May 25, 2007
VIA EDGAR
Securities and Exchange Commission
Division of Corporation Finance
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Rebekah Moore and Kevin W. Vaughn
Mail Stop-4561
Re: First Merchants Corporation
Form 10-K for Fiscal Year Ended December 31, 2006
Filed March 16, 2007
File No. 000-17071
Ladies and Gentlemen:
This correspondence is First Merchants Corporation's response to comments
received from the Securities and Exchange Commission on April 27, 2007,
regarding document revisions for future filings of First Merchants Corporation's
Form 10-K.
Note 1 Nature of Operations and Summary of Significant Accounting Policies,
page 25
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1. SEC Comment: Revise your future filings to clearly describe the nature
and extent of business transacted by First Merchants Reinsurance
Company, as well as your other insurance-related subsidiaries.
Specifically clarify the extent to which your subsidiary activities are
limited to agency or broker activities or if you engage in writing,
ceding, or assuming insurance paper.
First Merchants Corporation response: In future filings, we
propose to change the disclosure on page 4 of the 10-K to read
as follows: The Corporation operates First Merchants Insurance
Services, Inc. a full-service property, casualty, personal
lines, and employee benefit insurance agency headquartered in
Muncie, Indiana. The Corporation is also the majority owner of
Indiana Title Insurance Company, LLC which is a full-service
title insurance agency. The Corporation operates First
Merchants Reinsurance Co. Ltd., a small life reinsurance
company whose primary business includes underwriting short-
duration contracts of credit life and accidental and health
insurance policies and debt cancellation contracts. Such
policies and contracts are purchased by customers of the
Corporation's bank customers to cover the amount of debt
incurred by the insured. No policies are issued for loans
other than those originated by the subsidiary banks. First
Merchants Reinsurance Co. Ltd., limits its self-insurance risk
to the first $15,000 of exposure under each credit life policy
and $350 per month on each accident and health policy. The
company maintains the same standard for its debt cancellation
contracts.
2. SEC Comment: You state on page 4 that through various nonbank
subsidiaries you "offer personal and commercial lines of insurance and
engages in the title agency business and the reinsurance of credit
life, accident, and health insurance." This seems to conflict with your
disclosures in the third paragraph on page 4 where you characterize
First Merchants Reinsurance Co. Ltd as a "reinsurance agency". Please
revise to more clearly define for the reader the nature of the
activities of a reinsurance agency entity.
First Merchants Corporation Response: See response under item 1.
3. SEC Comment: Tell us and briefly disclose the business purpose for
domiciling First Merchants Reinsurance Company in the country of Turks
and Caicos Islands.
First Merchants Corporation Response: The primary business
reason for being domiciled in the country of Turks and Caicos
is for preferential tax treatment and less restrictive
insurance standards. The Corporation has determined the
company's domicile in the Turks and Caicos is not significant
and proposes to delete that disclosure in future filings.
4. SEC Comment: Please revise your future filings to clearly identify the
type of insurance products and contracts written by First Merchants
Reinsurance Company, and quantify the amount such business transacted
during the periods presented. Specify whether the entity enters into
short-duration or long duration contracts.
First Merchants Corporation Response: See response under item 1
above and 5 below.
5. SEC Comment: Please revise your future filings to provide the
disclosures required by SFAS 60 and SFAS 113, or tell us specifically
why you believe this guidance is not applicable to your situation.
Refer to paragraph 27 of SFAS 113 which requires quantification of
insurance assumed and ceded. To the extent certain of your insurance
subsidiaries do not absorb insurance risk or write insurance paper,
clearly disclose that fact.
First Merchants Response: The Corporation has determined that the
operations of First Merchants Reinsurance Company are immaterial
to the overall results of First Merchants Corporation. This
determination is based upon the following information regarding
First Merchants Reinsurance Company:
* Total Revenue: $261,495
* Net Income: $95,365
* Total Assets: $391,776
Our independent accounting firm, BKD, LLP is in agreement with
this determination.
6. SEC Comment: Revise your future filings to clearly identify any related
party nature to the transactions entered into by your insurance
subsidiaries. Discuss the extent to which insurance risk you assume is
related to loans you have originated.
First Merchants Corporation Response: See response under item 1.
7. SEC Comment: To the extent that First Merchants Reinsurance Company is
providing "self-insurance" to its parent or other related entities,
clearly disclose that fact in future filings and quantify the extent of
such activities. Clearly disclose how you accounted for such
intercompany transactions in your consolidated financial statements.
First Merchants Corporation Response: See response under item 1.
Note 4 Investment Securities, page 30
8. SEC Comment: In future filings, for securities that are underwater as
of the balance sheet date, please revise to clearly assert whether you
have both the intent and ability to hold them to the earlier of
recovery or maturity. Tell us whether you were able to make this
assertion as of the balance sheet dates presented in you Form 10-K for
the investment securities that were underwater at those dates. Refer to
the guidance of Staff Accounting Bulletin No. 59.
First Merchants Corporation Response: In future filings, for
securities that are underwater as of the balance sheet date,
we will revise our disclosures to clearly assert that the
Corporation has the intent and ability to hold the underwater
securities to the earlier of recovery or maturity. If the
Corporation is unable to make this assertion at any reporting
period, the Corporation will take the necessary actions to
recognize the unrealized loss in the appropriate period's
income statement. At December 31, 2006, the Corporation did
have both the ability and intent to hold all underwater
securities to the earlier of recovery or maturity.
Note 22 Derivative Instruments and Hedging Activities, page 52
9. SEC Comment: Include a more comprehensive disclosure of the hedged item
and the hedging strategy. For example, we noted in your Form 10-Q for
the period ended September 30, 2006 that the interest rate floors were
used to hedge prime based variable rate loans but could not locate
similar disclosures in your annual financial statements.
First Merchants Corporation Response: In future filings, we
propose to change Note 22 to read substantially as follows:
Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities
(SFAS 133), as amended and interpreted, establishes accounting
and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts,
and for hedging activities. As required by SFAS 133, the
Corporation records all derivatives on the balance sheet at
fair value. The accounting for changes in the fair value of
derivatives depends on the intended use of the derivative and
the resulting designation. Derivatives used to hedge the
exposure to changes in the fair value of an asset, liability,
or firm commitment attributable to a particular risk, such as
interest rate risk, are considered fair value hedges.
Derivatives used to hedge the exposure to variability in
expected future cash flows, or other types of forecasted
transactions, are considered cash flow hedges. Hedge
ineffectiveness, if any, is measured periodically throughout
the life of the hedging relationship.
The Corporation's objective in using derivatives is to add
stability to interest income and to manage its exposure to
changes in interest rates. To accomplish this objective, the
Corporation uses interest rate floors to protect the
Corporation against movements in interest rates below the
instruments' strike rates, over the lives of the agreements.
The interest rate floors have an aggregate notional amount of
$250,000,000, with strike rates that range from 6.0% to 7.5%,
and maturity dates through August 1, 2009. During 2006, such
derivatives were used to hedge the variable cash flows
associated with existing variable-rate loan asset pools that
are based on the prime rate (Prime). For accounting purposes,
the floors are designated as cash flow hedges of the overall
changes in cash flows on the first Prime-based interest
payments received by the Corporation each calendar month
during the terms of the hedges that, in aggregate for each
period, are interest payments on principal from specified
portfolios equal to the notional amounts of the floors.
For derivatives designated as cash flow hedges, the effective
portion of changes in the fair value of the derivative is
initially reported in other comprehensive income (outside of
earnings) and subsequently reclassified to earnings ("interest
income on loans") when the hedged transaction affects
earnings. Ineffectiveness resulting from the hedging
relationship, if any, is recorded as a gain or loss in
earnings as part of non-interest income. Based on the
Corporation's assessments both at inception and throughout the
life of the hedging relationship, it is probable that
sufficient Prime-based interest receipts will exist through
the maturity dates of the floors. The Corporation uses the
"Hypothetical Derivative Method" described in SFAS 133
Implementation Issue No. G20, "Cash Flow Hedges: Assessing and
Measuring the Effectiveness of a Purchased Option Used in a
Cash Flow Hedge," for its quarterly prospective and
retrospective assessments of hedge effectiveness, as well as
for measurements of hedge ineffectiveness. The Corporation
also monitors the risk of counterparty default on an ongoing
basis.
Prepayments in hedged loan portfolios are treated in a manner
consistent with the guidance in SFAS 133 Implementation Issue
No. G25, "Cash Flow hedges: Using the First-Payments-Received
Technique in Hedging the Variable Interest Payments on a Group
of Non-Benchmark-Rate-Based Loans," which allows the
designated forecasted transactions to be the variable,
Prime-rate-based interest payments on a rolling portfolio of
prepayable interest-bearing loans using the
first-payments-received technique, thereby allowing interest
payments from loans that prepay to be replaced with interest
payments from new loan originations.
As of December 31, 2006, no derivatives were designated as
fair value hedges or hedges of net investments in foreign
operations. Additionally, the Corporation does not use
derivatives for trading or speculative purposes and currently
does not have any derivatives that are not designated as
hedges.
At December 31, 2006, interest rate floors with a fair value
of $428,000 were included in other assets. For the year ended
December 31, 2006, the change in net unrealized losses of
$125,000 for derivatives designated as cash flow hedges is
separately disclosed in the statement of changes in
shareholders' equity and comprehensive income. No hedge
ineffectiveness on cash flow hedges was recognized during the
year ended December 31, 2006.
Amounts reported in accumulated other comprehensive income
related to derivatives will be reclassified to interest income
as interest payments are received on the Corporation's
variable-rate loan assets. For the year ended December 31,
2006, the change in net unrealized losses on cash flow hedges
reflects a reclassification of $38 of net unrealized losses
from accumulated other comprehensive income to interest
income. For the year ended December 31, 2007, the Corporation
estimates that an additional $50,000 will be reclassified from
accumulated other comprehensive income to interest income.
10. SEC Comment: Disclose the methods and assumptions used to estimate fair
value.
First Merchants Corporation Response: See response under item
9 paragraph 3.
11. SEC Comment: Disclose the methods used to assess hedge effectiveness,
both at inception and on an ongoing basis.
First Merchants Corporation Response: See response under item
9 paragraph 3.
12. SEC Comment: Disclose the amounts of the hedged items.
First Merchants Corporation Response: See response under item
9 paragraph 2.
13. SEC Comment: Disclose whether you are hedging individual loans, or if
you are hedging a pool of loans.
First Merchants Corporation Response: See response under item
9 paragraph 2.
14. SEC Comment: If you are hedging each loan individually, please disclose
how you considered paragraph 29(h) of SFAS 133, which specifically
disallows use of prime rate as a benchmark interest rate.
First Merchants Corporation Response: See response under item 13.
15. SEC Comment: If you are hedging a pool of loans, disclose what that
actual hedging item is for the pool of loans, i.e. the first interest
payments within a given period, or the overall changes in cash flows
and disclose how each loan met the requirements of paragraphs 28 and 29
of SFAS 133 to receive hedge accounting.
First Merchants Corporation Response: See response under item 9
paragraph 2.
16. SEC Comment: Disclose how you account for your hedging relationships
upon prepayment of loans, if allowed.
First Merchants Corporation Response: See response under item 9
paragraph 4.
In closing, First Merchants Corporation acknowledges that:
* the Corporation is responsible for the adequacy and accuracy of the
disclosure in the filing;
* staff comments or changes to disclosure in response to staff
comments do not foreclose the Commission from taking any action
with respect to the filing; and
* the Corporation may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
Sincerely,
Mark Hardwick
Executive Vice President
Chief Financial Officer
First Merchants Corporation