by
reference in this Form 10-K, the First Merchants Corporation
- Annual Report 2005 is provided solely for the information
of the Securities and Exchange Commission and is not
deemed "filed" as part of this Form 10-K)(2)
21 Subsidiaries of Registrant(2)
23 Consent of Independent Registered Public Accounting Firm(2)
24 Limited Power of Attorney(2)
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes - Oxley Act of 2002(2)
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes - Oxley Act of 2002(2)
32 Certifications Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002(2)
99.1 Financial statements and independent registered public
accounting firm's report for First Merchants Corporation
Employee Stock Purchase Plan (See Exhibit 13 to this Form
10-K)(2)
(1) Management contract or compensatory plan.
(2) Filed here within.
(3) Incorporated by reference to the registrant's Form 8-K filed on
April 19, 2002.
Page 39
EXHIBIT-10h
First Merchants Corporation Change of Control Agreement with
Kimberly J. Ellington dated January 1, 2005.
CHANGE OF CONTROL AGREEMENT
This Agreement is made and entered into as of January 1, 2005, by and
between First Merchants Corporation, an Indiana corporation (hereinafter
referred to as "Corporation"), with its principal office located at 200 East
Jackson Street, Muncie, Indiana, and Kimberly J. Ellington (hereinafter referred
to as "Executive"), of Yorktown, Indiana.
WHEREAS, the Corporation considers the continuance of proficient and
experienced management to be essential to protecting and enhancing the best
interests of the Corporation and its shareholders; and
WHEREAS, the Corporation desires to assure the continued services of
the Executive on behalf of the Corporation; and
WHEREAS, the Corporation recognizes that if faced with a proposal for a
Change of Control, as hereinafter defined, the Executive will have a significant
role in helping the Board of Directors assess the options and advising the Board
of Directors on what is in the best interests of the Corporation and its
shareholders; and it is necessary for the Executive to be able to provide this
advice and counsel without being influenced by the uncertainties of the
Executive's own situation; and
WHEREAS, the Corporation desires to provide fair and reasonable
benefits to the Executive on the terms and subject to the conditions set forth
in this Agreement.
NOW, THEREFORE, in consideration of the mutual covenants and
undertakings herein contained and the continued employment of the Executive by
the Corporation as its Senior Vice President and Director of Human Resources,
the Corporation and the Executive, each intending to be legally bound, covenant
and agree as follows:
1. Term of Agreement.
This Agreement shall continue in effect through December 31, 2005; provided, however, that
commencing on December 31, 2005 and each December 31 thereafter, the term of this Agreement shall
automatically be extended for one additional year unless, not later than October 31, 2005 or October 31
immediately preceding any December 31 thereafter, the Corporation shall have given the Executive notice
that it does not wish to extend this Agreement; and provided further, that if a Change of Control of the
Corporation, as defined in Section 2, shall have occurred during the original or extended term of this
Agreement, this Agreement shall continue in effect for a period of not less than twenty-four (24) months
beyond the month in which such Change of Control occurred.
2. Definitions.
For purposes of this Agreement, the following definitions shall apply:
A. Cause: "Cause" shall mean:
(1) professional incompetence;
(2) willful misconduct;
(3) personal dishonesty;
(4) breach of fiduciary duty involving personal profit;
(5) intentional failure to perform stated duties;
(6) willful violation of any law, rule or regulation (other than traffic
violations or similar offenses) or final cease and desist orders; and
(7) any intentional material breach of any term, condition or covenant of
this Agreement.
(B) Change of Control: "Change of Control" shall mean:
(1) any person (as such term is used in Sections 13(d) and 14(d) of the
Securities Exchange Act of 1934 ["Exchange Act"]), other than the
Corporation, is or becomes the Beneficial Owner (as defined in Rule
13d-3 under the Exchange Act) directly or indirectly of securities of
the Corporation representing twenty-five percent (25%) or more of the
combined voting power of the Corporation's then outstanding securities;
(2) persons constituting a majority of the Board of Directors of the
Corporation were not directors of the Corporation for at least the
twenty-four (24) preceding months;
(3) the stockholders of the Corporation approve a merger or consolidation
of the Corporation with any other corporation, other than (a) a merger
or consolidation which would result in the voting securities of the
Corporation outstanding immediately prior thereto continuing to
represent (either by remaining outstanding or by being converted into
voting securities of the surviving entity) more than fifty percent
(50%) of the combined voting power of the voting securities of the
Corporation or such surviving entity outstanding immediately after such
a merger or consolidation, or (b) a merger or consolidation effected to
implement a recapitalization of the Corporation (or similar
transaction) in which no person acquires fifty percent (50%) or more of
the combined voting power of the Corporation's then outstanding
securities; or
(4) the stockholders of the Corporation approve a plan of complete
liquidation of the Corporation or an agreement for the sale or
disposition by the Corporation of all or substantially all of the
Corporation's assets.
(C) Date of Termination: "Date of Termination" shall mean the date stated in the
Notice of Termination (as hereinafter defined) or thirty (30) days from the
date of delivery of such notice, as hereinafter defined, whichever comes first.
(D) Disability: "Disability" shall mean the definition of such term as used in the
disability policy then in effect for the Corporation, and a determination of
full disability by the Corporation; provided that in the event there is no
disability insurance then in force, "disability" shall mean incapacity due to
physical or mental illness which will have caused the Executive to have been
unable to perform his duties with the Corporation on a full time basis for one
hundred eighty (180) consecutive calendar days.
(E) Notice of Termination: "Notice of Termination" shall mean a written notice,
communicated to the other parties hereto, which shall indicate the specific
termination provisions of this Agreement relied upon and set forth in
reasonable detail the facts and circumstances claimed to provide a basis for
termination of the Executive's employment under the provisions so indicated.
(F) Retirement: "Retirement" shall mean termination of employment by the Executive
in accordance with the Corporation's normal retirement policy generally
applicable to its salaried employees in effect at the time of a Change of
Control.
3. Termination.
(A) General. If any of the events described in Section 2 constituting a Change in
Control of the Corporation shall have occurred, the Executive shall be entitled
to the benefits described in Section 4 upon the subsequent termination of the
Executive's employment during the term of this Agreement, unless such
termination is (a) because of the death or Disability of the Executive, (b) by
the Corporation for Cause, or (c) by the Executive other than on account of
Constructive Termination (as hereinafter defined).
(B) If, following a Change of Control, the Executive's employment shall be
terminated for Cause, the Corporation shall pay him his salary through the Date
of Termination at the rate in effect on the date of the Notice of Termination,
and the Corporation shall have no further obligations under this Agreement.
If, following a Change of Control, the Executive's employment shall be
terminated as a result of death or Disability, compensation to the Executive
shall be made pursuant to the Corporation's then existing policies on death or
Disability, and the Corporation shall have no further obligations under this
Agreement. If, following a Change of Control, the Executive's employment is
terminated by and at the request of the Executive as a result of Retirement,
compensation to the Executive shall be made pursuant to the Corporation's
normal retirement policy generally applicable to its salaried employees at the
time of the Change of Control, and the Corporation shall have no further
obligations under this Agreement.
(C) Constructive Termination. The Executive shall be entitled to terminate his
employment upon the occurrence of Constructive Termination. For purposes of
this Agreement, "Constructive Termination" shall mean, without the Executive's
express written consent, the occurrence, after a Change of Control of the
Corporation, of any of the following circumstances:
(1) the assignment to the Executive of any duties inconsistent (unless in
the nature of a promotion) with the position in the Corporation that
the Executive held immediately prior to the Change of Control of the
Corporation, or a significant adverse reduction or alteration in the
nature or status of the Executive's position, duties or
responsibilities or the conditions of the Executive's employment from
those in effect immediately prior to such Change of Control;
(2) a reduction in the Executive's annual base salary, as in effect
immediately prior to the Change of Control of the Corporation or as the
same may be adjusted from time to time, except for across-the-board
salary reductions similarly affecting all management personnel of the
Corporation;
(3) the Corporation requires the Executive to be relocated anywhere other
than its offices in Muncie, Indiana;
(4) the taking of any action to deprive the Executive of any material
fringe benefit enjoyed by him at the time of the Change of Control, or
the failure to provide him with the number of paid vacation days to
which he is entitled on the basis of years of service with the
Corporation and in accordance with the Corporation's normal vacation
policy in effect at the time of the Change of Control;
(5) the failure to continue to provide the Executive with benefits
substantially similar to those enjoyed by the Executive under any of
the Corporation's life insurance, medical, health and accident, or
disability plans in which the Executive was participating at the time
of the Change of Control of the Corporation, or the taking of any
action which would directly or indirectly materially reduce any of such
benefits; or
(6) the failure of the Corporation to continue this Agreement in effect, or
to obtain a satisfactory agreement from any successor to assume and
agree to perform this Agreement, as contemplated in Section 5 hereof.
4. Compensation Upon Termination.
Following a Change of Control, if his employment by the Corporation shall be terminated by the
Executive on account of Constructive Termination or by the Corporation other than for Cause, death,
Disability, or Retirement (by and at the request of the Executive), then the Executive shall be entitled
to the benefits provided below:
(A) No later than the fifth day following the Date of Termination, the Corporation
shall pay to the Executive his full base salary through the Date of
Termination, at the rate in effect at the time Notice of Termination is given,
plus all other amounts to which the Executive is entitled under any incentive,
bonus or other compensation plan of the Corporation in effect at the time such
payments are due;
(B) In lieu of any further salary payments to the Executive for periods subsequent
to the Date of Termination, no later than the fifth day following the Date of
Termination, the Corporation shall pay to the Executive a lump sum severance
payment, in cash, equal to two (2.00) times the sum of (a) the Executive's
annual base salary rate as in effect on the date of the Notice of Termination,
and (b) the largest bonus received by the Executive during the two (2) years
immediately preceding the Date of Termination under the Corporation's
Management Incentive Plan covering the Executive;
(C) During the period beginning with the Executive's Date of Termination and
continuing until the earlier of (a) the second anniversary of such Date of
Termination, or (b) Executive's sixty-fifth (65th) birthday, the Corporation
shall arrange to provide the Executive with life, disability, accident and
health insurance benefits substantially similar to those which the Executive
was receiving immediately prior to the Notice of Termination and shall pay the
same percentage of the cost of such benefits as the Corporation was paying on
the Executive's behalf on the date of such Notice;
(D) In lieu of shares of common stock of the Corporation ("Corporation Shares")
issuable upon the exercise of outstanding options ("Options"), if any, granted
to the Executive under any Corporation stock option plan (which Options shall
be cancelled upon the making of the payment referred to below), the Executive
shall receive an amount in cash equal to the product of (a) the excess of the
higher of the closing price of Corporation Shares as reported on the NASDAQ
National Market System, the American Stock Exchange or the New York Stock
Exchange, wherever listed, on or nearest the Date of Termination or the highest
per share price for Corporation Shares actually paid in connection with any
Change of Control of the Corporation, over the per share exercise price of each
Option held by the Executive (whether or not then fully exercisable), times (b)
the number of Corporation Shares covered by each such Option;
(E) If the payments or benefits, if any, received or to be received by the
Executive (whether under this Agreement or under any other plan, arrangement,
or agreement between the Executive and the Corporation), in connection with
termination or Constructive Termination of the Executive's employment following
a Change of Control, constitute an "excess parachute payment" within the
meaning of ss.280G of the Internal Revenue Code ("Code"), the Corporation shall
pay to the Executive, no later than the fifth day following the Date of
Termination, an additional amount (as determined by the Corporation's
independent public accountants) equal to the excise tax, if any, imposed on the
"excess parachute payment" under ss.4999 of the Code; provided, however, if the
amount of such excise tax is finally determined to be more or less than the
amount paid to the Executive hereunder, the Corporation (or the Executive if
the finally determined amount is less than the original amount paid) shall pay
the difference between the amount originally paid and the finally determined
amount to the other party no later than the fifth day following the date such
final determination is made;
(F) The Corporation shall pay to the Executive all reasonable legal fees and
expenses incurred by the Executive as a result of such termination (including
all such fees and expenses, if any, incurred in contesting or disputing any
such termination or in seeking to obtain or enforce any right or benefit
provided by this Agreement), unless the decision-maker in any proceeding,
contest, or dispute arising hereunder makes a formal finding that the Executive
did not have a reasonable basis for instituting such proceeding, contest, or
dispute;
(G) The Corporation shall provide the Executive with individual out-placement
services in accordance with the general custom and practice generally accorded
to an executive of the Executive's position.
5. Successors; Binding Agreement.
(A) The Corporation shall require any successor (whether direct or indirect, by
purchase, merger, consolidation or otherwise) to all or substantially all of
the business and/or assets of the Corporation to expressly assume and agree to
perform this Agreement in the same manner and to the same extent that the
Corporation would be required to perform it if no such succession had taken
place. Failure of the Corporation to obtain such assumption and agreement
prior to the effectiveness of any such succession shall be a breach of this
Agreement and shall entitle the Executive to compensation from the Corporation
in the same amount and on the same terms to which the Executive would be
entitled hereunder if the Executive terminates his employment on account of
Constructive Termination following a Change of Control of the Corporation,
except that for the purposes of implementing the foregoing, the date on which
any such succession becomes effective shall be deemed the Date of Termination.
As used in this Agreement, "the Corporation" shall mean the Corporation and any
successor to its business and/or assets as aforesaid which assumes and agrees
to perform this Agreement, by operation of law or otherwise.
(B) This Agreement shall inure to the benefit of and be enforceable by the
Executive and his personal or legal representatives, executors, administrators,
successors, heirs, distributees, devisees and legatees. If the Executive
should die while any amount would still be payable to the Executive hereunder
had the Executive continued to live, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of this Agreement
to the devisee, legatee or other designee or, if there is no such designee, to
his estate.
6. Miscellaneous.
No provision of this Agreement may be modified, waived or discharged unless such waiver,
modification or discharge is agreed to in writing and signed by the Executive and such officer as may be
specifically designated by the Corporation. No waiver by either party hereto at the time of any breach by
the other party hereto of, or compliance with, any condition or provision of this Agreement to be
performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions
at the same or at any prior or subsequent time. No agreement or representations, oral or otherwise,
express or implied, with respect to the subject matter hereof have been made by either party which are not
expressly set forth in this Agreement. The validity, interpretation, construction and performance of this
Agreement shall be governed by the laws of the State of Indiana without regard to its conflicts of law
principles. All references to a section of the Exchange Act or the Code shall be deemed also to refer to
any successor provisions to such section. Any payments provided for hereunder shall be paid net of any
applicable withholding required under federal, state or local law. The obligations of the Corporation
under Section 4 shall survive the expiration of the term of this Agreement.
7. Validity.
The invalidity or unenforceability of any provision of this Agreement shall not affect the
validity or enforceability of any other provision of this Agreement, which shall remain in full force and
effect.
8. Counterparts.
This Agreement may be executed in several counterparts, each of which shall be deemed to be an
original, but all of which together shall constitute one and the same instrument.
9. Arbitration.
Any dispute or controversy arising under or in connection with this Agreement shall be settled
exclusively by arbitration, conducted before a panel of three (3) arbitrators in Muncie, Indiana in
accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered
on the arbitrator's award in any court having jurisdiction; provided, however, that the Executive shall be
entitled to seek specific performance of his right to be paid until the Date of Termination during the
pendency of any dispute or controversy arising under or in connection with this Agreement.
10. Entire Agreement.
This Agreement sets forth the entire agreement of the parties hereto in respect of the subject
matter contained herein and supersedes all prior agreements, promises, covenants, arrangements,
communications, representations or warranties, whether oral or written, by any officer, employee or
representative of any party hereto; and any prior agreement of the parties hereto in respect of the
subject matter contained herein is hereby terminated and cancelled.
IN WITNESS WHEREOF, the Corporation has caused this Agreement to be executed by their duly
authorized officers, and the Executive has hereunder subscribed his name, as of the day and year first
above written.
"CORPORATION" "EXECUTIVE"
FIRST MERCHANTS CORPORATION
By ______________________________ By ______________________________
Michael L. Cox, Kimberly J. Ellington
President & Chief Executive Officer
EXHIBIT-10i
First Merchants Corporation Change of Control Agreement with
Jeffrey B. Lorentson dated January 1, 2004.
CHANGE OF CONTROL AGREEMENT
This Agreement is made and entered into as of January 1, 2004, by and
between First Merchants Corporation, an Indiana corporation (hereinafter
referred to as "Corporation"), with its principal office located at 200 East
Jackson Street, Muncie, Indiana, and Jeffrey B. Lorentson (hereinafter referred
to as "Executive"), of Fishers, Indiana.
WHEREAS, the Corporation considers the continuance of proficient and
experienced management to be essential to protecting and enhancing the best
interests of the Corporation and its shareholders; and
WHEREAS, the Corporation desires to assure the continued services of
the Executive on behalf of the Corporation; and
WHEREAS, the Corporation recognizes that if faced with a proposal for a
Change of Control, as hereinafter defined, the Executive will have a significant
role in helping the Board of Directors assess the options and advising the Board
of Directors on what is in the best interests of the Corporation and its
shareholders; and it is necessary for the Executive to be able to provide this
advice and counsel without being influenced by the uncertainties of the
Executive's own situation; and
WHEREAS, the Corporation desires to provide fair and reasonable
benefits to the Executive on the terms and subject to the conditions set forth
in this Agreement.
NOW, THEREFORE, in consideration of the mutual covenants and
undertakings herein contained and the continued employment of the Executive by
the Corporation as its First Vice President and Corporate Controller, the
Corporation and the Executive, each intending to be legally bound, covenant and
agree as follows:
1. Term of Agreement.
This Agreement shall continue in effect through December 31, 2004; provided, however,
that commencing on December 31, 2004 and each December 31 thereafter, the term of this
Agreement shall automatically be extended for one additional year unless, not later than
October 31, 2004 or October 31 immediately preceding any December 31 thereafter, the
Corporation shall have given the Executive notice that it does not wish to extend this
Agreement; and provided further, that if a Change of Control of the Corporation, as defined in
Section 2, shall have occurred during the original or extended term of this Agreement, this
Agreement shall continue in effect for a period of not less than twenty-four (24) months beyond
the month in which such Change of Control occurred.
2. Definitions.
For purposes of this Agreement, the following definitions shall apply:
A. Cause: "Cause" shall mean:
(1) professional incompetence;
(2) willful misconduct;
(3) personal dishonesty;
(4) breach of fiduciary duty involving personal profit;
(5) intentional failure to perform stated duties;
(6) willful violation of any law, rule or regulation (other than
traffic violations or similar offenses) or final cease and
desist orders; and
(7) any intentional material breach of any term, condition or
covenant of this Agreement.
(B) Change of Control: "Change of Control" shall mean:
(1) any person (as such term is used in Sections 13(d) and 14(d)
of the Securities Exchange Act of 1934 ["Exchange Act"]),
other than the Corporation, is or becomes the Beneficial
Owner (as defined in Rule 13d-3 under the Exchange Act)
directly or indirectly of securities of the Corporation
representing twenty-five percent (25%) or more of the
combined voting power of the Corporation's then outstanding
securities;
(2) persons constituting a majority of the Board of Directors of
the Corporation were not directors of the Corporation for at
least the twenty-four (24) preceding months;
(3) the stockholders of the Corporation approve a merger or
consolidation of the Corporation with any other corporation,
other than (a) a merger or consolidation which would result
in the voting securities of the Corporation outstanding
immediately prior thereto continuing to represent (either by
remaining outstanding or by being converted into voting
securities of the surviving entity) more than fifty percent
(50%) of the combined voting power of the voting securities
of the Corporation or such surviving entity outstanding
immediately after such a merger or consolidation, or (b) a
merger or consolidation effected to implement a
recapitalization of the Corporation (or similar transaction)
in which no person acquires fifty percent (50%) or more of
the combined voting power of the Corporation's then
outstanding securities; or
(4) the stockholders of the Corporation approve a plan of
complete liquidation of the Corporation or an agreement for
the sale or disposition by the Corporation of all or
substantially all of the Corporation's assets.
(C) Date of Termination: "Date of Termination" shall mean the date
stated in the Notice of Termination (as hereinafter defined) or
thirty (30) days from the date of delivery of such notice, as
hereinafter defined, whichever comes first.
(D) Disability: "Disability" shall mean the definition of such term as
used in the disability policy then in effect for the Corporation, and
a determination of full disability by the Corporation; provided that
in the event there is no disability insurance then in force,
"disability" shall mean incapacity due to physical or mental illness
which will have caused the Executive to have been unable to perform
his duties with the Corporation on a full time basis for one hundred
eighty (180) consecutive calendar days.
(E) Notice of Termination: "Notice of Termination" shall mean a written
notice, communicated to the other parties hereto, which shall
indicate the specific termination provisions of this Agreement relied
upon and set forth in reasonable detail the facts and circumstances
claimed to provide a basis for termination of the Executive's
employment under the provisions so indicated.
(F) Retirement: "Retirement" shall mean termination of employment by the
Executive in accordance with the Corporation's normal retirement
policy generally applicable to its salaried employees in effect at
the time of a Change of Control.
3. Termination.
(A) General. If any of the events described in Section 2 constituting a
Change in Control of the Corporation shall have occurred, the
Executive shall be entitled to the benefits described in Section 4
upon the subsequent termination of the Executive's employment during
the term of this Agreement, unless such termination is (a) because of
the death or Disability of the Executive, (b) by the Corporation for
Cause, or (c) by the Executive other than on account of Constructive
Termination (as hereinafter defined).
(B) If, following a Change of Control, the Executive's employment shall
be terminated for Cause, the Corporation shall pay him his salary
through the Date of Termination at the rate in effect on the date of
the Notice of Termination, and the Corporation shall have no further
obligations under this Agreement. If, following a Change of Control,
the Executive's employment shall be terminated as a result of death
or Disability, compensation to the Executive shall be made pursuant
to the Corporation's then existing policies on death or Disability,
and the Corporation shall have no further obligations under this
Agreement. If, following a Change of Control, the Executive's
employment is terminated by and at the request of the Executive as a
result of Retirement, compensation to the Executive shall be made
pursuant to the Corporation's normal retirement policy generally
applicable to its salaried employees at the time of the Change of
Control, and the Corporation shall have no further obligations under
this Agreement.
(C) Constructive Termination. The Executive shall be entitled to
terminate his employment upon the occurrence of Constructive
Termination. For purposes of this Agreement, "Constructive
Termination" shall mean, without the Executive's express written
consent, the occurrence, after a Change of Control of the
Corporation, of any of the following circumstances:
(1) the assignment to the Executive of any duties inconsistent
(unless in the nature of a promotion) with the position in
the Corporation that the Executive held immediately prior to
the Change of Control of the Corporation, or a significant
adverse reduction or alteration in the nature or status of
the Executive's position, duties or responsibilities or the
conditions of the Executive's employment from those in
effect immediately prior to such Change of Control;
(2) a reduction in the Executive's annual base salary, as in
effect immediately prior to the Change of Control of the
Corporation or as the same may be adjusted from time to
time, except for across-the-board salary reductions
similarly affecting all management personnel of the
Corporation;
(3) the Corporation requires the Executive to be relocated
anywhere other than its offices in Muncie, Indiana;
(4) the taking of any action to deprive the Executive of any
material fringe benefit enjoyed by him at the time of the
Change of Control, or the failure to provide him with the
number of paid vacation days to which he is entitled on the
basis of years of service with the Corporation and in
accordance with the Corporation's normal vacation policy in
effect at the time of the Change of Control;
(5) the failure to continue to provide the Executive with
benefits substantially similar to those enjoyed by the
Executive under any of the Corporation's life insurance,
medical, health and accident, or disability plans in which
the Executive was participating at the time of the Change of
Control of the Corporation, or the taking of any action
which would directly or indirectly materially reduce any of
such benefits; or
(6) the failure of the Corporation to continue this Agreement in
effect, or to obtain a satisfactory agreement from any
successor to assume and agree to perform this Agreement, as
contemplated in Section 5 hereof.
4. Compensation Upon Termination.
Following a Change of Control, if his employment by the Corporation shall be
terminated by the Executive on account of Constructive Termination or by the Corporation other
than for Cause, death, Disability, or Retirement (by and at the request of the Executive), then
the Executive shall be entitled to the benefits provided below:
(A) No later than the fifth day following the Date of Termination, the
Corporation shall pay to the Executive his full base salary through
the Date of Termination, at the rate in effect at the time Notice of
Termination is given, plus all other amounts to which the Executive
is entitled under any incentive, bonus or other compensation plan of
the Corporation in effect at the time such payments are due;
(B) In lieu of any further salary payments to the Executive for periods
subsequent to the Date of Termination, no later than the fifth day
following the Date of Termination, the Corporation shall pay to the
Executive a lump sum severance payment, in cash, equal to one (1.00)
times the sum of (a) the Executive's annual base salary rate as in
effect on the date of the Notice of Termination, and (b) the largest
bonus received by the Executive during the two (2) years immediately
preceding the Date of Termination under the Corporation's Management
Incentive Plan covering the Executive;
(C) During the period beginning with the Executive's Date of Termination
and continuing until the earlier of (a) the second anniversary of
such Date of Termination, or (b) Executive's sixty-fifth (65th)
birthday, the Corporation shall arrange to provide the Executive with
life, disability, accident and health insurance benefits
substantially similar to those which the Executive was receiving
immediately prior to the Notice of Termination and shall pay the same
percentage of the cost of such benefits as the Corporation was paying
on the Executive's behalf on the date of such Notice;
(D) In lieu of shares of common stock of the Corporation ("Corporation
Shares") issuable upon the exercise of outstanding options
("Options"), if any, granted to the Executive under any Corporation
stock option plan (which Options shall be cancelled upon the making
of the payment referred to below), the Executive shall receive an
amount in cash equal to the product of (a) the excess of the higher
of the closing price of Corporation Shares as reported on the NASDAQ
National Market System, the American Stock Exchange or the New York
Stock Exchange, wherever listed, on or nearest the Date of
Termination or the highest per share price for Corporation Shares
actually paid in connection with any Change of Control of the
Corporation, over the per share exercise price of each Option held by
the Executive (whether or not then fully exercisable), times (b) the
number of Corporation Shares covered by each such Option;
(E) If the payments or benefits, if any, received or to be received by
the Executive (whether under this Agreement or under any other plan,
arrangement, or agreement between the Executive and the Corporation),
in connection with termination or Constructive Termination of the
Executive's employment following a Change of Control, constitute an
"excess parachute payment" within the meaning of ss.280G of the
Internal Revenue Code ("Code"), the Corporation shall pay to the
Executive, no later than the fifth day following the Date of
Termination, an additional amount (as determined by the Corporation's
independent public accountants) equal to the excise tax, if any,
imposed on the "excess parachute payment" under ss.4999 of the Code;
provided, however, if the amount of such excise tax is finally
determined to be more or less than the amount paid to the Executive
hereunder, the Corporation (or the Executive if the finally
determined amount is less than the original amount paid) shall pay
the difference between the amount originally paid and the finally
determined amount to the other party no later than the fifth day
following the date such final determination is made;
(F) The Corporation shall pay to the Executive all reasonable legal fees
and expenses incurred by the Executive as a result of such
termination (including all such fees and expenses, if any, incurred
in contesting or disputing any such termination or in seeking to
obtain or enforce any right or benefit provided by this Agreement),
unless the decision-maker in any proceeding, contest, or dispute
arising hereunder makes a formal finding that the Executive did not
have a reasonable basis for instituting such proceeding, contest, or
dispute;
(G) The Corporation shall provide the Executive with individual
out-placement services in accordance with the general custom and
practice generally accorded to an executive of the Executive's
position.
5. Successors; Binding Agreement.
(A) The Corporation shall require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Corporation to
expressly assume and agree to perform this Agreement in the same
manner and to the same extent that the Corporation would be required
to perform it if no such succession had taken place. Failure of the
Corporation to obtain such assumption and agreement prior to the
effectiveness of any such succession shall be a breach of this
Agreement and shall entitle the Executive to compensation from the
Corporation in the same amount and on the same terms to which the
Executive would be entitled hereunder if the Executive terminates his
employment on account of Constructive Termination following a Change
of Control of the Corporation, except that for the purposes of
implementing the foregoing, the date on which any such succession
becomes effective shall be deemed the Date of Termination. As used
in this Agreement, "the Corporation" shall mean the Corporation and
any successor to its business and/or assets as aforesaid which
assumes and agrees to perform this Agreement, by operation of law or
otherwise.
(B) This Agreement shall inure to the benefit of and be enforceable by
the Executive and his personal or legal representatives, executors,
administrators, successors, heirs, distributees, devisees and
legatees. If the Executive should die while any amount would still
be payable to the Executive hereunder had the Executive continued to
live, all such amounts, unless otherwise provided herein, shall be
paid in accordance with the terms of this Agreement to the devisee,
legatee or other designee or, if there is no such designee, to his
estate.
6. Miscellaneous.
No provision of this Agreement may be modified, waived or discharged unless such
waiver, modification or discharge is agreed to in writing and signed by the Executive and such
officer as may be specifically designated by the Corporation. No waiver by either party hereto
at the time of any breach by the other party hereto of, or compliance with, any condition or
provision of this Agreement to be performed by such other party shall be deemed a waiver of
similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.
No agreement or representations, oral or otherwise, express or implied, with respect to the
subject matter hereof have been made by either party which are not expressly set forth in this
Agreement. The validity, interpretation, construction and performance of this Agreement shall
be governed by the laws of the State of Indiana without regard to its conflicts of law
principles. All references to a section of the Exchange Act or the Code shall be deemed also
to refer to any successor provisions to such section. Any payments provided for hereunder
shall be paid net of any applicable withholding required under federal, state or local law.
The obligations of the Corporation under Section 4 shall survive the expiration of the term of
this Agreement.
7. Validity.
The invalidity or unenforceability of any provision of this Agreement shall not
affect the validity or enforceability of any other provision of this Agreement, which shall
remain in full force and effect.
8. Counterparts.
This Agreement may be executed in several counterparts, each of which shall be deemed
to be an original, but all of which together shall constitute one and the same instrument.
9. Arbitration.
Any dispute or controversy arising under or in connection with this Agreement shall be
settled exclusively by arbitration, conducted before a panel of three (3) arbitrators in
Muncie, Indiana in accordance with the rules of the American Arbitration Association then in
effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction;
provided, however, that the Executive shall be entitled to seek specific performance of his
right to be paid until the Date of Termination during the pendency of any dispute or
controversy arising under or in connection with this Agreement.
10. Entire Agreement.
This Agreement sets forth the entire agreement of the parties hereto in respect of the
subject matter contained herein and supersedes all prior agreements, promises, covenants,
arrangements, communications, representations or warranties, whether oral or written, by any
officer, employee or representative of any party hereto; and any prior agreement of the parties
hereto in respect of the subject matter contained herein is hereby terminated and cancelled.
IN WITNESS WHEREOF, the Corporation and the Bank have caused this Agreement to be
executed by their duly authorized officers, and the Executive has hereunder subscribed his
name, as of the day and year first above written.
"CORPORATION" "EXECUTIVE"
FIRST MERCHANTS CORPORATION
By ______________________________ By ______________________________
Michael L. Cox, Jeffrey B. Lorentson
President & Chief Executive Officer
EXHIBIT-13
FIRST MERCHANTS CORPORATION - ANNUAL REPORT 2005
EXHIBIT 13--FIRST MERCHANTS CORPORATION - ANNUAL REPORT 2005
FINANCIAL REVIEW
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA 1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 19
CONSOLIDATED FINANCIAL STATEMENTS 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 24
ANNUAL MEETING, STOCK PRICE AND DIVIDEND INFORMATION 52
COMMON STOCK LISTING 53
FORM 10-K, FINANCIAL INFORMATION AND CODE OF ETHICS 54
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
(in thousands, except share data) 2005 2004 2003 2002 2001
===================================================================================================================================
Operations (3)(5)(6)
Net Interest Income
Fully Taxable Equivalent (FTE) Basis .............. $ 114,907 $ 108,986 $ 106,899 $ 96,599 $ 66,806
Less Tax Equivalent Adjustment ......................... 3,778 3,597 3,757 3,676 2,445
---------- ---------- ---------- ---------- ----------
Net Interest Income .................................... 111,129 105,389 103,142 92,923 64,361
Provision for Loan Losses .............................. 8,354 5,705 9,477 7,174 3,576
---------- ---------- ---------- ---------- ----------
Net Interest Income
After Provision for Loan Losses ................... 102,775 99,684 93,665 85,749 60,785
Total Other Income ..................................... 34,717 34,554 35,902 27,077 18,543
Total Other Expenses ................................... 93,957 91,642 91,279 71,009 45,195
---------- ---------- ---------- ---------- ----------
Income Before Income Tax Expense .................. 43,535 42,596 38,288 41,817 34,133
Income Tax Expense ..................................... 13,296 13,185 10,717 13,981 11,924
---------- ---------- ---------- ---------- ----------
Net Income ............................................. $ 30,239 $ 29,411 $ 27,571 $ 27,836 $ 22,209
========== ========== ========== ========== ==========
Per share data (1)(3)(5)(6)
Basic Net Income ....................................... $ 1.64 $ 1.59 $ 1.51 $ 1.70 $ 1.63
Diluted Net Income ..................................... 1.63 1.58 1.50 1.69 1.61
Cash Dividends Paid .................................... .92 .92 .90 .86 .84
December 31 Book Value ................................. 17.02 16.93 16.42 15.24 12.82
December 31 Market Value (Bid Price) ................... 26.00 28.30 25.51 21.67 21.78
Average balances (3)(5)(6)
Total Assets ........................................... $3,179,464 $3,109,104 $2,960,195 $2,406,251 $1,689,694
Total Loans (4) ........................................ 2,434,134 2,369,017 2,281,614 1,842,429 1,270,555
Total Deposits ......................................... 2,418,752 2,365,306 2,257,075 1,857,053 1,331,631
Securities Sold Under Repurchase Agreements
(long-term portion) ............................... 181 66,535 44,394
Total Federal Home Loan Bank Advances .................. 227,311 225,375 208,733 155,387 103,941
Total Subordinated Debentures, Revolving
Credit Lines and Term Loans ...................... 106,811 96,230 94,203 52,756 2,571
Total Stockholders' Equity ............................. 315,525 310,004 293,603 237,575 166,232
Year-end balances (3)(5)(6)
Total Assets ........................................... $3,237,079 $3,191,668 $3,076,812 $2,678,687 $1,787,035
Total Loans (4) ........................................ 2,462,337 2,431,418 2,356,546 2,025,922 1,359,893
Total Deposits ......................................... 2,382,576 2,408,150 2,362,101 2,036,688 1,421,251
Securities Sold Under Repurchase Agreements
(long-term portion) .............................. 320 23,632 32,500
Total Federal Home Loan Bank Advances .................. 247,865 223,663 212,779 184,677 103,499
Total Subordinated Debentures, Revolving
Credit Lines and Term Loans ...................... 103,956 97,206 97,782 72,488 8,500
Total Stockholders' Equity ............................. 313,396 314,603 303,965 261,129 179,128
Financial ratios (3)(5)(6)
Return on Average Assets ............................... .95% .95% .93% 1.16% 1.31%
Return on Average Stockholders' Equity ................. 9.58 9.49 9.39 11.72 13.36
Average Earning Assets to Total Assets ................. 90.93 90.28 89.99 91.38 93.29
Allowance for Loan Losses as % of Total Loans .......... 1.02 .93 1.08 1.11 1.11
Dividend Payout Ratio .................................. 56.44 58.23 60.00 50.89 52.17
Average Stockholders' Equity to Average Assets ......... 9.92 9.97 9.92 9.87 9.84
Tax Equivalent Yield on Earning Assets (2) ............. 6.26 5.72 5.98 6.83 7.80
Cost of Supporting Liabilities ......................... 2.29 1.84 1.97 2.44 3.56
Net Interest Margin on Earning Assets .................. 3.97 3.88 4.01 4.39 4.24
(1) Restated for all stock dividends and stock splits.
(2) 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.
(3) Business combinations that affect the comparability of the 2005, 2004 and
2003 information are discussed in Note 2 to the Consolidated Financial
Statements.
(4) Includes loans held for sale.
(5) On April 1, 2002, the Corporation acquired 100 percent of the outstanding
stock of Lafayette Bancorporation, the holding company of Lafayette Bank
and Trust Company, N.A. ("Lafayette"), which is located in Lafayette,
Indiana. Lafayette is a national chartered bank with branches located in
central Indiana. Lafayette Bancorporation was merged into the Corporation,
and Lafayette maintained its bank charter as a subsidiary of First
Merchants Corporation. The Corporation issued approximately 3,057,298
shares of its common stock at a cost of $21.30 per share and approximately
$50,867,000 in cash to complete the transaction. As a result of the
acquisition, the Corporation has an opportunity to increase its customer
base and continue to increase its market share. The purchase had a recorded
acquisition price of $115,978,000, including investments of $104,717,000;
loans of $552,016,000; premises and equipment of $10,269,000; other assets
of $64,074,000; deposits of $607,281,000; other liabilities of $81,762,000
and goodwill of $57,893,000. None of the goodwill is deductible for tax
purposes. Additionally, core deposit intangibles totaling $16,052,000 were
recognized and are being amortized over 10 years using the 150 percent
declining balance method. The combination was accounted for under the
purchase method of accounting. All assets and liabilities were recorded at
their fair values as of April 1, 2002. The purchase accounting adjustments
are being amortized over the life of the respective asset or liability.
Lafayette's results of operations are included in the Corporation's
consolidated results of operations beginning April 1, 2002.
(6) On July 1, 2001, the Corporation acquired 100 percent of the outstanding
stock of Francor Financial, Inc., the holding company of Frances Slocum
Bank & Trust Company, N.A. ("Frances Slocum"), which is located in Wabash,
Indiana. Frances Slocum is a national chartered bank with branches located
in east-central Indiana. Francor Financial, Inc. was merged into the
Corporation, and Frances Slocum maintained its bank charter as a subsidiary
of First Merchants Corporation. The Corporation issued 784,838 shares of
its common stock at a cost of $19.53 per share and $14,490,985 in cash to
complete the transaction. As a result of the acquisition, the Corporation
has an opportunity to increase its customer base and continue to increase
its market share. The purchase had a recorded acquisition price of
$29,454,000, including investments of $6,348,000; loans of $134,505,000;
premises and equipment of $4,401,000; other assets of $28,233,000; deposits
of $150,252,000; other liabilities of $6,492,000 and goodwill of
$7,907,000. None of the goodwill is deductible for tax purposes.
Additionally, core deposit intangibles totaling $4,804,000 were recognized
and are being amortized over 10 years using the 150 percent declining
balance method. The combination was accounted for under the purchase method
of accounting. All assets and liabilities were recorded at their fair
values as of July 1, 2001. The purchase accounting adjustments are being
amortized over the life of the respective asset or liability. Frances
Slocum's results of operations are included in the Corporation's
consolidated results of operations beginning July 1, 2001.
2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
First Merchants Corporation ("Corporation") from time to time includes
forward-looking statements in its oral and written communication. The
Corporation may include forward-looking statements in filings with the
Securities and Exchange Commission, such as Form 10-K and Form 10-Q, in other
written materials and in oral statements made by senior management to analysts,
investors, representatives of the media and others. The Corporation intends
these forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995, and the Corporation is including this statement for purposes of
these safe harbor provisions. Forward-looking statements can often be identified
by the use of words like "estimate," "project," "intend," "anticipate," "expect"
and similar expressions. These forward-looking statements include:
o statements of the Corporation's goals, intentions and expectations;
o statements regarding the Corporation's business plan and growth
strategies;
o statements regarding the asset quality of the Corporation's loan and
investment portfolios; and
o estimates of the Corporation's risks and future costs and benefits.
These forward-looking statements are subject to significant risks, assumptions
and uncertainties, including, among other things, the following important
factors which could affect the actual outcome of future events:
o fluctuations in market rates of interest and loan and deposit
pricing, which could negatively affect the Corporation's net
interest margin, asset valuations and expense expectations;
o adverse changes in the economy, which might affect the Corporation's
business prospects and could cause credit-related losses and
expenses;
o adverse developments in the Corporation's loan and investment
portfolios;
o competitive factors in the banking industry, such as the trend
towards consolidation in the Corporation's market; and
o changes in the banking legislation or the regulatory requirements of
federal and state agencies applicable to bank holding companies and
banks like the Corporation's affiliate banks.
Because of these and other uncertainties, the Corporation's actual future
results may be materially different from the results indicated by these
forward-looking statements. In addition, the Corporation's past results of
operations do not necessarily indicate its future results.
CRITICAL ACCOUNTING POLICIES
Generally accepted accounting principles require management to apply significant
judgment to certain accounting, reporting and disclosure matters. Management
must use assumptions and estimates to apply those principles where actual
measurement is not possible or practical. For a complete discussion of the
Corporation's significant accounting policies, see the notes to the consolidated
financial statements and discussion throughout this Annual Report. Below is a
discussion of the Corporation's critical accounting policies. These policies are
critical because they are highly dependent upon subjective or complex judgments,
assumptions and estimates. Changes in such estimates may have a significant
impact on the
3
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES continued
Corporation's financial statements. Management has reviewed the application of
these policies with the Corporation's Audit Committee.
Allowance for Loan Losses. The allowance for loan losses represents management's
estimate of probable losses inherent in the Corporation's loan portfolio. In
determining the appropriate amount of the allowance for loan losses, management
makes numerous assumptions, estimates and assessments.
The Corporation's strategy for credit risk management includes conservative
credit policies and underwriting criteria for all loans, as well as an overall
credit limit for each customer significantly below legal lending limits. The
strategy also emphasizes diversification on a geographic, industry and customer
level, regular credit quality reviews and management reviews of large credit
exposures and loans experiencing deterioration of credit quality.
The Corporation's allowance consists of three components: probable losses
estimated from individual reviews of specific loans, probable losses estimated
from historical loss rates, and probable losses resulting from economic,
environmental, qualitative or other deterioration above and beyond what is
reflected in the first two components of the allowance.
Larger commercial loans that exhibit probable or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and legal options available to the Corporation. Included in the review of
individual loans are those that are impaired as provided in SFAS No. 114,
Accounting by Creditors for Impairment of a Loan. Any allowances for impaired
loans are measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate or fair value of the underlying
collateral. The Corporation evaluates the collectibility of both principal and
interest when assessing the need for a loss accrual. Historical loss rates are
applied to other commercial loans not subject to specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans
are not individually risk graded. Reserves are established for each pool of
loans using loss rates based on a five year average net charge-off history by
loan category.
Historical loss allocations for commercial and consumer loans may be adjusted
for significant factors that, in management's judgment, reflect the impact of
any current conditions on loss recognition. Factors which management considers
in the analysis include the effects of the national and local economies, trends
in the volume of loans, changes in mix, concentrations of loans in specific
industries, asset quality trends (delinquencies, charge-offs and nonaccrual
loans), risk management and loan administration, changes in the internal lending
policies and credit standards, collection practices and examination results from
bank regulatory agencies and the Corporation's internal loan review.
An unallocated reserve, primarily based on the factors noted above, is
maintained to recognize the imprecision in estimating and measuring loss when
evaluating reserves
4
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES continued
for individual loans or pools of loans. Allowances on individual loans and
historical loss allocations are reviewed quarterly and adjusted as necessary
based on changing borrower and/or collateral conditions.
The Corporation's primary market areas for lending are north-central and
east-central Indiana and Columbus, Ohio. When evaluating the adequacy of
allowance, consideration is given to this regional geographic concentration and
the closely associated effect changing economic conditions have on the
Corporation's customers.
The Corporation has not substantively changed any aspect of its overall approach
in the determination of the allowance for loan losses. There have been no
material changes in assumptions or estimation techniques as compared to prior
periods that impacted the determination of the current period allowance.
Valuation of Securities. The Corporation's available-for-sale security portfolio
is reported at fair value. The fair value of a security is determined based on
quoted market prices. If quoted market prices are not available, fair value is
determined based on quoted prices of similar instruments. Available-for-sale and
held-to-maturity securities are reviewed quarterly for possible
other-than-temporary impairment. The review includes an analysis of the facts
and circumstances of each individual investment such as the length of time the
fair value has been below cost, the expectation for that security's performance,
the credit worthiness of the issuer and the Corporation's ability to hold the
security to maturity. A decline in value that is considered to be other-than
temporary is recorded as a loss within other operating income in the
consolidated statements of income.
Pension. The Corporation provides pension benefits to its employees. In
accordance with applicable accounting rules, the Corporation does not
consolidate the assets and liabilities associated with the pension plan.
Instead, the Corporation recognizes a prepaid asset for contributions the
Corporation has made to the pension plan in excess of pension expense. The
measurement of the prepaid asset and the annual pension expense involves
actuarial and economic assumptions.
The assumptions used in pension accounting relate to the expected rate of return
on plan assets, the rate of increase in salaries, the interest-crediting rate,
the discount rate, and other assumptions. See Note 16 "Employee Benefit Plans"
in the Annual Report for the specific assumptions used by the Corporation.
The annual pension expense for the Corporation is currently most sensitive to
the discount rate. Each 25 basis point reduction in the 2006 discount rate of
5.5 percent would increase the Corporation's 2006 pension expense by
approximately $93,000. In addition, each 25 basis point reduction in the 2006
expected rate of return of 7.5 percent would increase the Corporation's 2006
pension expense by approximately $97,000.
Goodwill and Intangibles. For purchase acquisitions, the Company is required to
record the assets acquired, including identified intangible assets, and the
liabilities assumed at their fair value, which in many instances involves
estimates based on third party valuations, such as appraisals, or internal
valuations based on
5
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES continued
discounted cash flow analyses or other valuation techniques that may include
estimates of attrition, inflation, asset growth rates or other relevant factors.
In addition, the determination of the useful lives for which an intangible asset
will be amortized is subjective.
Goodwill and indefinite-lived assets recorded must be reviewed for impairment on
an annual basis, as well as on an interim basis if events or changes indicate
that the asset might be impaired. An impairment loss must be recognized for any
excess of carrying value over fair value of the goodwill or the indefinite-lived
intangible with subsequent reversal of the impairment loss being prohibited. The
tests for impairment fair values are based on internal valuations using
management's assumptions of future growth rates, future attrition, discount
rates, multiples of earnings or other relevant factors. The resulting estimated
fair values could have a significant impact on the carrying values of goodwill
or intangibles and could result in impairment losses being recorded in future
periods.
BUSINESS SUMMARY
The Corporation is a diversified financial holding company headquartered in
Muncie, Indiana. Since its organization in 1982, the Corporation has grown to
include nine affiliate banks with over 65 locations in 17 Indiana and 3 Ohio
counties. In addition to its branch network, the Corporation's delivery channels
include ATMs, check cards, interactive voice response systems and internet
technology.
The Corporation's business activities are currently limited to one significant
business segment, which is community banking. The Corporation's financial
service affiliates include nine nationally chartered banks: First Merchants
Bank, N.A., The Madison Community Bank, N.A., First United Bank, N.A., United
Communities National Bank, First National Bank, Decatur Bank and Trust Company,
N.A., Frances Slocum Bank & Trust Company, N.A., Lafayette Bank and Trust
Company, N.A. and Commerce National Bank. Effective January 1, 2006, First
United Bank, N.A. was merged into First Merchants Bank, N.A., and the name of
the continuing institution is First Merchants Bank, N.A. The banks provide
commercial and retail banking services. In addition, the Corporation's trust
company, multi-line insurance company and title company provide trust asset
management services, retail and commercial insurance agency services and title
services, respectively.
Management believes that its mission, guiding principles and strategic
initiatives produce profitable growth for stockholders. Our vision is to satisfy
all the financial needs of our customers, help them succeed financially and be
recognized as the premier financial services company in our markets. Our primary
strategy to achieve this vision is to increase product usage and focus on
providing each customer with all of the financial products that fulfill their
needs. Our cross-sell strategy and diversified business model facilitate growth
in strong and weak economic cycles.
Management believes it is important to maintain a well controlled environment as
we continue to grow our businesses. Sound credit policies are maintained and
have resulted in declining nonperforming loans and net charge-offs as a
percentage of loans outstanding from the prior year. Interest rate and market
risks inherent in
6
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS SUMMARY continued
our asset and liability balances are managed within prudent ranges, while
ensuring adequate liquidity and funding.
RESULTS OF OPERATIONS
As of December 31, 2005 total assets equaled $3,237,079,000, an increase of
$45,411,000 from December 31, 2004. Of this amount, loans increased $30,919,000,
investments increased $12,731,000, intangibles, including goodwill, decreased
$2,451,000 and cash value of life insurance increased by $1,518,000. Details of
these changes are discussed within the "EARNING ASSETS" section of Management's
Discussion and Analysis of Financial Condition and Results of Operations.
As of December 31, 2004 total assets equaled $3,191,668,000, an increase of
$114,856,000 or 3.7 percent over 2003. Of this amount, loans increased
$74,548,000 and investments increased $64,738,000.
Net income for 2005 totaled $30,239,000, an increase of $828,000 or 2.8 percent
from 2004. Diluted earnings per share totaled $1.63, a 3.2 percent increase from
$1.58 reported for 2004. The increase was primarily attributable to an improved
net interest margin of 9 basis points as compared to 2004. However, the
improvement to net interest margin and its impact to net income was partially
mitigated by a $1,630,000 pension curtailment loss recorded during the year.
These factors and others are discussed within the respective sections of
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Net income for 2004 totaled $29,411,000, an increase of $1,840,000 or 6.7
percent. The increase was primarily attributable to loan growth and improved
credit quality. Diluted earnings per share totaled $1.58, a 5.3 percent increase
from $1.50 reported for 2003. These factors and others are discussed within the
respective sections of Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Return on equity totaled 9.58 percent in 2005, 9.49 percent in 2004, and 9.39
percent in 2003. Return on assets totaled .95 percent in 2005, .95 percent in
2004, and .93 percent in 2003. Multiple factors impacting the reported financial
results are discussed within the respective sections of Management's Discussion
and Analysis of Financial Condition and Results of Operations.
7
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL
The Corporation's regulatory capital continues to exceed regulatory "well
capitalized" standards. Tier I regulatory capital consists primarily of total
stockholders' equity and subordinated debentures issued to business trusts
categorized as qualifying borrowings, less non-qualifying intangible assets and
unrealized net securities gains. The Corporation's Tier I capital to average
assets ratio was 7.70 percent and 7.50 percent at December 31, 2005 and 2004,
respectively. In addition, at December 31, 2005, the Corporation had a Tier I
risk-based capital ratio of 9.66 percent and total risk-based capital ratio of
11.72 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's GAAP capital ratio, defined as total stockholders' equity to
total assets, equaled 9.68 percent as of December 31, 2005, down from 9.86
percent in 2004. When the Corporation acquires other companies for stock, GAAP
capital increases by the entire amount of the purchase price.
The Corporation's tangible capital ratio, defined as total stockholders' equity
less intangibles net of tax to total assets less intangibles net of tax, equaled
5.82 percent as of December 31, 2005 down from 5.92 percent in 2004.
Management believes that all of the above capital ratios are meaningful
measurements for evaluating the safety and soundness of the Corporation.
Additionally, management believes the following table is also meaningful when
considering performance measures of the Corporation. The table details and
reconciles tangible earnings per share, return on tangible capital and tangible
assets to traditional GAAP measures.
December 31,
(Dollars in Thousands) 2005 2004
========================================================================================
Average Goodwill..................................... $ 112,281 $ 112,281
Average Core Deposit Intangible (CDI)................ 19,001 22,164
Average Deferred Tax on CDI.......................... (6,959) (8,105)
---------- ----------
Intangible Adjustment.............................. $ 124,323 $ 126,340
========== ==========
Average Stockholders' Equity (GAAP Capital).......... $ 315,525 $ 310,004
Intangible Adjustment................................ (124,323) (126,340)
---------- ----------
Average Tangible Capital........................... $ 191,202 $ 183,664
========== ==========
Average Assets....................................... $3,179,464 $3,109,104
Intangible Adjustment................................ (124,323) (126,340)
---------- ----------
Average Tangible Assets............................ $3,055,141 $2,982,764
========== ==========
Net Income........................................... $ 30,239 $ 29,411
CDI Amortization, net of tax......................... 1,955 2,133
---------- ----------
Tangible Net Income................................ $ 32,194 $ 31,544
========== ==========
Diluted Earnings per Share........................... $ 1.63 $ 1.58
Diluted Tangible Earnings per Share.................. $ 1.73 $ 1.69
Return on Average GAAP Capital....................... 9.58% 9.49%
Return on Average Tangible Capital................... 16.84% 17.49%
Return on Average Assets............................. 0.95% 0.95%
Return on Average Tangible Assets.................... 1.05% 1.06%
8
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ASSET QUALITY/PROVISION FOR LOAN LOSSES
The Corporation's primary business focus is small business and middle market
commercial and residential real estate, auto and small consumer lending, which
results in portfolio diversification. Management ensures that appropriate
methods to understand and underwrite risk are utilized. Commercial loans are
individually underwritten and judgmentally risk rated. They are periodically
monitored and prompt corrective actions are taken on deteriorating loans. Retail
loans are typically underwritten with statistical decision-making tools and are
managed throughout their life cycle on a portfolio basis.
The allowance for loan losses is maintained through the provision for loan
losses, which is a charge against earnings. The amount provided for loan losses
and the determination of the adequacy of the allowance are based on a continuous
review of the loan portfolio, including an internally administered loan "watch"
list and an independent loan review. The evaluation takes into consideration
identified credit problems, as well as the possibility of losses inherent in the
loan portfolio that are not specifically identified. (See Critical Accounting
Policies)
At December 31, 2005, non-performing loans totaled $14,305,000, a decrease of
$4,976,000, as noted in the following table. Loans 90 days past due other than
non-accrual and restructured loans increased by $349,000. The amount of
non-accrual loans totaled $10,030,000 at December 31, 2005. Non-performing loans
will increase or decrease going forward due to portfolio growth, routine problem
loans recognition and resolution through collections, sales or charge-offs. The
performance of any loan can be affected by external factors, such as economic
conditions, or factors particular to a borrower, such as actions of a borrower's
management.
At December 31, 2005, impaired loans totaled $52,380,000, an increase of
$2,969,000 from year end 2004. At December 31, 2005, a specific allowance for
losses was not deemed necessary for impaired loans totaling $44,840,000, but a
specific allowance of $2,824,000 was recorded for the remaining balance of
impaired loans of $7,540,000 and is included in the Corporation's allowance for
loan losses. The average balance of impaired loans for 2005 was $44,790,000. The
increase of total impaired loans is primarily due to the increase of performing,
substandard classified loans, which comprise a portion of the Corporation's
total impaired loans. A loan is deemed impaired when, based on current
information or events, it is probable that all amounts due of principal and
interest according to the contractual terms of the loan agreement will not be
collected. For the Corporation, all performing, substandard classified loans are
included in the impaired loan total.
At December 31, 2005, the allowance for loan losses was $25,188,000, an increase
of $2,640,000 from year end 2004. As a percent of loans, the allowance was 1.02
percent at December 31, 2005 and .93 percent at December 31, 2004. Management
believes that the allowance for loan losses is adequate to cover losses inherent
in the loan portfolio at December 31, 2005. The process for determining the
adequacy of the allowance for loan losses is critical to our financial results.
It requires management to make difficult, subjective and complex judgments, as a
result of the need to make estimates about the effect of matters that are
uncertain. Therefore, the allowance for loan losses, considering current factors
at the time, including economic conditions and ongoing internal and external
examination processes, will
9
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ASSET QUALITY/PROVISION FOR LOAN LOSSES continued
increase or decrease as deemed necessary to ensure the allowance for loan losses
remains adequate. In addition, the allowance as a percentage of charge-offs and
nonperforming loans will change at different points in time based on credit
performance, loan mix and collateral values.
The provision for loan losses in 2005 was $8,354,000, an increase of $2,649,000
from $5,705,000 in 2004. The Corporation's provision for loan losses increased
primarily due to an increase in the five-year rolling historical loan charge-off
ratio utilized within the Corporation's allowance for loan losses calculation.
The provision for loan losses in 2004 was $5,705,000, a decrease of $3,772,000
from $9,477,000 in 2003. The Corporation's allowance for loan losses reflected
decreased non-performing loans and specific reserves, resulting in decreased
provision expense in 2004.
The following table summarizes the non-accrual, contractually past due 90 days
or more other than non-accruing and restructured loans for the Corporation.
(Dollars in Thousands) December 31,
2005 2004
================================================================================
Non-accrual loans .............................. $10,030 $15,355
Loans contractually
past due 90 days or more
other than non-accruing ..................... 3,965 1,907
Restructured loans ............................. 310 2,019
------- -------
Total ....................................... $14,305 $19,281
======= =======
The table below represents loan loss experience for the years indicated.
(Dollars in Thousands) 2005 2004 2003
========================================================================================================
Allowance for loan losses:
Balance at January 1 .................................. $22,548 $25,493 $22,417
------- ------- -------
Chargeoffs ............................................ 7,744 10,901 12,139
Recoveries ............................................ 2,030 2,251 2,011
------- ------- -------
Net chargeoffs ........................................ 5,714 8,650 10,128
Provision for loan losses ............................. 8,354 5,705 9,477
Allowance acquired in acquisitions..................... 3,727
------- ------- -------
Balance at December 31 ................................ $25,188 $22,548 $25,493
======= ======= =======
Ratio of net chargeoffs during the period to
average loans outstanding during the period .......... .23% .37% .44%
LIQUIDITY
Liquidity management is the process by which the Corporation ensures that
adequate liquid funds are available for the Corporation and its subsidiaries.
These funds are necessary in order for the Corporation and its subsidiaries to
meet financial commitments on a timely basis. These commitments include
withdrawals by depositors, funding credit obligations to borrowers, paying
dividends to shareholders, paying operating expenses, funding capital
expenditures, and maintaining deposit reserve requirements. Liquidity is
monitored and closely managed by the asset/liability committees at each
subsidiary and by the Corporation's asset/liability committee.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY continued
The liquidity of the Corporation is dependent upon the receipt of dividends from
its bank subsidiaries, which are subject to certain regulatory limitations as
explained in Note 14 to the consolidated financial statements, and access to
other funding sources. Liquidity of the Corporation's bank subsidiaries is
derived primarily from core deposit growth, principal payments received on
loans, the sale and maturity of investment securities, net cash provided by
operating activities, and access to other funding sources.
The most stable source, of liability-funded liquidity for both the long-term and
short-term, is deposit growth and retention in the core deposit base. In
addition, the Corporation utilizes advances from the Federal Home Loan Bank
("FHLB") and a revolving line of credit with LaSalle Bank, N.A. ("LaSalle") as
funding sources. At December 31, 2005, total borrowings from the FHLB were
$247,865,000, and the outstanding balance of the LaSalle revolving line of
credit totaled $15,000,000. The Corporation's bank subsidiaries have pledged
certain mortgage loans and certain investments to the FHLB. The total available
remaining borrowing capacities from FHLB and LaSalle at December 31, 2005, were
$62,228,000 and $5,000,000, respectively.
The principal source of asset-funded liquidity is investment securities
classified as available-for-sale, the market values of which totaled
$422,627,000 at December 31, 2005. Securities classified as held-to-maturity
that are maturing within a short period of time can also be a source of
liquidity. Securities classified as held-to-maturity and that are maturing in
one year or less totaled $733,000 at December 31, 2005. In addition, other types
of assets-such as cash and due from banks, federal funds sold and securities
purchased under agreements to resell, and loans and interest-bearing deposits
with other banks maturing within one year-are sources of liquidity.
In the normal course of business, the Corporation is a party to a number of
other off-balance sheet activities that contain credit, market and operational
risk that are not reflected in whole or in part in the Corporation's
consolidated financial statements. Such activities include: traditional
off-balance sheet credit-related financial instruments, commitments under
operating leases and long-term debt.
The Corporation provides customers with off-balance sheet credit support through
loan commitments and standby letters of credit. Summarized credit-related
financial instruments at December 31, 2005 are as follows:
At December 31,
(Dollars in Thousands) 2005
================================================================================
Amounts of commitments:
Loan commitments to extend credit .......................... $574,384
Standby letters of credit .................................. 30,410
--------
$604,794
========
Since many of the commitments are expected to expire unused or be only partially
used, the total amount of unused commitments in the preceding table does not
necessarily represent future cash requirements.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY continued
In addition to owned banking facilities, the Corporation has entered into a
number of long-term leasing arrangements to support the ongoing activities of
the Corporation. The required payments under such commitments and other
borrowing arrangements at December 31, 2005 are as follows:
2010
(Dollars in Thousands) 2006 2007 2008 2009 2010 and after Total
===========================================================================================================
Operating leases $ 2,055 $ 1,756 $ 1,275 $ 1,111 $ 1,057 $ 1,649 $ 8,903
Federal funds purchased 50,000 50,000
Securities sold under
repurchase agreements 106,415 106,415
Federal Home Loan Bank advances 56,335 32,495 32,839 11,382 35,192 79,622 247,865
Subordinated debentures,
revolving credit lines and
term loans 15,000 88,956 103,956
-------- ------- ------- ------- -------- -------- --------
Total $229,805 $34,251 $34,114 $12,493 $ 36,249 $170,227 $517,139
======== ======= ======= ======= ======== ======== ========
The Corporation has various purchase obligations for new facilities or
improvements to existing facilities. At December 31, 2005, the Corporation's
purchase obligations outstanding totaled $6,156,000.
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK
Asset/Liability Management has been an important factor in the Corporation's
ability to record consistent earnings growth through periods of interest rate
volatility and product deregulation. Management and the Board of Directors
monitor the Corporation's liquidity and interest sensitivity positions at
regular meetings to review how changes in interest rates may affect earnings.
Decisions regarding investment and the pricing of loan and deposit products are
made after analysis of reports designed to measure liquidity, rate sensitivity,
the Corporation's exposure to changes in net interest income given various rate
scenarios and the economic and competitive environments.
It is the objective of the Corporation to monitor and manage risk exposure to
net interest income caused by changes in interest rates. It is the goal of the
Corporation's Asset/Liability function to provide optimum and stable net
interest income. To accomplish this, management uses two asset liability tools.
GAP/Interest Rate Sensitivity Reports and Net Interest Income Simulation
Modeling are both constructed, presented and monitored quarterly.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued
Management believes that the Corporation's liquidity and interest sensitivity
position at December 31, 2005, remained adequate to meet the Corporation's
primary goal of achieving optimum interest margins while avoiding undue interest
rate risk. The following table presents the Corporation's interest rate
sensitivity analysis as of December 31, 2005.
(Dollars in Thousands) At December 31, 2005
-----------------------------------------------------------------------------------------------------------------------------------
1-180 DAYS 181-365 DAYS 1-5 YEARS BEYOND 5 YEARS TOTAL
===================================================================================================================================
Rate-Sensitive Assets:
Interest-bearing deposits ............................... $ 8,748 $ 8,748
Investment securities ................................... 56,711 $ 47,049 $ 245,520 $ 84,986 434,266
Loans ................................................... 1,057,267 310,978 888,487 205,605 2,462,337
Federal Reserve and Federal Home Loan Bank stock ........ 21,665 1,535 23,200
---------- ---------- ---------- ---------- ----------
Total rate-sensitive assets ........................ 1,122,726 358,027 1,155,672 292,126 2,928,551
---------- ---------- ---------- ---------- ----------
Rate-Sensitive Liabilities:
Federal funds purchased ................................. 50,000 50,000
Interest-bearing deposits ............................... 1,355,305 233,450 428,325 51,161 2,068,241
Securities sold under repurchase agreements ............. 106,295 120 106,415
Federal Home Loan Bank advances ......................... 38,500 17,835 111,908 79,622 247,865
Subordinated debentures, revolving credit
lines and term loans ................................. 15,000 88,956 103,956
---------- ---------- ---------- ---------- ----------
Total rate-sensitive liabilities ................... 1,565,100 251,405 540,233 219,739 2,576,477
---------- ---------- ---------- ---------- ----------
Interest rate sensitivity gap by period .................... $ (442,374) $ 106,622 $ 615,439 $ 72,387
Cumulative rate sensitivity gap ............................ (447,374) (335,752) 279,687 352,074
Cumulative rate sensitivity gap ratio
at December 31, 2005 .................................... 71.7% 81.5% 111.9% 113.7%
at December 31, 2004 .................................... 81.9% 90.0% 114.3% 116.1%
The Corporation had a cumulative negative gap of $335,752,000 in the one-year
horizon at December 31, 2005, just over 10.4 percent of total assets.
The Corporation places its greatest credence in net interest income simulation
modeling. The above GAP/Interest Rate Sensitivity Report is believed by the
Corporation's management to have two major shortfalls. The GAP/Interest Rate
Sensitivity Report fails to precisely gauge how often an interest rate sensitive
product reprices, nor is it able to measure the magnitude of potential future
rate movements.
Net interest income simulation modeling, or earnings-at-risk, measures the
sensitivity of net interest income to various interest rate movements. The
Corporation's asset liability process monitors simulated net interest income
under three separate interest rate scenarios; base, rising and falling.
Estimated net interest income for each scenario is calculated over a 12-month
horizon. The immediate and parallel changes to the base case scenario used in
the model are presented below. The interest rate scenarios are used for
analytical purposes and do not necessarily represent management's view of future
market movements. Rather, these are intended to provide a measure of the degree
of volatility interest rate movements may introduce into the earnings of the
Corporation.
The base scenario is highly dependent on numerous assumptions embedded in the
model, including assumptions related to future interest rates. While the base
sensitivity analysis incorporates management's best estimate of interest rate
and balance sheet dynamics under various market rate movements, the actual
behavior and resulting earnings impact will likely differ from that projected.
For mortgage-related assets, the base simulation model captures the expected
prepayment behavior under changing interest rate environments. Assumptions and
methodologies regarding the interest rate or balance behavior of indeterminate
maturity products, e.g., savings, money market,
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued
NOW and demand deposits reflect management's best estimate of expected future
behavior.
The comparative rising and falling scenarios for the period ending December 31,
2006 assume further interest rate changes in addition to the base simulation
discussed above. These changes are immediate and parallel changes to the base
case scenario. In addition, total rate movements (beginning point minus ending
point) to each of the various driver rates utilized by management in the base
simulation for the period ended December 31, 2006 are as follows:
Driver Rates RISING FALLING
================================================================================
Prime 200 Basis Points (200) Basis Points
Federal Funds 200 (200)
One-Year CMT 200 (200)
Two-Year CMT 200 (200)
Three-Year CMT 200 (200)
Five-Year CMT 200 (200)
CD's 200 (89)
FHLB Advances 200 (200)
Results for the base, rising and falling interest rate scenarios are listed
below, based upon the Corporation's rate sensitive assets and liabilities at
November 30, 2005. The net interest income shown represents cumulative net
interest income over a 12-month time horizon. Balance sheet assumptions used for
the base scenario are the same for the rising and falling simulations.
BASE RISING FALLING
===============================================================================
Net Interest Income (Dollars in Thousands) $111,989 $114,930 $109,220
Variance from base $ 2,941 $ (2,769)
Percent of change from base 2.63% (2.47)%
The comparative rising and falling scenarios for the period ended December 31,
2005 assume further interest rate changes in addition to the base simulation
discussed above. These changes are immediate and parallel changes to the base
case scenario. In addition, total rate movements (beginning point minus ending
point) to each of the various driver rates utilized by management in the base
simulation for the period ended December 31, 2005 are as follows:
Driver Rates RISING FALLING
================================================================================
Prime 200 Basis Points (200) Basis Points
Federal Funds 200 (200)
One-Year CMT 200 (200)
Two-Year CMT 200 (200)
CD's 200 (74)
FHLB Advances 200 (200)
Results for the base, rising and falling interest rate scenarios are listed
below. The net interest income shown represents cumulative net interest income
over a 12-month time horizon. Balance sheet assumptions used for the base
scenario are the same for the rising and falling simulations.
BASE RISING FALLING
================================================================================
Net Interest Income (Dollars in Thousands) $109,311 $117,212 $ 97,757
Variance from base $ 7,901 $(11,554)
Percent of change from base 7.2% (10.6)%
14
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
EARNING ASSETS
Earnings assets increased approximately $43,397,000 during 2005 as compared to
2004. Loans grew by $30,919,000. Positive growth of commercial and industrial
loans, real estate construction and farmland real estate loans totaled
approximately $45,622,000. In addition, individuals' loans for household and
other personal expenditures grew approximately $1,607,000 during 2005. These
increases were mitigated by a decline in residential real estate loans,
agriculture loans and leases of approximately $14,773,000.
The table below reflects the earning asset mix for the years 2005 and 2004 (at
December 31).
Earning Assets
(Dollars in Thousands) December 31,
===================================================================================
2005 2004
---------- ----------
Interest-bearing time deposits ................. $ 8,748 $ 9,343
Investment securities available for sale ....... 422,627 416,177
Investment securities held to maturity ......... 11,639 5,358
Mortgage loans held for sale ................... 4,910 3,367
Loans .......................................... 2,457,427 2,428,051
Federal Reserve and Federal Home Loan Bank stock 23,200 22,858
---------- ----------
Total ...................................... $2,928,551 $2,885,154
========== ==========
DEPOSITS AND BORROWINGS
The table below reflects the level of deposits and borrowed funds (federal funds
purchased; repurchase agreements; Federal Home Loan Bank advances; subordinated
debentures, revolving credit lines and term loans) based on year-end levels at
December 31, 2005 and 2004.
(Dollars in Thousands) December 31,
2005 2004
---------- ----------
Deposits ........................................... $2,382,576 $2,408,150
Federal funds purchased ............................ 50,000 32,550
Securities sold under repurchase agreements ........ 106,415 87,472
Federal Home Loan Bank advances .................... 247,865 223,663
Subordinated debentures, revolving credit lines
and term loans .................................. 103,956 97,206
---------- ----------
$2,890,812 $2,849,041
========== ==========
The Corporation has continued to leverage its capital position with Federal Home
Loan Bank advances, as well as repurchase agreements which are pledged against
acquired investment securities as collateral for the borrowings. The interest
rate risk is included as part of the Corporation's interest simulation discussed
in Management's Discussion and Analysis of Financial Condition and Results of
Operations under the headings "LIQUIDITY" and "INTEREST SENSITIVITY AND
DISCLOSURES ABOUT MARKET RISK".
NET INTEREST INCOME
Net interest income is the primary source of the Corporation's earnings. It is a
function of net interest margin and the level of average earning assets. The
following table presents the Corporation's asset yields, interest expense, and
net interest income as a percent of average earning assets for the three-year
period ending in 2005.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
NET INTEREST INCOME continued
In 2005, asset yields increased 54 basis points (FTE) and interest cost
increased 45 basis points, resulting in a 9 basis point (FTE) increase in net
interest income as compared to 2004. The improvement in margin was primarily a
result of eight 25 basis point overnight federal funds rate increases by the
Federal Open Market Committee during this period. As a result, the Corporation's
prime lending rates increased accordingly, while offsetting deposit rate
increases were less significant.
In 2004, asset yields decreased 26 basis points (FTE) and interest cost
decreased 13 basis points, resulting in a 13 basis point (FTE) decrease in net
interest income as compared to 2003. Margins remained compressed through the
first half of 2004 as the combined first and second quarters net interest margin
equaled 3.87 percent. In June 2004, the first of five 25 basis point overnight
federal funds rate increases by the Federal Open Market Committee occurred,
helping increase the combined third and fourth quarter net interest margin to
3.90 percent. However, the net interest margin for the 2004 fourth quarter
declined to 3.85 percent. This was primarily due to the reversal of
approximately $340,000 of interest income in the fourth quarter, related to
loans placed on non-accrual status and charged-off during the quarter. In
addition, the Corporation maintained an average federal funds sold position of
approximately $60 million, which generated lower yields.
(Dollars in Thousands) December 31,
2005 2004 2003
---- ---- ----
Net Interest Income .......................... $ 111,129 $ 105,389 $ 103,142
FTE Adjustment ............................... $ 3,778 $ 3,597 $ 3,757
Net Interest Income
On a Fully Taxable Equivalent Basis ........ $ 114,907 $ 108,986 $ 106,899
Average Earning Assets ....................... $2,891,121 $2,806,776 $2,663,853
Interest Income (FTE) as a Percent
of Average Earning Assets .................. 6.26% 5.72% 5.98%
Interest Expense as a Percent
of Average Earning Assets .................. 2.29% 1.84% 1.97%
Net Interest Income (FTE) as a Percent
of Average Earning Assets .................. 3.97% 3.88% 4.01%
Average earning assets include the average balance of securities classified as
available for sale, computed based on the average of the historical amortized
cost balances without the effects of the fair value adjustment. In addition,
annualized amounts are computed utilizing a 30/360 day basis.
OTHER INCOME
The Corporation offers a wide range of fee-based services. Fee schedules are
regularly reviewed by a pricing committee to ensure that the products and
services offered by the Corporation are priced to be competitive and profitable.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OTHER INCOME continued
Other income in 2005 amounted to $34,717,000, a .5 percent increase from 2004.
The change in other income from 2005 to 2004 was minor and primarily
attributable to fluctuations within the following other income items:
1. Insurance commissions increased by $733,000, due to the receipt of
increased profit sharing payments from insurance underwriters, as
compared to the same period in 2004.
2. Fees on debit cards and ATMs increased by approximately $899,000 as
compared to the same period in 2004. This was primarily a result of
increased card usage by customers.
3. Net gains and fees on sales of mortgage loans decreased by $727,000
from the same period in 2004, as stabilizing mortgage interest rates
caused reduced volumes of mortgage refinancing.
4. In 2005, sales of available for sale securities resulted in a net
loss of $2,000; however, in 2004, sales of available for sale
securities resulted in net gains totaling $1,188,000.
Other income in 2004 amounted to $34,554,000, a 3.8 percent decline from 2003.
The decrease of $1,348,000 is primarily attributable to the following factors:
1. Net gains and fees on sales of mortgage loans included in other
income decreased by $2,759,000 due to decreased mortgage volume
during 2004.
2. Life insurance proceeds included in other income was $0 for 2004
compared to $535,000 for 2003.
3. Service charges on deposit accounts increased $533,000 or 4.8
percent due to increased number of customer accounts and price
adjustments.
4. Revenues from fiduciary activities increased $896,000 or 13.3
percent due to expansion, market improvements and price adjustments.
OTHER EXPENSES
Other expenses represent non-interest operating expenses of the Corporation.
Other expenses amounted to $93,957,000 in 2005, an increase of 2.5 percent from
the prior year, or $2,315,000. A pension accounting loss, totaling approximately
$1,630,000, was recorded during the first quarter of 2005 and accounts for most
of the increase. The loss resulted from the curtailment of the accumulation of
defined benefits in the Corporation's defined benefit plan.
Other expenses amounted to $91,642,000 in 2004, an increase of 0.4 percent from
the prior year, or $363,000. The following factors account for most of the 2004
increase:
1. Salaries and benefit expense grew $1,995,000 or 4.0 percent, due to
normal salary increases and additional salary cost related to the
March 1, 2003 acquisition of Commerce National.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OTHER EXPENSES continued
2. Prepayment penalties for early prepayment of FHLB advances totaled
$340,000 for 2003 and no such penalties were incurred during 2004.
3. Investment securities write-downs totaling $615,000 were incurred in
2003, resulting from other-than-temporary losses being recognized on
two securities. No investment security write-downs, resulting from
other-than temporary losses, were incurred during 2004.
4. In 2003, the Corporation incurred $460,000 expense to fund the
anticipation of a settlement of a claim. No such expense was
incurred during 2004.
INCOME TAXES
Income tax expense totaled $13,296,000 for 2005, which is an increase of
$111,000 from 2004. The 2005 increase in tax expense is primarily a result of
the increase of the 2005 income before income tax, as compared to 2004.
In addition, the effective tax rates for the periods ending December 31, 2005,
2004 and 2003 were 30.5 percent, 31.0 percent and 28.0 percent, respectively.
The effective tax rate has remained lower than the federal statutory income tax
rate of 34 percent, primarily due to the Corporation's tax-exempt investment
income on securities and loans, income tax credits generated from investments in
affordable housing projects, income generated by subsidiaries domiciled in a
state with no state or local income tax, increases in tax exempt earnings from
bank-owned life insurance contracts and reduced state taxes, resulting from the
effect of state income apportionment.
INFLATION
Changing prices of goods, services and capital affect the financial position of
every business enterprise. The level of market interest rates and the price of
funds loaned or borrowed fluctuate due to changes in the rate of inflation and
various other factors, including government monetary policy.
Fluctuating interest rates affect the Corporation's net interest income, loan
volume and other operating expenses, such as employee salaries and benefits,
reflecting the effects of escalating prices, as well as increased levels of
operations and other factors. As the inflation rate increases, the purchasing
power of the dollar decreases. Those holding fixed-rate monetary assets incur a
loss, while those holding fixed-rate monetary liabilities enjoy a gain. The
nature of a financial holding company's operations is such that there will
generally be an excess of monetary assets over monetary liabilities, and, thus,
a financial holding company will tend to suffer from an increase in the rate of
inflation and benefit from a decrease.
OTHER
The Securities and Exchange Commission maintains a Web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the commission, including the
Corporation, and that address is (http://www.sec.gov).
18
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee, Board of Directors and Stockholders
First Merchants Corporation
Muncie, Indiana
We have audited the accompanying consolidated balance sheets of First Merchants
Corporation as of December 31, 2005 and 2004, and the related consolidated
statements of income, comprehensive income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 2005. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the 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 referred to above present
fairly, in all material respects, the financial position of First Merchants
Corporation as of December 31, 2005 and 2004, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2005, in conformity with accounting principles generally accepted in the United
States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of First Merchants
Corporation's internal control over financial reporting as of December 31, 2005
based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and
our report dated January 27, 2006 expressed unqualified opinions on management's
assessment and on the effectiveness of the Corporation's internal control over
financial reporting.
BKD, LLP
Indianapolis, Indiana
January 27, 2006
19
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets
(in thousands, except share data) December 31,
==============================================================================================================================
2005 2004
Assets
Cash and due from banks ........................................................... $ 70,417 $ 69,960
Interest-bearing time deposits .................................................... 8,748 9,343
Investment securities
Available for sale ............................................................. 422,627 416,177
Held to maturity (fair value of $11,510 and $5,520) ............................ 11,639 5,358
----------- -----------
Total investment securities .................................................. 434,266 421,535
Mortgage loans held for sale ...................................................... 4,910 3,367
Loans, net of allowance for loan losses of $25,188 and $22,548 .................... 2,432,239 2,405,503
Premises and equipment ............................................................ 39,417 38,254
Federal Reserve and Federal Home Loan Bank stock .................................. 23,200 22,858
Interest receivable ............................................................... 19,690 17,318
Core deposit intangibles .......................................................... 17,567 20,669
Goodwill .......................................................................... 121,266 120,615
Cash value of life insurance ...................................................... 43,579 42,061
Other assets ...................................................................... 21,780 20,185
----------- -----------
Total assets ................................................................. $ 3,237,079 $ 3,191,668
=========== ===========
Liabilities
Deposits
Noninterest-bearing ............................................................. $ 314,335 $ 330,685
Interest-bearing ................................................................ 2,068,241 2,077,465
----------- -----------
Total deposits ................................................................ 2,382,576 2,408,150
Borrowings ........................................................................ 508,236 440,891
Interest payable .................................................................. 5,874 4,411
Other liabilities ................................................................. 26,997 23,613
----------- -----------
Total liabilities ............................................................. 2,923,683 2,877,065
Commitments and Contingent Liabilities
Stockholders' equity
Preferred stock, no-par value
Authorized and unissued -- 500,000 shares
Common stock, $.125 stated value
Authorized -- 50,000,000 shares
Issued and outstanding - 18,416,714 and 18,573,997 shares ...................... 2,302 2,322
Additional paid-in capital ........................................................ 145,682 150,862
Retained earnings ................................................................. 174,717 161,459
Accumulated other comprehensive loss .............................................. (9,305) (40)
----------- -----------
Total stockholders' equity ................................................... 313,396 314,603
----------- -----------
Total liabilities and stockholders' equity ................................... $ 3,237,079 $ 3,191,668
=========== ===========
See notes to consolidated financial statements.
20
Consolidated Statements of Income
(in thousands, except share data) Year Ended December 31,
===================================================================================================================================
2005 2004 2003
Interest income
Loans receivable
Taxable ............................................................. $158,436 $139,953 $141,236
Tax exempt .......................................................... 643 581 707
Investment securities
Taxable ............................................................. 9,612 8,371 6,105
Tax exempt .......................................................... 6,374 6,098 6,270
Federal funds sold .................................................... 264 165 487
Deposits with financial institutions .................................. 695 555 76
Federal Reserve and Federal Home Loan Bank stock ...................... 1,185 1,251 649
-------- -------- --------
Total interest income ............................................. 177,209 156,974 155,530
-------- -------- --------
Interest expense
Deposits .............................................................. 46,121 33,844 34,858
Securities sold under repurchase agreements ........................... 1,612 517 1,521
Federal Home Loan Bank advances ....................................... 9,777 9,777 9,439
Subordinated debentures, revolving
credit lines and term loans ......................................... 7,432 6,784 6,161
Other borrowings ...................................................... 1,138 663 409
-------- -------- --------
Total interest expense ........................................... 66,080 51,585 52,388
-------- -------- --------
Net interest income ...................................................... 111,129 105,389 103,142
Provision for loan losses ............................................. 8,354 5,705 9,477
-------- -------- --------
Net interest income after provision for loan losses ...................... 102,775 99,684 93,665
-------- -------- --------
Other income
Fiduciary activities .................................................. 7,481 7,632 6,736
Service charges on deposit accounts ................................... 11,298 11,638 11,105
Other customer fees ................................................... 5,094 4,083 4,124
Net realized gains (losses) on
sales of available-for-sale securities .............................. (2) 1,188 950
Commission income ..................................................... 3,821 3,088 2,668
Earnings on cash surrender value
of life insurance ................................................... 1,667 1,798 1,347
Net gains and fees on sales of loans .................................. 2,902 3,629 6,388
Other income .......................................................... 2,456 1,498 2,584
-------- -------- --------
Total other income ............................................... 34,717 34,554 35,902
-------- -------- --------
Other expenses
Salaries and employee benefits ........................................ 54,059 52,479 50,484
Net occupancy expenses ................................................ 5,796 5,308 4,894
Equipment expenses .................................................... 7,562 7,665 8,073
Marketing expenses..................................................... 2,012 1,709 1,797
Outside data processing fees .......................................... 4,010 4,920 4,118
Printing and office supplies .......................................... 1,369 1,580 1,706
Core deposit amortization.............................................. 3,102 3,375 3,704
Other expenses ........................................................ 16,047 14,606 16,503
-------- -------- --------
Total other expenses ............................................. 93,957 91,642 91,279
-------- -------- --------
Income before income tax ................................................. 43,535 42,596 38,288
Income tax expense .................................................... 13,296 13,185 10,717
-------- -------- --------
Net income ............................................................... $ 30,239 $ 29,411 $ 27,571
======== ======== ========
Net income per share:
Basic ................................................................. $ 1.64 $ 1.59 $ 1.51
Diluted ............................................................... 1.63 1.58 1.50
See notes to consolidated financial statements.
21
Consolidated Statements of Comprehensive Income
Year Ended December 31,
(in thousands) 2005 2004 2003
===================================================================================================================================
Net income ............................................................................ $ 30,239 $ 29,411 $ 27,571
-------- -------- --------
Other comprehensive income (loss), net of tax:
Unrealized losses on securities available for sale:
Unrealized holding losses arising during the period,
net of income tax benefit of $3,562, $1,199 and $1,465............................ (6,615) (1,799) (2,197)
Less: Reclassification adjustment for gains (losses) included in net income,
net of income tax (expenses) benefit of $1, $(475) and $(380)................... (1) 713 570
Unrealized loss on pension minimum funding liability:
Unrealized loss arising during the period,
net of income tax benefit of $1,767, $150 and $357 ............................... (2,651) (227) (536)
-------- -------- --------
(9,265) (2,285) (2,231)
-------- -------- --------
COMPREHENSIVE INCOME $ 20,974 $ 27,126 $ 25,340
======== ======== ========
Consolidated Statements of Stockholders' Equity
(in thousands, except share data)
----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK ACCUMULATED OTHER
---------------------- ADDITIONAL RETAINED COMPREHENSIVE
SHARES AMOUNT PAID-IN CAPITAL EARNINGS INCOME (LOSS) TOTAL
---------- ------- --------------- -------- ----------------- -------
Balances, January 1, 2003 16,322,748 $ 2,040 $116,503 $138,110 $ 4,476 261,129
Net income for 2003.......................... 27,571 27,571
Cash dividends ($.90 per share).............. (16,557) (16,557)
Other comprehensive income (loss),
net of tax ............................... (2,231) (2,231)
Stock issued under employee benefit plans ... 39,747 5 814 819
Stock issued under dividend reinvestment
and stock purchase plan .................. 48,168 6 1,218 1,224
Stock options exercised ..................... 66,513 8 1,183 1,191
Stock redeemed .............................. (17,915) (2) (486) (488)
Issuance of stock related to acquisition..... 1,173,996 147 31,188 31,335
Five percent (5%) stock dividend............. 879,577 110 (110)
Cash paid in lieu of fractional shares....... (28) (28)
----------- -------- -------- --------- --------- ---------
Balances, December 31, 2003 18,512,834 2,314 150,310 149,096 2,245 303,965
Net income for 2004.......................... 29,411 29,411
Cash dividends ($.92 per share).............. (17,048) (17,048)
Other comprehensive income (loss),
net of tax ............................... (2,285) (2,285)
Stock issued under employee benefit plans ... 45,267 6 897 903
Stock issued under dividend reinvestment
and stock purchase plan .................. 50,799 6 1,272 1,278
Stock options exercised ..................... 90,338 11 1,393 1,404
Stock redeemed .............................. (193,789) (24) (4,702) (4,726)
Issuance of stock related to acquisition..... 68,548 9 1,692 1,701
----------- -------- -------- --------- --------- ---------
Balances, December 31, 2004 18,573,997 2,322 150,862 161,459 (40) 314,603
Net income for 2005.......................... 30,239 30,239
Cash dividends ($.92 per share).............. (16,981) (16,981)
Other comprehensive income (loss),
net of tax ............................... (9,265) (9,265)
Stock issued under employee benefit plans ... 43,238 6 908 914
Stock issued under dividend reinvestment
and stock purchase plan .................. 35,565 4 929 933
Stock options exercised ..................... 121,750 15 2,159 2,174
Stock redeemed .............................. (374,598) (47) (9,611) (9,658)
Issuance of stock related to acquisition..... 16,762 2 435 437
----------- -------- -------- --------- --------- ---------
Balances, December 31, 2005 18,416,714 $ 2,302 $145,682 $174,717 $ (9,305) $ 313,396
=========== ======== ======== ========= ========= =========
See notes to consolidated financial statements.
22
Consolidated Statements of Cash Flows
================================================================================================================================
Year Ended December 31,
(in thousands, except share data) 2005 2004 2003
================================================================================================================================
Operating activities:
Net income ......................................................... $ 30,239 $ 29,411 $ 27,571
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses ........................................ 8,354 5,705 9,477
Depreciation and amortization..................................... 5,070 5,064 4,769
Mortgage loans originated for sale ............................... (86,122) (83,313) (212,243)
Proceeds from sales of mortgage loans ............................ 84,579 82,989 230,745
Net change in
Interest receivable .......................................... (2,372) (478) 1,368
Interest payable ............................................. 1,463 (269) (1,695)
Other adjustments ................................................ 5,283 842 5,677
--------- --------- ---------
Net cash provided by operating activities .................... 46,494 39,951 65,669
--------- --------- ---------
Investing activities:
Net change in interest-bearing deposits ............................ 595 (1,202) (4,573)
Purchases of
Securities available for sale .................................... (97,861) (214,393) (260,467)
Proceeds from maturities of
Securities available for sale .................................... 69,236 116,294 174,003
Proceeds from sales of
Securities available for sale .................................... 4,718 32,336 58,245
Purchase of Federal Reserve and Federal Home Loan Bank stock (342) (7,356) (4,093)
Net change in loans ................................................ (35,090) (83,198) (56,825)
Net cash paid in acquisition ........................................ (213) (201) (7,793)
Other adjustments .................................................. (6,233) (6,106) (2,262)
--------- --------- ---------
Net cash used by investing activities......................... (65,190) (163,826) (103,765)
--------- --------- ---------
Cash flows from financing activities:
Net change in
Demand and savings deposits ...................................... (80,986) 89,008 39,400
Certificates of deposit and other time deposits .................. 55,412 (42,959) 14,476
Receipt of borrowings .............................................. 191,002 181,211 73,303
Repayment of borrowings ............................................ (123,657) (124,763) (84,755)
Cash dividends ..................................................... (16,981) (17,048) (16,557)
Stock issued under employee benefit plans .......................... 914 903 819
Stock issued under dividend reinvestment
and stock purchase plan .......................................... 933 1,278 1,224
Stock options exercised ............................................ 2,174 1,404 1,191
Stock redeemed ..................................................... (9,658) (4,726) (488)
Cash paid in lieu of issuing fractional shares ..................... (28)
--------- --------- ---------
Net cash provided by financing activities .................... 19,153 84,308 28,585
--------- --------- ---------
Net change in cash and cash equivalents ............................... 457 (39,567) (9,511)
Cash and cash equivalents, beginning of year .......................... 69,960 109,527 119,038
--------- --------- ---------
Cash and cash equivalents, end of year ................................ $ 70,417 $ 69,960 $ 109,527
========= ========= =========
Additional cash flows information:
Interest paid ....................................................... $ 64,617 $ 51,854 $ 53,727
Income tax paid ..................................................... 16,775 10,501 13,952
See notes to consolidated financial statements.
23
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"), The Madison Community Bank, N.A. ("Madison"), First United
Bank, N.A. ("First United"), United Communities National Bank ("United
Communities"), First National Bank ("First National"), Decatur Bank and Trust
Company, N.A. ("Decatur"), Frances Slocum Bank & Trust Company, N.A. ("Frances
Slocum"), Lafayette Bank and Trust Company, N.A. ("Lafayette"), and Commerce
National Bank ("Commerce National"), (collectively the "Banks"), Merchants Trust
Company, National Association ("MTC"), First Merchants Insurance Services, Inc.
("FMIS"), First Merchants Reinsurance Company ("FMRC")and Indiana Title
Insurance Company ("ITIC"), conform to generally accepted accounting principles
and reporting practices followed by the banking industry. The more significant
of the policies are described below. Effective January 1, 2006, First United was
merged into First Merchants, and the name of the continuing institution is First
Merchants Bank, N.A.
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 financial holding company whose principal activity is the
ownership and management of the Banks and operates in a single significant
business segment. The Banks operate under national bank charters and provide
full banking services. As national banks, the Banks are subject to the
regulation of the Office of the Comptroller of the Currency and the Federal
Deposit Insurance Corporation.
The Banks generate commercial, mortgage, and consumer loans and receive deposits
from customers located primarily in north-central and east-central Indiana and
Butler, Franklin and Hamilton counties in Ohio. The Banks' loans are generally
secured by specific items of collateral, including real property, consumer
assets and business assets.
CONSOLIDATION
The consolidated financial statements include the accounts of the Corporation
and all its subsidiaries, after elimination of all material intercompany
transactions.
INVESTMENT SECURITIES-Debt securities are classified as held to maturity when
the Corporation has the positive intent and ability to hold the securities to
maturity. Securities held to maturity are carried at amortized cost. Debt
securities not classified as held to maturity are classified as available for
sale. Securities available for sale are carried at fair value with unrealized
gains and losses reported separately in accumulated other comprehensive income,
net of tax.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES continued
Amortization of premiums and accretion of discounts are recorded as interest
income from securities. Realized gains and losses are recorded as net security
gains (losses). Gains and losses on sales of securities are determined on the
specific-identification method.
Available-for-sale and held-to-maturity securities are reviewed quarterly for
possible other-than-temporary impairment. The review includes an analysis of the
facts and circumstances of each individual investment such as the length of time
the fair value has been below cost, the expectation for that security's
performance, the credit worthiness of the issuer and the Corporation's ability
to hold the security to maturity. A decline in value that is considered to be
other-than temporary is recorded as a loss within other operating income in the
consolidated statements of income.
LOANS HELD FOR SALE are carried at the lower of aggregate cost or market. Market
is determined using the aggregate method. Net unrealized losses, if any, are
recognized through a valuation allowance by charges to income based on the
difference between estimated sales proceeds and aggregate cost.
LOANS held in the Corporation's portfolio are carried at the principal amount
outstanding. Certain nonaccrual and substantially delinquent loans may be
considered to be impaired. A loan is impaired when, based on current information
or events, it is probable that the Banks will be unable to collect all amounts
due (principal and interest) according to the contractual terms of the loan
agreement. In applying the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 114, the Corporation considers its investment in
one-to-four family residential loans and consumer installment loans to be
homogeneous and therefore excluded from separate identification for evaluation
of impairment. Interest income is accrued on the principal balances of loans,
except for installment loans with add-on interest, for which a method that
approximates the level yield method is used. The accrual of interest on impaired
loans is discontinued when, in management's opinion, the borrower may be unable
to meet payments as they become due. When interest accrual is discontinued, all
unpaid accrued interest is reversed when considered uncollectable. Interest
income is subsequently recognized only to the extent cash payments are received.
Certain loan fees and direct costs are being deferred and amortized as an
adjustment of yield on the loans.
ALLOWANCE FOR LOAN LOSSES is maintained to absorb losses inherent in the loan
portfolio and is based on ongoing, quarterly assessments of the probable losses
inherent in the loan portfolio. The allowance is increased by the provision for
loan losses, which is charged against current operating results. Loan losses are
charged against the allowance when management believes the uncollectibility of a
loan balance is confirmed. Subsequent recoveries, if any, are credited to the
allowance. The Corporation's methodology for assessing the appropriateness of
the allowance consists of three key elements - the determination of the
appropriate reserves for specifically identified loans, historical losses, and
economic, environmental or qualitative factors.
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES continued
Larger commercial loans that exhibit probable or observed credit weaknesses are
subject to individual review. Where appropriate, reserves are allocated to
individual loans based on management's estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and legal options available to the Corporation. Included in the review of
individual loans are those that are impaired as provided in SFAS No. 114. Any
allowances for impaired loans are measured based on the present value of
expected future cash flows discounted at the loan's effective interest rate or
fair value of the underlying collateral. The Corporation evaluates the
collectibility of both principal and interest when assessing the need for a loss
accrual. Historical loss rates are applied to other commercial loans not subject
to specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans
are not individually risk graded. Reserves are established for each pool of
loans using loss rates based on a five year average net charge-off history by
loan category.
Historical loss allocations for commercial and consumer loans may be adjusted
for significant factors that, in management's judgment, reflect the impact of
any current conditions on loss recognition. Factors which management considers
in the analysis include the effects of the national and local economies, trends
in the volume of loans, changes in mix, concentration of loans in specific
industries, asset quality trends (delinquencies, charge-offs and nonaccrual
loans), risk management and loan administration, changes in the internal lending
policies and credit standards, collection practices and examination results from
bank regulatory agencies and the Corporation's internal loan review.
An unallocated reserve, primarily based on the factors noted above, is
maintained to recognize the imprecision in estimating and measuring loss when
evaluating reserves for individual loans or pools of loans. Allowances on
individual loans and historical loss allocations are reviewed quarterly and
adjusted as necessary based on changing borrower and/or collateral conditions.
PREMISES AND EQUIPMENT are carried at cost net of accumulated depreciation.
Depreciation is computed using the straight-line and declining balance methods
based on the estimated useful lives of the assets. Maintenance and repairs are
expensed as incurred, while major additions and improvements are capitalized.
Gains and losses on dispositions are included in current operations.
FEDERAL RESERVE AND FEDERAL HOME LOAN BANK STOCK are required investments for
institutions that are members of the Federal Reserve Bank ("FRB") and Federal
Home Loan Bank ("FHLB") systems. The required investment in the common stock is
based on a predetermined formula.
INTANGIBLE ASSETS that are subject to amortization, including core deposit
intangibles, are being amortized on both the straight-line and accelerated basis
over 10 years. Intangible assets are periodically evaluated as to the
recoverability of their carrying value.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 1
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES continued
GOODWILL is maintained by applying the provisions of SFAS No. 142. Goodwill is
reviewed for impairment annually in accordance with this statement with any loss
recognized through the income statement, at that time.
INCOME TAX in the consolidated statements of income includes deferred income tax
provisions or benefits for all significant temporary differences in recognizing
income and expenses for financial reporting and income tax purposes. The
Corporation files consolidated income tax returns with its subsidiaries.
STOCK OPTIONS are granted for a fixed number of shares to employees. The
Corporation's stock-based employee compensation plans are described more fully
in Note 16. 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.
APB No. 25 requires compensation expense for stock options to be recognized only
if the market price of the underlying stock exceeds the exercise price on the
date of the grant. Accordingly, the Corporation recognized compensation expense
of $12,000 in 2003, related to specific grants in which the market price
exceeded the exercise price. For all remaining grants, no stock-based employee
compensation cost is reflected in net income, as options granted under those
plans had an exercise price equal to the market value of the underlying common
stock on the grant date.
During the quarter ended December 31, 2005, the Corporation accelerated the
vesting of options previously granted, and the vesting period for the 2005
grants was established so the those grants would be fully vested by year-end.
The terms of the acceleration are such that no expense will be recognized by the
Corporation on those grants, although it has reported the impact of the
acceleration in its proforma disclosures of earnings per share.
The following table illustrates the effect on net income and earnings per share
if the Corporation had applied the fair value provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
Year Ended December 31
2005 2004 2003
---------------------------------
Net income, as reported ...................... $30,239 $29,411 $27,571
Add: Total stock-based employee compensation
cost included in reported net income, net
of income taxes ........................... 12
Less: Total stock-based employee compensation
cost determined under the fair value based
method, net of income taxes ............... (2,159) (1,083) (1,034)
------- ------- -------
Pro forma net income $28,080 $28,328 $26,549
======= ======= =======
Earnings per share:
Basic - as reported ....................... $ 1.64 $ 1.59 $ 1.51
Basic - pro forma ......................... $ 1.52 $ 1.53 $ 1.46
Diluted - as reported ..................... $ 1.63 $ 1.58 $ 1.50
Diluted - pro forma ....................... $ 1.51 $ 1.52 $ 1.45
EARNINGS PER SHARE have been computed based upon the weighted average common and
common equivalent shares outstanding during each year.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 2
BUSINESS COMBINATIONS
Effective September 1, 2005, the Corporation acquired Trustcorp Financial
Services of Greenville, Inc., an Ohio corporation, which was merged into FMIS, a
wholly-owned subsidiary of the Corporation. The Corporation issued 16,762 shares
of its common stock at a cost of $26.10 per share to complete the transaction.
The acquisition was deemed to be an immaterial acquisition.
Effective October 15, 2004, the Corporation acquired Mangas Agencies, Inc.,
which was merged into FMIS, a wholly-owned subsidiary of the Corporation. The
Corporation issued 68,548 shares of its common stock at a cost of $24.80 per
share to complete the transaction. The acquisition was deemed to be an
immaterial acquisition.
On March 1, 2003, the Corporation acquired 100 percent of the outstanding stock
of CNBC Bancorp, the holding company of Commerce National and CNBC Trust I.
Commerce National is a national chartered bank located in Columbus, Ohio. CNBC
Bancorp was merged into the Corporation, and Commerce National maintained its
national charter as a wholly-owned subsidiary of the Corporation. CNBC Trust I
is also maintained as a wholly-owned subsidiary of the Corporation. The
Corporation issued approximately 1,225,242 shares of its common stock and
approximately $24,562,000 in cash to complete the transaction. As a result of
the acquisition, the Corporation will have an opportunity to increase its
customer base and continue to increase its market share. The purchase had a
recorded acquisition price of $55,729,000, including goodwill of $30,291,000
none of which is deductible for tax purposes. Additionally, core deposit
intangibles totaling $8,171,000 were recognized and are being amortized over 10
years using the 150 percent declining balance method.
The combination was accounted for under the purchase method of accounting. All
assets and liabilities were recorded at their fair values as of March 1, 2003.
The purchase accounting adjustments are being amortized over the life of the
respective asset or liability. Commerce National's results of operations are
included in the Corporation's consolidated income statement beginning March 1,
2003. The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition.
Investments....................... $ 12,500
Loans............................. 298,702
Premises and equipment............ 1,293
Core deposit intangibles.......... 8,171
Goodwill.......................... 30,291
Other............................. 20,789
--------
Total assets acquired.......... 371,746
--------
Deposits.......................... 271,537
Other............................. 44,480
--------
Total liabilities acquired..... 316,017
--------
Net assets acquired............ $ 55,729
========
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 2
BUSINESS COMBINATIONS continued
The following proforma disclosures, including the effect of the purchase
accounting adjustments, depict the results of operations as though the CNBC
Bancorp merger had taken place on January 1, 2003.
Year Ended
December 31,
2003
------
Net Interest Income........... $104,797
Net Income.................... 23,601
Per Share - combined:
Basic Net Income........... 1.28
Diluted Net Income......... 1.27
Effective January 1, 2003, the Corporation formed MTC, a wholly-owned subsidiary
of the Corporation, through a capital contribution totaling approximately
$2,038,000. On January 1, 2003, MTC purchased the trust operations of First
Merchants, First National and Lafayette for a fair value acquisition price of
$20,687,000. MTC united the trust and asset management services of all affiliate
banks of the Corporation. All intercompany transactions related to this purchase
by MTC have been eliminated in the consolidated financial statements of the
Corporation.
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, 2005, was
$5,394,000.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 4
INVESTMENT SECURITIES
-----------------------------------------------------------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
===================================================================================================================================
Available for sale at December 31, 2005
U.S. Treasury .......................................... $ 1,586 $ 1 $ 1,585
U.S. Government-sponsored agency securities ............ 83,026 $ 1 1,836 81,191
State and municipal .................................... 167,095 2,159 1,131 168,123
Mortgage-backed securities ............................. 168,019 139 5,656 162,502
Other asset-backed securities .......................... 1 1
Marketable equity securities ........................... 9,660 435 9,225
-------- -------- -------- --------
Total available for sale ............................ 429,387 2,299 9,059 422,627
-------- -------- -------- --------
Held to maturity at December 31, 2005
State and municipal .................................... 11,609 283 412 11,480
Mortgage-backed securities ............................. 30 30
-------- -------- -------- --------
Total held to maturity .............................. 11,639 283 412 11,510
-------- -------- -------- --------
Total investment securities ......................... $441,026 $ 2,582 $ 9,471 $434,137
======== ======== ======== ========
Available for sale at December 31, 2004
U.S. Treasury .......................................... $ 1,745 $ 1 $ 1,744
U.S. Government-sponsored agency securities ............ 65,325 $ 73 332 65,066
State and municipal .................................... 150,284 5,243 82 155,445
Mortgage-backed securities ............................. 183,200 485 1,980 181,705
Other asset-backed securities .......................... 18 18
Marketable equity securities ........................... 12,191 8 12,199
-------- -------- -------- --------
Total available for sale ............................ 412,763 5,809 2,395 416,177
-------- -------- -------- --------
Held to maturity at December 31, 2004
State and municipal .................................... 5,306 162 5,468
Mortgage-backed securities ............................. 52 52
-------- -------- -------- --------
Total held to maturity .............................. 5,358 162 5,520
-------- -------- -------- --------
Total investment securities ......................... $418,121 $ 5,971 $ 2,395 $421,697
======== ======== ======== ========
Certain investments in debt securities are reported in the financial statements
at an amount less than their historical cost. The historical cost of these
investments totaled $337,959,000 and $192,366,000 at December 31, 2005 and 2004,
respectively. Total fair value of these investments was $328,488,000 and
$189,971,000, which is approximately 75.7 and 45.1 percent of the Corporation's
available-for-sale and held-to-maturity investment portfolio at December 31,
2005 and 2004, respectively. These declines primarily resulted from recent
increases in market interest rates.
Based on evaluation of available evidence, including recent changes in market
interest rates, credit rating information and information obtained from
regulatory filings, management believes the declines in fair value for these
securities are temporary. Should the impairment of any of these securities
become other than temporary, the cost basis of the investment will be reduced
and the resulting loss recognized in net income in the period the
other-than-temporary impairment is identified.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 4
INVESTMENT SECURITIES continued
The following tables show the Corporation's gross unrealized losses and fair
value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2005 and 2004:
Less than 12 12 Months or
Months Longer Total
-----------------------------------------------------------------------
GROSS GROSS GROSS
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
-----------------------------------------------------------------------
Temporarily impaired investment
securities at December 31, 2005:
U.S. Treasury ........................................... $ 1,487 $ (1) $ 1,487 $ (1)
U.S. Government-sponsored agency securities ............. 31,692 (581) $ 45,466 $ (1,255) 77,158 (1,836)
State and municipal ..................................... 90,905 (1,501) 2,124 (42) 93,029 (1,543)
Mortgage-backed securities .............................. 59,595 (1,511) 96,120 (4,141) 155,715 (5,652)
Marketable equity securities ............................ 27 (8) 1,072 (431) 1,099 (439)
-------- -------- -------- -------- -------- --------
Total temporarily impaired investment securities ..... $183,706 $ (3,602) $144,782 $ (5,869) $328,488 $ (9,471)
======== ======== ======== ======== ======== ========
Less than 12 12 Months or
Months Longer Total
-----------------------------------------------------------------------
GROSS GROSS GROSS
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
-----------------------------------------------------------------------
Temporarily impaired investment
securities at December 31, 2004:
U.S. Treasury ........................................... $ 1,496 $ (1) $ 1,496 $ (1)
U.S. Government-sponsored agency securities ............. 46,227 (303) $ 1,472 $ (29) 47,699 (332)
State and municipal ..................................... 2,976 (20) 1,094 (62) 4,070 (82)
Mortgage-backed securities .............................. 109,213 (1,129) 27,493 (851) 136,706 (1,980)
-------- -------- -------- -------- -------- --------
Total temporarily impaired investment securities ..... $159,912 $ (1,453) $ 30,059 $ (942) $189,971 $ (2,395)
======== ======== ======== ======== ======== ========
The amortized cost and fair value of securities available for sale and held to
maturity at December 31, 2005, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because issuers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
-----------------------------------------------------------------------------------------------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY
AMORTIZED COST FAIR VALUE AMORTIZED COST FAIR VALUE
===================================================================================================================================
Maturity distribution at December 31, 2005:
Due in one year or less.......................................... $ 12,838 $ 12,845 $ 733 $ 734
Due after one through five years ................................ 170,744 168,207 1,943 1,976
Due after five through ten years ................................ 52,629 53,734 960 928
Due after ten years ............................................. 15,496 16,112 7,973 7,842
-------- -------- -------- --------
251,707 250,898 11,609 11,480
Mortgage-backed securities ...................................... 168,019 162,503
Other asset-backed securities ................................... 1 1 30 30
Marketable equity securities .................................... 9,660 9,225
-------- -------- -------- --------
Totals ........................................................ $429,387 $422,627 $ 11,639 $ 11,510
======== ======== ======== ========
Securities with a carrying value of approximately $190,079,000 and $157,356,000
were pledged at December 31, 2005 and 2004 to secure certain deposits and
securities sold under repurchase agreements, and for other purposes as permitted
or required by law.
Proceeds from sales of securities available for sale during 2005, 2004 and 2003
were $4,718,000, $32,336,000, and $58,245,000. Gross gains of $28,000,
$1,502,000 and
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 4
INVESTMENT SECURITIES continued
$950,000 in 2005, 2004 and 2003, and gross losses of $30,000 and $314,000 in
2005 and 2004 were realized on those sales.
NOTE 5
LOANS AND ALLOWANCE
2005 2004
==========================================================================================================
Loans at December 31:
Commercial and industrial loans ......................................... $ 461,102 $ 451,227
Agricultural production financing and other loans to farmers ............ 95,130 98,902
Real estate loans:
Construction ....................................................... 174,783 164,738
Commercial and farmland ............................................ 734,865 709,163
Residential ........................................................ 751,217 761,163
Individuals' loans for household and other personal expenditures ........ 200,139 198,532
Tax-exempt loans ........................................................ 8,263 8,203
Lease financing receivables, net of unearned income ..................... 8,713 11,311
Other loans ............................................................. 23,215 24,812
----------- -----------
2,457,427 2,428,051
Allowance for loan losses .............................................. (25,188) (22,548)
----------- -----------
Total loans ........................................................ $ 2,432,239 $ 2,405,503
=========== ===========
2005 2004 2003
===============================================================================
Allowance for loan losses:
Balance, January 1 ................... $ 22,548 $ 25,493 $ 22,417
Allowance acquired in acquisitions ... 3,727
Provision for losses ................. 8,354 5,705 9,477
Recoveries on loans .................. 2,030 2,251 2,011
Loans charged off .................... (7,744) (10,901) (12,139)
-------- -------- --------
Balance, December 31 ................. $ 25,188 $ 22,548 $ 25,493
======== ======== ========
Information on nonaccruing, contractually past due 90 days or more other than
nonaccruing and restructured loans is summarized below:
2005 2004 2003
================================================================================
At December 31:
Non-accrual loans .......................... $10,030 $15,355 $19,453
Loans contractually past due 90 days
or more other than nonaccruing ........... 3,965 1,907 6,530
Restructured loans ......................... 310 2,019 641
------- ------- -------
Total non-performing loans ............ $14,305 $19,281 $26,624
======= ======= =======
Nonaccruing loans are loans which are reclassified to a nonaccruing status when
in management's judgment the collateral value and financial condition of the
borrower do not justify accruing interest. Interest previously recorded, but not
deemed collectible, is reversed and charged against current income. Interest
income on these loans is then recognized when collected.
Restructured loans are loans for which the contractual interest rate has been
reduced or other concessions are granted to the borrower, because of a
deterioration in the financial condition of the borrower resulting in the
inability of the borrower to meet the original contractual terms of the loans.
32
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: 2005 2004 2003
========================================================================================================
As of, and for the year ending December 31:
Impaired loans with an allowance ............................. $ 7,540 $ 7,728 $12,725
Impaired loans for which the discounted
cash flows or collateral value exceeds the
carrying value of the loan ............................... 44,840 41,683 32,047
------- ------- -------
Total impaired loans .................................. $52,380 $49,411 $44,772
======= ======= =======
Total impaired loans as a percent
of total loans ........................................... 2.13% 2.03% 1.90%
Allowance for impaired loans (included in the
Corporation's allowance for loan losses) ................. $ 2,824 $ 1,673 $ 5,728
Average balance of impaired loans ............................ 44,790 59,568 50,245
Interest income recognized on impaired loans ................. 3,747 4,166 3,259
Cash basis interest included above ........................... 3,951 3,029 2,714
NOTE 6
PREMISES AND EQUIPMENT
2005 2004
================================================================================
Cost at December 31:
Land .......................................... $ 8,653 $ 8,281
Buildings and leasehold improvements .......... 43,001 40,520
Equipment ..................................... 40,155 38,852
-------- --------
Total cost ................................ 91,809 87,653
Accumulated depreciation and amortization ..... (52,392) (49,399)
-------- --------
Net ....................................... $ 39,417 $ 38,254
======== ========
The Corporation is committed under various noncancelable lease contracts for
certain subsidiary office facilities and equipment. Total lease expense for
2005, 2004 and 2003 was $2,391,000, $2,151,000 and $1,629,000, respectively. The
future minimum rental commitments required under the operating leases in effect
at December 31, 2005, expiring at various dates through the year 2016 are as
follows for the years ending December 31:
====================================================
2006 ................................ $2,055
2007 ................................ 1,756
2008 ................................ 1,275
2009 ................................ 1,111
2010 ................................ 1,057
After 2010 ........................... 1,649
------
Total future minimum obligations $8,903
======
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 7
GOODWILL
The changes in the carrying amount of goodwill at December 31 are noted below.
No impairment loss was recorded in 2005 and 2004.
2005 2004
==============================================================================
Balance, January 1 .............................. $ 120,615 $ 118,679
Goodwill acquired ............................... 651 1,900
Adjustments to previously
acquired goodwill ............................. 36
--------- ---------
Balance, December 31 ............................ $ 121,266 $ 120,615
========= =========
NOTE 8
CORE DEPOSIT INTANGIBLES
The carrying basis and accumulated amortization of recognized core deposit
intangibles at December 31 were:
2005 2004
==============================================================================
Gross carrying amount ........................... $ 31,073 $ 31,073
Accumulated amortization ........................ (13,506) (10,404)
--------- ---------
Core deposit intangibles ..................... $ 17,567 $ 20,669
========= =========
Amortization expense for the years ended December 31, 2005, 2004 and 2003, was
$3,102,000, $3,375,000 and $3,704,000, respectively. Estimated amortization
expense for each of the following five years is:
2006 ................................ $ 3,046
2007 ................................ 3,046
2008 ................................ 3,046
2009 ................................ 3,046
2010 ................................ 2,937
After 2010 .......................... 2,397
-------
$17,518
=======
NOTE 9
DEPOSITS
2005 2004
================================================================================
Deposits at December 31:
Demand deposits ............................. $ 690,923 $ 703,989
Savings deposits ............................ 566,212 634,132
Certificates and other time deposits
of $100,000 or more ....................... 276,679 258,362
Other certificates and time deposits ........ 848,762 811,667
---------- ----------
Total deposits .......................... $2,382,576 $2,408,150
========== ==========
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 9
DEPOSITS continued
=====================================================
Certificates and other time deposits maturing
in years ending December 31:
2006 ....................... $ 677,656
2007 ....................... 278,882
2008 ....................... 107,440
2009 ....................... 37,568
2010 ....................... 19,122
After 2010 ................. 4,773
----------
$1,125,441
==========
NOTE 10
BORROWINGS
2005 2004
================================================================================
Borrowings at December 31:
Federal funds purchased ........................... $ 50,000 $ 32,550
Securities sold under repurchase agreements ....... 106,415 87,472
Federal Home Loan Bank advances ................... 247,865 223,663
Subordinated debentures, revolving credit
lines and term loans ............................ 103,956 97,206
-------- --------
Total borrowings .............................. $508,236 $440,891
======== ========
Securities sold under repurchase agreements consist of obligations of the Banks
to other parties. The obligations are secured by U.S. Treasury, U.S.
Government-sponsored agency security obligations and corporate asset-backed
securities. The maximum amount of outstanding agreements at any month-end during
2005 and 2004 totaled $106,415,000 and $87,472,000, and the average of such
agreements totaled $77,897,000 and $62,669,000 during 2005 and 2004.
Maturities of securities sold under repurchase agreements; Federal Home Loan
Bank advances; and subordinated debentures, revolving credit lines and term
loans as of December 31, 2005, are as follows:
SUBORDENATED DEBENTURES
SECURITIES SOLD UNDER FEDERAL HOME LOAN REVOLVING CREDIT LINES
REPURCHASE AGREEMENTS BANK ADVANCES AND TERM LOANS
--------------------------------------------------------------------------------------------------------------------------
AMOUNT AMOUNT AMOUNT
==========================================================================================================================
Maturities in years ending December 31:
2006 .............. $106,415 $ 56,335 $ 15,000
2007 .............. 32,495
2008 .............. 32,839
2009 .............. 11,382
2010 .............. 35,192
After 2010 ........ 79,622 88,956
-------- -------- --------
Total ...... $106,415 $247,865 $103,956
======== ======== ========
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 10
BORROWINGS continued
The terms of a security agreement with the FHLB require the Corporation to
pledge, as collateral for advances, qualifying first mortgage loans and all
otherwise unpledged investment securities in an amount equal to at least 145
percent of these advances. Advances are subject to restrictions or penalties in
the event of prepayment. The total available remaining borrowing capacity from
the FHLB at December 31, 2005, was $62,228,000.
Subordinated Debentures, Revolving Credit Lines and Term Loans. Three borrowings
were outstanding on December 31, 2005, for $103,956,000.
o First Merchants Capital Trust I. The subordinated debenture, entered
into on April 12, 2002, for $54,832,000 will mature on June 20,
2032. The Corporation may redeem the debenture no earlier than June
30, 2007, subject to the prior approval of the Federal Reserve, as
required by law or regulation. Interest is fixed at 8.75 percent and
payable on March 31, June 30, September 30 and December 31 of each
year.
o CNBC Statutory Trust I. As part of the March 1, 2003, acquisition of
CNBC Bancorp, the Corporation assumed $4,124,000 of a junior
subordinated debenture entered into on February 22, 2001. The
subordinated debenture of $4,124,000 will mature on February 22,
2031. Interest is fixed at 10.20 percent and payable on February 22
and August 22 of each year. The Corporation may redeem the
debenture, in whole or in part, at its option commencing February
22, 2011, at a redemption price of 105.10 percent of the outstanding
principal amount and, thereafter, at a premium which declines
annually. On or after February 22, 2021, the securities may be
redeemed at face value with prior approval of the Board of Governors
of the Federal Reserve System.
o LaSalle Bank, N.A. A Loan and Subordinated Debenture Loan Agreement
("LaSalle Agreement") was entered into with LaSalle Bank, N.A. on
March 25, 2003 and later amended as of March 9, 2005. The LaSalle
Agreement includes three credit facilities:
o The Term Loan of $5,000,000 matures on March 7, 2012. Interest
is calculated at a floating rate equal to the lender's prime
rate or LIBOR plus 1.00 percent. The Term Loan is secured by
100 percent of the common stock of First Merchants. The
Agreement contains several restrictive covenants, including
the maintenance of various capital adequacy levels, asset
quality and profitability ratios, and certain restrictions on
dividends and other indebtedness.
o The Revolving Loan had a balance of $15,000,000 at December
31, 2005. Interest is payable quarterly based on LIBOR plus 1
percent. Principal and interest are due on or before March
7,2006. The total principal amount outstanding at any one time
may not exceed $20,000,000. The Revolving Loan is secured by
100 percent of the common stock of First Merchants. The
Agreement contains several restrictive covenants, including
the maintenance of various capital adequacy levels,
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 10
BORROWINGS continued
asset quality and profitability ratios, and certain
restrictions on dividends and other indebtedness.
o The Subordinated Debenture of $25,000,000 matures on March 7,
2012. Interest is calculated at a floating rate equal to, at
the Corporation's option, either the lender's prime rate or
LIBOR plus 1.50 percent. The Subordinated Debenture is treated
as Tier 2 Capital for regulatory capital purposes.
NOTE 11
LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheets. The loans are serviced primarily for the Federal
Home Loan Mortgage Corporation, and the unpaid balances totaled $107,730,000,
$113,344,000 and $105,865,000 at December 31, 2005, 2004 and 2003. The amount of
capitalized servicing assets is considered immaterial.
NOTE 12
INCOME TAX
2005 2004 2003
================================================================================================================================
Income tax expense for the year ended December 31:
Currently payable:
Federal ................................................................ $ 14,814 $ 11,934 $ 9,475
State .................................................................. 2,231 1,772 1,569
Deferred:
Federal ................................................................ (3,248) (615) (597)
State .................................................................. (501) 94 270
-------- -------- --------
Total income tax expense ............................................ $ 13,296 $ 13,185 $ 10,717
======== ======== ========
Reconciliation of federal statutory to actual tax expense:
Federal statutory income tax at 34% .................................... $ 14,802 $ 14,483 $ 13,030
Tax-exempt interest .................................................... (2,141) (2,098) (2,198)
Graduated tax rates .................................................... 345 335 289
Effect of state income taxes ........................................... 1,132 1,178 1,213
Earnings on life insurance ............................................. (439) (472) (512)
Tax credits ............................................................ (395) (274) (317)
Other .................................................................. (8) 33 (788)
-------- -------- --------
Actual tax expense ................................................. $ 13,296 $ 13,185 $ 10,717
======== ======== ========
Tax expense (benefit) applicable to security gains and losses for the years
ended December 31, 2005, 2004 and 2003, was $(1,000), $475,000 and $380,000,
respectively.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 12
INCOME TAX continued
A cumulative net deferred tax asset (liability) is included in the consolidated
balance sheets. The components of the net asset (liability) are as follows:
2005 2004
======================================================================================================================
Deferred tax asset (liability) at December 31:
Assets:
Differences in accounting for loan losses ............................. $10,609 $ 9,438
Deferred compensation ................................................. 2,768 2,707
Difference in accounting for pensions
and other employee benefits ......................................... 2,707
State income tax ...................................................... 311 524
Net unrealized loss on securities available for sale................... 2,365
Other ................................................................. 255 222
------- -------
Total assets ...................................................... 19,015 12,891
------- -------
Liabilities:
Differences in depreciation methods ................................... 3,450 3,469
Differences in accounting for loans and securities .................... 6,505 8,181
Differences in accounting for loan fees ............................... 613 628
Differences in accounting for pensions
and other employee benefits ......................................... 339
Net unrealized gain on securities available for sale................... 2,220
Other ................................................................. 2,575 1,317
------- -------
Total liabilities ................................................. 13,143 16,154
------- -------
Net deferred tax asset (liability) ................................ $ 5,872 $(3,263)
======= =======
NOTE 13
COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business there are outstanding commitments and
contingent liabilities, such as commitments to extend credit and standby letters
of credit, which are not included in the accompanying financial statements. The
Corporation's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments for commitments to extend credit and
standby letters of credit is represented by the contractual or notional amount
of those instruments. The Banks use the same credit policies in making such
commitments as they do for instruments that are included in the consolidated
balance sheets.
Financial instruments whose contract amount represents credit risk as of
December 31, were as follows:
2005 2004
-------- --------
Commitments
to extend credit $574,384 $540,087
Standby letters
of credit 30,410 22,024
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
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 13
COMMITMENTS AND CONTINGENT LIABILITIES continued
include accounts receivable, inventory, property and equipment, and
income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Banks to
guarantee the performance of a customer to a third party.
The Corporation and subsidiaries are also subject to claims and lawsuits, which
arise primarily in the ordinary course of business. It is the opinion of
management that the disposition or ultimate resolution of such claims and
lawsuits will not have a material adverse effect on the consolidated financial
position of the Corporation.
NOTE 14
STOCKHOLDERS' EQUITY
National banking laws restrict the maximum amount of dividends that a bank may
pay in any calendar year. National banks are limited to the bank's retained net
income (as defined) for the current year plus those for the previous two years.
At December 31, 2005, First National and Frances Slocum had no retained net
profits available for 2006 dividends to the Corporation. The amount at December
31, 2005, available for 2006 dividends from First Merchants, Madison, First
United, United Communities, Decatur, Lafayette, Commerce National and MTC to the
Corporation totaled $3,690,000, $5,135,000, $1,102,000, $2,484,000, $183,000,
$1,190,000, $2,439,000 and $837,000, respectively.
Total stockholders' equity for all subsidiaries at December 31, 2005, was
$417,712,000, of which $400,652,000 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.
On August 15, 2003 and August 13, 2002, the Board of Directors of the
Corporation declared a five percent (5%) stock dividend on its outstanding
common shares. The new shares were distributed on September 12, 2003 and
September 13, 2002, to holders of record on August 29, 2003 and August 30, 2002,
respectively.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 15
REGULATORY CAPITAL
The Corporation and Banks are subject to various regulatory capital requirements
administered by the federal banking agencies and are assigned to a capital
category. The assigned capital category is largely determined by three ratios
that are calculated according to the regulations: total risk adjusted capital,
Tier 1 capital, and Tier 1 leverage ratios. The ratios are intended to measure
capital relative to assets and credit risk associated with those assets and
off-balance sheet exposures of the entity. The capital category assigned to an
entity can also be affected by qualitative judgments made by regulatory agencies
about the risk inherent in the entity's activities that are not part of the
calculated ratios.
There are five capital categories defined in the regulations, ranging from well
capitalized to critically undercapitalized. Classification of a bank in any of
the undercapitalized categories can result in actions by regulators that could
have a material effect on a bank's operations.
At December 31, 2005, the management of the Corporation believes that it meets
all capital adequacy requirements to which it is subject. The most recent
notifications from the regulatory agencies categorized the Corporation and Banks
as well capitalized under the regulatory framework for prompt corrective action.
To be categorized as well capitalized, the Banks must maintain a minimum total
capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier
I capital to average assets of 10 percent, 6 percent and 5 percent,
respectively. There have been no conditions or events since that notification
that management believes have changed this categorization.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 15
REGULATORY CAPITAL continued
Actual and required capital amounts and ratios are listed below.
2005 2004
-----------------------------------------------------------------------------------------------------------------------------------
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)(2)(to risk-weighted assets)
Consolidated ...................... $285,823 11.72% $195,449 8.00% $275,786 11.57% $190,736 8.00%
First Merchants ................... 69,691 11.93 46,747 8.00 68,064 11.47 47,474 8.00
Madison ........................... 27,386 11.82 18,542 8.00 25,496 11.36 17,962 8.00
First United ...................... 7,988 11.09 5,761 8.00 7,703 11.86 5,196 8.00
Randolph County ................... 8,847 11.58 6,111 8.00
Union County ...................... 16,293 12.00 10,858 8.00
United Communities ................ 26,057 11.66 17,872 8.00
First National .................... 10,243 11.29 7,260 8.00 10,198 11.42 7,146 8.00
Decatur ........................... 11,597 11.75 7,895 8.00 11,419 11.62 7,862 8.00
Frances Slocum .................... 18,907 13.52 11,188 8.00 17,491 12.93 10,825 8.00
Lafayette ......................... 74,089 11.49 51,568 8.00 71,962 11.35 50,701 8.00
Commerce National ................. 42,025 11.11 30,539 8.00 36,829 10.70 27,532 8.00
Tier I Capital (1)(2)(to risk-weighted assets)
Consolidated ...................... $235,635 9.66% $ 97,725 4.00% $228,234 9.57% $ 95,368 4.00%
First Merchants ................... 63,550 10.88 23,374 4.00 62,310 10.50 23,737 4.00
Madison ........................... 25,115 10.84 9,271 4.00 23,671 10.54 8,981 4.00
First United ...................... 7,237 10.05 2,880 4.00 7,100 10.93 2,598 4.00
Randolph County ................... 7,998 10.47 3,055 4.00
Union County ...................... 14,596 10.75 5,429 4.00
United Communities ................ 23,711 10.61 8,936 4.00
First National .................... 9,489 10.46 3,630 4.00 9,322 10.44 3,573 4.00
Decatur ........................... 10,808 10.95 3,948 4.00 10,635 10.82 3,931 4.00
Frances Slocum..................... 17,152 12.27 5,594 4.00 15,793 11.67 5,412 4.00
Lafayette ......................... 67,795 10.52 25,784 4.00 67,028 10.58 25,350 4.00
Commerce National ................. 32,350 8.55 15,270 4.00 27,648 8.03 13,766 4.00
Tier I Capital (1)(2)(to average assets)
Consolidated ...................... $235,635 7.70% $122,396 4.00% $228,234 7.50% $121,711 4.00%
First Merchants ................... 63,550 8.28 30,701 4.00 62,310 7.78 32,024 4.00
Madison ........................... 25,115 9.38 10,716 4.00 23,671 9.01 10,510 4.00
First United ...................... 7,237 7.83 3,696 4.00 7,100 7.68 3,700 4.00
Randolph County ................... 7,998 8.42 3,799 4.00
Union County ...................... 14,596 7.47 7,814 4.00
United Communities ................ 23,711 7.93 11,953 4.00
First National .................... 9,489 8.20 4,630 4.00 9,322 7.99 4,664 4.00
Decatur ........................... 10,808 8.47 5,104 4.00 10,635 7.96 5,342 4.00
Frances Slocum..................... 17,152 9.96 6,886 4.00 15,793 9.58 6,593 4.00
Lafayette ......................... 67,795 7.86 34,484 4.00 67,028 7.94 33,747 4.00
Commerce National ................. 32,350 7.41 17,641 4.00 27,648 7.01 15,785 4.00
(1) As defined by regulatory agencies
(2) Effective January 1, 2005, The Union County National Bank ("Union County")
was merged into The Randolph County Bank, N.A. ("Randolph County") and the
name of the continuing institution is United Communities National Bank
("United Communities").
NOTE 16
EMPLOYEE BENEFIT PLANS
The Corporation's defined-benefit pension plans cover substantially all of the
Corporation's 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.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
The table below sets forth the plans' funded status and amounts recognized in
the consolidated balance sheets at December 31, using measurement dates of
September 30, 2005 and 2004.
December 31
2005 2004
===============================================================================
Change in benefit obligation
Benefit obligation at beginning of year ......... $ 50,358 $ 45,579
Service cost .................................... 578 1,920
Interest cost ................................... 2,633 2,789
Actuarial (gain) loss ........................... (677) 1,917
Benefits paid ................................... (2,116) (1,847)
-------- --------
Benefit obligation at end of year ............... 50,776 50,358
-------- --------
Change in plan assets
Fair value of plan assets at beginning of year .. 39,027 33,940
Actual return on plan assets .................... 2,978 3,080
Benefits paid ................................... (2,116) (1,847)
Employer contributions .......................... 24 3,854
-------- --------
Fair value of plan assets at end of year ........ 39,913 39,027
-------- --------
Unfunded status ................................. (10,863) (11,331)
Unrecognized net actuarial loss ................. 10,268 10,944
Unrecognized prior service cost ................. 62 1,697
Unrecognized transition asset ................... (27)
-------- --------
Prepaid benefit cost (liability) ................ (533) 1,283
Additional pension liability .................... (8,199) (5,416)
-------- --------
Net minimum liability ........................... $ (8,732) $ (4,133)
======== ========
Amounts recognized in the balance sheets consist of:
Prepaid benefit cost (liability) ................ $ (533) $ 1,283
Additional pension liability .................... (8,199) (5,416)
Intangible asset ................................ 62 1,697
Deferred taxes .................................. 3,255 1,487
Accumulated other comprehensive loss ............ 4,882 2,232
-------- --------
Net amount recognized ................................ $ (533) $ 1,283
======== ========
In January 2005, the Board of Directors of the Corporation approved the
curtailment of the accumulation of defined benefits for future services provided
by certain participants in the First Merchants Corporation Retirement Pension
Plan (the "Plan"). Employees of the Corporation and certain of its subsidiaries
who are participants in the Plan were notified that, on and after March 1, 2005,
no additional pension benefits will be earned by employees who have not both
attained the age of fifty-five (55) and accrued at least ten (10) years of
"Vesting Service". As a result of this action, the Corporation incurred a
$1,630,000 pension curtailment loss to record previously unrecognized prior
service costs in accordance with SFAS No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Plans and for Termination
Benefits." This loss was recognized and recorded by the Corporation in 2005.
At December 31, 2005 and 2004, the plans' accumulated benefit obligation totaled
$48,646,000 and $43,161,000, respectively. Projected future benefit payments in
years ending December 31 are as follows:
2006 ................................ $ 2,068
2007 ................................ 2,200
2008 ................................ 2,269
2009 ................................ 2,396
2010 ................................ 2,560
2011 to 2015 ......................... 15,431
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
The Corporation's planned and required contributions to its defined-benefit
pension plans in 2006 total $467,000. The Corporation's required contributions
paid to its defined-benefit pension plans in 2005 totaled $24,000.
At September 30, 2005 the plans' assets were allocated 66 percent to equity
securities, 32 percent to debt securities, and 2 percent to other plan assets.
The targeted allocation for those categories of plan assets are 45 to 75
percent, 25 to 55 percent, and 0 to 10 percent, respectively.
At September 30, 2004 the plans' assets were allocated 68 percent to equity
securities, 28 percent to debt securities, and 4 percent to real estate and
other plan assets. The targeted allocation for those categories of plan assets
are 40 to 80 percent, 20 to 60 percent and 1 to 15 percent, respectively.
2005 2004 2003
==============================================================================================
Pension cost includes the following components:
Service cost-benefits earned during the year ............ $ 578 $ 1,920 $ 1,564
Interest cost on projected benefit obligation ........... 2,633 2,789 2,617
Actual return on plan assets ............................ (2,978) (3,080) (3,876)
Net amortization and deferral ........................... (23) 614 1,617
Pension curtailment loss ................................ 1,630
------- ------- -------
Total pension cost .................................. $ 1,840 $ 2,243 $ 1,922
======= ======= =======
2005 2004 2003
=============================================================================================
Assumptions used in the accounting as of December 31 were:
Discount rate ........................................ 5.50% 6.00% 6.25%
Rate of increase in compensation ..................... 4.00% 4.00% 4.00%
Expected long-term rate of return on assets .......... 7.50% 8.00% 8.00%
The above assumptions used to measure benefit obligations as of the plan's
measurement date were the same assumptions used to determine the net benefit
cost.
At September 30, 2005 and 2004, the Corporation based its estimate of the
expected long-term rate of return on analysis of the historical returns of the
plans and current market information available. The plans' investment strategies
are to provide for preservation of capital with an emphasis on long-term growth
without undue exposure to risk. The assets of the plans' are invested in
accordance with the plans' Investment Policy Statement, subject to strict
compliance with ERISA and any other applicable statutes.
The plans' risk management practices include quarterly evaluations of investment
managers, including reviews of compliance with investment manager guidelines and
restrictions; ability to exceed performance objectives; adherence to the
investment philosophy and style; and ability to exceed the performance of other
investment managers. The evaluations are reviewed by management with appropriate
follow-up and actions taken, as deemed necessary. The Investment Policy
Statement generally allows investments in cash and cash equivalents, real
estate, fixed income debt securities and equity securities, and specifically
prohibits investments in derivatives, options, futures, private placements,
short selling, non-marketable securities and purchases of non-investment grade
bonds.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
At December 31, 2005, the maturities of the plans' debt securities ranged from
135 days to 12.4 years, with a weighted average maturity of 3.1 years. At
December 31, 2004, the maturities of the plans' debt securities ranged from 14
days to 6.2 years, with a weighted average maturity of 2.9 years.
The 1994 Stock Option Plan reserved 546,978 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. No shares remain available for grant under the
1994 Plan.
The 1999 Long-term Equity Incentive Plan, which became effective as of July 1,
1999, authorizes the Corporation to grant stock-based incentive awards,
including stock options, to eligible employees of the Corporation or its
subsidiaries. The aggregate number of shares that are available for grants under
that Plan in any calendar year is equal to the sum of: (a) 1 percent of the
number of common shares of the Corporation outstanding as of the last day of the
preceding calendar year; plus (b) the number of shares that were available for
grants, but not granted, under the Plan in any previous year; but in no event
will the number of shares available for grants in any calendar year exceed 1.5
percent of the number of common shares of the Corporation outstanding as of the
last day of the preceding calendar year. Options, which have a ten year life,
become 100 percent vested ranging from three months to two years and are fully
exercisable when vested. The 1999 Long-term Equity Incentive Plan will expire in
2009.
The table below is a summary of the status of the Corporation's stock option
plans and changes in those plans as of and for the years ended December 31,
2005, 2004 and 2003.
Year Ended December 31, 2005 2004 2003
----------------------------------------------------------------------------------------------------------------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
==================================================================================================================================
Outstanding, beginning of year ............. 1,019,643 $ 22.00 951,509 $ 20.71 842,583 $ 19.89
Granted .................................... 225,970 26.58 185,170 25.60 190,714 23.46
Exercised .................................. (96,620) 16.59 (95,899) 15.48 (69,672) 16.93
Cancelled .................................. (44,206) 25.32 (21,137) 25.36 (12,116) 22.27
--------- --------- -------
Outstanding, end of year ................... 1,104,787 $ 23.28 1,019,643 $ 22.00 951,509 $ 20.71
========= ========= =======
Options exercisable at year end ............ 1,061,372 693,560 653,040
Weighted-average fair value of
options granted during the year ......... $ 6.93 $ 6.98 $ 5.99
As of December 31, 2005, other information by exercise price range for option s
outstanding and exercisable is as follows:
OUTSTANDING EXERCISABLE
--------------------------------------------------------------------------------- -------------------------------
EXERCISE PRICE NUMBER WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
RANGE OF SHARES EXERCISE PRICE REMAINING CONTRACTUAL LIFE OF SHARES EXERCISE PRICE
=========================================================================================================================
$ 13.89 - $21.85 369,851 $18.52 3.6 years 369,507 $18.52
22.22 - 25.60 380,952 24.67 7.2 years 347,917 24.60
25.90 - 26.93 353,984 26.74 8.3 years 343,948 26.77
--------- ---------
1,104,787 $23.28 6.3 years 1,061,372 $23.19
========= =========
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
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:
2005 2004 2003
---- ---- ----
Risk-free interest rates........ 4.05% 4.57% 3.55%
Dividend yields................. 3.56% 3.64% 3.65%
Volatility factors of expected
market price common stock... 30.20% 30.89% 31.29%
Weighted-average expected
life of the options ........ 8.50 years 8.50 years 8.50 years
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 in Note 1 to the consolidated financial statements.
The First Merchants Corporation 2004 Employee Stock Purchase Plan provides
eligible employees of the Corporation and its subsidiaries an opportunity to
purchase shares of common stock of the Corporation through annual offerings
financed by payroll deductions. A total of 400,000 shares of the Corporation's
common stock were 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. At December 31, 2005, $470,000 has been withheld from
compensation, plus interest, toward the purchase of shares after June 30, 2006,
the end of the annual offering period. Participants under the plan purchased
43,238 shares in 2005 at $21.12 per share. The fair value on the purchase date
was $24.85.
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 Note 1 to the consolidated financial
statements and were estimated using an option pricing model with the following
assumptions for 2005, 2004 and 2003, respectively: dividend yield of 3.56, 3.64
and 3.65, percent; an expected life of one year for all years; expected
volatility of 30.20, 30.89 and 31.29 percent; and risk-free interest rates of
4.05, 4.57 and 3.55 percent. The fair value of those purchase rights granted in
2005, 2004 and 2003 was $4.90, $6.38 and $4.81 respectively.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 16
EMPLOYEE BENEFIT PLANS continued
The First Merchants Corporation Retirement and Income Savings Plan (the "Savings
Plan"), a Section 401(k) qualified defined contribution plan, was amended on
March 1, 2005 to provide enhanced retirement benefits, including employer and
matching contributions, for eligible employees of the Corporation and its
subsidiaries. The Corporation matches employees' contributions primarily at the
rate of 50 percent for the first 6 percent of base salary contributed by
participants. Beginning in 2005, employees who have completed 1,000 hours of
service and are an active employee on the last day of the year receive an
additional retirement contribution after year-end. The amount of a participant's
retirement contribution varies from 2 to 7 percent of salary based upon years of
service. Full vesting occurs after 5 years of service. The Corporations' expense
for the Savings Plan was $2,052,000 for 2005, $660,000 for 2004, and $600,000
for 2003.
The Corporation maintains supplemental executive retirement and other
nonqualified retirement plans for the benefit of certain directors and officers.
Under the plans, the Corporation agrees to pay retirement benefits that are
actuarially determined based upon plan participants' compensation amounts and
years of service. Accrued benefits payable totaled $3,307,000 and $3,004,000 at
December 31, 2005 and 2004. Benefit plan expense was $571,000, $615,000 and
$485,000 for 2005, 2004 and 2003.
The Corporation maintains post-retirement benefit plans that provide health
insurance benefits to retirees. The plans allow retirees to be carried under the
Corporation's health insurance plan, generally from ages 55 to 65. The retirees
pay most of the premiums due for their coverage, with amounts paid by retirees
ranging from 70 to 100 percent of the premiums payable. The accrued benefits
payable under the plans totaled $1,084,000 and $1,022,000 at December 31, 2005
and 2004. Post-retirement plan expense totaled $120,000, $202,000 and $240,000
for the years ending December 31, 2005, 2004 and 2003.
NOTE 17
NET INCOME PER SHARE
====================================================================================================================================
Year Ended December 31, 2005 2004 2003
------------------------------------------------------------------------------------------------------------------------------------
WEIGHTED-AVERAGE PER SHARE WEIGHTED-AVERAGE PER SHARE WEIGHTED-AVERAGE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT
====================================================================================================================================
Basic net income per share:
Net income available to
common stockholders .......... $30,239 18,484,832 $1.64 $29,411 18,540,451 $1.59 $27,571 18,233,855 $1.51
===== ===== =====
Effect of dilutive stock options.. 110,863 126,826 137,575
------- ---------- ------- ---------- ------- ----------
Diluted net income per share:
Net income available to
common stockholders
and assumed conversions ...... $30,239 18,595,695 $1.63 $29,411 18,667,277 $1.58 $27,571 18,371,430 $1.50
======= ========== ===== ======= ========== ===== ======= ========== =====
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 17
NET INCOME PER SHARE continued
Options to purchase 214,840, 320,661 and 233,658 shares of common stock with
weighted average exercise prices of $26.81, $24.66 and $24.01 at December 31,
2005, 2004 and 2003 were excluded from the computation of diluted net income per
share because the options exercise price was greater than the average market
price of the common stock.
NOTE 18
FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument:
CASH AND CASH EQUIVALENTS The fair value of cash and cash equivalents
approximates carrying value.
INTEREST-BEARING TIME DEPOSITS The fair value of interest-bearing time deposits
approximates carrying value.
INVESTMENT SECURITIES Fair values are based on quoted market prices.
MORTGAGE LOANS HELD FOR SALE The fair value of mortgages held for sale
approximates carrying values.
LOANS For both short-term loans and variable-rate loans that reprice frequently
and with no significant change in credit risk, fair values are based on carrying
values. The fair value for other loans is estimated using discounted cash flow
analyses, using interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality.
FEDERAL RESERVE AND FEDERAL HOME LOAN BANK STOCK The fair value of FRB and FHLB
stock is based on the price at which it may be resold to the FRB and FHLB.
INTEREST RECEIVABLE/PAYABLE The fair values of interest receivable/payable
approximate carrying values.
CASH VALUE OF LIFE INSURANCE The fair value of cash value of life insurance
approximates carrying value.
DEPOSITS The fair values of noninterest-bearing demand accounts,
interest-bearing demand accounts and savings deposits are equal to the amount
payable on demand at the balance sheet date. The carrying amounts for variable
rate, fixed-term certificates of deposit approximate their fair values at the
balance sheet date. Fair values for fixed-rate certificates of deposit and other
time deposits are estimated using a discounted cash flow calculation that
applies interest rates currently being offered on certificates to a schedule of
aggregated expected monthly maturities on such time deposits.
BORROWINGS The fair value of borrowings is estimated using a discounted cash
flow calculation, based on current rates for similar debt, except for short-term
and
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 18
FAIR VALUES OF FINANCIAL INSTRUMENTS continued
adjustable rate borrowing arrangements. At December 31, the fair value for these
instruments approximates carrying value.
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:
2005 2004
-----------------------------------------------------------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
===================================================================================================================================
Assets at December 31:
Cash and cash equivalents .................................. $ 70,417 $ 70,417 $ 69,960 $ 69,960
Interest-bearing time deposits ............................. 8,748 8,748 9,343 9,343
Investment securities available for sale ................... 422,627 422,627 416,177 416,177
Investment securities held to maturity ..................... 11,639 11,510 5,358 5,520
Mortgage loans held for sale ............................... 4,910 4,910 3,367 3,367
Loans ...................................................... 2,432,239 2,511,784 2,405,503 2,415,924
FRB and FHLB stock ......................................... 23,200 23,200 22,858 22,858
Interest receivable ........................................ 19,690 19,690 17,318 17,318
Cash value of life insurance ............................... 43,579 43,579 42,061 42,061
Liabilities at December 31:
Deposits ................................................... 2,382,576 2,250,494 2,408,150 2,404,595
Borrowings:
Federal funds purchased ................................ 50,000 50,000 32,550 32,550
Securities sold under repurchase agreements ............ 106,415 106,415 87,472 85,136
FHLB advances .......................................... 247,865 248,303 223,663 234,247
Subordinated debentures, revolving credit
lines and term loans ................................. 103,956 115,822 97,206 105,139
Interest payable ........................................... 5,874 5,874 4,411 4,411
NOTE 19
CONDENSED FINANCIAL INFORMATION (parent company only)
Presented below is condensed financial information as to financial position,
results of operations, and cash flows of the Corporation:
CONDENSED BALANCE SHEETS
December 31,
2005 2004
================================================================================
Assets
Cash .............................................. $ 2,749 $ 987
Investment securities available for sale........... 3,500 3,500
Investment in subsidiaries ........................ 404,974 401,721
Goodwill .......................................... 448 448
Other assets ...................................... 12,259 10,039
-------- --------
Total assets ................................... $423,930 $416,695
======== ========
Liabilities
Borrowings ........................................ $103,956 $ 97,206
Other liabilities ................................. 6,578 4,886
-------- --------
Total liabilities .............................. 110,534 102,092
Stockholders' equity ................................. 313,396 314,603
-------- --------
Total liabilities and stockholders' equity ..... $423,930 $416,695
======== ========
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 19
CONDENSED FINANCIAL INFORMATION (parent company only) continued
CONDENSED STATEMENTS OF INCOME
December 31,
2005 2004 2003
===================================================================================================================================
Income
Dividends from subsidiaries ................................................ $ 30,930 $ 28,983 $ 45,445
Administrative services fees from subsidiaries.............................. 13,823 13,767 10,849
Other income ............................................................... 644 375 472
-------- -------- --------
Total income ............................................................ 45,397 43,125 56,766
-------- -------- --------
Expenses
Amortization of core deposit intangibles
and fair value adjustments ................................................ 11 11 26
Interest expense............................................................ 7,432 6,785 6,463
Salaries and employee benefits.............................................. 12,500 11,240 9,531
Net occupancy expenses...................................................... 1,294 1,481 1,869
Equipment expenses.......................................................... 3,418 2,918 1,955
Telephone expenses.......................................................... 1,181 1,383 1,571
Postage and courier expense ................................................ 1,528 1,467 970
Other expenses.............................................................. 2,394 1,761 2,760
-------- -------- --------
Total expenses .......................................................... 29,758 27,046 25,145
-------- -------- --------
Income before income tax benefit and equity in
undistributed income of subsidiaries ......................................... 15,639 16,079 31,621
Income tax benefit ...................................................... 5,404 4,557 5,577
-------- -------- --------
Income before equity in undistributed income of subsidiaries ................. 21,043 20,636 37,198
Equity in undistributed (distributions in excess of)
income of subsidiaries ................................................... 9,196 8,775 (9,627)
-------- -------- --------
Net Income ................................................................... $ 30,239 $ 29,411 $ 27,571
======== ======== ========
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31,
=====================================================================================================================
2005 2004 2003
=====================================================================================================================
Operating activities:
Net income ........................................................ $ 30,239 $ 29,411 $ 27,571
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization .................................................... 11 11 26
Distributions in excess of (equity in undistributed)
income of subsidiaries ............... ........................ (9,196) (8,775) (9,627)
Net change in:
Other assets ................................................. (2,220) (535) 2,406
Other liabilities ............................................ 1,680 461 (6)
-------- -------- --------
Net cash provided by operating activities ................. 20,514 20,573 20,370
-------- -------- --------
Investing activities - Investment in subsidiaries .................... (2,884) (2,289) (25,858)
-------- -------- --------
Net cash used by investing activities ..................... (2,884) (2,289) (25,858)
-------- -------- --------
Financing activities:
Cash dividends .................................................... (16,981) (17,048) (16,557)
Borrowings......................................................... 9,833 7,251 47,594
Repayment of borrowings ........................................... (3,083) (9,594) (29,550)
Stock issued under employee benefit plans ......................... 914 903 819
Stock issued under dividend reinvestment
and stock purchase plan ......................................... 933 1,278 1,339
Stock options exercised ........................................... 2,174 1,404 1,191
Stock redeemed .................................................... (9,658) (4,726) (489)
Cash paid in lieu of issuing fractional shares .................... (28)
-------- -------- --------
Net cash provided (used) by financing activities .......... (15,868) (20,532) 4,319
-------- -------- --------
Net change in cash ................................................... 1,762 (2,248) (1,169)
Cash, beginning of year .............................................. 987 3,235 4,404
-------- -------- --------
Cash, end of year .................................................... $ 2,749 $ 987 $ 3,235
======== ======== ========
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
NOTE 20
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth certain quarterly results for the years ended
December 31, 2005 and 2004:
------------------------------------------------------------------------------------------------------------------------------------
AVERAGE SHARES OUTSTANDING NET INCOME PER SHARE
QUARTER INTEREST INTEREST NET INTEREST PROVISION FOR NET -------------------------- --------------------
ENDED INCOME EXPENSE INCOME LOAN LOSSES INCOME BASIC DILUTED BASIC DILUTED
2005:
March ............ $ 41,315 $ 14,373 $ 26,942 $ 2,667 $ 6,567 18,559,664 18,696,526 $ .35 $ .35
June ............. 43,513 15,592 27,921 1,948 7,921 18,435,677 18,536,137 .43 .43
September......... 45,567 17,427 28,140 1,794 8,220 18,478,154 18,590,034 .45 .44
December.......... 46,814 18,688 28,126 1,945 7,531 18,458,990 18,557,622 .41 .41
---------- ---------- ----------- -------- -------- ----- -----
$ 177,209 $ 66,080 $ 111,129 $ 8,354 $ 30,239 18,484,832 18,595,695 $1.64 $1.63
========== ========== =========== ======== ======== ===== =====
2004:
March ............ $ 38,224 $ 12,592 $ 25,632 $ 1,372 $ 6,935 18,518,282 18,645,571 $ .37 $ .37
June ............. 38,099 12,252 25,847 1,720 7,355 18,511,190 18,633,301 .40 .40
September......... 39,801 13,009 26,792 1,380 7,653 18,548,041 18,658,459 .41 .41
December.......... 40,850 13,732 27,118 1,233 7,468 18,583,492 18,720,802 .41 .40
---------- ---------- ----------- -------- -------- ----- -----
$ 156,974 $ 51,585 $ 105,389 $ 5,705 $ 29,411 18,540,451 18,667,277 $1.59 $1.58
========== ========== =========== ======== ======== ===== =====
NOTE 21
ACCOUNTING MATTERS
Share-Based Compensation
In December, 2004, FASB issued an amendment to SFAS 123 (SFAS 123R), which
eliminates the ability to account for share-based compensation transactions
using Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and generally requires that such transactions be accounted for using
a fair value-based method. On April 14, 2005, the SEC amended the compliance
date for SFAS 123R from the beginning of the first interim or annual period that
begins after June 15, 2005 to the next fiscal year beginning after June 15,
2005. The Corporation adopted SFAS 123R as of January 1, 2006. The effect on the
Corporation's results of operations depends on the level of future option grants
and the calculation of the fair value of the options granted at such future
date, as well as the vesting periods provided and possible performance condition
requirements, and so cannot currently be predicted for future awards.
SFAS 123R applies to all awards granted after the effective date and to awards
modified, repurchased, or cancelled after that date. The statement establishes
standards for accounting for share-based payment transactions. Share-based
payment transactions are those in which an entity exchanges its equity
instruments for goods or services or in which an entity incurs liabilities in
exchange for goods or services that are based on the fair value of the entity's
equity instruments or that may be settled by the issuance of these equity
instruments. SFAS 123R covers a wide range of share-based compensation
arrangements including stock options, restricted share plans, performance-based
awards, share appreciation rights and employee stock purchase plans.
As of January 1, 2006, the Corporation applied SFAS 123R using the modified
prospective method. This method requires that compensation expense be recorded
for all unvested stock options and restricted stock awards over the requisite
service period (generally the vesting schedule). For liability-classified
awards, the
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(table dollar amounts in thousands, except share data)
Note 21
ACCOUNTING MATTERS continued
Corporation measures the cost of employee services received in exchange for an
award based on its current fair value; the fair value is remeasured subsequently
at each reporting date through the settlement date, and changes in fair value
are recognized as compensation cost. For equity-classified awards, the grant
date fair value is recognized in earnings over the requisite service period.
Earnings Per Share
The FASB has issued a proposed amendment to SFAS No. 128, Earnings Per Share, to
clarify guidance for mandatorily convertible instruments, the treasury stock
method, contingently issuable shares, and contracts that may be settled in cash
of shares. The primary impact on the Corporation of the proposed Statement is
the change to the treasury stock method for year-to-date diluted earnings per
share.
Currently SFAS No. 128 requires that the number of incremental shares included
in the denominator be determined by computing a year-to-date weighted average of
the number of incremental shares included in each quarterly diluted EPS
computation. Under this proposed Statement, the number of incremental shares
included in year-to-date diluted earnings per share would be computed using the
average market price of common shares for the year-to-date period, independent
of the quarterly computations. This computational change is not expected to have
a significant impact on the Corporation's diluted earnings per share.
51
ANNUAL MEETING, STOCK PRICE AND DIVIDEND INFORMATION
The 2006 Annual Meeting of Stockholders
of First Merchants Corporation
will be held...
Thursday, April 13, 2006 at 3:30 p.m.
Horizon Convention Center
401 South High Street
Muncie, Indiana
STOCK INFORMATION
PRICE PER SHARE
QUARTER HIGH LOW DIVIDENDS DECLARED(1)
================================================================================================================================
2005 2004 2005 2004 2005 2004
-------------------------- --------------------------- ---------------------------
First Quarter ............. $ 28.57 $ 26.33 $ 25.09 $ 23.50 $ .23 $ .23
Second Quarter ............. 26.06 25.88 23.05 22.20 .23 .23
Third Quarter .............. 27.30 25.77 24.75 22.96 .23 .23
Fourth Quarter ............. 26.89 29.19 23.98 24.15 .23 .23
(1) The Liquidity section of Management's Discussion & Analysis of Financial
Condition and Results of Operations and Note 14 to Consolidated Financial
Statements include discussions regarding dividend restrictions from the
bank subsidiaries to the Corporation.
The table above lists per share prices and dividend payments during 2005 and
2004. Prices are as reported by the National Association of Securities Dealers
Automated Quotation - National Market System.
Numbers rounded to nearest cent when applicable.
52
COMMON STOCK LISTING
COMMON STOCK LISTING
First Merchants Corporation common stock is traded over-the-counter on the
NASDAQ National Market System. Quotations are carried in many daily papers. The
NASDAQ symbol is FRME (Cusip #320817-10-9). At the close of business on January
31, 2006, the number of shares outstanding was 18,420,077. There were 6,061
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. Brian Edwards
Shareholder Relations Officer
First Merchants Corporation
P. O. Box 792
Muncie, Indiana 47308-0792
765-741-7278
800-262-4261 Ext. 7278
Stock Transfer Agent and Registrar
American Stock Transfer & Trust Company
59 Maiden Lane, 1st Floor
New York, NY 10038
53
FORM 10-K, FINANCIAL INFORMATION AND CODE OF ETHICS
FORM 10-K, FINANCIAL INFORMATION AND CODE OF ETHICS
The 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.
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
The Corporation has adopted a Code of Ethics that applies to its Chief Executive
Officer, Chief Operating Officer, Chief Financial Officer, Controller and
Treasurer. It is part of the Corporation's Code of Business Conduct, which
applies to all employees and directors of the Corporation and its affiliates. A
copy of the Code of Ethics may be obtained, free of charge, by writing to First
Merchants Corporation at 200 East Jackson Street, Muncie, IN 47305. In addition,
the Code of Ethics is maintained on the Corporation's web site, which can be
accessed at http://www.firstmerchants.com.
Please contact:
Mr. Mark Hardwick
Executive Vice President
and Chief Financial Officer
First Merchants Corporation
P. O. Box 792
Muncie, Indiana 47308-0792
765-751-1857
1-800-262-4261 Ext. 1857
54
EXHIBIT-21
SUBSIDIARIES OF THE REGISTRANT
EXHIBIT 21--SUBSIDIARIES OF THE REGISTRANT
--------------------------------------------------------------------------------
State of
Name Incorporation
---- -------------
First Merchants Bank, National Association (also doing
business as First Merchants Bank of Hamilton County)......U.S.
The Madison Community Bank, National Association............U.S.
United Communities National Bank............................U.S.
The First National Bank of Portland.........................U.S.
Decatur Bank & Trust Company, National Association..........U.S.
Frances Slocum Bank & Trust Company, National Association...U.S.
Lafayette Bank and Trust Company, National Association......U.S.
Commerce National Bank......................................U.S.
First Merchants Capital Trust I.........................Delaware
First Merchants Insurance Services, Inc..................Indiana
First Merchants Reinsurance Co. Ltd.....................Providencials Turkes and
Caicos, Island
Indiana Title Insurance Company..........................Indiana
Indiana Title Insurance Company, LLC.....................Indiana
FMB Portfolio Management, Inc...........................Delaware
UCNB Portfolio Management, Inc..........................Delaware
Wabash Valley Investments, Inc............................Nevada
Wabash Valley, LLC........................................Nevada
Wabash Valley Holdings, Inc...............................Nevada
Merchants Trust Company, National Association...............U.S.
CNBC Statutory Trust I...............................Connecticut
EXHIBIT-23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
EXHIBIT 23 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in this Annual Report on Form 10-K
and the registration statements on Form S-8, (File No.s 033-54065, 333-116074,
333-111374, 333-50484, 333-80119 and 333-80117) of First Merchants Corporation
(the "Corporation") of our reports dated January 27, 2006, on the consolidated
financial statements of the Corporation as of year ended December 31, 2005 and
on our audit of internal control over financial reporting of the Corporation as
of December 31, 2005, which reports are included in this Annual Report on Form
10-K.
/s/ BKD, LLP
Indianapolis, Indiana
March 13, 2006
EXHIBIT-24
LIMITED POWER OF ATTORNEY
EXHIBIT 24--LIMITED POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that the undersigned directors and officers of
First Merchants Corporation, an Indiana corporation, hereby constitute and
appoint Mark K. Hardwick, the true and lawful agent and attorney-in-fact of the
undersigned with full power and authority in said agent and attorney-in-fact to
sign for the undersigned and in their respective names as directors and officers
of the Corporation the Form 10-K of the Corporation to be filed with the
Securities and Exchange Commission, Washington, D.C., under the Securities
Exchange Act of 1934, as amended, and to sign any amendment to such Form 10-K,
hereby ratifying and confirming all acts taken by such agent and
attorney-in-fact, as herein authorized.
Dated: February 14, 2006
/s/ Michael L. Cox /s/ James F. Ault
-------------------------------------- ------------------------------------
Michael L. Cox President and James F. Ault Director
Chief Executive
Officer (Principal
Executive Officer)
/s/Mark K. Hardwick /s/ Richard A. Boehning
-------------------------------------- ------------------------------------
Mark K. Hardwick Executive Vice Richard A. Boehning Director
President and Chief
Financial Officer
(Principal Financial
and Principal
Accounting Officer)
/s/ Thomas B. Clark
------------------------------------
Thomas B. Clark Director
/s/ Michael L. Cox
------------------------------------
Michael L. Cox Director
/s/ Roderick English
------------------------------------
Roderick English Director
/s/ Dr. Jo Ann M. Gora
------------------------------------
Dr. Jo Ann M. Gora Director
/s/ Barry J. Hudson
------------------------------------
Barry J. Hudson Director
/s/ Robert T. Jaffares
------------------------------------
Robert T. Jeffares Director
/s/ Thomas D. McAuliffe
------------------------------------
Thomas D. McAuliffe Director
/s/ Michael C. Rechin
------------------------------------
Michael C. Rechin Director
/s/ Charles E. Schalliol
------------------------------------
Charles E. Schalliol Director
/s/ Robert M. Smitson
------------------------------------
Robert M. Smitson Director
------------------------------------
Jean L. Wojtowicz Director
EXHIBIT-31.1
FIRST MERCHANTS CORPORATION
FORM 10-K
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
-------------
I, Michael L. Cox, President and Chief Executive Officer of First Merchants
Corporation, certify that:
1. I have reviewed this Annual Report on Form 10-K of First Merchants
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in the Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report, based on such evaluation;
and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board or directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 16, 2006 /s/Michael L. Cox
----------------------------------------
Michael L. Cox
President and Chief Executive Officer
(Principal Executive Officer)
EXHIBIT-31.2
FIRST MERCHANTS CORPORATION
FORM 10-K
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
-------------
I, Mark K. Hardwick, Senior Vice President and Chief Financial Officer of First
Merchants Corporation, certify that:
1. I have reviewed this Annual Report on Form 10-K of First Merchants
Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in the Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report, based on such evaluation;
and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board or directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 16, 2006 /s/Mark K. Hardwick
----------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Principal Accounting Officer)
EXHIBIT-32
CERTIFICATIONS PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the annual report of First Merchants Corporation (the
"Corporation") on Form 10-K for the period ending December 31, 2005 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"), I
Michael L. Cox, President and Chief Executive Officer of the Corporation, do
hereby certify, in accordance with 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)); and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Corporation.
Date March 16, 2006 by /s/ Michael L. Cox
--------------------------- -------------------------------------
Michael L. Cox
President and Chief Executive Officer
(Principal Executive Officer)
A signed copy of this written statement required by Section 906 has been
provided to First Merchants Corporation and will be retained by First Merchants
Corporation and furnished to the Securities and Exchange Commission or its staff
upon request.
In connection with the annual report of First Merchants Corporation (the
"Corporation") on Form 10-K for the period ending December 31, 2005 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"), I
Mark K. Hardwick, Senior Vice President and Chief Financial Officer of the
Corporation, do hereby certify, in accordance with 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)); and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Corporation.
Date March 16, 2006 by /s/ Mark K. Hardwick
--------------------------- -------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Principal Accounting Officer)
A signed copy of this written statement required by Section 906 has been
provided to First Merchants Corporation and will be retained by First Merchants
Corporation and furnished to the Securities and Exchange Commission or its staff
upon request.
EXHIBIT-99.1
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT
FOR FIRST MERCHANTS CORPORATION EMPLOYEE STOCK PURCHASE PLAN
EXHIBIT 99.1--FINANCIAL STATEMENTS AND INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM'S REPORT FOR FIRST MERCHANTS CORPORATION EMPLOYEE STOCK
PURCHASE PLAN
--------------------------------------------------------------------------------
The annual financial statements and independent registered public accounting
firm's report thereon for First Merchants Corporation Employee Stock Purchase
Plan for the year ending December 31, 2005, will be filed as an amendment to the
2005 Annual Report on Form 10-K.