Business Overview
First Merchants Corporation (FRME) is a financial holding company headquartered in Muncie, Indiana, with a rich history dating back to 1893. Over the past decade, the company has demonstrated a steadfast commitment to strategic growth, operational excellence, and delivering exceptional shareholder returns.
First Merchants Corporation was founded in 1982 and operates as a financial holding company, conducting its banking operations through its wholly-owned subsidiary, First Merchants Bank. The company has a long-standing presence in Indiana, Michigan, and Ohio, where it has meticulously cultivated a diversified community banking model. First Merchants offers a comprehensive suite of financial services to individuals and businesses alike, fostering deep relationships and driving sustainable growth in its core markets.
The company operates 115 banking locations across Indiana, Ohio, Michigan, and Illinois, providing a full range of financial services including commercial and consumer lending, deposit products, trust and wealth management services, and brokerage services. First Merchants' primary business segment is community banking, which encompasses accepting deposits, making consumer, commercial, agricultural, public finance and real estate loans, providing personal and corporate trust services, offering full-service brokerage and private wealth management, and providing letters of credit, repurchase agreements and other corporate services.
Growth Strategy
The company's growth strategy has been characterized by a combination of organic expansion and strategic acquisitions. In 2007, First Merchants formed First Merchants Capital Trust II, a wholly-owned statutory business trust, to issue trust preferred securities to investors. This move enhanced the company's capital structure and provided additional funding for growth initiatives. In 2015, First Merchants expanded its footprint into the central Indiana market through the acquisition of Ameriana Bancorp, Inc. and its subsidiary Ameriana Capital Trust I. More recently, in 2022, the company made a significant acquisition of Level One Bancorp, Inc., which expanded its presence in Michigan and provided access to Level One's private wealth management capabilities.
Resilience and Risk Management
First Merchants has demonstrated resilience in the face of industry challenges, including economic cycles and evolving regulatory requirements. Following the 2008 financial crisis, the company focused on managing nonperforming assets and strengthening its capital position. This disciplined approach to capital allocation and prudent risk management has become a hallmark of First Merchants' operations. As of September 30, 2024, the company's tangible common equity ratio stood at a robust 8.76%, well above the regulatory well-capitalized threshold, underscoring its financial strength and resilience.
Shareholder Value Creation
One of the standout achievements of First Merchants has been its impressive track record of shareholder value creation. Over the past decade, the company has delivered a staggering 10.2% compounded annual growth rate in earnings per share, reflecting its ability to consistently generate profitable growth. This performance has been mirrored in the company's tangible book value per share, which has increased by an impressive 38% over the last two years, reaching $26.64 as of September 30, 2024.
Financials
First Merchants' strategic focus on organic growth and selective acquisitions has paid dividends. The company's total assets have grown at a remarkable 12% compound annual rate over the past decade, reaching $18.3 billion as of September 30, 2024. This expansion has been fueled by a steady increase in both loans and deposits, with the loan portfolio growing 1.9% on an annualized basis during the first nine months of 2024.
For the fiscal year 2023, First Merchants reported revenue of $651.00 million, net income of $223.79 million, and operating cash flow (OCF) and free cash flow (FCF) of $258.83 million each. In the most recent quarter (Q3 2024), the company reported revenue of $155.98 million, net income of $49.19 million, and OCF and FCF of $76.83 million each. While revenue increased year-over-year, net income, OCF, and FCF all decreased, primarily due to a $9.11 million loss on the sale of available-for-sale securities. This decrease was partially offset by increases in customer-related fees and gains on sales of mortgage loans.
Net interest income, which comprises 82.4% of First Merchants' revenues for the nine months ended September 30, 2024, has faced some pressure. The net interest margin on a fully taxable equivalent (FTE) basis decreased 6 basis points to 3.23% for the three months ended September 30, 2024, compared to the same period in 2023. For the nine months ended September 30, 2024, the net interest margin on an FTE basis decreased 26 basis points to 3.16% compared to the same period in 2023. These decreases were primarily due to increases in the cost of funds, which outpaced increases in asset yields.
Noninterest income totaled $24.9 million for the three months ended September 30, 2024, a decrease of $3.0 million, or 10.7%, compared to the same period in 2023. This decrease was primarily driven by $9.1 million in losses on sales of available-for-sale securities associated with repositioning the bond portfolio. However, this was partially offset by increases in gains and fees on sales of loans, fiduciary and wealth management fees, and gains on cash surrender value of life insurance.
Noninterest expense totaled $94.6 million for the three months ended September 30, 2024, a slight increase of $0.8 million, or 0.8%, from the third quarter of 2023. This increase was primarily due to higher equipment expenses, mainly related to software, and increased FDIC assessments.
Loan Portfolio and Credit Quality
First Merchants' loan portfolio, excluding loans held for sale, increased $160.8 million, or 1.9% annualized, from December 31, 2023 to $12.6 billion at September 30, 2024. This growth was primarily driven by increases in commercial and industrial, residential real estate, public finance, and home equity loans, partially offset by decreases in commercial real estate non-owner occupied, construction, agricultural, and consumer loans.
The company maintains a diversified loan portfolio, with the largest segments being commercial and industrial at 31.8% and commercial real estate non-owner occupied at 17.8% of the total loan portfolio as of September 30, 2024. The allowance for credit losses on loans (ACL-loans) decreased $17.1 million from December 31, 2023 to $187.8 million at September 30, 2024, representing 1.48% of total loans compared to 1.64% at the end of 2023.
Nonperforming assets plus accruing loans 90 days or more delinquent increased to $78.4 million at September 30, 2024 from $58.6 million at December 31, 2023, primarily due to an increase in nonaccrual balances in commercial real estate non-owner occupied, partially offset by a decline in the residential loan portfolio.
Technological Innovation
The company's commitment to technological innovation has also been a key driver of its success. In 2024, First Merchants completed the rollout of four major technology initiatives, including the deployment of digital banking platforms for both consumer and commercial clients, as well as a new wealth management platform. These investments have enhanced the customer experience, improved operational efficiency, and positioned the company for continued growth in its fee-based business lines.
Liquidity
Despite the challenges posed by the COVID-19 pandemic, First Merchants has demonstrated its resilience and adaptability. The company's proactive credit risk management and prudent loan underwriting practices have allowed it to navigate the economic uncertainty, with nonperforming assets and past due loans remaining well below industry averages.
First Merchants maintains a strong liquidity position with $359.13 million in cash and available credit lines of $75 million through a revolving credit facility with U.S. Bank, N.A. as of the most recent quarter. The company's debt-to-equity ratio is 0.3975, indicating relatively low leverage. The current ratio and quick ratio both stand at 0.1212.
Future Outlook
Looking ahead, First Merchants is poised for continued success. The company's recent decision to exit its retail banking operations in the Chicago metropolitan area, through the sale of five branches to Old Second National Bank, reflects its strategic focus on its core Midwest markets. This divestiture will allow First Merchants to redeploy capital and resources to drive organic growth, while also positioning the company to capitalize on potential M&A opportunities that align with its disciplined acquisition criteria.
First Merchants expects to record a $20-25 million gain on the sale of the 5 Illinois branches in Q4 2024. The company plans to use this gain to support additional balance sheet restructuring, which management believes will position the company for higher earnings in the future. While specific guidance for 2025 has not been provided, the company's CFO, Michele Kawiecki, indicated that they expect to provide more details on the 2025 outlook during the January call.
Regarding the near-term outlook, First Merchants anticipates a stable net interest margin in Q4 2024, with the bond portfolio restructuring helping to offset some of the pressure from potential Federal Reserve rate cuts. The company's adjusted net interest margin improved by 7 basis points quarter-over-quarter in Q3 2024, helping drive pre-provision net revenue growth and a sub 55% efficiency ratio.
Conclusion
In conclusion, First Merchants Corporation has established itself as a premier community banking institution, with a rich history, a proven track record of shareholder value creation, and a clear vision for the future. The company's solid financial performance, strong liquidity position, and strategic initiatives position it well for continued growth. As First Merchants continues to execute on its strategic initiatives, investors can look forward to the continued growth and long-term success of this Midwest financial institution, despite potential headwinds from interest rate fluctuations and economic uncertainties.