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 September 30, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from _______ to _______ Commission File Number 0-17071 First Merchants Corporation (Exact name of registrant as specified in its charter) Indiana 35-1544218 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 200 East Jackson 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 checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of October 17, 2005, there were 18,508,305 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.........................14 Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................................24 Item 4. Controls and Procedures.....................................24 PART II. Other Information: Item 1. Legal Proceedings...........................................25 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..............................25 Item 3. Defaults Upon Senior Securities.............................25 Item 4. Submission of Matters to a Vote of Security Holders.........25 Item 5. Other Information...........................................25 Item 6. Exhibits....................................................26 Signatures...................................................................27 Index to Exhibits............................................................28 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) <TABLE> September 30, December 31, 2005 2004 ------------ ------------ (Unaudited) <S> <C> <C> ASSETS: Cash and due from banks ....................................... $ 81,310 $ 69,960 Interest-bearing deposits...................................... 10,708 9,343 Investment securities available for sale ...................... 424,818 416,177 Investment securities held to maturity ........................ 11,976 5,358 Mortgage loans held for sale................................... 5,026 3,367 Loans, net of allowance for loan losses of $25,149 and $22,548. 2,418,782 2,405,503 Premises and equipment ........................................ 38,473 38,254 Federal Reserve and Federal Home Loan Bank stock............... 23,165 22,858 Interest receivable ........................................... 19,561 17,318 Goodwill ...................................................... 121,266 120,615 Core deposit intangibles ...................................... 18,331 20,669 Cash surrender value of life insurance......................... 43,230 42,061 Other assets .................................................. 21,792 20,185 ----------- ----------- Total assets .............................................. $ 3,238,438 $ 3,191,668 =========== =========== LIABILITIES: Deposits: Noninterest-bearing ......................................... $ 346,318 $ 330,685 Interest-bearing ............................................ 2,118,975 2,077,465 ----------- ----------- Total deposits ............................................ 2,465,293 2,408,150 Borrowings .................................................... 423,959 440,891 Interest payable .............................................. 5,643 4,411 Other liabilities.............................................. 25,153 23,613 ----------- ----------- Total liabilities ......................................... 2,920,048 2,877,065 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 - 18,507,970 and 18,573,997 shares.... 2,313 2,322 Additional paid-in capital .................................... 148,004 150,862 Retained earnings ............................................. 171,419 161,459 Accumulated other comprehensive income (loss).................. (3,346) (40) ----------- ----------- Total stockholders' equity ................................ 318,390 314,603 ----------- ----------- Total liabilities and stockholders' equity ................ $ 3,238,438 $ 3,191,668 =========== =========== </TABLE> 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) <TABLE> Three Months Ended Nine Months Ended September 30, September 30, -------------------- --------------------- 2005 2004 2005 2004 ------- ------- -------- -------- <S> <C> <C> <C> <C> Interest Income: Loans receivable Taxable ................................................... $40,853 $35,342 $116,506 $103,590 Tax exempt ................................................ 160 143 483 443 Investment securities Taxable ................................................... 2,427 2,146 7,132 6,147 Tax exempt ................................................ 1,595 1,679 4,702 4,529 Federal funds sold .......................................... 51 18 190 73 Deposits with financial institutions ........................ 185 154 493 388 Federal Reserve and Federal Home Loan Bank stock ............ 296 319 889 954 ------- ------- -------- -------- Total interest income ..................................... 45,567 39,801 130,395 116,124 ------- ------- -------- -------- Interest expense: Deposits .................................................... 12,172 8,487 32,707 24,556 Borrowings .................................................. 5,255 4,522 14,685 13,297 ------- ------- ------- ------- Total interest expense .................................... 17,427 13,009 47,392 37,853 ------- ------- ------- ------- Net Interest Income ........................................... 28,140 26,792 83,003 78,271 Provision for loan losses ..................................... 1,794 1,380 6,409 4,472 ------- ------- ------- ------- Net Interest Income After Provision for Loan Losses ........... 26,346 25,412 76,594 73,799 ------- ------- ------- ------- Other Income: Net realized gains on sales of available-for-sale securities. 16 332 22 732 Other income ................................................ 8,764 8,079 26,566 25,151 ------- ------- ------- ------- Total other income ............................................ 8,780 8,411 26,588 25,883 ------- ------- ------- ------- Other expenses: Salaries and benefits ....................................... 13,384 13,087 41,463 39,170 Other expenses .............................................. 9,917 9,703 29,268 28,806 ------- ------- ------- ------- Total other expenses .......................................... 23,301 22,790 70,731 67,976 ------- ------- ------- ------- Income before income tax ...................................... 11,825 11,033 32,451 31,706 Income tax expense ............................................ 3,605 3,380 9,743 9,763 ------- ------- ------- ------- Net Income .................................................... $ 8,220 $ 7,653 $22,708 $21,943 ======= ======= ======= ======= Per share: Basic ..................................................... $ .45 $ .41 $ 1.23 $ 1.18 Diluted ................................................... .44 .41 1.22 1.18 Dividends ................................................. .23 .23 .69 .69 </TABLE> 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) <TABLE> Three Months Ended Nine Months Ended September 30 September 30 ---------------------- ---------------------- 2005 2004 2005 2004 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net Income...................................................................... $ 8,220 $ 7,653 $ 22,708 $ 21,943 Other comprehensive income, net of tax: Unrealized gains (losses) on securities available for sale: Unrealized holding gains (losses) arising during the period, net of income tax (expense) benefit of $589, $(3,104), $2,195 and $(359)......... (883) 4,656 (3,293) 539 Less: Reclassification adjustment for gains included in net income, net of income tax expense of $6, $133, $9 and $293......... 10 199 13 439 --------- --------- --------- --------- (893) 4,457 (3,306) 100 --------- --------- --------- --------- Comprehensive income ........................................................... $ 7,327 $ 12,110 $ 19,402 $ 22,043 ========= ========= ========= ========= </TABLE> 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) <TABLE> <CAPTION> 2005 2004 --------- --------- <S> <C> <C> Balances, January 1 ............................................ $ 314,603 $ 303,965 Net income ..................................................... 22,708 21,943 Cash dividends ................................................. (12,748) (12,777) Other comprehensive income (loss), net of tax................... (3,306) 100 Stock issued under employee benefit plans....................... 913 903 Stock issued under dividend reinvestment and stock purchase plan 638 977 Stock options exercised ........................................ 2,114 981 Stock redeemed ................................................. (6,970) (2,430) Issuance of stock in acquisition................................ 438 --------- --------- Balances, September 30 ......................................... $ 318,390 $ 313,662 ========= ========= </TABLE> 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) <TABLE> Nine Months Ended September 30, ---------------------------------- 2005 2004 ---------------- --------------- <S> <C> <C> Cash Flows From Operating Activities: Net income........................................................................ $ 22,708 $ 21,943 Adjustments to reconcile net income to net cash provided by operating activities Provision for loan losses....................................................... 6,409 4,472 Depreciation and amortization................................................... 3,829 3,810 Mortgage loans originated for sale.............................................. (55,065) (66,111) Proceeds from sales of mortgage loans........................................... 53,406 66,439 Change in interest receivable................................................... (2,243) (754) Change in interest payable...................................................... 1,232 1,026 Other adjustments............................................................... 3,397 2,557 --------------- --------------- Net cash provided by operating activities..................................... $ 33,673 $ 33,382 --------------- --------------- Cash Flows From Investing Activities: Net change in interest-bearing deposits........................................... $ (1,365) $ (4,063) Purchases of securities available for sale........................................ (77,867) (170,719) Proceeds from maturities of securities available for sale......................... 54,770 76,414 Proceeds from sales of securities available for sale.............................. 2,023 32,336 Purchase of Federal Reserve and Federal Home Loan Bank Stock...................... (307) (7,248) Net change in loans............................................................... (19,688) (46,525) Other adjustments................................................................. (4,048) (4,768) --------------- --------------- Net cash used by investing activities......................................... $ (46,482) $ (124,573) --------------- --------------- Cash Flows From Financing Activities: Net change in Demand and savings deposits..................................................... $ (171,585) $ 20,514 Certificates of deposit and other time deposits................................. 228,729 74,204 Borrowings...................................................................... 99,151 (4,641) Repayment of borrowings......................................................... (116,083) Cash dividends.................................................................... (12,748) (12,777) Stock issued under employee benefit plans......................................... 913 903 Stock issued under dividend reinvestment and stock purchase plans................. 638 977 Stock options exercised........................................................... 2,114 981 Stock redeemed.................................................................... (6,970) (2,430) --------------- --------------- Net cash provided by financing activities..................................... 24,159 77,731 --------------- --------------- Net Change in Cash and Cash Equivalents............................................. 11,350 (13,460) Cash and Cash Equivalents, January 1................................................ 69,960 109,527 --------------- --------------- Cash and Cash Equivalents, September 30............................................. $ 81,310 $ 96,067 =============== =============== </TABLE> 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 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. 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, 2004 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 and nine month periods ended September 30, 2005 are not necessarily indicative of the results to be expected for the year. Stock options are granted for a fixed number of shares to employees. The Corporation's stock option plans are accounted for in accordance with Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and related interpretations. APB No. 25 requires compensation expense for stock options to be recognized only if the market price of the underlying stock exceeds the exercise price on the date of the grant. For all grants, no stock-based employee compensation cost is reflected in net income, as options granted under those plans had an exercise price equal to the market value of the underlying common stock on the grant date. During the three months ended September 30, 2005, the Corporation accelerated the vesting of options previously granted, and the vesting period for 2005 grants was established so that those grants would be fully vested by year-end. The term of the acceleration is such that no expense will be recognized by the Corporation on those grants, although it will continue to report the impact of the acceleration in its proforma disclosures of the earnings per share. The following table illustrates the effect on net income and earnings per share if the Corporation has applied the fair value provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ------------------------ 2005 2004 2005 2004 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Net income, as reported ..................................... $ 8,220 $ 7,653 $ 22,708 $ 21,943 Add: Total stock-based employee compensation cost included in reported net income, net of income taxes........................................... Less: Total stock-based employee compensation cost determined under the fair value based method, net of income taxes .............................. (1,083) (140) (1,630) (599) ---------- ---------- ---------- ---------- Pro forma net income ........................................ $ 7,137 $ 7,513 $ 21,078 $ 21,344 ========== ========== ========== ========== Earnings per share: Basic - as reported ...................................... $ .45 $ .41 $ 1.23 $ 1.18 Basic - pro forma ........................................ .39 .41 1.14 1.15 Diluted - as reported .................................... .44 .41 1.22 1.18 Diluted - pro forma ...................................... .38 .40 1.13 1.14 </TABLE> Page 8
FIRST MERCHANTS CORPORATION FORM 10-Q NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Table dollars in thousands) (Unaudited) NOTE 1. General (continued) The Corporation makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, available on its website at www.firstmerchants.com without charge, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. Additionally, upon request the Corporation will also provide without charge, a copy of its Form 10-Q to any shareholder by mail. Requests should be sent to Mr. Brian Edwards, Shareholder Relations Officer, First Merchants Corporation, P.O. Box 792, Muncie, IN 47308-0792. NOTE 2. Impact of Accounting Changes In June 2005, the FASB Board decided not to provide additional guidance on the meaning of other-than-temporary impairment, but directed the FASB staff to issue a staff position (FSP) which will be retitled FSP 115-1 "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments". The final FSP will supersede EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," and EITF Topic No. D-44, "Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value."FSP FAS 115-1 will replace guidance in EITF Issue 03-1 on loss recognition with references to existing other-than-temporary impairment guidance, such as FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities". FSP FAS 115-1 will clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. FSP FAS 115-1 will be effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The Corporation has consistently followed the loss recognition guidance in SFAS No. 115, so the adoption of FSP FAS 115-1 will not have any significant impact on the Corporation's financial condition or results of operation. On April 14, 2005, the SEC amended the compliance date for SFAS No. 123(R) from the beginning of the first interim or annual period that begins after June 15, 2005 to the next fiscal year beginning after June 15, 2005. Early adoption is permitted in periods in which financial statements have not yet been issued. The Corporation expects to adopt SFAS No. 123(R) as of January 1, 2006. The effect on the Corporation's results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted for future awards. The FASB has issued a proposed amendment to SFAS No. 128, Earnings per Share, to clarify guidance for mandatorily convertible instruments, the treasury stock method, contingently issuable shares, and contracts that may be settled in cash or shares. The primary impact on the Corporation of the proposed Statement is the change to the treasury stock method for year-to-date diluted earnings per share. Currently SFAS No. 128 requires that the number of incremental shares included in the denominator be determined by computing a year-to-date weighted average of the number of incremental shares included in each quarterly diluted EPS computation. Under this proposed Statement, the number of incremental shares included in year-to-date diluted earnings per share would be computed using the average market price of common shares for the year-to-date period, independent of the quarterly computations. This computational change is not expected to have a significant impact on the Corporation's diluted earnings per share. Page 9
FIRST MERCHANTS CORPORATION FORM 10-Q NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Table dollars in thousands) (Unaudited) <TABLE> NOTE 3. Investment Securities Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value <S> <C> <C> <C> <C> Available for sale at September 30, 2005 U.S. Treasury ........................ $ 1,495 $ (1) $ 1,494 U.S. Government-sponsored agency securities................... 78,002 $ (965) 77,037 State and municipal .................. 162,982 3,325 (427) 165,880 Mortgage-backed securities ........... 173,121 213 (3,400) 169,934 Other asset-backed securities......... 16 16 Marketable equity securities.......... 10,870 (413) 10,457 -------- -------- -------- -------- Total available for sale ......... 426,486 3,538 (5,206) 424,818 -------- -------- -------- -------- Held to maturity at September 30, 2005 State and municipal................... 11,933 399 (275) 12,057 Mortgage-backed securities............ 43 43 -------- -------- -------- -------- Total held to maturity ........... 11,976 399 (275) 12,100 -------- -------- -------- -------- Total investment securities ...... $438,462 $ 3,937 $ (5,481) $436,918 ======== ======== ======== ======== </TABLE> <TABLE> <CAPTION> Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value <S> <C> <C> <C> <C> Available for sale at December 31, 2004 U.S. Treasury ........................ $ 1,745 $ (1) $ 1,744 U.S. Government-sponsored agency securities .................. 65,325 $ 73 (332) 65,066 State and municipal .................. 150,284 5,243 (82) 155,445 Mortgage-backed securities ........... 183,200 485 (1,980) 181,705 Other asset-backed securities......... 18 18 Marketable equity securities ......... 12,191 8 12,199 -------- -------- -------- -------- Total available for sale .......... 412,763 5,809 (2,395) 416,177 -------- -------- -------- -------- Held to maturity at December 31, 2004 State and municipal .................. 5,306 162 5,468 Mortgage-backed securities ........... 52 52 -------- -------- -------- -------- Total held to maturity ............ 5,358 162 5,520 -------- -------- -------- -------- Total investment securities ....... $418,121 $ 5,971 $ (2,395) $421,697 ======== ======== ======== ======== </TABLE> Page 10
FIRST MERCHANTS CORPORATION FORM 10-Q NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Table dollars in thousands) (Unaudited) NOTE 4. Loans and Allowance <TABLE> September 30, December 31, 2005 2004 ----------- ----------- <S> <C> <C> Loans: Commercial and industrial loans .............................................. $ 476,010 $ 451,227 Agricultural production financing and other loans to farmers ................. 94,262 98,902 Real estate loans: Construction ............................................................... 171,667 164,738 Commercial and farmland .................................................... 719,154 709,163 Residential ................................................................ 746,777 761,163 Individuals' loans for household and other personal expenditures ............. 186,792 198,532 Tax-exempt loans ............................................................. 12,439 8,203 Lease financing receivables, net of unearned income........................... 9,538 11,311 Other loans .................................................................. 27,292 24,812 ----------- ----------- 2,443,931 2,428,051 Allowance for loan losses..................................................... (25,149) (22,548) ----------- ----------- Total Loans............................................................... $ 2,418,782 $ 2,405,503 =========== =========== Nine Months Ended September 30, 2005 2004 ----------- ----------- Allowance for loan losses: Balances, January 1 .......................................................... $ 22,548 $ 25,493 Provision for losses ......................................................... 6,409 4,472 Recoveries on loans .......................................................... 1,436 1,234 Loans charged off ............................................................ (5,244) (5,956) ----------- ----------- Balances, September 30 ....................................................... $ 25,149 $ 25,243 =========== =========== </TABLE> Information on nonaccruing, contractually past due 90 days or more other than nonaccruing and restructured loans is September 30, December 31, summarized below: 2005 2004 ================================================================================ Non-accrual loans................................ $ 11,757 $ 15,355 Loans contractually past due 90 days or more other than nonaccruing................. 3,560 1,907 Restructured loans............................... 454 2,019 -------- -------- Total........................................ $ 15,771 $ 19,281 ======== ======== Page 11
FIRST MERCHANTS CORPORATION FORM 10-Q NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Table dollars in thousands) (Unaudited) NOTE 5. Net Income Per Share <TABLE> Three Months Ended September 30, 2005 2004 ------------------------------------------- ------------------------------------------- Weighted- Weighted- Average Per Share Average Per Share Income Shares Amount Income Shares Amount ------ ------ ------ ------ ------ ------ <S> <C> <C> <C> <C> <C> <C> Basic net income per share: Net income available to common stockholders................. $ 8,220 18,478,154 $ .45 $ 7,653 18,548,041 $ .41 ========== ========== Effect of dilutive stock options........ 111,880 110,418 ---------- ------------ ---------- ------------ Diluted net income per share: Net income available to common stockholders and assumed conversions............. $ 8,220 18,590,034 $ .44 $ 7,653 18,658,459 $ .41 ========== ============ ========== ========== ============ ========== </TABLE> Options to purchase 207,349 and 415,186 shares for the three months ended September 30, 2005 and 2004 were not included in the earnings per share calculation because the exercise price exceeded the average market price. <TABLE> <CAPTION> Nine Months Ended September 30, 2005 2004 --------------------------------------- --------------------------------------- Weighted- Weighted- Average Per Share Average Per Share Income Shares Amount Income Shares Amount ---------- ------------ ---------- ---------- ------------ ---------- <S> <C> <C> <C> <C> <C> <C> Basic net income per share: Net income available to common stockholders................. $ 22,708 18,490,866 $ 1.23 $ 21,943 18,525,947 $ 1.18 ========== ========== Effect of dilutive stock options........ 115,042 123,632 ---------- ------------ ---------- ------------ Diluted net income per share: Net income available to common stockholders and assumed conversions............. $ 22,708 18,605,908 $ 1.22 $ 21,943 18,649,579 $ 1.18 ========== ============ ========== ========== ============ ========== </TABLE> Options to purchase 170,312 and 295,025 shares for the nine months ended September 30, 2005 and 2004 were not included in the earnings per share calculation because the exercise price exceeded the average market price. Page 12
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. 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 and nine months ended September 30, 2005. <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------------ ------------------------ 2005 2004 2005 2004 ---------- ---------- ---------- ---------- Pension Cost - ------------ <S> <C> <C> <C> <C> Service cost............................................ $ 145 $ 480 $ 434 $ 1,440 Interest cost .......................................... 658 697 1,974 2,091 Expected return on plan assets ......................... (768) (701) (2,305) (2,103) Amortization of the transition asset.................... (7) (37) (20) (113) Amortization of prior service cost...................... 1 34 4 103 Amortization of the net loss............................ 24 88 70 264 Curtailment loss........................................ 1,630 ---------- ---------- ---------- ---------- Total Pension Cost................................ $ 53 $ 561 $ 1,787 $ 1,682 ========== ========== ========== ========== </TABLE> Page 13
FIRST MERCHANTS CORPORATION FORM 10-Q Item 2. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations - -------------- FORWARD-LOOKING STATEMENTS The Corporation from time to time includes forward-looking statements in its oral and written communication. The Corporation may include forward-looking statements in filings with the Securities and Exchange Commission, such as this Form 10-Q, in other written materials and in oral statements made by senior management to analysts, investors, representatives of the media and others. The Corporation intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and the Corporation is including this statement for purposes of these safe harbor provisions. Forward-looking statements can often be identified by the use of words like "believe", "continue", "pattern", "estimate", "project", "intend", "anticipate", "expect" and similar expressions or future or conditional verbs such as "will", "would", "should", "could", "might", "can", "may", or similar expressions. These forward-looking statements include: * statements of the Corporation's goals, intentions and expectations; * statements regarding the Corporation's business plan and growth strategies; * statements regarding the asset quality of the Corporation's loan and investment portfolios; and * estimates of the Corporation's risks and future costs and benefits. These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors which could affect the actual outcome of future events: * fluctuations in market rates of interest and loan and deposit pricing, which could negatively affect the Corporation's net interest margin, asset valuations and expense expectations; * adverse changes in the economy, which might affect the Corporation's business prospects and could cause credit-related losses and expenses; * adverse developments in the Corporation's loan and investment portfolios; * competitive factors in the banking industry, such as the trend towards consolidation in the Corporation's market; * changes in the banking legislation or the regulatory requirements of federal and state agencies applicable to bank holding companies and banks like the Corporation's affiliate banks; * acquisitions of other businesses by the Corporation and integration of such acquired businesses; * changes in market, economic, operational, liquidity, credit and interest rate risks associated with the Corporation's business; and * the continued availability of earnings and excess capital sufficient for the lawful and prudent declaration and payment of cash dividends. Because of these and other uncertainties, the Corporation's actual future results may be materially different from the results indicated by these forward- looking statements. In addition, the Corporation's past results of operations do not necessarily indicate its future results. Page 14
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 management to apply significant judgments to various accounting, reporting and disclosure matters. Management of the Corporation must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. For a complete discussion of the Corporation's significant accounting policies, see "Notes to the Consolidated Financial Statements" in the Corporation's 2004 Annual Report. 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. Management has reviewed the application of these policies with the Audit Committee of the Corporation's Board of Directors. For a discussion of applying critical accounting policies, see "Critical Accounting Policies" within the Corporation's 2004 Annual Report. BUSINESS SUMMARY The Corporation is a financial holding company headquartered in Muncie, Indiana. Since its organization in 1982, the Corporation has grown to include 9 affiliate banks with 65 locations in 17 Indiana and 3 Ohio counties. In addition to its branch network, the Corporation's delivery channels include ATMs, check cards, interactive voice response systems and internet technology. The Corporation's business activities are currently limited to one significant business segment, which is community banking. The Corporation's financial service affiliates include 9 nationally chartered banks: First Merchants Bank, N.A., The Madison Community Bank, N.A., First United Bank, N.A., United Communities National Bank, First National Bank, Decatur Bank and Trust Company, N.A., Frances Slocum Bank & Trust Company, N.A., Lafayette Bank and Trust Company, N.A. and Commerce National Bank. The banks provide commercial and retail banking services. In addition, the Corporation's trust company, multi-line insurance company and title company provide trust asset management services, retail and commercial insurance agency services and title services, respectively. Management believes that its mission, guiding principles and strategic initiatives produce profitable growth for stockholders. Our vision is to satisfy all the financial needs of our customers, help them succeed financially and be recognized as the premier financial services company in our markets. Our primary strategy to achieve this vision is to increase product usage and focus on providing each customer with all of the financial products that fulfill their needs. Our cross-sell strategy and diversified business model facilitate growth in strong and weak economic cycles. Management believes it is important to maintain a well controlled environment as we continue to grow our businesses. Sound credit policies are maintained and have resulted in declining nonperforming loans and net charge-offs as a percentage of loans outstanding from the prior period. 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 September 30, 2005, equaled $8,220,000, compared to $7,653,000 in the same period of 2004. Diluted earnings per share were $.44, an increase of 7.3 percent from the $.41 reported for the third quarter 2004. The increase in earnings is primarily due to an increase in net interest margin, which is partially offset by an increase of the provision for loan losses during the period. These factors are discussed within the respective sections of Management's Discussion and Analysis of Financial Condition and Results of Operations. Net income for the nine months ended September 30, 2005, equaled $22,708,000, compared to $21,943,000 during the same period in 2004. Diluted earnings per share were $1.22, a 3.4 percent increase from the $1.18 reported in 2004. The increase in earnings is primarily due to an increase in net interest margin, which is partially offset by an increase of the provision for loan losses during the period. 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 September 30, 2005, were 1.03 percent and 10.38 percent, respectively, compared with .98 percent and 9.88 percent for the same period of 2004. Page 15
FIRST MERCHANTS CORPORATION FORM 10-Q Item 2. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations continued - ------------------------ RESULTS OF OPERATIONS (continued) Annualized returns on average assets and average stockholders' equity for the nine months ended September 30, 2005 were .95 percent and 9.62 percent, respectively, compared with .95 percent and 9.50 percent for the same period of 2004. CAPITAL The Corporation's regulatory capital continues to exceed regulatory "well capitalized" standards. Tier I regulatory capital consists primarily of total stockholders' equity and subordinated debentures issued to business trusts categorized as qualifying borrowings, less non-qualifying intangible assets and unrealized net securities gains. The Corporation's Tier I capital to average assets ratio was 7.7 percent at September 30, 2005 and 7.5 percent at year end 2004. In addition, at September 30, 2005, the Corporation had a Tier I risk-based capital ratio of 9.8 percent and total risk-based capital ratio of 11.9 percent. Regulatory capital guidelines require a Tier I risk-based capital ratio of 4.0 percent and a total risk-based capital ratio of 8.0 percent. The Corporation's GAAP capital ratio, defined as total stockholders' equity to total assets, equaled 9.8 percent at September 30, 2005 and 9.9 percent at December 31, 2004. When the Corporation acquires other companies for stock, GAAP capital increases by the entire amount of the purchase price. The Corporation's tangible capital ratio, defined as total stockholders' equity less intangibles net of tax to total assets less intangibles net of tax, equaled 6.0 percent as of September 30, 2005, and 5.9 percent at December 31, 2004. Management believes that all of the above capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation. Additionally, management believes the following table is also meaningful when considering performance measures of the Corporation. The table details and reconciles tangible earnings per share, return on tangible capital and tangible assets to traditional GAAP measures. September 30, December 31, (Dollars in thousands) 2005 2004 Average Goodwill .......................... $ 112,281 $ 112,281 Average Core Deposit Intangible (CDI) ..... 19,382 22,164 Average Deferred Tax on CDI ............... (7,097) (8,105) ----------- ----------- Intangible Adjustment ................... $ 124,566 $ 126,340 =========== =========== Average Stockholders' Equity (GAAP Capital) $ 314,856 $ 310,004 Intangible Adjustment ..................... (124,566) (126,340) ----------- ----------- Average Tangible Capital ................ $ 190,290 $ 183,664 =========== =========== Average Assets ............................ $ 3,185,815 $ 3,109,104 Intangible Adjustment ..................... (124,566) (126,340) ----------- ----------- Average Tangible Assets ................. $ 3,061,249 $ 2,982,764 =========== =========== Net Income ................................ $ 22,708 $ 29,411 CDI Amortization, net of tax .............. 1,474 2,133 ----------- ----------- Tangible Net Income ..................... $ 24,182 $ 31,544 =========== =========== Diluted Earnings per Share ................ $ 1.22 $ 1.58 Diluted Tangible Earnings per Share ....... $ 1.30 $ 1.69 Return on Average GAAP Capital ............ 9.62% 9.49% Return on Average Tangible Capital ........ 16.94% 17.49% Return on Average Assets .................. 0.95% 0.95% Return on Average Tangible Assets ......... 1.05% 1.06% Page 16
FIRST MERCHANTS CORPORATION FORM 10-Q ASSET QUALITY/PROVISION FOR LOAN LOSSES The Corporation's primary business focus is middle market commercial and residential real estate, auto and small consumer lending, which results in portfolio diversification. Management ensures that appropriate methods to understand and underwrite risk are utilized. Commercial loans are individually underwritten and judgmentally risk rated. They are periodically monitored and prompt corrective actions are taken on deteriorating loans. Retail loans are typically underwritten with statistical decision-making tools and are managed throughout their life cycle on a portfolio basis. The allowance for loan losses is maintained through the provision for loan losses, which is a charge against earnings. The amount provided for loan losses and the determination of the adequacy of the allowance are based on a continuous review of the loan portfolio, including an internally administered loan "watch" list and an 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 September 30, 2005, non-performing loans totaled $15,771,000, a decrease of $3,510,000 from December 31, 2004, as noted in Note 4. Loans and Allowance, included within the Notes to Consolidated Condensed Financial Statements of this Form 10-Q. At September 30, 2005, impaired loans totaled $43,357,000, a decrease of $6,054,000 from December 31, 2004. At September 30, 2005, an allowance for losses was not deemed necessary for impaired loans totaling $34,818,000, but an allowance of $2,427,000 was recorded for the remaining balance of impaired loans of $8,538,000 and is included in the Corporation's allowance for loan losses. At December 31, 2004, impaired loans totaled $49,411,000. An allowance for losses was not deemed necessary for impaired loans totaling $41,683,000, but an allowance of $1,673,000 was recorded for the remaining balance of impaired loans of $7,728,000 and is included in the Corporation's allowance for loan losses. The average balance of impaired loans for 2004 was $59,568,000. At September 30, 2005, the allowance for loan losses was $25,149,000, an increase of $2,601,000 from year end 2004. As a percent of loans, the allowance was 1.03 percent at September 30, 2005 and .93 percent at December 31, 2004. The allowance for loan losses increased due to additional provision for loan losses expense recorded, which is discussed below. The provision for loan losses for the first nine months of 2005 was $6,409,000, an increase of $1,937,000 from $4,472,000 for the same period in 2004. The Corporation's provision for loan losses increased primarily due to an increase in the five-year rolling historical loan charge-off ratio utilized within the Corporation's allowance for loan losses calculation. Page 17
FIRST MERCHANTS CORPORATION FORM 10-Q LIQUIDITY Liquidity management is the process by which the Corporation ensures that adequate liquid funds are available for the Corporation and its subsidiaries. These funds are necessary in order for the Corporation and its subsidiaries to meet financial commitments on a timely basis. These commitments include withdrawals by depositors, funding credit obligations to borrowers, paying dividends to shareholders, paying operating expenses, funding capital expenditures, and maintaining deposit reserve requirements. Liquidity is monitored and closely managed by the asset/liability committees at each subsidiary and by the Corporation's asset/liability committee. The liquidity of the Corporation is dependent upon the receipt of dividends from its bank subsidiaries, which are subject to certain regulatory limitations and access to other funding sources. Liquidity of the Corporation's bank subsidiaries is derived primarily from core deposit growth, principal payments received on loans, the sale and maturity of investment securities, net cash provided by operating activities, and access to other funding sources. The most stable source of liability-funded liquidity for both the long- term and short-term is deposit growth and retention in the core deposit base. In addition, the Corporation utilizes advances from the Federal Home Loan Bank. ("FHLB") and a revolving line of credit with LaSalle Bank, N.A. as funding sources. At September 30, 2005, total borrowings from the FHLB were $231,448,000. The Corporation's bank subsidiaries have pledged certain mortgage loans and certain investments to the FHLB. The total available remaining borrowing capacity from the FHLB at September 30, 2005, was $90,126,000. At September 30, 2005, the Corporation's revolving line of credit had a balance of $13,500,000 and a remaining borrowing capacity of $6,500,000. The principal source of asset-funded liquidity is investment securities classified as available-for-sale, the market values of which totaled $424,818,000 at September 30, 2005, an increase of $8,641,000 or 2.1 percent over December 31, 2004. 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 $1,053,000 at September 30, 2005. In addition, other types of assets such as cash and due from banks, federal funds sold and securities purchased under agreements to resell, and loans and interest-bearing deposits with other banks maturing within one year are sources of liquidity. In the normal course of business, the Corporation is a party to a number of other off-balance sheet activities that contain credit, market and operational risk that are not reflected in whole or in part in the Corporation's consolidated financial statements. Such activities include: traditional off-balance sheet credit-related financial instruments, commitments under operating leases and long-term debt. The Corporation provides customers with off-balance sheet credit support through loan commitments and standby letters of credit. Summarized credit-related financial instruments at September 30, 2005 are as follows: At September 30, (Dollars in thousands) 2005 ================================================================================ Amounts of commitments: Loan commitments to extend credit ............................... $ 546,209 Standby letters of credit ....................................... 27,462 ---------- $ 573,671 ========== 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, the Corporation has entered into a number of long-term leasing arrangements to support the ongoing activities of the Corporation. The required payments under such commitments and long-term debt at September 30, 2005 are as follows: <TABLE> <CAPTION> 2005 2006 2007 2008 2009 2010 Total (Dollars in thousands) remaining and after ======================================================================================================= <S> <C> <C> <C> <C> <C> <C> <C> Operating leases ......... $ 438 $ 1,515 $ 1,144 $ 880 $ 829 $ 2,286 $ 7,092 Long-term debt ........... 99,555 48,859 32,495 31,882 11,385 199,783 423,959 -------- -------- -------- -------- -------- -------- -------- Total .................... $ 99,993 $ 50,374 $ 33,639 $ 32,762 $ 12,214 $202,069 $431,051 ======== ======== ======== ======== ======== ======== ======== </TABLE> Page 18
FIRST MERCHANTS CORPORATION FORM 10-Q INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK Asset/Liability Management has been an important factor in the Corporation's ability to record consistent earnings growth through periods of interest rate volatility and product deregulation. Management and the Board of Directors monitor the Corporation's liquidity and interest sensitivity positions at regular meetings to review how changes in interest rates may affect earnings. Decisions regarding investment and the pricing of loan and deposit products are made after analysis of reports designed to measure liquidity, rate sensitivity, the Corporation's exposure to changes in net interest income given various rate scenarios and the economic and competitive environments. It is the objective of the Corporation to monitor and manage risk exposure to net interest income caused by changes in interest rates. It is the goal of the Corporation's Asset Liability function to provide optimum and stable net interest income. To accomplish this, management uses two asset liability tools. GAP/Interest Rate Sensitivity Reports and Net Interest Income Simulation Modeling are both constructed, presented, and monitored quarterly. Management believes that the Corporation's liquidity and interest sensitivity position at September 30, 2005, remained adequate to meet the Corporation's primary goal of achieving optimum interest margins while avoiding undue interest rate risk. The Corporation places its greatest credence in net interest income simulation modeling. The GAP/Interest Rate Sensitivity Report is believed by the Corporation's management to have two major shortfalls. The GAP/Interest Rate Sensitivity Report fails to precisely gauge how often an interest rate sensitive product reprices, nor is it able to measure the magnitude of potential future rate movements. Net interest income simulation modeling, or earnings-at-risk, measures the sensitivity of net interest income to various interest rate movements. The Corporation's asset liability process monitors simulated net interest income under three separate interest rate scenarios; base, rising and falling. Estimated net interest income for each scenario is calculated over a 12-month horizon. The immediate and parallel changes to the base case scenario used in the model are presented below. The interest rate scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may introduce into the earnings of the Corporation. The base scenario is highly dependent on numerous assumptions embedded in the model, including assumptions related to future interest rates. While the base sensitivity analysis incorporates management's best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact will likely differ from that projected. For mortgage-related assets, the base simulation model captures the expected prepayment behavior under changing interest rate environments. Assumptions and methodologies regarding the interest rate or balance behavior of indeterminate maturity products, e.g., savings, money market, NOW and demand deposits reflect management's best estimate of expected future behavior. Page 19
FIRST MERCHANTS CORPORATION FORM 10-Q The comparative rising and falling scenarios for the period ended August 31, 2006 assume further interest rate changes in addition to the base simulation discussed above. These changes are immediate and parallel changes to the base case scenario. In addition, total rate movements (beginning point minus ending point) to each of the various driver rates utilized by management in the base simulation for the period ended August 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) CD's 200 (91) FHLB Advances 200 (200) Results for the base, rising and falling interest rate scenarios are listed below, based upon the Corporation's rate sensitive assets and liabilities at August 31, 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 $106,411 $110,914 $100,179 Variance from base $ 4,504 $ (6,232) Percent of change from base 4.2% (5.9)% The comparative rising and falling scenarios for the period ended December 31, 2005 assume further interest rate changes in addition to the base simulation discussed above. These changes are immediate and parallel changes to the base case scenario. In addition, total rate movements (beginning point minus ending point) to each of the various driver rates utilized by management in the base simulation for the period ended December 31, 2005 are as follows: Driver Rates RISING FALLING ============================================================= Prime 200 Basis Points (200) Basis Points Federal Funds 200 (200) One-Year CMT 200 (200) Two-Year CMT 200 (200) CD's 200 (74) FHLB Advances 200 (200) Results for the base, rising and falling interest rate scenarios are listed below. The net interest income shown represents cumulative net interest income over a 12-month time horizon. Balance sheet assumptions used for the base scenario are the same for the rising and falling simulations. BASE RISING FALLING (Dollars in thousands) ========================================================================= Net Interest Income $109,311 $117,212 $ 97,757 Variance from base $ 7,901 $(11,554) Percent of change from base 7.2% (10.6)% Page 20
FIRST MERCHANTS CORPORATION FORM 10-Q EARNING ASSETS The following table presents the earning asset mix as of September 30, 2005, and December 31, 2004. Loans increased approximately $8,641,000 from December 31, 2004 to September 30, 2005, and investment securities increased by approximately $15,259,000 during the same period. Real estate construction, real estate commercial and farmland, commercial and industrial loans, tax exempt loans and other loans increased approximately $48,419,000 during the first nine months of 2005 as compared to the balances outstanding at December 31, 2004. These increases were offset by a $30,880,000 decline in agricultural loans, residential real estate loans, leases and loans to individuals. <TABLE> - ---------------------------------------------------------------------------------------------------- EARNING ASSETS (Dollars in thousands) September 30, December 31, 2005 2004 - ---------------------------------------------------------------------------------------------------- <S> <C> <C> Federal funds sold and interest-bearing time deposits $ 10,708 $ 9,343 Investment securities available for sale ............ 424,818 416,177 Investment securities held to maturity .............. 11,976 5,358 Mortgage loans held for sale ........................ 5,026 3,367 Loans ............................................... 2,443,931 2,428,051 Federal Reserve and Federal Home Loan Bank stock 23,165 22,858 ---------- ---------- Total .......................... $2,919,624 $2,885,154 ========== ========== </TABLE> - -------------------------------------------------------------------------------- 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 September 30, 2005 and December 31, 2004. (Dollars in thousands) September 30, December 31, 2005 2004 ---------- ---------- Deposits ........................................ $2,465,293 $2,408,150 Federal funds purchased.......................... 19,450 32,550 Securities sold under repurchase agreements...... 70,605 87,472 Federal Home Loan Bank advances ................. 231,448 223,663 Subordinated debentures, revolving credit lines and term loans................................ 102,456 97,206 ---------- ---------- $2,889,252 $2,849,041 ========== ========== The Corporation has continued to leverage its capital position with Federal Home Loan Bank advances, as well as repurchase agreements which are pledged against acquired investment securities as collateral for the borrowings. The interest rate risk is included as part of the Corporation's interest simulation discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations under the headings "LIQUIDITY" and "INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK". Page 21
FIRST MERCHANTS CORPORATION FORM 10-Q NET INTEREST INCOME Net Interest Income is the primary source of the Corporation's earnings. It is a function of net interest margin and the level of average earning assets. The table below presents the Corporation's asset yields, interest expense, and net interest income as a percent of average earning assets for the three and nine months ended September 30, 2005 and 2004. During the nine months ended September 30, 2005, asset yields increased 44 basis points (FTE) and interest costs increased 37 basis points resulting in a seven basis point (FTE) increase in net interest income as compared to the same period in 2004. The improvement in margin was primarily a result of five 25 basis point overnight federal funds rate increases by the Federal Open Market Committee during this period. As a result, the Corporation's prime lending rates increased accordingly, while offsetting deposit rate increases were less significant. <TABLE> Three Months Ended Nine Months Ended September 30, September 30, ------------------------ ------------------------ (Dollars in Thousands) 2005 2004 2005 2004 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Annualized Net Interest Income........................ $ 112,560 $ 107,168 $ 110,670 $ 104,362 Annualized FTE Adjustment............................. $ 3,781 $ 3,924 $ 3,723 $ 3,569 Annualized Net Interest Income On a Fully Taxable Equivalent Basis................. $ 116,341 $ 111,092 $ 114,393 $ 107,931 Average Earning Assets................................ $2,908,431 $2,818,392 $2,891,142 $2,772,189 Interest Income (FTE) as a Percent of Average Earning Assets........................... 6.40% 5.79% 6.15% 5.71% Interest Expense as a Percent of Average Earning Assets........................... 2.40% 1.85% 2.19% 1.82% Net Interest Income (FTE) as a Percent of Average Earning Assets........................... 4.00% 3.94% 3.96% 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. </TABLE> Page 22
FIRST MERCHANTS CORPORATION FORM 10-Q OTHER INCOME Other income in the third quarter of 2005 was $369,000 or 4.4 percent higher than the same quarter of 2004. Most of the increase was related to an increase in fees for debit card usage. Other income in the first nine months of 2005 was $705,000 or 2.7 percent higher than the same period of 2004. Four items primarily account for the change: 1. Insurance commissions increased by $714,000, due to the receipt of larger profit sharing payments from insurance underwriters, as compared to the same period in 2004. 2. An increase of $542,000 in fees for debit card usage. 3. A cash payment was received of approximately $232,000, related to the Corporation's membership in a credit card network that was merged with another card network. 4. Gains on loan sales decreased by $697,000 or 32.4 percent from the same period in 2004 as stabilizing mortgage rates caused reduced volume from refinancing of mortgage loans. OTHER EXPENSES Total other expenses represent non-interest expenses of the Corporation. Total other expenses during the third quarter of 2005 increased from the third quarter of 2004 by $511,000 or 2.2 percent. Other expense in the first nine months of 2005 was $2,755,000 or 4.1 percent higher than the same period in 2004. Two areas account for most of the change: 1. A pension accounting loss, totaling approximately $1,630,000, recorded during the first quarter of 2005. The loss resulted from the curtailment of the accumulation of defined benefits in the Corporation's defined benefit pension plan. 2. In 2004, the Corporation reversed an accrual of $260,000 on a claim that was settled for less than the accrued amount causing a reduction in other expenses in the second quarter of 2004. Page 23
FIRST MERCHANTS CORPORATION FORM 10-Q INCOME TAXES Income tax expense, for the nine months ended September 30, 2005, decreased by $20,000 from the same period in 2004. The effective tax rate was 30.0 and 30.8 percent for the 2005 and 2004 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 the Corporation, 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, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation's management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of it's disclosure controls and procedures. Based upon that evaluation, the Corporation's Chief Executive Officer and Chief Financial Officer concluded that the Corporation's disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Corporation reports filed or submitted under the Securities Exchange Act of 1934 is 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 the Corporation's internal controls over financial reporting identified in connection with the evaluation referenced above that occurred during the Corporation's last fiscal quarter that have materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting. Page 24
FIRST MERCHANTS CORPORATION FORM 10-Q PART II. OTHER INFORMATION Item 1. Legal Proceedings - -------------------------- None Item 2. Unregistered Sales of Equity Securities and Use of Proceeds - --------------------------------------------------- a. On September 1, 2005, the Corporation issued 16,762 unregistered shares of its common stock pursuant to a Merger Agreement dated September 1, 2005, between the Corporation, First Merchants Insurance Services, Inc. and Trustcorp Financial Services of Greenville, Inc. ("Trustcorp"). The Corporation issued the unregistered shares to the shareholders of Trustcorp, at a value of $25.95 per share, in exchange for all the common stock of Trustcorp. The issuance by the Corporation of its shares of common stock were not registered under the Securities Act of 1933, as amended ("Securities Act"). The shares were issued pursuant to the exemption contemplated in Section 4 (2) of the Securities Act, for transactions not involving a public offering. b. None c. Issuer Purchases of Equity Securities The following table presents information relating to the Corporation's purchases of its equity securities during the quarter ended September 30, 2005, as follows(1): <TABLE> <CAPTION> 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) ------ ---------------- -------------- ------------------------- ------------------------ <S> <C> <C> <C> <C> 07/01/05 - 07/31/05 5,967(2) $26.67 0 0 08/01/05 - 08/31/05 693(2) $26.00 0 0 09/01/05 - 09/30/05 0 0 0 0 </TABLE> (1) On February 8, 2005, the Corporation's Board authorized management to repurchase up to 250,000 shares of the Corporation's Common Stock. On June 14, 2005 and August 9, 2005, the Corporation's Board authorized management to repurchase additional shares of the Corporation's Common Stock, totaling 6,500 and 243,500 shares, respectively. These authorizations were not publicly announced and expire February 14, 2006. There were 243,500 remaining shares that may yet be purchased pursuant to such authorizations as of September 30, 2005. (2) All shares were purchased in connection with the exercise of certain outstanding 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 25
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 29 Executive Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 31.2 Certification of Chief 30 Financial Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 32 Certifications Pursuant to 31 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Page 26
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: November 9, 2005 by /s/ Michael L. Cox -------------------------- ------------------------------------- Michael L. Cox President and Chief Executive Officer Date: November 9, 2005 by /s/ Mark K. Hardwick -------------------------- ------------------------------------- Mark K. Hardwick Senior Vice President and Chief Financial Officer (Principal Financial and Chief Accounting Officer) Page 27
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 29 Executive Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 31.2 Certification of Chief 30 Financial Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 32 Certifications Pursuant to 31 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Page 28
EXHIBIT-31.1 FIRST MERCHANTS CORPORATION FORM 10-Q CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION - ------------- I, Michael L. Cox, President and Chief Executive Officer of First Merchants Corporation, certify that: 1. I have reviewed this 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: November 9, 2005 /s/Michael L. Cox ---------------------------------------- Michael L. Cox President and Chief Executive Officer Page 29
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, Senior 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: November 9, 2005 /s/Mark K. Hardwick ---------------------------------------- Mark K. Hardwick Senior Vice President and Chief Financial Officer (Principal Financial and Chief Accounting Officer) Page 30
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 September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I Michael L. Cox, President and Chief Executive Officer of the Corporation, do hereby certify, in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. Date: November 9, 2005 by /s/ Michael L. Cox --------------------------- ------------------------------------- Michael L. Cox President and Chief 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 September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I Mark K. Hardwick, Senior Vice President and Chief Financial Officer of the Corporation, do hereby certify, in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. Date: November 9, 2005 by /s/ Mark K. Hardwick --------------------------- ------------------------------------- Mark K. Hardwick Senior 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 31