Executive Summary / Key Takeaways
- First Merchants Corporation is leveraging recent strategic divestitures and significant technology investments to sharpen its focus on core Midwest markets (Indiana, Ohio, Michigan) and drive organic growth in loans, deposits, and fee income.
- Q1 2025 results demonstrate positive momentum with strong GAAP EPS growth (17.5% YOY) and improved profitability metrics, fueled by balance sheet growth, margin expansion, fee income growth, and expense discipline.
- Management is guiding for continued mid to high single-digit loan growth and mid to high single-digit noninterest income growth in 2025, supported by robust pipelines and benefits from enhanced digital platforms and specialized teams.
- Despite potential headwinds from future rate cuts and external uncertainties like tariffs, the company expects net interest income to grow and maintains a stable credit outlook with ample reserves, targeting a normalized charge-off range of 15-20 basis points.
- Strong capital levels (8.9% TCE/TA, 11.50% CET1) provide strategic flexibility for supporting organic growth, opportunistic share repurchases at attractive valuations, and potential selective M&A within core markets.
A Midwest Banking Story: Transformation Meets Core Strength
First Merchants Corporation, a financial holding company with roots tracing back to the First Merchants Bank established in Muncie, Indiana in 1893, has long centered its strategy on community banking with a distinct commercial focus. Operating primarily across Indiana, Ohio, and Michigan, the company has grown its footprint significantly over the decades, notably through acquisitions like Ameriana Bancorp and Level One Bancorp, which materially expanded its presence. This history has shaped FRME into a regional player known for its local expertise and relationship-driven approach, particularly within the small business and middle market commercial segments.
In recent years, FRME has undertaken a deliberate transformation to optimize its operational efficiency and enhance its competitive positioning. This culminated in 2024 with the completion of four major technology initiatives: upgrading its in-branch account origination platform (Terafina), modernizing its online and mobile banking platforms for both consumer and commercial clients (Q2 (QTWO)), enhancing its private wealth platform (SS&C (SSNC) InnoTrust and Black Diamond), and improving its wire transfer system (Finastra). These investments were strategically designed to streamline processes, empower sales teams with better tools, and significantly improve the client experience across all delivery channels.
The strategic implication of these technological advancements is profound. In an increasingly digital banking landscape where larger competitors like Fifth Third Bancorp (FITB) and M&T Bank (MTB) often boast superior digital infrastructure and efficiency derived from scale, FRME's targeted technology upgrades aim to close the gap. While precise, directly comparable performance metrics across all platforms are challenging to ascertain, management emphasizes that these initiatives were intended to be self-funded through the elimination of legacy system costs, positioning FRME to compete more effectively for digitally-savvy customers and enhance its fee income generating capabilities, particularly in areas like Treasury Management and Private Wealth. This focus on technology, integrated with its strong local brand and relationship banking model, forms a key part of FRME's competitive moat, allowing it to differentiate itself from larger, more transactional institutions while gaining an edge over smaller, less technologically advanced community banks.
Complementing its technology push, FRME recently completed a strategic divestiture, selling five non-core branches in the suburban Chicago market in late 2024. This decision, driven by a recognition of being "sub-scale" in that specific market, allows the company to sharpen its focus and resources on its core, higher-potential markets in Indiana, Ohio, and Michigan. This geographic reprioritization, coupled with the enhanced technological capabilities and the formalization of specialized teams like the "upper middle market" group, underpins FRME's strategy for focused organic growth in 2025 and beyond.
Performance Reflecting Strategic Momentum
The impact of these strategic actions is beginning to manifest in FRME's financial performance. The first quarter of 2025 saw net income available to common stockholders rise to $54.9 million, a notable 15.6% increase compared to the same period in 2024. This translated into GAAP earnings per share of $0.94, up 17.5% from $0.80 a year prior. Management highlighted that core EPS growth, adjusted for prior year technology integration expenses, also showed a healthy 10.6% increase. This performance improvement was attributed to a combination of balance sheet growth, margin enhancement, fee income expansion, and effective expense management.
Net interest income, the primary revenue driver, stood at $130.3 million in Q1 2025. On a fully tax-equivalent (FTE) basis, net interest margin reached 3.22%, an increase of 12 basis points from 3.10% in Q1 2024. While FTE asset yields saw a 26 basis point decrease year-over-year due to the impact of prior period FOMC rate cuts on the company's variable-rate loan portfolio, this was more than offset by a significant 49 basis point decrease in the total cost of interest-bearing liabilities, driven by proactive deposit pricing discipline. The cost of total deposits declined meaningfully to 2.23% in Q1 2025, reflecting successful efforts in managing deposit mix and costs, particularly in public funds and maturity deposits, despite some increased competition observed during the quarter. The strategic decision to reallocate cash flows from maturing securities (with a roll-off yield around 2.16%) towards funding higher-yielding loan growth, rather than reinvesting in lower-rate securities, is expected to continue supporting net interest income going forward.
Noninterest income contributed $30.0 million in Q1 2025, a 12.8% increase from the prior year. This growth was primarily fueled by a $1.8 million increase in net gains and fees on sales of loans, notably driven by strong performance in the mortgage banking business which saw unit volume up over 15% and dollar volume up over 30% year-over-year. Earnings on cash surrender value of life insurance also contributed positively. Management expects continued mid to high single-digit growth in noninterest income, with double-digit growth anticipated specifically in mortgage banking and wealth management, leveraging the recent technology investments and focused sales efforts.
Expense discipline remains a core focus. Noninterest expense decreased by 4.2% year-over-year in Q1 2025 to $92.9 million. This reduction was largely due to lower salaries and employee benefits, benefiting from the voluntary early retirement program completed in Q1 2024 and the headcount impact of the Chicago branch sale, as well as a decrease in outside data processing fees following the completion of digital platform conversions. This cost control contributed to a solid efficiency ratio, aligning with management's goal of maintaining a sub-55% level and driving positive operating leverage.
Balance Sheet Strength and Credit Quality
FRME's balance sheet reflects a focus on supporting loan growth while managing funding costs and maintaining strong capital. Total assets stood at $18.4 billion at March 31, 2025. The total loan portfolio grew by 4.8% on an annualized basis in Q1 2025, reaching $13.0 billion. This growth was primarily driven by the commercial segment, particularly C&I loans, which saw a significant increase, and contributions from commercial real estate (owner occupied), public finance, and residential loans. This offset declines in investment real estate (non-owner occupied), construction, home equity, and consumer personal loans. Loan pipelines remain strong, supporting management's continued optimism for growth.
Deposit balances experienced a slight decrease in Q1 2025, totaling $14.5 billion. This was mainly due to decreases in time and demand deposits, partially offset by growth in savings and brokered CDs. The decline was attributed to a decrease in public funds, although wholesale deposits saw an increase. Despite the slight decrease, core deposits represent a robust 91.3% of the portfolio, and the average account balance is a granular $36,000. Insured deposits constitute 69.6% of the total, with ample available liquidity from on-balance sheet sources and borrowing capacity from the FHLB ($625.4 million) and Federal Reserve ($2.4 billion) to cover uninsured balances. Total borrowings increased in the quarter, primarily through FHLB advances and federal funds purchased, utilized to fund loan growth and supplement deposits.
Credit quality remains stable, although certain metrics saw increases in Q1 2025. Total past due loans increased by $23.8 million to $140.0 million, with the most significant increase in the 60-89 days past due category, driven by commercial and industrial and commercial real estate (owner occupied). Nonaccrual loans also increased by $8.1 million to $81.9 million, primarily in commercial real estate (owner occupied) and residential loans, partially offset by a decrease in commercial and industrial nonaccruals. Management noted a subsequent event in April 2025 where a $22.0 million multi-family construction relationship in nonaccrual status was fully collected, which is expected to reduce nonaccrual balances in Q2.
The Allowance for Credit Losses (ACL) on loans totaled $192.0 million, representing 1.47% of total loans, a slight decrease from 1.50% at year-end 2024. Net charge-offs were $4.9 million in Q1 2025, with a provision for credit losses of $4.2 million. Management maintains that the allowance is adequate, guided by the CECL methodology and a target coverage ratio around 1.5%. They are actively monitoring potential impacts from external factors like tariffs through direct borrower communication but have not identified specific widespread credit problems so far. The outlook for credit quality is stable, with a normalized charge-off range of 15-20 basis points expected.
Capital levels are strong, exceeding regulatory requirements for a well-capitalized institution. The tangible common equity to tangible assets ratio was 8.90% at quarter-end, and the CET1 ratio was 11.50%. Management views this strong capital base as providing significant strategic flexibility. They are focused on optimizing capital deployment, prioritizing supporting organic balance sheet growth. Given the current stock valuation relative to historical averages, they are also opportunistic and active in share repurchases, viewing it as an effective way to return value to shareholders when the stock is trading below perceived intrinsic value. A new $100 million share repurchase program was approved in March 2025, with $10 million already repurchased in Q1. They also redeemed $30.0 million of subordinated debt in Q1 2025, further optimizing their capital structure.
Outlook and Investment Thesis
First Merchants enters 2025 from a position of strength, having completed significant operational and technological transformations and strategically refined its geographic focus. The investment thesis centers on the company's ability to leverage its enhanced capabilities and sharpened market focus to drive consistent organic growth, improve profitability, and deliver shareholder value, supported by a strong balance sheet and disciplined risk management.
Management's guidance for 2025 reflects this optimism: mid to high single-digit loan growth, mid to high single-digit noninterest income growth, and minimal expense growth (1-3%). They expect net interest income to grow, supported by deposit cost management and strategic asset allocation, even in a potentially declining rate environment (models suggest ~2-3 bps margin compression per 25 bps Fed cut, but deposit beta and asset repricing could mitigate this).
Key factors supporting this outlook include robust loan pipelines, particularly in C&I and new IRE construction projects, the benefits of the new digital platforms driving efficiency and fee income growth (especially in mortgage and wealth management), and continued expense discipline post-transformation.
However, investors should monitor several risks. The impact of potential future Fed rate cuts on the net interest margin, while expected to be manageable, remains a key variable. External uncertainties, particularly regarding the impact of proposed tariffs on commercial borrowers, could affect loan demand and credit quality, although management is actively monitoring this. Increased competition for deposits could pressure funding costs. While credit quality is currently viewed as stable, any deterioration in economic conditions could lead to higher nonperforming assets and provision expense.
Despite these risks, FRME's strong capital position provides a buffer and strategic flexibility. The company's commitment to returning capital through dividends and opportunistic share repurchases, combined with its focus on profitable organic growth and potential selective accretive M&A, positions it to continue building tangible book value and deliver value to shareholders.
Conclusion
First Merchants has successfully executed a multi-year transformation, emerging with a more focused geographic footprint, enhanced technological capabilities, and a clear strategy for driving performance in its core Midwest markets. The strong results in Q1 2025 underscore the positive momentum building from these initiatives. While external economic and interest rate factors present potential headwinds, management's proactive approach to balance sheet management, coupled with robust pipelines and disciplined expense control, supports an outlook for continued growth in net interest income and overall profitability. The company's strong capital base provides resilience and flexibility, allowing it to pursue organic and inorganic growth opportunities while returning value to shareholders. For investors seeking exposure to a well-managed regional bank leveraging technology and strategic focus to drive performance, First Merchants presents a compelling opportunity, provided they monitor execution against growth targets and the evolving credit and interest rate environment.