FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
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 Street
Muncie, IN 47305-2814
(Address of principal executive offices) (Zip code)
(765) 747-1500
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
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.
(Check one):
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 Exchange Act). Yes [ ] No [X]
As of April 18, 2006, there were 18,442,576 outstanding common shares, without
par value, of the registrant.
FIRST MERCHANTS CORPORATION
FORM 10-Q
INDEX
Page No.
PART I. Financial Information:
Item 1. Financial Statements:
Consolidated Condensed Balance Sheets........................3
Consolidated Condensed Statements of Income..................4
Consolidated Condensed Statements of
Comprehensive Income.........................................5
Consolidated Condensed Statements of
Stockholders' Equity.........................................6
Consolidated Condensed Statements of Cash Flows..............7
Notes to Consolidated Condensed Financial Statements.........8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................17
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.................................................27
Item 4. Controls and Procedures.....................................27
PART II. Other Information:
Item 1. Legal Proceedings...........................................28
Item 1.A. Risk Factors................................................28
Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds..............................28
Item 3. Defaults Upon Senior Securities.............................28
Item 4. Submission of Matters to a Vote of Security Holders.........28
Item 5. Other Information...........................................28
Item 6. Exhibits....................................................29
Signatures...................................................................30
Index to Exhibits............................................................31
Page 2
FIRST MERCHANTS CORPORATION
FORM 10-Q
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
March 31, December 31,
2006 2005
------------ ------------
(Unaudited)
ASSETS:
Cash and due from banks ....................................... $ 59,176 $ 70,417
Interest-bearing deposits...................................... 9,104 8,748
Investment securities available for sale ...................... 431,190 422,627
Investment securities held to maturity ........................ 10,461 11,639
Mortgage loans held for sale................................... 5,170 4,910
Loans, net of allowance for loan losses of $25,623 and $25,188. 2,465,865 2,432,239
Premises and equipment ........................................ 39,029 39,417
Federal Reserve and Federal Home Loan Bank stock............... 23,421 23,200
Interest receivable ........................................... 19,035 19,690
Core deposit intangibles ...................................... 16,805 17,567
Goodwill ...................................................... 121,369 121,266
Cash surrender value of life insurance......................... 43,964 43,579
Other assets .................................................. 25,346 21,780
----------- -----------
Total assets .............................................. $ 3,269,935 $ 3,237,079
=========== ===========
LIABILITIES:
Deposits:
Noninterest-bearing ......................................... $ 325,548 $ 314,335
Interest-bearing ............................................ 2,120,524 2,068,241
----------- -----------
Total deposits ............................................ 2,446,072 2,382,576
Borrowings .................................................... 469,002 508,236
Interest payable .............................................. 6,412 5,874
Other liabilities.............................................. 31,711 26,997
----------- -----------
Total liabilities ......................................... 2,953,197 2,923,683
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY:
Perferred stock, no-par value:
Authorized and unissued - 500,000 shares
Common Stock, $.125 stated value:
Authorized --- 50,000,000 shares
Issued and outstanding - 18,440,316 and 18,416,714 shares.... 2,305 2,302
Additional paid-in capital .................................... 146,374 145,682
Retained earnings ............................................. 177,975 174,717
Accumulated other comprehensive loss .......................... (9,916) (9,305)
----------- -----------
Total stockholders' equity ................................ 316,738 313,396
----------- -----------
Total liabilities and stockholders' equity ................ $ 3,269,935 $ 3,237,079
=========== ===========
See notes to consolidated condensed financial statements.
Page 3
FIRST MERCHANTS CORPORATION
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
2006 2005
Interest Income:
Loans receivable
Taxable ................................................... $ 43,079 $ 36,822
Tax exempt ................................................ 168 134
Investment securities
Taxable ................................................... 2,726 2,329
Tax exempt ................................................ 1,647 1,553
Federal funds sold .......................................... 17 27
Deposits with financial institutions ........................ 114 142
Federal Reserve and Federal Home Loan Bank stock ............ 311 308
-------- --------
Total interest income ..................................... 48,062 41,315
-------- --------
Interest expense:
Deposits .................................................... 14,419 9,806
Borrowings .................................................. 6,054 4,567
-------- --------
Total interest expense .................................... 20,473 14,373
-------- --------
Net Interest Income ........................................... 27,589 26,942
Provision for loan losses ..................................... 1,726 2,667
-------- --------
Net Interest Income After Provision for Loan Losses ........... 25,863 24,275
-------- --------
Total other income ............................................ 8,597 9,046
Total other expenses:
Salaries and benefits ....................................... 14,392 14,821
Other expenses .............................................. 9,396 9,410
-------- --------
Total other expenses ...................................... 23,788 24,231
Income before income tax ...................................... 10,672 9,090
Income tax expense ............................................ 3,163 2,523
-------- --------
Net Income .................................................... $ 7,509 $ 6,567
======== ========
Per share:
Basic ..................................................... $ .41 $ .35
Diluted ................................................... .41 .35
Dividends ................................................. .23 .23
See notes to consolidated condensed financial statements.
Page 4
FIRST MERCHANTS CORPORATION
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)
Three Months Ended
March 31
----------------------
2006 2005
--------- ---------
Net Income...................................................................... $ 7,509 $ 6,567
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 $407, and $2,522 ................................... (611) (3,783)
--------- ---------
Comprehensive income ........................................................... $ 6,898 $ 2,784
========= =========
See notes to consolidated condensed financial statements.
Page 5
FIRST MERCHANTS CORPORATION
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands)
(Unaudited)
2006 2005
--------- ---------
Balances, January 1 ............................................ $ 313,396 $ 314,603
Net income ..................................................... 7,509 6,567
Cash dividends on common stock ................................. (4,238) (4,264)
Cash dividends on restricted stock awards ...................... (13)
Other comprehensive income (loss), net of tax................... (611) (3,783)
Stock issued under dividend reinvestment and stock purchase plan 291 335
Stock options exercised ........................................ 255 757
Tax benefit from stock options exercised ....................... 24
Stock redeemed ................................................. (69) (3,617)
Share-based compensation ....................................... 194
--------- ---------
Balances, March 31 ............................................. $ 316,738 $ 310,598
========= =========
See notes to consolidated condensed financial statements.
Page 6
FIRST MERCHANTS CORPORATION
FORM 10-Q
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Three Months Ended
March 31,
------------------------------------
2006 2005
---------------- ----------------
Cash Flows From Operating Activities:
Net income........................................................................ $ 7,509 $ 6,567
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses....................................................... 1,726 2,667
Depreciation and amortization................................................... 1,323 2,276
Share-based compensation........................................................ 194
Tax benefits from stock options exercised....................................... (24)
Mortgage loans originated for sale.............................................. (28,586) (12,840)
Proceeds from sales of mortgage loans........................................... 28,326 13,123
Change in interest receivable................................................... 655 712
Change in interest payable...................................................... 538 885
Other adjustments............................................................... 2,000 2,111
---------------- ----------------
Net cash provided by operating activities..................................... 13,661 15,501
---------------- ----------------
Cash Flows From Investing Activities:
Net change in interest-bearing deposits........................................... (356) (1,394)
Purchases of
Securities available for sale................................................... (22,781) (11,654)
Proceeds from maturities of
Securities available for sale................................................... 13,282 16,246
Securities held to maturity..................................................... 949 1,048
Proceeds from sales of securities available for sale..............................
Purchase of Federal Reserve and
Federal Home Loan Bank Stock.................................................... (221) (25)
Net change in loans............................................................... (35,352) 13,225
Other adjustments................................................................. (935) (510)
---------------- ----------------
Net cash provided (used) by investing activities.............................. (45,414) 16,936
---------------- ----------------
Cash Flows From Financing Activities:
Net change in
Demand and savings deposits..................................................... (56,553) (95,211)
Certificates of deposit and other time deposits................................. 120,049 139,280
Borrowings........................................................................ 36,150 (49,698)
Repayment of borrowings........................................................... (75,384)
Cash dividends on common stock.................................................... (4,238) (4,264)
Cash dividends on restricted stock awards......................................... (13)
Stock issued under dividend reinvestment and stock purchase plan.................. 291 335
Stock options exercised........................................................... 255 757
Tax benefit from stock options exercised.......................................... 24
Stock redeemed.................................................................... (69) (3,617)
---------------- ----------------
Net cash provided (used) by financing activities.............................. 20,512 (12,418)
---------------- ----------------
Net Change in Cash and Cash Equivalents............................................. (11,241) 20,019
Cash and Cash Equivalents, January 1................................................ 70,417 69,960
---------------- ----------------
Cash and Cash Equivalents, March 31................................................. $ 59,176 $ 89,979
================ ================
Additional cash flows information:
Interest paid .................................................................... $ 19,935 $ 13,488
Income tax paid .................................................................. 500
See notes to consolidated condensed financial statements.
Page 7
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
NOTE 1. General
Financial Statement Preparation
The significant accounting policies followed by First Merchants Corporation
("Corporation") and its wholly owned subsidiaries for interim financial
reporting are consistent with the accounting policies followed for annual
financial reporting, except as discussed below within the caption "Change in
Accounting Principle". All adjustments, which are of a normal recurring nature
and are in the opinion of management necessary for a fair statement of the
results for the periods reported, have been included in the accompanying
consolidated condensed financial statements.
The consolidated condensed balance sheet of the Corporation as of December 31,
2005 has been derived from the audited consolidated balance sheet of the
Corporation as of that date. Certain information and note disclosures normally
included in the Corporation's annual financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted. These consolidated condensed financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Corporation's Form 10-K annual
report filed with the Securities and Exchange Commission. The results of
operations for the three month period ended March 31, 2006 are not necessarily
indicative of the results to be expected for the year.
Change in Accounting Principle
Effective January 1, 2006, the Corporation adopted Statement of Financial
Accounting Standards No. 123(R), Share-Based Payment ("SFAS 123(R)"). SFAS
123(R) addresses all forms of share-based payment awards, including shares under
employee stock purchase plans, stock options, restricted stock and stock
appreciation rights. SFAS 123(R) requires all share-based payments to be
recognized as expense, based upon their fair values, in the financial statements
over the vesting period of the awards. The Corporation has elected the modified
prospective application and, as a result, has recorded approximately $194,000 in
compensation expense related to vested stock options, Employee Stock Purchase
Plan options and restricted stock awards, less estimated forfeitures, for the
three month period ended March 31, 2006.
NOTE 2. Share-Based Compensation
Stock options and restricted stock awards ("RSAs") have been issued to
directors, officers and other management employees under the Corporation's 1994
Stock Option Plan and The 1999 Long-term Equity Incentive Plan. The stock
options, which have a ten year life, become 100 percent vested ranging from
three months to two years and are fully exercisable when vested. Option exercise
prices equal the Corporation's common stock closing price on NASDAQ on the date
of grant. RSAs provide for the issuance of shares of the Corporation's common
stock at no cost to the holder and generally vest after three years. The RSAs
vest only if the employee is actively employed by the Corporation on the vesting
date and, therefore, any unvested shares are forfeited.
The Corporation's 2004 Employee Stock Purchase Plan ("ESPP") provides eligible
employees of the Corporation and its subsidiaries an opportunity to purchase
shares of common stock of the Corporation through annual offerings financed by
payroll deductions. The price of the stock to be paid by the employees may not
be less than 85 percent of the lesser of the fair market value of the
Corporation's common stock at the beginning or at the end of the offering
period. Common stock purchases are made annually and are paid through advance
payroll deductions of up to 20 percent of eligible compensation.
SFAS 123(R) requires the Corporation to begin recording compensation expense in
2006 related to unvested share-based awards outstanding as of December 31, 2005,
by recognizing the unamortized grant date fair value of these awards over the
remaining service periods of those awards, with no change in historical reported
fair values and earnings. Awards granted after December 31, 2005 are valued at
fair value in accordance with provisions of SFAS 123(R) and are recognized on a
straight-line basis over the service periods of each award. To complete the
exercise of vested stock options, RSA's and ESPP options, the Corporation
generally issues new shares from its authorized but unissued share pool. At
March 31, 2006, share-based compensation for the three months ended March 31,
2006 totaled $194,000, and has been recognized as a component of salaries and
benefits expense in the accompanying Consolidated Condensed Statements of
Income.
Page 8
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
NOTE 2. Share-Based Compensation continued
Prior to 2006, the Corporation accounted for share-based compensation in
accordance with APB 25 using the intrinsic value method, which did not require
that compensation expense be recognized for the Corporation's stock and ESPP
options; however, under APB 25, the Corporation was required to record
compensation expense over the vesting period for the value of RSAs granted, if
any.
The Corporation provided pro forma disclosure amounts in accordance with SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure"
(SFAS No. 148), as if the fair value method defined by SFAS No. 123 had been
applied to its share-based compensation. The Corporation's net income and net
income per share for the three months ended March 31, 2005 would have been
reduced if compensation expense related to stock and ESPP options had been
recorded in the financial statements, based on fair value at the grant dates.
The estimated fair value of the stock options granted during 2006 and in prior
years was calculated using a Black Scholes option pricing model. The following
summarizes the assumptions used in the 2006 Black Scholes model:
Risk-free interest rate 4.59%
Expected price volatility 29.84%
Dividend yield 3.54%
Forfeiture rate 4.00%
Weighted-average expected life, until exercise 5.75 years
The Black Scholes model incorporates assumptions to value share-based awards.
The risk-free rate of interest, for periods equal to the expected life of the
option, is based on a zero-coupon U.S. government instrument over a similar
contractual term of the equity instrument. Expected price volatility is based on
historical volatility of the Corporation's common stock. In addition, the
Corporation generally uses historical information to determine the dividend
yield and weighted-average expected life of the options, until exercise.
Separate groups of employees that have similar historical exercise behavior with
regard to option exercise timing and forfeiture rates are considered separately
for valuation and attribution purposes.
Share-based compensation expense recognized in the Consolidated Condensed
Statements of Income is based on awards ultimately expected to vest and is
reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods,
if actual forfeitures differ from those estimates. Pre-vesting forfeitures were
estimated to be approximately 4 percent for the three months ended March 31,
2006, based on historical experience. In the Corporation's pro forma disclosures
required under SFAS 123(R) for the periods prior to fiscal 2006, the Corporation
accounted for forfeitures as they occurred.
As a result of adopting SFAS 123(R), net income of the Corporation for the three
months ended March 31, 2006 was $161,000 lower (net of $33,000 in tax benefits),
than if it had continued to account for share-based compensation under APB 25.
The impact on both basic and diluted earnings per share for the three months
ended March 31, 2006 was less than $.01 per share.
Page 9
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
NOTE 2. Share-Based Compensation continued
Pro forma net income, as if the fair value based method had been applied to all
awards, is as follows:
(In thousands, except for per share amounts)
Three Months Ended
March 31,
2006 2005
-------------------------
Net income as reported ................................................... $ 7,509 $ 6,567
Add: Share-based compensation awards recorded as expense,
net of income taxes ................................................. 161
Less: Share-based compensation cost, determined under
the fair value based method, net of income taxes .................... (161) (276)
---------- ----------
Pro forma net income ..................................................... $ 7,509 $ 6,291
========== ==========
Earnings per share:
Basic - as reported ................................................. $ .41 $ .35
Basic - pro forma ................................................... .41 .34
Diluted - as reported ............................................... .41 .35
Diluted - pro forma ................................................. .41 .34
The following table summarizes the components of the Corporation's share-based
compensation awards recorded as expense:
Three Months Ended
March 31,
2006
-----------
Stock and ESPP Options:
Pre-tax compensation expense ........................................$ 136
Income tax benefit .................................................. (12)
----------
Stock and ESPP option expense, net of income taxes .......................$ 124
==========
Restricted Stock Awards:
Pre-tax compensation expense ........................................$ 58
Income tax benefit .................................................. (21)
----------
Restricted stock awards expense, net of income taxes .....................$ 37
==========
Total Share-Based Compensation:
Pre-tax compensation expense ........................................$ 194
Income tax benefit .................................................. (33)
----------
Total share-based compensation expense, net of income taxes ..............$ 161
==========
Page 10
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
NOTE 2. Share-Based Compensation continued
As of March 31, 2006, unrecognized compensation expense related to stock
options, RSAs and ESPP options totaling $437,000, $1,219,000 and $53,000,
respectively, is expected to be recognized over weighted-average periods of
1.60, 2.83 and .25 years, respectively.
Stock option activity under the Corporation's stock option plans as of March 31,
2006 and changes during the three months ended March 31, 2006 were as follows:
Weighted-
Average
Weighted- Remaining
Number Average Contractual Aggregate
of Exercise Term Intrinsic
Shares Price (in Years) Value
---------- ------------ ----------- ----------
Outstanding at January 1, 2006 .................. 1,104,787 $ 23.28
Granted ......................................... 74,570 25.14
Exercised ....................................... (13,929) 16.89
Cancelled ....................................... (217) 26.27
----------
Outstanding at March 31, 2006 ................... 1,165,211 $ 23.48 6.35 $2,814,000
==========
Vested and Expected to Vest at March 31, 2006.... 1,159,772 $ 23.47 .11 $2,812,000
Exercisable at March 31, 2006 ................... 1,079,140 $ 23.34 6.08 $2,787,000
The weighted-average grant date fair value was $6.15 for stock options granted
during the three months ended March 31, 2006.
The aggregate intrinsic value in the table above represents the total pre-tax
intrinsic value (the difference between the Corporation's closing stock price on
the last trading day of the first quarter of 2006 and the exercise price,
multiplied by the number of in-the-money options) that would have been received
by the option holders had all option holders exercised their stock options on
March 31, 2006. The amount of aggregate intrinsic value will change based on the
fair market value of the Corporation's common stock.
The aggregate intrinsic value of stock options exercised during first quarter
2006 was $130,000. Exercise of options during this same period resulted in cash
receipts of $166,000. The Corporation recognized a tax benefit of approximately
$24,000 in the first quarter 2006, related to the exercise of employee stock
options and has been recorded as an increase to additional paid-in capital.
The following table summarizes information on unvested restricted stock awards
outstanding as of March 31, 2006:
Weighted-Average
Number of Grant-Date Fair
Shares Value
---------- -----------
Unvested RSAs at January 1, 2006 ............. 0 0
Granted ...................................... 58,167 $ 25.10
Forfeited ....................................
Vested .......................................
----------
Unvested RSAs at March 31, 2006 .............. 58,167 $ 25.10
==========
Page 11
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
NOTE 2. Share-Based Compensation continued
The grant date fair value of ESPP options was estimated at the beginning of the
July 1, 2005 offering period and approximates $212,000. The ESPP options vest
during the twelve month period ending June 30, 2006. At March 31, 2006, total
unrecognized compensation expense related to unvested ESPP options was $53,000,
which is expected to be recognized over a period of three months.
NOTE 3. Investment Securities
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available for sale at March 31, 2006
U.S. Treasury ........................ $ 1,595 $ (1) $ 1,594
U.S. Government-sponsored
agency securities................... 94,737 $ 23 (2,036) 92,724
State and municipal .................. 162,593 2,075 (1,244) 163,424
Mortgage-backed securities ........... 169,542 106 (6,247) 163,401
Marketable equity securities.......... 10,423 (376) 10,047
-------- -------- -------- --------
Total available for sale ......... 438,890 2,204 (9,904) 431,190
-------- -------- -------- --------
Held to maturity at March 31, 2006
State and municipal................... 10,437 306 (338) 10,405
Mortgage-backed securities............ 24 24
-------- -------- -------- --------
Total held to maturity ........... 10,461 306 (338) 10,429
-------- -------- -------- --------
Total investment securities ...... $449,351 $ 2,510 $(10,242) $441,619
======== ======== ======== ========
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
======== ======== ======== ========
Page 12
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
NOTE 4. Loans and Allowance
March 31, December 31,
2006 2005
----------- -----------
Loans:
Commercial and industrial loans .............................................. $ 486,411 $ 461,102
Agricultural production financing and other loans to farmers ................. 87,433 95,130
Real estate loans:
Construction ............................................................... 175,784 174,783
Commercial and farmland .................................................... 743,905 734,865
Residential ................................................................ 746,410 751,217
Individuals' loans for household and other personal expenditures ............. 202,478 200,139
Tax-exempt loans ............................................................. 13,656 8,263
Lease financing receivables, net of unearned income........................... 8,193 8,713
Other loans .................................................................. 27,218 23,215
----------- -----------
2,491,488 2,457,427
Allowance for loan losses..................................................... (25,623) (25,188)
----------- -----------
Total Loans............................................................... $ 2,465,865 $ 2,432,239
=========== ===========
Three Months Ended
March 31,
2006 2005
----------- -----------
Allowance for loan losses:
Balances, January 1 .......................................................... $ 25,188 $ 22,548
Provision for losses ......................................................... 1,726 2,667
Recoveries on loans .......................................................... 308 222
Loans charged off ............................................................ (1,599) (949)
----------- -----------
Balances, March 31 ........................................................... $ 25,623 $ 24,488
=========== ===========
Information on nonaccruing, contractually
past due 90 days or more other than
nonaccruing and restructured loans is March 31, December 31,
summarized below: 2006 2005
================================================================================
Non-accrual loans................................ $ 11,424 $ 10,030
Loans contractually past due 90 days
or more other than nonaccruing................. 5,188 3,965
Restructured loans............................... 114 310
-------- --------
Total........................................ $ 16,726 $ 14,305
======== ========
Page 13
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
NOTE 5. Net Income Per Share
Basic net income per share is computed by dividing net income by the weighted-
average shares outstanding during the reporting period. Diluted net income per
share is computed by dividing net income by the combination of all dilutive
common share equivalents, comprised of shares issuable under the Corporation's
share-based compensation plans, and the weighted-average shares outstanding
during the reporting period.
Dilutive common share equivalents include the dilutive effect of in-the-money
share-based awards, which are calculated based on the average share price for
each period using the treasury stock method. Under the treasury stock method,
the exercise price of share-based awards, the amount of compensation expense, if
any, for future service that the Corporation has not yet recognized, and the
amount of estimated tax benefits that would be recorded in additional
paid-in-captial when share-based awards are exercised, are assumed to be used to
repurchase common stock in the current period.
Three Months Ended March 31,
2006 2005
------------------------------------------- ------------------------------------------
Weighted- Weighted-
Net Average Per Share Net Average Per Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
Basic net income per share:
Net income available to
common stockholders......................$ 7,509 18,425,047 $ .41 $ 6,567 18,559,664 $ .35
========== ==========
Effect of dilutive common
share equivalents .......................... 107,089 136,862
---------- ------------ ---------- ------------
Diluted net income per share:
Net income available to
common stockholders
and assumed conversions..................$ 7,509 18,532,136 $ .41 $ 6,567 18,696,526 $ .35
========== ============ ========== ========== ============ ==========
Stock options to purchase 397,339 and 152,158 shares for the three months ended
March 31, 2006 and 2005 were not included in the earnings per share calculation
because the exercise price exceeded the average market price.
Page 14
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
Note 6. Defined Benefit Pension Costs
The Corporation has defined benefit pension plans covering substantially all
employees. The plans provide benefits that are based on the employees'
compensation and years of service. The Corporation uses an actuarial calculation
to determine pension plan costs and paid no contributions to its defined-benefit
pension plans during the first quarter of 2006.
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 recorded 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 the first
quarter of 2005.
The following represents the pension cost for the three months ended March 31,
2006.
Three Months Ended
March 31,
2006 2005
-------------------------
Pension Cost
------------
Service cost............................................ $ 131 $ 145
Interest cost .......................................... 683 658
Expected return on plan assets ......................... (728) (768)
Amortization of the transition asset.................... (7)
Amortization of prior service cost...................... 1 1
Amortization of the net loss............................ 87 24
Curtailment loss........................................ 1,630
---------- ----------
Total Pension Cost................................ $ 174 $ 1,683
========== ==========
Page 15
FIRST MERCHANTS CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Table dollars in thousands)
(Unaudited)
Note 7. Impact of Accounting Changes
In March 2006, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 156 ("SFAS No. 156"). This Statement amends
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, with respect to the accounting for separately
recognized servicing assets and servicing liabilities.
SFAS No. 156 requires an entity to initially recognize a servicing asset or
servicing liability at fair value each time it undertakes an obligation to
service a financial asset by entering into a servicing contract in other
specific situations.
In addition, SFAS No. 156 permits an entity to choose either of the following
subsequent measurement methods for each class of separately recognized servicing
assets and servicing liabilities:
o Amortization method- Amortize servicing assets or servicing liabilities in
proportion to and over the period of estimated net servicing income or net
servicing loss and assess servicing assets or servicing liabilities for
impairment or increased obligation, based on fair value at each reporting
date.
o Fair value measurement method- Measure servicing assets or servicing
liabilities at fair value at each reporting date and report changes in fair
value in earnings in the period in which the changes occur.
SFAS No. 156 is effective for the Corporation at the beginning of its first
fiscal year that begins after September 15, 2006, and should be applied
prospectively for recognition and initial measurement of servicing assets and
servicing liabilities. Earlier adoption is permitted as of the beginning of an
entity's fiscal year, provided the entity has not yet issued financial
statements, including interim financial statements, for any period of that
fiscal year.
The Corporation did not early adopt SFAS No. 156 on January 1, 2006. The
Corporation is currently evaluating the effect of adoption of this Statement on
its financial condition and results of operations.
Page 16
FIRST MERCHANTS CORPORATION
FORM 10-Q
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
--------------
FORWARD-LOOKING STATEMENTS
We from time to time include forward-looking statements in our oral and written
communication. We may include forward-looking statements in filings with the
Securities and Exchange Commission, such as this Form 10-Q, in other written
materials and in oral statements made by senior management to analysts,
investors, representatives of the media and others. We intend 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 we are 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 our goals, intentions and expectations;
* statements regarding our business plan and growth strategies;
* statements regarding the asset quality of our loan and investment
portfolios; and
* estimates of our 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 our net interest margin, asset valuations
and expense expectations;
* adverse changes in the economy, which might affect our business
prospects and could cause credit-related losses and expenses;
* adverse developments in our loan and investment portfolios;
* competitive factors in the banking industry, such as the trend towards
consolidation in our market;
* changes in the banking legislation or the regulatory requirements of
federal and state agencies applicable to bank holding companies and
banks like our affiliate banks;
* acquisitions of other businesses by us and integration of such acquired
businesses;
* changes in market, economic, operational, liquidity, credit and interest
rate risks associated with our 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, our actual future results may be
materially different from the results indicated by these forward- looking
statements. In addition, our past results of operations do not necessarily
indicate our anticipated future results.
Page 17
FIRST MERCHANTS CORPORATION
FORM 10-Q
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations continued
------------------------
CRITICAL ACCOUNTING POLICIES
Generally accepted accounting principles are complex and require us to apply
significant judgments to various accounting, reporting and disclosure matters.
We must use assumptions and estimates to apply these principles where actual
measurement is not possible or practical. For a complete discussion of our
significant accounting policies, see "Notes to the Consolidated Financial
Statements" in the Corporation's Annual Report on Form 10-K for the year ended
December 31, 2005. Certain policies are considered 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
financial statements. We have reviewed the application of these policies with
the Audit Committee of our Board of Directors.
We believe there have been no significant changes during the quarter ended March
31, 2006 to the items that we disclosed as our critical accounting policies and
estimates in Management's Discussion and Analysis of Financial Condition and
Results of Operations in the Corporation's Annual Report on Form 10-K for the
year ended December 31, 2005.
BUSINESS SUMMARY
We are a financial holding company headquartered in Muncie, Indiana. Since our
organization in 1982, we have grown to include 8 affiliate banks with 65
locations in 17 Indiana and 3 Ohio counties. In addition to our branch network,
our delivery channels include ATMs, check cards, interactive voice response
systems and internet technology.
Our business activities are currently limited to one significant business
segment, which is community banking. Our financial service affiliates include
eight nationally chartered banks: First Merchants Bank, N.A., The Madison
Community 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. The banks
provide commercial and retail banking services. In addition, our trust company,
multi-line insurance company and title company provide trust asset management
services, retail and commercial insurance agency services and title services,
respectively.
We believe that our 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.
We believe it is important to maintain a well controlled environment as we
continue to grow our businesses. Sound credit policies are maintained and
interest rate and market risks inherent in our asset and liability balances are
managed within prudent ranges, while ensuring adequate liquidity and funding.
Our stockholder value has continued to increase due to customer satisfaction and
the balanced way we manage our business risk.
RESULTS OF OPERATIONS
Net income for the three months ended March 31, 2006, equaled $7,509,000,
compared to $6,567,000 in the same period of 2005. Diluted earnings per share
were $.41, an increase of 17.1 percent from the $.35 reported for the first
quarter 2005. The increase in earnings during the period is due to an increase
in net interest income, a decrease in the provision for loan losses, and a
pension accounting loss recorded in the first quarter 2005, resulting from the
curtailment of the accumulation of defined benefits in the Corporation's defined
benefit plan. These factors are discussed within the respective sections of
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Annualized returns on average assets and average stockholders' equity for the
three months ended March 31, 2006, were .93 percent and 9.49 percent,
respectively, compared with .83 percent and 8.33 percent for the same period of
2005.
Page 18
FIRST MERCHANTS CORPORATION
FORM 10-Q
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations continued
------------------------
CAPITAL
Our 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. Our Tier I capital to average assets ratio was 7.8 percent at
March 31, 2006 and 7.7 percent at year end 2005. In addition, at March 31, 2006,
we had a Tier I risk-based capital ratio of 9.7 percent and total risk-based
capital ratio of 11.7 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.
Our GAAP capital ratio, defined as total stockholders' equity to total assets,
equaled 9.7 percent at March 31, 2006 and December 31, 2005. When we acquire
other companies for stock, GAAP capital increases by the entire amount of the
purchase price.
Our tangible capital ratio, defined as total stockholders' equity less
intangibles net of tax to total assets less intangibles net of tax, equaled 5.9
percent as of March 31, 2006, and 5.8 percent at December 31, 2005.
We believe that all of the above capital ratios are meaningful measurements for
evaluating our safety and soundness. Additionally, we believe the following
table is also meaningful when considering our performance measures. The table
details and reconciles tangible earnings per share, return on tangible capital
and tangible assets to traditional GAAP measures.
March 31, December 31,
(Dollars in thousands) 2006 2005
Average Goodwill .......................... $ 121,369 $ 120,867
Average Core Deposit Intangible (CDI) ..... 17,171 19,087
Average Deferred Tax on CDI ............... (6,237) (7,141)
----------- -----------
Intangible Adjustment ................... $ 132,303 $ 132,813
=========== ===========
Average Stockholders' Equity (GAAP Capital) $ 316,629 $ 315,907
Intangible Adjustment ..................... (132,303) (132,813)
----------- -----------
Average Tangible Capital ................ $ 184,326 $ 183,094
=========== ===========
Average Assets ............................ $ 3,235,933 $ 3,195,784
Intangible Adjustment ..................... (132,303) (132,813)
----------- -----------
Average Tangible Assets ................. $ 3,103,630 $ 3,062,971
=========== ===========
Net Income ................................ $ 7,509 $ 30,239
CDI Amortization, net of tax .............. 480 1,952
----------- -----------
Tangible Net Income ..................... $ 7,989 $ 32,191
=========== ===========
Diluted Earnings per Share ................ $ 0.41 $ 1.63
Diluted Tangible Earnings per Share ....... $ 0.43 $ 1.73
Return on Average GAAP Capital ............ 9.49% 9.58%
Return on Average Tangible Capital ........ 17.34% 17.58%
Return on Average Assets .................. 0.93% 0.95%
Return on Average Tangible Assets ......... 1.03% 1.05%
Page 19
FIRST MERCHANTS CORPORATION
FORM 10-Q
ASSET QUALITY/PROVISION FOR LOAN LOSSES
Our primary business focus is middle market commercial and residential real
estate, auto and small consumer lending, which results in portfolio
diversification. We ensure 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 ongoing 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.
At March 31, 2006, non-performing loans totaled $16,726,000, an increase of
$2,421,000 from December 31, 2005, as noted in Note 4. Loans and Allowance,
included within the Notes to Consolidated Condensed Financial Statements of this
Form 10-Q. This increase was primarily due to one commercial loan credit added
to non-performing loans, during the first quarter of 2006.
At March 31, 2006, impaired loans totaled $54,295,000, an increase of $1,915,000
from December 31, 2005. At March 31, 2006, an allowance for losses was not
deemed necessary for impaired loans totaling $44,795,000, but an allowance of
$3,523,000 was recorded for the remaining balance of impaired loans of
$9,500,000 and is included in our allowance for loan losses.
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 our 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 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 March 31, 2006, the allowance for loan losses was $25,623,000, an increase of
$435,000 from year end 2005. As a percent of loans, the allowance was 1.03
percent at March 31, 2006 and 1.02 percent at December 31, 2005.
The provision for loan losses for the first three months of 2006 was $1,726,000,
a decrease of $941,000 from $2,667,000 for the same period in 2005.
Page 20
FIRST MERCHANTS CORPORATION
FORM 10-Q
LIQUIDITY
Liquidity management is the process by which we ensure that adequate liquid
funds are available for us and our subsidiaries. These funds are necessary in
order for us and our 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 our asset/liability committee.
Our liquidity is dependent upon our receipt of dividends from our bank
subsidiaries, which are subject to certain regulatory limitations and access to
other funding sources. Liquidity of our bank subsidiaries is derived primarily
from core deposit growth, principal payments received on loans, the sale and
maturity of investment securities, net cash provided by operating activities,
and access to other funding sources.
The most stable source of liability-funded liquidity for both the long- term and
short-term is deposit growth and retention in the core deposit base. In
addition, we utilize advances from the Federal Home Loan Bank. ("FHLB") and a
revolving line of credit with LaSalle Bank, N.A. as funding sources. At March
31, 2006, total borrowings from the FHLB were $225,640,000. Our bank
subsidiaries have pledged certain mortgage loans and certain investments to the
FHLB. The total available remaining borrowing capacity from the FHLB at March
31, 2006, was $82,557,000. At March 31, 2006, our revolving line of credit had a
balance of $13,000,000 and a remaining borrowing capacity of $7,000,000.
The principal source of asset-funded liquidity is investment securities
classified as available-for-sale, the market values of which totaled
$431,190,000 at March 31, 2006, an increase of $8,563,000 or 2.0 percent over
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
$674,000 at March 31, 2006. 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, we are 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 our consolidated financial
statements. Such activities include: traditional off-balance sheet
credit-related financial instruments, commitments under operating leases and
long-term debt.
We provide customers with off-balance sheet credit support through loan
commitments and standby letters of credit. Summarized credit-related financial
instruments at March 31, 2006 are as follows:
At March 31,
(Dollars in thousands) 2006
================================================================================
Amounts of commitments:
Loan commitments to extend credit ............................... $ 617,967
Standby letters of credit ....................................... 31,266
----------
$ 649,233
==========
Since many of the commitments are expected to expire unused or be only partially
used, the total amount of unused commitments in the preceding table does not
necessarily represent future cash requirements.
In addition to owned banking facilities, we have entered into a number of
long-term leasing arrangements to support our ongoing activities. The required
payments under such commitments and long-term debt at March 31, 2006 are as
follows:
2006 2007 2008 2009 2010 2011 Total
(Dollars in thousands) remaining and after
=======================================================================================================
Operating leases ......... $ 1,542 $ 1,756 $ 1,275 $ 1,111 $ 1,057 $ 1,649 $ 8,390
Long-term debt ........... 172,741 45,495 32,806 13,378 35,179 169,403 469,002
-------- -------- -------- -------- -------- -------- --------
Total .................... $174,283 $ 47,251 $ 34,081 $ 14,489 $ 36,236 $171,052 $477,392
======== ======== ======== ======== ======== ======== ========
Page 21
FIRST MERCHANTS CORPORATION
FORM 10-Q
INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK
Asset/Liability Management has been an important factor in our ability to record
consistent earnings growth through periods of interest rate volatility and
product deregulation. Management and the Board of Directors monitor our
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, our exposure to changes in net
interest income given various rate scenarios and the economic and competitive
environments.
It is our objective to monitor and manage risk exposure to net interest income
caused by changes in interest rates. It is the goal our Asset Liability function
to provide optimum and stable net interest income. To accomplish this, we use
two asset liability tools. GAP/Interest Rate Sensitivity Reports and Net
Interest Income Simulation Modeling are both constructed, presented, and
monitored quarterly.
We believe that our liquidity and interest sensitivity position at March 31,
2006, remained adequate to meet our primary goal of achieving optimum interest
margins while avoiding undue interest rate risk.
We place our greatest credence in net interest income simulation modeling. The
GAP/Interest Rate Sensitivity Report is believed by our 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. Our 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 our view of future market movements. Rather, these are
intended to provide a measure of the degree of volatility interest rate
movements may introduce into our earnings.
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 our 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, NOW and demand deposits, reflect
our best estimate of expected future behavior.
Page 22
FIRST MERCHANTS CORPORATION
FORM 10-Q
The comparative rising and falling scenarios for the period ended February 28,
2007 assume further interest rate changes in addition to the base simulation
discussed above. These changes are immediate and parallel changes to the base
case scenario. In addition, total rate movements (beginning point minus ending
point) to each of the various driver rates utilized by us in the base simulation
for the period ended February 28, 2007 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 (59)
FHLB Advances 200 (200)
Results for the base, rising and falling interest rate scenarios are listed
below, based upon our rate sensitive assets and liabilities at February 28,
2006. 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
(Dollars in thousands)
=========================================================================
Net Interest Income $110,882 $112,447 $100,249
Variance from base $ 1,565 $(10,633)
Percent of change from base 1.41% (9.59)%
The comparative rising and falling scenarios for the period ended 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 us 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 our 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
(Dollars in thousands)
=========================================================================
Net Interest Income $111,989 $114,930 $109,220
Variance from base $ 2,941 $ (2,769)
Percent of change from base 2.63% (2.47)%
Page 23
FIRST MERCHANTS CORPORATION
FORM 10-Q
EARNING ASSETS
The following table presents the earning asset mix as of March 31, 2006, and
December 31, 2005.
Loans increased approximately $34,321,000 from December 31, 2005 to March 31,
2006, and investment securities increased by approximately $7,385,000 during the
same period. Real estate construction, real estate commercial and farmland,
commercial and industrial loans, tax exempt loans and other loans increased
approximately $47,085,000 during the first three months of 2006 as compared to
the balances outstanding at December 31, 2005. These increases were offset by a
$12,764,000 decline in agricultural loans, residential real estate loans and
leases.
----------------------------------------------------------------------------------------------------
EARNING ASSETS
(Dollars in thousands) March 31, December 31,
2006 2005
----------------------------------------------------------------------------------------------------
Interest-bearing time deposits ...................... $ 9,104 $ 8,748
Investment securities available for sale ............ 431,190 422,627
Investment securities held to maturity .............. 10,461 11,639
Mortgage loans held for sale ........................ 5,170 4,910
Loans ............................................... 2,491,488 2,457,427
Federal Reserve and Federal Home Loan Bank stock 23,421 23,200
---------- ----------
Total .......................... $2,970,834 $2,928,551
========== ==========
--------------------------------------------------------------------------------
DEPOSITS AND BORROWINGS
The table below reflects the level of deposits and borrowed funds (federal funds
purchased; repurchase agreements; Federal Home Loan Bank advances; and
subordinated debentures, revolving credit lines and term loans) based on period
ending amounts as of March 31, 2006 and December 31, 2005.
(Dollars in thousands) March 31, December 31,
2006 2005
---------- ----------
Deposits ........................................ $2,446,072 $2,382,576
Federal funds purchased.......................... 64,150 50,000
Securities sold under repurchase agreements...... 77,256 106,415
Federal Home Loan Bank advances ................. 225,640 247,865
Subordinated debentures, revolving credit lines
and term loans................................ 101,956 103,956
---------- ----------
$2,915,074 $2,890,812
========== ==========
We have continued to leverage our 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 our 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".
Page 24
FIRST MERCHANTS CORPORATION
FORM 10-Q
NET INTEREST INCOME
Net Interest Income is the primary source of our earnings. It is a function of
net interest margin and the level of average earning assets. The table below
presents our asset yields, interest expense, and net interest income as a
percent of average earning assets for the three months ended March 31, 2006 and
2005.
During the three months ended March 31, 2006, asset yields increased 74 basis
points (FTE) and interest costs increased 76 basis points, resulting in a two
basis point (FTE) decrease in net interest income as compared to the same period
in 2005. The increases in interest income and interest expense were primarily a
result of seven 25 basis point overnight federal funds rate increases by the
Federal Open Market Committee during this period.
Three Months Ended
March 31,
(Dollars in thousands) 2006 2005
Annualized Net Interest Income........................ $ 110,356 $ 107,768
Annualized FTE Adjustment............................. $ 3,910 $ 3,634
Annualized Net Interest Income
On a Fully Taxable Equivalent Basis................. $ 114,267 $ 111,402
Average Earning Assets................................ $2,953,290 $2,866,551
Interest Income (FTE) as a Percent
of Average Earning Assets........................... 6.64% 5.90%
Interest Expense as a Percent
of Average Earning Assets........................... 2.77% 2.01%
Net Interest Income (FTE) as a Percent
of Average Earning Assets........................... 3.87% 3.89%
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.
Page 25
FIRST MERCHANTS CORPORATION
FORM 10-Q
OTHER INCOME
Other income in the first three months of 2006 was $449,000 or 5.0 percent lower
than the same period of 2005.
Three items primarily account for the change:
1. We realized an increase of $318,000 in debit card fees due to greater
usage by customers.
2. Service charges in the first quarter of 2006 were $297,000 lower than
the same period in 2005.
3. A cash payment was received in the first quarter of 2005 of
approximately $232,000, related to our membership in a credit card
network that was merged with another card network. No such payment was
received during the same period in 2006.
OTHER EXPENSES
Other expenses in the first three months of 2006 was $443,000 or 1.8 percent
lower than the same period in 2005.
Two areas account for most of the change:
1. A pension accounting loss, totaling approximately $1,630,000, was
recorded during the first quarter of 2005. The loss resulted from the
curtailment of the accumulation of defined benefits in our defined
benefit pension plan.
2. Salary expenses were $1,033,000 higher in the first quarter of 2006,
as compared to the same period in 2005, primarily due to staff
additions and normal annual increases. In addition, salary expenses of
$194,000 were recorded in the first quarter of 2006, due to share-based
compensation expense recorded.
Page 26
FIRST MERCHANTS CORPORATION
FORM 10-Q
INCOME TAXES
Income tax expense, for the three months ended March 31, 2006, increased by
$640,000 from the same period in 2005. The effective tax rate was 29.6 and 27.8
percent for the 2006 and 2005 periods.
OTHER
The Securities and Exchange Commission maintains a Web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission, including us, and that
address is (http://www.sec.gov).
Item 3. Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------
The information required under this item is included as part of Management's
Discussion and Analysis of Financial Condition and Results of Operations, under
the headings "LIQUIDITY" and "INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET
RISK".
Item 4. Controls and Procedures
-------------------------------------------------------------------
At the end of the period covered by this report, we carried out an evaluation,
under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures. Based upon
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our 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 our reports filed or submitted
under the Securities Exchange Act of 1934 are recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission's rules and forms.
There have been no changes in our internal controls over financial reporting
identified in connection with the evaluation referenced above that occurred
during our last fiscal quarter that have materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
Page 27
FIRST MERCHANTS CORPORATION
FORM 10-Q
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
---------------------------
None
Item 1.A. Risk Factors
----------------------
There have been no material changes from the risk factors previously disclosed
in the Corporation's December 31, 2005 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds
---------------------------------------------------
a. None
b. None
c. Issuer Purchases of Equity Securities
The following table presents information relating to our purchases of equity
securities during the quarter ended March 31, 2006, 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)
------ ---------------- -------------- ------------------------- ------------------------
01/01/06 - 01/31/06 2,648(2) $26.85 0 0
02/01/06 - 02/28/06 0 0 0 0
03/01/06 - 03/31/06 0 0 0 0
(1) On February 14, 2006, the Corporation's Board authorized management to
repurchase up to 250,000 shares of the Corporation's Common Stock. This
authorization was not publicly announced and expires February 13, 2007. There
were 250,000 remaining shares that may yet be purchased pursuant to such
authorizations as of March 31, 2006.
(2) These shares were purchased in connection with the exercise of certain
outstanding stock options.
Item 3. Defaults Upon Senior Securities
----------------------------------------
None
Item 4. Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
None
Item 5. Other Information
--------------------------
a. None
b. None
Page 28
FIRST MERCHANTS CORPORATION
FORM 10-Q
PART II. OTHER INFORMATION
Item 6. Exhibits
-----------------------------------------
Exhibit No.: Description of Exhibit: Form 10-Q Page No.:
------------ ------------------------- -------------------
31.1 Certification of Chief 32
Executive Officer Pursuant
to Section 302 of the
Sarbanes - Oxley Act of
2002
31.2 Certification of Chief 33
Financial Officer Pursuant
to Section 302 of the
Sarbanes - Oxley Act of
2002
32 Certifications Pursuant to 34
18 U.S.C. Section 1350, as
Adopted Pursuant to Section
906 of the Sarbanes-Oxley
Act of 2002
Page 29
FIRST MERCHANTS CORPORATION
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
First Merchants Corporation
---------------------------
(Registrant)
Date: May 9, 2006 by /s/ Michael C. Rechin
-------------------------- -------------------------------------
Michael C. Rechin
Executive Vice President and
Chief Operating Officer
(Principal Executive Officer)
Date: May 9, 2006 by /s/ Mark K. Hardwick
-------------------------- -------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Chief Accounting Officer)
Page 30
FIRST MERCHANTS CORPORATION
FORM 10-Q
INDEX TO EXHIBITS
INDEX TO EXHIBITS
(a)3. Exhibits:
Exhibit No.: Description of Exhibit: Form 10-Q Page No.:
------------ ------------------------- -------------------
31.1 Certification of Chief 32
Executive Officer Pursuant
to Section 302 of the
Sarbanes - Oxley Act of
2002
31.2 Certification of Chief 33
Financial Officer Pursuant
to Section 302 of the
Sarbanes - Oxley Act of
2002
32 Certifications Pursuant to 34
18 U.S.C. Section 1350, as
Adopted Pursuant to Section
906 of the Sarbanes-Oxley
Act of 2002
Page 31
EXHIBIT-31.1
FIRST MERCHANTS CORPORATION
FORM 10-Q
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
-------------
I, Michael C. Rechin, Executive Vice President and Chief Operating Officer of
First Merchants Corporation, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q 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: May 9, 2006 /s/Michael C. Rechin
----------------------------------------
Michael C. Rechin
Executive Vice President and
Chief Operating Officer
(Principal Executive Officer)
Page 32
EXHIBIT-31.2
FIRST MERCHANTS CORPORATION
FORM 10-Q
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
-------------
I, Mark K. Hardwick, Executive Vice President and Chief Financial Officer of
First Merchants Corporation, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q 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: May 9, 2006 /s/Mark K. Hardwick
----------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Chief Accounting Officer)
Page 33
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 quarterly report of First Merchants Corporation (the
"Corporation") on Form 10-Q for the period ending March 31, 2006 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I
Michael C. Rechin, Executive Vice President and Chief Operating 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: May 9, 2006 by /s/ Michael C. Rechin
--------------------------- -------------------------------------
Michael C. Rechin
Executive Vice President and
Chief Operating 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 quarterly report of First Merchants Corporation (the
"Corporation") on Form 10-Q for the period ending March 31, 2006 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I Mark
K. Hardwick, Executive Vice President and Chief Financial Officer of the
Corporation, do hereby certify, in accordance with 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)); and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Corporation.
Date: May 9, 2006 by /s/ Mark K. Hardwick
--------------------------- -------------------------------------
Mark K. Hardwick
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Chief 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.
Page 34