Financial
REVIEW
Independent Auditor's Report 17
Five-Year Summary of
Selected Financial Data 18
Management's
Discussion & Analysis 19
Consolidated
Financial Statements 28
Notes to Consolidated
Financial Statements 32
- ----------------------------
INDEPENDENT AUDITOR'S REPORT
- ----------------------------
To the Stockholders and Board of Directors
First Merchants Corporation
Muncie, Indiana
We have audited the consolidated balance sheet of First Merchants Corporation
and subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1998 (pages 28-47). These consolidated
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements described above present
fairly, in all material respects, the consolidated financial position of First
Merchants Corporation and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
OLIVE llp
Indianapolis, Indiana
January 15, 1999
17
FIVE-YEAR SUMMARY of SELECTED FINANCIAL DATA
(In Thousands, Except Share Data)
====================================================================================================================================
1998 1997 1996 1995 1994
====================================================================================================================================
OPERATIONS
Net Interest Income
Fully Taxable Equivalent Basis ........................ $ 44,253 $ 42,139 $ 39,258 $ 37,049 $ 35,909
Less Tax Equivalent Adjustment .......................... 2,575 2,389 2,111 1,952 1,971
---------- ---------- ---------- ---------- ----------
Net Interest Income ..................................... 41,678 39,750 37,147 35,097 33,938
Provision for Loan Losses ............................... 1,984 1,297 1,253 1,388 1,202
---------- ---------- ---------- ---------- ----------
Net Interest Income
After Provision for Loan Losses ....................... 39,694 38,453 35,894 33,709 32,736
Total Other Income ...................................... 11,725 9,229 8,342 7,592 6,919
Total Other Expenses .................................... 27,895 25,748 24,135 22,992 22,632
---------- ---------- ---------- ---------- ----------
Income Before Income Tax Expense ...................... 23,524 21,934 20,101 18,309 17,023
Income Tax Expense ...................................... 8,125 7,561 6,959 6,261 5,660
---------- ---------- ---------- ---------- ----------
Net Income .............................................. $ 15,399 $ 14,373 $ 13,142 $ 12,048 $ 11,363
========== ========== ========== ========== ==========
PER SHARE DATA (1)
Basic Net Income ........................................ $ 1.53 $ 1.44 $ 1.33 $ 1.23 $ 1.15
Diluted Net Income ...................................... 1.51 1.43 1.32 1.21 1.15
Cash Dividends Paid (2) ................................. .77 .69 .59 .51 .47
December 31 Book Value .................................. 13.04 12.20 11.38 10.66 9.39
December 31 Market Value (Bid Price) .................... 26.00 24.33 16.83 17.17 13.89
AVERAGE BALANCES
Total Assets ............................................ $1,064,714 $ 993,338 $ 932,144 $ 890,995 $ 853,257
Total Loans ............................................. 721,931 675,892 585,905 544,457 513,784
Total Deposits .......................................... 856,725 800,118 753,661 728,826 698,644
Securities Sold Under Repurchase Agreements
(long-term portion) ................................... 16,182
Total Federal Home Loan Bank Advances ................... 26,942 15,455 9,192 9,000 7,692
Total Stockholders' Equity .............................. 126,712 117,014 108,094 99,033 91,466
YEAR-END BALANCES
Total Assets ............................................ $1,177,172 $1,020,136 $ 967,993 $ 942,156 $ 868,153
Total Loans ............................................. 743,748 703,784 631,700 553,074 528,641
Total Deposits .......................................... 926,844 843,812 794,451 783,936 720,009
Securities Sold Under Repurchase Agreements
(long-term portion) ................................... 28,000
Total Federal Home Loan Bank Advances ................... 43,268 20,700 9,150 9,000 8,000
Total Stockholders' Equity .............................. 131,497 121,969 112,687 104,967 92,754
FINANCIAL RATIOS
Return on Average Assets ................................ 1.45% 1.45% 1.41% 1.35% 1.33%
Return on Average Stockholders' Equity .................. 12.15 12.28 12.16 12.17 12.42
Average Earning Assets to Total Assets .................. 95.13 94.77 94.48 94.86 94.46
Allowance for Loan Losses as % of Total Loans ........... .99 .96 1.05 1.21 1.25
Dividend Payout Ratio ................................... 50.47 47.93 40.85 39.49 39.44
Average Stockholders' Equity to Average Assets .......... 11.90 11.78 11.60 11.11 10.72
Tax Equivalent Yield on Earning Assets (3) .............. 8.13 8.27 8.13 8.09 7.41
Cost of Supporting Liabilities .......................... 3.76 3.79 3.67 3.71 2.95
Net Interest Margin on Earning Assets ................... 4.37 4.48 4.46 4.38 4.46
(1) Restated for 3-for-2 stock splits distributed October, 1995 and October,
1998.
(2) Dividends per share is for First Merchants Corporation only, not restated
for pooling transactions.
(3) 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.
18
Management's
Discussion &
ANALYSIS
The Corporation's financial data
for periods prior to mergers, which
were accounted for as pooling of
interests, has been restated.
o Return on Average Assets
(percent)
[THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.]
1996 1.41%
1997 1.45%
1998 1.45%
o Return on Average Equity
(percent)
[THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.]
1996 12.16%
1997 12.28%
1998 12.15%
RESULTS of OPERATIONS
Net income amounted to $15,399,000 or $1.53 per share, a 6.2 percent
increase over 1997 at $1.44 per share. Diluted net income per share amounted to
$1.51, a 5.6 percent increase over the 1997 figure of $1.43.
Return on assets was 1.45 percent in 1998 and 1997, up from 1.41 percent in
1996.
Return on equity was 12.15 percent in 1998, 12.28 percent in 1997 and 12.16
percent in 1996.
In 1998, First Merchants Corporation ("Corporation") recorded the
twenty-third consecutive year of improvement in net income on both an aggregate
and per share basis.
CAPITAL
The Corporation's capital strength continues to exceed regulatory minimums
and peer group averages. Management believes that strong capital is a distinct
advantage in the competitive environment in which the Corporation operates and
will provide a solid foundation for continued growth.
The Corporation's Tier I capital to average assets ratio was 11.9 percent
at year-end 1998, equaling 11.9 percent at December 31, 1997. At December 31,
1998, the Corporation had a Tier I risk-based capital ratio of 16.0 percent,
total risk-based capital ratio of 16.9 percent, and a leverage 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 has an employee stock purchase plan and an employee stock
option plan. Activity under these plans is described in Note 15 to the
Consolidated Financial Statements. The transactions under these plans have not
had a material effect on the Corporation's capital position.
ASSET QUALITY/PROVISION for LOAN LOSSES
The Corporation's asset quality and loan loss experience have consistently
been superior to that of its peer group, as summarized on the following page.
Asset quality has been a major factor in the Corporation's ability to generate
consistent profit improvement.
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 independent loan
review provided by an outside accounting firm. The evaluation takes into
consideration identified credit problems, as well as the possibility of losses
inherent in the loan portfolio that cannot be specifically identified.
continued
19
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MANAGEMENT'S DISCUSSION & ANALYSIS
- ----------------------------------
The following table summarizes the risk elements for the Corporation.
December 31,
================================================================================
1998 1997
================================================================================
(Dollars in Thousands)
Non-accrual loans ..................................... $ 735 $1,410
Loans contractually
past due 90 days or more
other than non-accruing ............................. 2,275 1,972
Restructured loans .................................... 926 282
------ ------
Total ............................................... $3,936 $3,664
====== ======
- --------------------------------------------------------------------------------
The Corporation's asset quality and loan loss experience have consistently been
superior to that of its peer group. Asset quality has been a major factor in the
Corporation's ability to generate consistent profit improvement.
ASSET QUALITY/PROVISION for LOAN LOSSES continued
At December 31, 1998, non-performing loans totaled $3,936,000, an increase
of $272,000, and one non-accrual loan totaling $367,000 was restructured. At
December 31, 1998, impaired loans totaled $8,828,000, an increase of $6,277,000,
due to the addition of two loans totaling $5,402,000. As of December 31, 1998,
the two businesses were experiencing negative cash flows. However, both loans
are current, and the Corporation believes that the underlying collateral does
not warrant a specific reserve.
The Corporation adopted Statement of Financial Accounting Standards
("SFAS") No. 114 and No. 118, Accounting by Creditors for Impairment of a Loan
and Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures, on January 1, 1995. Impaired loans included in the table at left
totaled $2,222,000 at December 31, 1998. An allowance for losses at December 31,
1998, was not deemed necessary for impaired loans totaling $6,882,000, but an
allowance of $712,000 was recorded for the remaining balance of impaired loans
of $1,946,000. The average balance of impaired loans for 1998 was $8,318,000.
At December 31, 1998, the allowance for loan losses was $7,412,000, up
$634,000 from year end 1997. As a percent of loans, the allowance was .99
percent, up from .96 percent at year-end 1997.
The provision for loan losses in 1998 was $1,984,000 compared to $1,297,000
in 1997.
o Net Loan Losses
(as a percent of average loans)
[THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.]
First Merchants Corporation Peer Group
--------------------------- ----------
1996 .23 .26
1997 .17 .29
1998 .18 NA
The table below presents loan loss experience for the years indicated and
compares the Corporation's loss experience to that of its peer group.
================================================================================
1998 1997 1996
================================================================================
(Dollars in Thousands)
Allowance for loan losses:
Balance at January 1 ........................... $6,778 $6,622 $6,696
------ ------ ------
Chargeoffs ................................... 1,881 1,609 1,636
Recoveries ................................... 531 468 309
------ ------ ------
Net chargeoffs ............................... 1,350 1,141 1,327
Provision for loan losses .................... 1,984 1,297 1,253
------ ------ ------
Balance at December 31 ....................... $7,412 $6,778 $6,622
====== ====== ======
Ratio of net chargeoffs during the period to
average loans outstanding during the period .... .18% .17% .23%
Peer Group ....................................... NA .29% .26%
20
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MANAGEMENT'S DISCUSSION & ANALYSIS
----------------------------------
LIQUIDITY, 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 ensure that changes in interest rates will not adversely
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.
The Corporation's liquidity and interest sensitivity position at December
31, 1998, remained adequate to meet the Corporation's primary goal of achieving
optimum interest margins while avoiding undue interest rate risk. The table
below presents the Corporation's interest rate sensitivity analysis as of
December 31, 1998.
Asset/Liability Management has been an important factor in the Corporation's
ability to record consistent earnings growth through periods of interest rate
volatility.
INTEREST RATE SENSITIVITY ANALYSIS
(Dollars in Thousands)
At December 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------------
1-180 Days 181-365 Days 1-5 Years Beyond 5 Years Total
- ------------------------------------------------------------------------------------------------------------------------------------
Rate-Sensitive Assets:
Federal funds sold and
interest-bearing deposits .......................... $ 38,170 $ 38,170
Investment securities ................................ 67,950 $ 44,812 $ 154,855 $ 61,744 329,361
Loans ................................................ 319,806 75,404 249,283 99,255 743,748
Federal Reserve and
Federal Home Loan Bank stock ......................... 3,723 3,723
---------- ---------- ---------- ---------- ----------
Total rate-sensitive assets ........................ 429,649 120,216 404,138 160,999 $1,115,002
---------- ---------- ---------- ---------- ----------
Rate-Sensitive Liabilities:
Interest-bearing deposits ............................ 363,969 179,739 258,564 1,275 803,547
Securities sold under repurchase agreements .......... 10,936 9,900 28,000 48,836
Other short-term borrowings .......................... 19,296 19,296
Federal Home Loan Bank advances ...................... 1,387 17,763 12,000 12,118 43,268
---------- ---------- ---------- ---------- ----------
Total rate-sensitive liabilities ................... 395,588 207,402 298,564 13,393 914,947
---------- ---------- ---------- ---------- ----------
Interest rate sensitivity gap by period ................ $ 34,061 $ (87,186) $ 105,574 $ 147,606
Cumulative rate sensitivity gap ........................ 34,061 (53,125) 52,449 200,055
Cumulative rate sensitivity gap ratio
at December 31, 1998 ................................. 108.6% 91.2% 105.8% 121.9%
The Corporation had a cumulative negative gap of $53,125,000 in the one-year
horizon at December 31, 1998, just over 4.5 percent of total assets. Net
interest income at financial institutions with negative gaps tends to increase
when rates decrease and decrease as interest rates increase.
21
- ----------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS
- ----------------------------------
LIQUIDITY, INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK continued
The Corporation places its greatest credence in net interest income
simulation modeling. The GAP/Interest Rate Sensitivity Report is known 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.
The Corporation's asset liability process monitors simulated net interest
income under three separate interest rate scenarios; rising (rate shock),
falling (rate shock) and flat. Net interest income is simulated over an 18-month
horizon. By policy, the difference between the best performing and the worst
performing rate scenarios are not allowed to show a variance greater than 5
percent.
Assumed interest rate changes are simulated to move incrementally over 18
months. The total rate movement (beginning point minus ending point) to
noteworthy interest rate indexes are as follows:
================================================================================
Rising Falling
================================================================================
Prime 300 Basis Points (300)Basis Points
Federal Funds 300 (300)
90-Day T-Bill 310 (275)
One-Year T-Bill 290 (270)
Three-Year T-Bill 290 (265)
Five-Year T-Note 290 (255)
Ten-Year T-Note 290 (245)
Interest Checking 100 ( 67)
MMIA Savings 150 (100)
Money Market Index 292 (243)
Regular Savings 100 (267)
- --------------------------------------------------------------------------------
Results for the flat, rising (rate shock), and falling (rate shock) interest
rate scenarios are listed below. The net interest income shown represents
cumulative net interest income over an 18-month time horizon. Balance sheet
assumptions are the same under both scenarios:
================================================================================
Flat/Base Rising Falling
================================================================================
Net Interest Income (Dollars in Thousands) $ 64,520 $ 63,838 $ 62,713
Change vs. Flat/Base Scenario $ (682) $ (1,807)
Percent Change (1.06%) (2.80%)
- --------------------------------------------------------------------------------
22
----------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS
----------------------------------
EARNING ASSETS
Earning assets increased $151.2 million during 1998.
The table at right reflects the earning asset mix for the years 1998 and
1997 (at December 31).
Loans grew by $39.7 million while investment securities increased by $81.8
million, reflecting the Corporation's strategy to leverage its strong capital
position.
Earning Assets
(Dollars in Millions)
================================================================================
December 31,
1998 1997
================================================================================
Federal funds sold and interest-bearing time deposits .... $ 38.2 $ 9.4
Securities available for sale ............................ 308.5 212.0
Securities held to maturity .............................. 20.9 35.3
Mortgage loans held for sale ............................. 0.8 0.5
Loans .................................................... 743.0 703.3
Federal Reserve and Federal Home Loan
Bank stock ............................................... 3.7 3.4
-------- ------
Total .................................................. $1,115.1 $963.9
======== ======
- --------------------------------------------------------------------------------
DEPOSITS, SECURITIES SOLD UNDER REPURCHASE AGREEMENTS, OTHER SHORT-TERM
BORROWINGS AND FEDERAL HOME LOAN BANK ADVANCES
The table at right reflects the level of deposits and borrowed funds
(Federal funds purchased, repurchase agreements, U.S. Treasury demand notes and
Federal Home Loan Bank advances) based on year-end levels at December 31, 1998
and 1997.
As of December 31 (Dollars in Millions)
- --------------------------------------------------------------------------------
SECURITIES SOLD UNDER OTHER SHORT-TERM FEDERAL HOME LOAN
DEPOSITS REPURCHASE AGREEMENTS BORROWINGS BANK ADVANCES
- --------------------------------------------------------------------------------
1998 $926.8 $48.8 $19.3 $43.3
1997 $843.8 $15.4 $11.4 $20.7
- --------------------------------------------------------------------------------
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 reflects the Corporation's asset yields, interest expense,
and net interest income as a percent of average earning assets for the
three-year period ending in 1998.
Asset yields declined .14 percent (FTE) in 1998, due primarily to a decline
in interest rates. Interest costs declined by .03 percent resulting in a .11
percent decrease in net interest income (FTE) as a percent of average earning
assets. Despite this "spread" decrease, net interest income increased by $2.1
million, due to the growth in average earning assets of $71.6 million.
(Dollars in Thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME INTEREST EXPENSE NET INTEREST INCOME NET INTEREST INCOME
(FTE) as a Percent of as a Percent of (FTE) as a Percent of AVERAGE on a fully Taxable
Average Earning Assets Average Earning Assets Average Earning Assets EARNING ASSETS Equivalent Basis
- ------------------------------------------------------------------------------------------------------------------------------------
1998 8.13% 3.76% 4.37% $1,012,907 $44,253
1997 8.27 3.79 4.48 941,351 42,139
1996 8.13 3.67 4.46 880,729 39,258
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.
- ------------------------------------------------------------------------------------------------------------------------------------
23
- ----------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS
- ----------------------------------
OTHER INCOME
The Corporation has placed emphasis on the growth of non-interest income in
recent years by offering a wide range of fee-based services. Fee schedules are
regularly reviewed by a pricing committee to ensure that the products and
services offered by the Corporation are priced to be competitive and profitable.
Other income in 1998 amounted to $11,725,000, or 27 percent higher than in
1997. The increase of $2,496,000 is primarily attributable to the following
factors:
1. Revenues from fiduciary activity grew $778,000, or 23.2 percent, due to
strong new business activity and markets.
2. Commission income increased $711,000, or 230.1 percent, due to the
acquisition of the Muncie office of Insurance & Risk Management, Inc.,
renamed First Merchants Insurance Services, on April 1, 1998.
3. Other customer fees increased $453,000, or 23.7 percent, due to increased
electronic delivery methods and some minor price adjustments.
4. Other income increased $483,000, or 159.9 percent, due primarily to a
$442,000 gain on sale of a Bank building.
Other income in 1997 amounted to $9,229,000, or 10.6 percent higher than in
1996. The increase of $887,000 is primarily attributable to the following
factors:
1. Revenues from fiduciary activity grew $388,000, or 13.1 percent, due to
strong new business activity and markets.
2. Service charges on deposit accounts increased $341,000, or 11.3 percent,
due to account growth and some minor price adjustments.
3. Purchase money order agent fees increased $71,000, or 14.6 percent, due to
increased sales volume.
OTHER EXPENSES
Total "other expenses" represent non-interest operating expenses of the
Corporation. Those expenses amounted to $27,895,000 in 1998, an increase of 8.3
percent from the prior year, or $2,147,000. Four major areas account for most of
the increase:
1. Salary and benefit expenses, which account for over one-half of the
Corporation's non-interest operating expenses, grew by $1,319,000, or 9.2
percent, due to normal salary increases and staff additions.
2. Equipment expenses increased $375,000, or 16.0 percent, reflecting the
Corporation's efforts to improve efficiency and provide electronic service
delivery to its customers.
3. Net occupancy expense increased $212,000, or 13.1 percent, due primarily to
increased branch expansion into new markets.
Operating costs in 1998 included start-up expenses for three banking centers
opened in new markets. These banking centers helped implement our strategy of
enlarging our presence in rapidly growing areas and should have a positive
effect on earnings in 1999 and succeeding years.
24
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MANAGEMENT'S DISCUSSION & ANALYSIS
----------------------------------
OTHER EXPENSES continued
Expenses for 1997 amounted to $25,748,000, an increase of 6.7 percent from
the prior year, or $1,613,000.
Four major areas account for most of the increase:
1. Salary and benefit expenses, which account for over one-half of the
Corporation's non-interest operating expenses, grew by $889,000, or 6.6
percent, due to normal salary increases and staff additions.
2. Equipment expenses increased $193,000, or 9.0 percent, reflecting the
Corporation's efforts to improve efficiency and provide electronic service
delivery to its customers.
3. Marketing expenses rose $145,000, or 20.5 percent, due to more aggressive
product promotion.
4. Outside data processing fees grew by $176,000, or 19.5 percent, due to
increased debit card, credit card and trust activity.
INCOME TAXES
The increase in 1998 tax expense of $564,000 is attributable primarily to a
$1,590,000 increase in net pre-tax income, mitigated somewhat by a $347,000
increase in tax-exempt income. Likewise, the $602,000 increase in 1997 resulted
primarily from a $1,833,000 increase in pre-tax net income, mitigated somewhat
by a $514,000 increase in tax-exempt income.
ACCOUNTING MATTERS
Accounting for Derivative Instruments and Hedging Activities
During 1998, the Financial Accounting Standards Board (FASB) issued
Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
This Statement requires companies to record derivatives on the balance sheet at
their fair value. Statement No. 133 also acknowledges that the method of
recording a gain or loss depends on the use of the derivative.
The new Statement applies to all entities. If hedge accounting is elected
by the entity, the method of assessing the effectiveness of the hedging
derivative and the measurement approach of determining the hedge's
ineffectiveness must be established at the inception of the hedge.
Statement No. 133 amends Statement No. 52 and supersedes Statements No. 80,
105 and 119. Statement No. 107 is amended to include the disclosure provisions
about the concentrations of credit risk from Statement No. 105. Several Emerging
Issues Task Force consensuses are also changed or nullified by the provisions of
Statement No. 133.
Statement No. 133 will be effective for all fiscal years beginning after
June 15, 1999. The Statement may not be applied retroactively to financial
statements of prior periods. The adoption of this Statement will have no
material impact on the Corporation's financial condition or result of
operations.
25
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MANAGEMENT'S DISCUSSION & ANALYSIS
- ----------------------------------
ACCOUNTING MATTERS continued
Accounting for Mortgage-Backed Securities Retained After the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise
Also in 1998, the FASB issued Statement No. 134, Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise. It establishes accounting
standards for certain activities of mortgage banking enterprises and for other
enterprises with similar mortgage operations. This Statement amends Statement
No. 65.
Statement No. 134, as previously amended by Statements No. 115 and 125,
required a mortgage banking enterprise to classify a mortgage-backed security as
a trading security following the securitization of the mortgage loan held for
sale. This Statement further amends Statement No. 65 to require that after the
securitization of mortgage loans held for sale, an entity engaged in mortgage
banking activities must classify the resulting mortgage-backed security or other
retained interests based on the entity's ability and intent to sell or hold
those investments.
The determination of the appropriate classification for securities retained
after the securitization of mortgage loans by a mortgage banking enterprise now
conforms to Statement No. 115. The only new requirement is that if an entity has
a sales commitment in place, the security must be classified into trading.
This Statement is effective for the first fiscal quarter beginning after
December 15, 1998. On the date this Statement is initially applied, an entity
may reclassify mortgage-backed securities and other beneficial interests
retained after the securitization of mortgage loans held for sale from the
trading category, except for those with sales commitments in place. Those
securities and other interests shall be classified based on the entity's present
ability and intent to hold the investments. The adoption of this Statement will
have no material impact on the Corporation's financial condition and result of
operations.
Reporting on the Costs of Start-Up Activities
During 1998, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Position 98-5, Reporting on the Costs of Start-Up Activities.
Statement of Position 98-5 will affect all non-governmental entities, including
not-for-profits, reporting start-up costs in their financial statements.
Some existing industry practices result in the capitalization and
amortization of start-up costs. This Statement of Position requires that
start-up costs be expensed when incurred. The Statement of Position applies to
start-up activities and organizational costs associated with both development
stage and established operating entities.
According to Statement of Position 98-5, start-up activities are "those
one-time activities related to opening a new facility, introducing a new product
or service, conducting business in a new territory, conducting business with a
new class of customer or beneficiary, initiating a new process in an existing
facility, or commencing some new operation. Start-up activities include
activities related to organizing a new entity (commonly referred to as
organizational costs)."
Statement of Position 98-5 is effective for fiscal years beginning on or
after December 15, 1998. Earlier application is encouraged in fiscal years
during which annual financial statements have not yet been issued. The adoption
of this Statement will not have a material impact on the Corporation's financial
condition or result of operations.
26
----------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS
----------------------------------
INFLATION
Changing prices of goods, services and capital affect the financial
position of every business enterprise. The level of market interest rates and
the price of funds loaned or borrowed fluctuate due to changes in the rate of
inflation and various other factors, including government monetary policy.
Fluctuating interest rates affect the Corporation's net interest income,
loan volume and other operating expenses, such as employee salaries and
benefits, reflecting the effects of escalating prices, as well as increased
levels of operations and other factors. As the inflation rate increases, the
purchasing power of the dollar decreases. Those holding fixed-rate monetary
assets incur a loss, while those holding fixed-rate monetary liabilities enjoy a
gain. The nature of a bank holding company's operations is such that there will
be an excess of monetary assets over monetary liabilities, and, thus, a bank
holding company will tend to suffer from an increase in the rate of inflation
and benefit from a decrease.
YEAR 2000
The Corporation has conducted a comprehensive review of its computer
systems to identify the systems that could be affected by the Year 2000 Issue
and has developed an implementation plan to resolve the issue. The Year 2000
Issue is the result of computer programs being written using two digits rather
than four to define the applicable year. Any of the Corporation's programs that
have time-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations. The Corporation is utilizing both internal and external
resources to identify, correct and test the systems for the Year 2000
compliance. The Corporation began the testing phase during the third quarter of
1998. Core application testing should be completed by March 31, 1999.
The Corporation has contacted the companies that supply or service its
material operations to certify that their respective computer systems are Year
2000 compliant. In addition to possible expenses related to the Corporation's
systems and those of the Corporation's service providers, the Corporation could
incur losses if Year 2000 problems affect any of its depositors or borrowers.
Such problems could include delayed loan payments, due to Year 2000 problems
affecting any of its significant borrowers or impairing the payroll systems of
large employers in its market area. Because the Corporation's loan portfolio to
corporate and individual borrowers is diversified and its market area does not
depend significantly upon one employer or industry, the Corporation does not
expect any such Year 2000 related difficulties that may affect its depositors
and borrowers to significantly affect its net earnings or cash flows.
The Board of Directors reviews, on a quarterly basis, the progress in
addressing Year 2000 issues. The Corporation believes that its costs related to
upgrading systems and software for Year 2000 compliance will not exceed
$900,000. As of December 31, 1998, the Corporation has spent approximately
$625,000 in connection with Year 2000 compliance. Of the $625,000 approximately
$550,000 has been capitalized as the Corporation replaced and upgraded
non-compliant systems. Although the Corporation believes it is taking the
necessary steps to address the Year 2000 compliance issue, no assurances can be
given that some problems will not occur or that the Corporation will not incur
significant additional expenses in future periods.
WEB SITE
The Securities and Exchange Commission maintains a Web site that
contains reports, proxy and information statements and other information
regarding registrants with the commission, including the Corporation;
http://www.sec.gov is that address.
27
CONSOLIDATED BALANCE SHEET
(In Thousands, Except Share Data)
December 31,
===================================================================================================================
1998 1997
===================================================================================================================
ASSETS
Cash and due from banks .............................................. $ 33,908 $ 33,127
Federal funds sold ................................................... 37,315 9,050
----------- -----------
Cash and cash equivalents .......................................... 71,223 42,177
Interest-bearing time deposits ....................................... 855 385
Investment securities
Available for sale ................................................. 308,507 212,040
Held to maturity (fair value of $21,184 and $35,429) ............... 20,854 35,332
----------- -----------
Total investment securities ...................................... 329,361 247,372
Mortgage loans held for sale ......................................... 776 471
Loans ................................................................ 742,972 703,313
Less: Allowance for loan losses .................................... (7,412) (6,778)
----------- -----------
Net loans ........................................................ 735,560 696,535
Premises and equipment ............................................... 16,954 15,382
Federal Reserve and Federal Home Loan Bank stock ..................... 3,723 3,373
Interest receivable .................................................. 9,173 8,968
Core deposit intangibles and goodwill ................................ 3,117 1,625
Other assets ......................................................... 6,430 3,848
----------- -----------
Total assets ....................................................... $ 1,177,172 $ 1,020,136
=========== ===========
LIABILITIES
Deposits
Noninterest-bearing ................................................ $ 123,297 $ 115,613
Interest-bearing ................................................... 803,547 728,199
----------- -----------
Total deposits ................................................... 926,844 843,812
Borrowings ............................................................. 111,400 47,529
Interest payable ....................................................... 3,614 3,615
Other liabilities ...................................................... 3,817 3,211
----------- -----------
Total liabilities ................................................ 1,045,675 898,167
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY
Preferred stock, no-par value
Authorized and unissued - 500,000 shares
Common stock, $.125 stated value
Authorized - 20,000,000 shares
Issued and outstanding - 10,086,083 and 6,664,439 shares ........... 1,261 833
Additional paid-in capital ........................................... 24,969 24,140
Retained earnings .................................................... 103,076 95,449
Accumulated other comprehensive income ............................... 2,191 1,547
----------- -----------
Total stockholders' equity ......................................... 131,497 121,969
----------- -----------
Total liabilities and stockholders' equity ......................... $ 1,177,172 $ 1,020,136
=========== ===========
See Notes to Consolidated Financial Statements.
28
CONSOLIDATED STATEMENT OF INCOME
(In Thousands, Except Share Data)
Year Ended December 31,
==================================================================================================================
1998 1997 1996
==================================================================================================================
Interest Income
Loans receivable
Taxable .............................................. $ 63,062 $ 59,773 $ 52,096
Tax exempt ........................................... 201 116 90
Investment securities
Taxable .............................................. 10,858 10,818 12,832
Tax exempt ........................................... 4,582 4,320 3,832
Federal funds sold ..................................... 720 172 498
Deposits with financial institutions ................... 27 34 16
Federal Reserve and Federal Home Loan Bank stock ....... 278 242 132
-------- -------- --------
Total interest income .............................. 79,728 75,475 69,496
-------- -------- --------
Interest Expense
Deposits ............................................... 33,752 31,920 29,139
Securities sold under repurchase agreements ............ 2,015 1,563 2,137
Federal Home Loan Bank advances ........................ 1,645 949 523
Other borrowings ....................................... 638 1,293 550
-------- -------- --------
Total interest expense ............................. 38,050 35,725 32,349
-------- -------- --------
Net Interest Incomei ..................................... 41,678 39,750 37,147
Provision for loan losses .............................. 1,984 1,297 1,253
-------- -------- --------
Net Interest Income After
Provision for Loan Losses ................................ 39,694 38,453 35,894
-------- -------- --------
Other Income
Fiduciary activities ................................... 4,133 3,355 2,967
Service charges on deposit accounts .................... 3,303 3,365 3,024
Other customer fees .................................... 2,365 1,912 1,659
Net realized gains (losses) on
sales of available-for-sale securities ............... 119 (14) 148
Commission income ...................................... 1,020 309 344
Other income ........................................... 785 302 200
-------- -------- --------
Total other income ................................. 11,725 9,229 8,342
-------- -------- --------
Other Expenses
Salaries and employee benefits ......................... 15,641 14,322 13,433
Net occupancy expenses ................................. 1,832 1,620 1,537
Equipment expenses ..................................... 2,720 2,345 2,152
Marketing expense ...................................... 817 851 706
Deposit insurance expense .............................. 100 97 12
Outside data processing fees ........................... 1,061 1,077 901
Printing and office supplies ........................... 893 1,021 923
Other expenses ......................................... 4,831 4,415 4,471
-------- -------- --------
Total other expenses ............................... 27,895 25,748 24,135
-------- -------- --------
Income Before Income Tax ................................. 23,524 21,934 20,101
Income tax expense ..................................... 8,125 7,561 6,959
-------- -------- --------
Net Income ............................................... $ 15,399 $ 14,373 $ 13,142
======== ======== ========
Net Income Per Share:
Basic .................................................. $ 1.53 $ 1.44 $ 1.33
Diluted ................................................ 1.51 1.43 1.32
See Notes to Consolidated Financial Statements.
29
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollar Amounts In Thousands)
Year Ended December 31,
===========================================================================================================================
1998 1997 1996
===========================================================================================================================
Net income ................................................................ $ 15,399 $ 14,373 $ 13,142
-------- -------- --------
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 of $(487), $(424) and $601 .......................... 715 623 (882)
Less: Reclassification adjustment for (gains) losses
included in net income, net of income tax of $48, ($6) and $60 ........ (71) 8 (88)
-------- -------- --------
644 631 (970)
-------- -------- --------
Comprehensive income ...................................................... $ 16,043 $ 15,004 $ 12,172
======== ======== ========
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In Thousands, Except Share Data)
- ------------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK ACCUMULATED
---------------------- OTHER
ADDITIONAL RETAINED COMPREHENSIVE
SHARES AMOUNT PAID-IN CAPITAL EARNINGS INCOME TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Balances, January 1, 1996 ...................... 6,562,290 $ 820 $22,055 $ 80,205 $1,886 $104,966
Net income for 1996 .......................... 13,142 13,142
Cash dividends ($.59 per share) .............. (5,369) (5,369)
Other comprehensive income, net of tax ....... (970) (970)
Stock issued under employee benefit plans .... 15,175 2 296 298
Stock issued under dividend reinvestment
and stock purchase plan .................... 21,712 3 555 558
Stock options exercised ...................... 4,237 64 64
Cash paid in lieu of issuing fractional shares (95) (2) (2)
----------- ------- ------- --------- ------ --------
Balances, December 31, 1996 .................... 6,603,319 825 22,968 87,978 916 112,687
Net income for 1997 .......................... 14,373 14,373
Cash dividends ($.69 per share) .............. (6,902) (6,902)
Other comprehensive income, net of tax ....... 631 631
Stock issued under employee benefit plans .... 13,690 2 289 291
Stock issued under dividend reinvestment
and stock purchase plan .................... 23,276 3 723 726
Stock options exercised ...................... 24,154 3 160 163
----------- ------- ------- --------- ------ --------
Balances, December 31, 1997 .................... 6,664,439 833 24,140 95,449 1,547 121,969
Net income for 1998 .......................... 15,399 15,399
Cash dividends ($.77 per share) .............. (7,772) (7,772)
Other comprehensive income, net of tax ....... 644 644
Stock issued under employee benefit plans .... 14,471 2 383 385
Stock issued under dividend reinvestment
and stock purchase plan .................... 19,092 2 677 679
Stock options exercised ...................... 31,606 4 267 271
Stock redeemed ............................... (2,000) (72) (72)
Three-for-two stock split .................... 3,358,760 420 (420)
Cash paid in lieu of issuing fractional shares (285) (6) (6)
----------- ------- ------- --------- ------ --------
Balances, December 31, 1998 .................... 10,086,083 $ 1,261 $24,969 $(103,076 $2,191 $131,497
=========== ======= ======= ========= ====== ========
See Notes to Consolidated Financial Statements.
30
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands, Except Share Data)
Year Ended December 31,
====================================================================================================================================
1998 1997 1996
====================================================================================================================================
Operating Activities:
Net income ........................................................... $ 15,399 $ 14,373 $ 13,142
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for loan losses .......................................... 1,984 1,297 1,253
Depreciation and amortization ...................................... 1,970 1,810 1,626
Amortization of goodwill and intangibles ........................... 184 89 131
Deferred income tax ................................................ 28 (35) 401
Securities amortization, net ....................................... 179 236 188
Securities losses (gains), net ..................................... (119) 14 (148)
Gain on sale of premises and equipment ............................. (442)
Mortgage loans originated for sale ................................. (10,251) (7,139) (2,501)
Proceeds from sales of mortgage loans .............................. 9,946 6,952 2,952
Net change in
Interest receivable .............................................. (205) (325) 357
Interest payable ....................................................... (1) 239 (40)
Other adjustments ...................................................... (2,426) (1,050) (593)
--------- --------- ---------
Net cash provided by operating activities .............................. 16,246 16,461 16,768
--------- --------- ---------
Investing Activities:
Net change in interest-bearing deposits ............................. (470) (95) (31)
Purchases of
Securities available for sale ..................................... (184,585) (68,524) (113,473)
Securities held to maturity ............................................ (90) (2,652) (22,450)
Proceeds from maturities of
Securities available for sale ..................................... 83,556 73,786 96,441
Securities held to maturity ....................................... 14,250 15,878 35,715
Proceeds from sales of
Securities available for sale ..................................... 5,886 10,552 13,120
Net change in loans ................................................. (41,009) (73,038) (80,404)
Acquisition of insurance subsidiary ................................. (1,254)
Purchase of Federal Home Loan Bank stock ............................ (350) (283) (389)
Purchases of premises and equipment .................................... (4,447) (2,157) (2,083)
Proceeds from sale of fixed assets .................................. 1,029
Other investing activities .......................................... (104) 236 71
--------- --------- ---------
Net cash used by investing activities ............................... (127,588) (46,297) (73,483)
--------- --------- ---------
Financing Activities:
Net change in
Demand and savings deposits ....................................... 77,474 16,242 (19,168)
Certificates of deposit and other time deposits ................... 5,558 33,119 29,683
Repurchase agreements and other borrowings ............................. 41,303 (18,208) 7,659
Federal Home Loan Bank advances ..................................... 27,657 11,550 7,150
Repayment of Federal Home Loan Bank advances ........................ (5,089) (7,000)
Cash dividends ...................................................... (7,772) (6,902) (5,369)
Stock issued under employee benefit plans .............................. 385 291 298
Stock issued under dividend reinvestment
and stock purchase plan ........................................... 679 726 558
Stock options exercised ............................................. 271 163 64
Stock redeemed ...................................................... (72)
Cash paid in lieu of issuing fractional shares ...................... (6) (2)
--------- --------- ---------
Net cash provided by financing activities .............................. 140,388 36,981 13,873
--------- --------- ---------
Net Change in Cash and Cash Equivalents ................................ 29,046 7,145 (42,842)
Cash and Cash Equivalents, Beginning of Year ........................... 42,177 35,032 77,874
--------- --------- ---------
Cash and Cash Equivalents, End of Year ................................. $ 71,223 $ 42,177 $ 35,032
========= ========= =========
Additional Cash Flows Information:
Interest paid ....................................................... $ 38,051 $ 35,486 $ 32,388
Income tax paid ........................................................ 8,252 7,602 6,203
See Notes to Consolidated Financial Statements.
31
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 1
================================================================================
Nature of Operations and Summary of Significant Accounting Policies
The accounting and reporting policies of First Merchants Corporation
("Corporation"), and its wholly owned subsidiaries, First Merchants Bank, N.A.
("First Merchants"), Pendleton Banking Company ("Pendleton"), and its subsidiary
First Merchants Insurance Services, Inc., First United Bank ("First United"),
The Randolph County Bank ("Randolph County"), and Union County National Bank
("Union County"), (collectively "the Banks"), conform to generally accepted
accounting principles and reporting practices followed by the banking industry.
The more significant of the policies are described below.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The Corporation is a bank holding company whose principal activity is the
ownership and management of the Banks. First Merchants and Union County operate
under national bank charters and provide full banking services, including trust
services. As national banks, First Merchants and Union County are subject to the
regulation of the Office of the Comptroller of the Currency and the Federal
Deposit Insurance Corporation ("FDIC"). Pendleton, First United and Randolph
County operate under state bank charters and provide full banking services,
including trust services. As state banks, Pendleton, First United and Randolph
County are subject to the regulation of the Department of Financial
Institutions, State of Indiana, and the FDIC.
The Banks generate commercial, mortgage, and consumer loans and receive
deposits from customers located primarily in central and east central Indiana
and Butler County, Ohio. The Banks' loans are generally secured by specific
items of collateral, including real property, consumer assets, and business
assets. Although the Banks have a diversified loan portfolio, a substantial
portion of their debtors' ability to honor their contracts is dependent upon
economic conditions in the automotive and agricultural industries.
Consolidation
The consolidated financial statements include the accounts of the
Corporation and the Banks, after elimination of all material intercompany
transactions.
Investment Securities
Debt securities are classified as held to maturity when the Corporation has
the positive intent and ability to hold the securities to maturity. Securities
held to maturity are carried at amortized cost.
Debt securities not classified as held to maturity are classified as
available for sale. Securities available for sale are carried at fair value with
unrealized gains and losses reported as accumulated other comprehensive income
in stockholders' equity, net of tax.
Amortization of premiums and accretion of discounts are recorded as
interest income from securities. Realized gains and losses are recorded as net
security gains (losses). Gains and losses on sales of securities are determined
on the specific-identification method.
Loans Held for Sale are carried at the lower of aggregate cost or market. Market
is determined using the aggregate method. Net unrealized losses are recognized
through a valuation allowance by charges to income.
Loans are carried at the principal amount outstanding. Certain nonaccrual and
substantially delinquent loans may be considered to be impaired. A loan is
impaired when, based on current information or events, it is probable that the
Banks will be unable to collect all amounts due (principal and interest)
according to the contractual terms of the loan agreement. In applying the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 114, the
Corporation considers its investment in one-to-four family residential loans and
consumer installment loans to be homogeneous and therefore excluded from
separate identification for evaluation of impairment. Interest income is accrued
on the principal balances of loans, except for installment loans with add-on
interest, for which a method that approximates the level yield method is used.
The accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest is reversed when
considered uncollectible. Interest income is subsequently recognized only to the
extent cash payments are received.
Certain loan fees and direct costs are being deferred and amortized as an
adjustment of yield on the loans.
Allowance for Loan Losses is maintained to absorb potential loan losses based on
management's continuing review and evaluation of the loan portfolio and its
judgment as to the impact of economic conditions on the portfolio. The
evaluation by management includes consideration of past loan loss experience,
changes in the composition of the loan portfolio, the current condition and
amount of loans outstanding, and the probability of collecting all amounts due.
Impaired loans are measured by the present value of expected future cash flows,
or the fair value of the collateral of the loans, if collateral dependent.
The determination of the adequacy of the allowance for loan losses is based
on estimates that are particularly susceptible to significant changes in the
economic environment and market conditions. Management believes that, as of
December 31, 1998, the allowance for loan losses is adequate based on
information currently available. A worsening or protracted economic decline in
the area within which the Corporation operates would increase the likelihood of
additional losses due to credit and market risks and could create the need for
additional loss reserves.
32 continued
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)s
================================================================================
NOTE 1
================================================================================
Nature of Operations and Summary of Significant Accounting Policies continued
Premises and Equipment are carried at cost net of accumulated depreciation.
Depreciation is computed using the straight-line and declining balance methods
based on the estimated useful lives of the assets. Maintenance and repairs are
expensed as incurred, while major additions and improvements are capitalized.
Gains and losses on dispositions are included in current operations.
Federal Reserve and Federal Home Loan Bank Stock are required investments for
institutions that are members of the Federal Reserve Bank ("FRB") and Federal
Home Loan Bank ("FHLB") systems. The required investment in the common stock is
based on a predetermined formula.
Intangible Assets are being amortized on the straight-line basis over periods
ranging from 7 to 25 years. Such assets are periodically evaluated as to the
recoverability of their carrying value.
Income Tax in the consolidated statement of income includes deferred income tax
provisions or benefits for all significant temporary differences in recognizing
income and expenses for financial reporting and income tax purposes. The
Corporation files consolidated income tax returns with its subsidiaries.
Stock Options are granted for a fixed number of shares to employees with an
exercise price equal to the fair value of the shares at the date of grant. The
Corporation accounts for and will continue to account for stock option grants in
accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees,
and accordingly, recognizes no compensation expense for the stock option grants.
Earnings Per Share have been computed based upon the weighted average common and
common equivalent shares outstanding during each year and have been restated to
give effect to a three-for-two stock split distributed to stockholders on
October 23, 1998.
Reclassifications of certain amounts in the prior years consolidated financial
statements have been made to conform to the 1998 presentation.
================================================================================
NOTE 2
================================================================================
Business Combinations
On August 20, 1998, the Corporation signed a definitive agreement to
acquire all of the outstanding shares of Jay Financial Corporation, Portland,
Indiana. Under terms of the agreement, the Corporation will issue approximately
1,099,000 shares of its common stock. The transaction will be accounted for
under the pooling-of-interests method of accounting and is subject to approval
by appropriate regulatory agencies. Although the Corporation anticipates that
the merger will be consummated during the second quarter of 1999, there can be
no assurance that the acquisition will be completed. At December 31, 1997, Jay
Financial Corporation, had total assets and stockholders' equity of $104,977,000
and $13,627,000, respectively.
On October 27, 1998, the Corporation signed a definitive agreement to
acquire all of the outstanding shares of Anderson Community Bank, Anderson,
Indiana. Under terms of the agreement, the Corporation will issue approximately
811,000 shares of its common stock. The transaction will be accounted for under
the pooling-of-interests method of accounting and is subject to approval by
appropriate regulatory agencies. Although the Corporation anticipates that the
merger will be consummated during the second quarter of 1999, there can be no
assurance that the acquisition will be completed. At December 31, 1997, Anderson
Community Bank had total assets and stockholders' equity of $62,836,000 and
$6,448,000, respectively. The Anderson Community Bank will merge with Pendleton
to form the Madison Community Bank.
On August 1, 1996, the Corporation issued 1,414,028 shares of its common
stock in exchange for all of the outstanding shares of Union National Bancorp,
Liberty, Indiana. On October 2, 1996, the Corporation issued 848,558 shares of
its common stock in exchange for all of the outstanding shares of Randolph
County Bancorp, Winchester, Indiana. These transactions were accounted for under
the pooling-of-interests method of accounting. The financial information
contained herein reflects the mergers and reports the financial condition and
results of operations as though the Corporation had been combined as of January
1, 1996. Separate operating results of Union National Bancorp and Randolph
County Bancorp for the periods prior to the merger were as follows on page 34:
33
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 2
================================================================================
Business Combinations continued
================================================================================
1996
================================================================================
Net interest income:
First Merchants Corporation ............................ $33,060
Union National Bancorp ................................. 2,961
Randolph County Bancorp ................................ 1,126
-------
Combined ......................................... $37,147
=======
Net income:
First Merchants Corporation ............................ $11,556
Union National Bancorp ................................. 974
Randolph County Bancorp ................................ 612
-------
Combined ......................................... $13,142
=======
Net income per share:
Basic:
First Merchants Corporation ......................... $ 1.17
Union National Bancorp .............................. .10
Randolph County Bancorp ............................. .06
-------
Combined ......................................... $ 1.33
=======
Diluted:
First Merchants Corporation ......................... $ 1.16
Union National Bancorp .............................. .10
Randolph County Bancorp ............................. .06
-------
Combined ......................................... $ 1.32
=======
================================================================================
NOTE 3
================================================================================
Restriction on Cash and Due from Banks
The Banks are required to maintain reserve funds in cash and/or on deposit with
the Federal Reserve Bank. The reserve required at December 31, 1998, was
$12,229,000.
34
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
====================================================================================================================================
NOTE 4
====================================================================================================================================
Investment Securities
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Available for sale at December 31, 1998
U.S. Treasury ........................................... $ 20,269 $ 95 $ 20,364
Federal agencies ........................................ 52,598 577 $ 19 53,156
State and municipal ..................................... 86,537 2,620 4 89,153
Mortgage-backed securities .............................. 126,329 424 183 126,570
Other asset-backed securities ........................... 265 1 11 255
Corporate obligations ................................... 18,624 143 8 18,759
Marketable equity securities ............................ 250 250
-------- -------- -------- --------
Total available for sale ............................. 304,872 3,860 225 308,507
-------- -------- -------- --------
Held to maturity at December 31, 1998
U.S. Treasury ........................................... 249 4 253
Federal agencies ........................................ 500 1 501
State and municipal ..................................... 17,480 348 1 17,827
Mortgage-backed securities .............................. 864 3 867
Other asset-backed securities ........................... 1,761 2 27 1,736
-------- -------- -------- --------
Total held to maturity ............................... 20,854 358 28 21,184
-------- -------- -------- --------
Total investment securities .......................... $325,726 $ 4,218 $ 253 $329,691
======== ======== ======== ========
Available for sale at December 31, 1997
U.S. Treasury ........................................... $ 19,207 $ 104 $ 11 $ 19,300
Federal agencies ........................................ 66,783 405 48 67,140
State and municipal ..................................... 67,842 1,815 28 69,629
Mortgage-backed securities ................................. 36,682 362 86 36,958
Other asset-backed securities ........................... 487 2 54 435
Corporate obligations ................................... 18,219 139 30 18,328
Marketable equity securities ............................ 250 250
-------- -------- -------- --------
Total available for sale ............................. 209,470 2,827 257 212,040
-------- -------- -------- --------
Held to maturity at December 31, 1997
U.S. Treasury ........................................... 249 2 247
Federal agencies ........................................ 3,412 6 1 3,417
State and municipal ..................................... 26,206 252 2 26,456
Mortgage-backed securities ................................. 1,255 4 1 1,258
Other asset-backed securities ........................... 4,210 7 166 4,051
-------- -------- -------- --------
Total held to maturity ............................... 35,332 269 172 35,429
-------- -------- -------- --------
Total investment securities .......................... $244,802 $ 3,096 $ 429 $247,469
======== ======== ======== ========
The amortized cost and fair value of securities held to maturity and
available for sale at December 31, 1998, by contractual maturity, are shown on
the following page. Expected maturities will differ from contractual maturities
because issuers may have the right to call or prepay obligations with or without
call or prepayment penalties.
continued
35
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 4
================================================================================
Investment Securities continued
- ------------------------------------------------------------------------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY
AMORTIZED COST FAIR VALUE AMORTIZED COST FAIR VALUE
- ------------------------------------------------------------------------------------------------------------
Maturity distribution at December 31, 1998:
Due in one year or less .............. $ 52,579 $ 52,837 $ 5,370 $ 5,397
Due after one through five years ..... 93,213 94,927 10,741 11,003
Due after five through ten years ..... 26,830 28,047 1,638 1,701
Due after ten years .................. 5,406 5,621 480 480
-------- -------- -------- --------
178,028 181,432 18,229 18,581
Mortgage-backed securities ........... 126,329 126,570 864 867
Other asset-backed securities ........ 265 255 1,761 1,736
Marketable equity securities ......... 250 250
-------- -------- -------- --------
Totals ............................. $304,872 $308,507 $ 20,854 $ 21,184
======== ======== ======== ========
Securities with a carrying value of approximately $144,863,000 and $92,991,000
were pledged at December 31, 1998 and 1997, to secure certain deposits and
securities sold under repurchase agreements, and for other purposes as permitted
or required by law.
In addition, all otherwise unpledged securities are pledged as collateral
for Federal Home Loan Bank advances with qualified first mortgage loans.
Proceeds from sales of securities available for sale during 1998, 1997 and
1996 were $5,886,000, $10,552,000, and $13,120,000. Gross gains of $119,000 and
$148,000 in 1998 and 1996 and gross losses of $14,000 in 1997 were realized on
those sales.
================================================================================
NOTE 5
================================================================================
Loans and Allowance
============================================================================================
1998 1997
============================================================================================
Loans at December 31:
Commercial and industrial loans ................................ $ 169,685 $ 148,281
Bankers' acceptances and loans to financial institutions ....... 900 705
Agricultural production financing and other loans to farmers ... 16,661 16,764
Real estate loans:
Construction ............................................... 26,426 21,389
Commercial and farmland .................................... 95,172 97,503
Residential ................................................ 302,680 287,072
Individuals' loans for household and other personal expenditures 128,253 125,706
Tax-exempt loans ............................................... 2,115 2,598
Other loans .................................................... 1,217 3,782
--------- ---------
743,109 703,800
Unearned interest on loans ..................................... (137) (487)
--------- ---------
Total loans ................................................ $ 742,972 $ 703,313
========= =========
============================================================================================
1998 1997 1996
============================================================================================
Allowance for loan losses:
Balance, January 1............................... $ 6,778 $ 6,622 $(6,696)
Provision for losses............................. 1,984 1,297 1,253
Recoveries on loans.............................. 531 468 309
Loans charged off................................ (1,881) (1,609) (1,636)
------- ------- -------
Balance, December 31............................. $ 7,412 $ 6,778 $6,622
======= ======= ======
continued
36
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 5
================================================================================
Loans and Allowance continued
Information on impaired loans is summarized below:
================================================================================
1998 1997 1996
================================================================================
As of, and for, the year ending December 31:
Impaired loans with an allowance ................. $1,946 $1,476 $3,124
Impaired loans for which the discounted
cash flows or collateral value exceeds the
carrying value of the loan ................... 6,882 1,075 868
------ ------ ------
Total impaired loans ....................... $8,828 $2,551 $3,992
====== ====== ======
Allowance for impaired loans (included in the
Corporation's allowance for loan losses) ..... $ 712 $ 407 $1,092
Average balance of impaired loans ................ 8,318 3,414 5,213
Interest income recognized on impaired loans ..... 873 180 311
Cash basis interest included above ............... 745 162 291
The Banks have entered into transactions with certain directors, executive
officers, significant stockholders, and their affiliates or associates ("related
parties"). Such transactions were made in the ordinary course of business on
substantially the same terms and conditions, including interest rates and
collateral, as those prevailing at the same time for comparable transactions
with other customers, and did not, in the opinion of management, involve more
than normal credit risk or present other unfavorable features.
The aggregate amount of loans, as defined, to such related parties is as
shown on the right:
================================================================================
================================================================================
Balances, January 1, 1998 ... $ 12,433
New loans,
including renewals ....... 5,440
Payments, etc.,
including renewals ....... (5,432)
--------
Balances, December 31, 1998 . $ 12,441
========
================================================================================
NOTE 6
================================================================================
Premises and Equipment
================================================================================
1998 1997
================================================================================
Cost at December 31:
Land .......................................... $ 2,991 $ 2,826
Buildings and leasehold improvements .......... 15,660 13,723
Equipment ..................................... 16,385 15,320
-------- --------
Total cost .............................. 35,036 31,869
Accumulated depreciation ......................... (18,082) (16,487)
-------- --------
Net ..................................... $ 16,954 $ 15,382
======== ========
The Corporation is committed under various noncancelable lease contracts
for certain subsidiary office facilities. Total lease expense for 1998, 1997 and
1996 was $204,000, $141,000, and $134,000, respectively. The future minimum
rental commitments required under the operating leases in effect at December 31,
1998, expiring at various dates through the year 2016, follow on the right for
the years ending December 31:
================================================================================
================================================================================
1999 ........................................................... $180
2000 ........................................................... 159
2001 ........................................................... 116
2002 ........................................................... 99
2003 ........................................................... 48
After 2003 ..................................................... 177
----
Total future minimum obligations ............................ $779
====
37
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 7
================================================================================
Deposits
================================================================================
1998 1997
================================================================================
Deposits at December 31:
Demand deposits .................................. $261,708 $234,905
Savings deposits ................................. 227,624 176,953
Certificates and other time deposits
of $100,000 or more ............................ 91,579 104,100
Other certificates and time deposits ............. 345,933 327,854
-------- --------
Total deposits ............................... $926,844 $843,812
======== ========
================================================================================
================================================================================
Certificates and other time deposits maturing in years ending December 31:
1999............... $302,973
2000............... 87,437
2001............... 26,694
2002 .............. 13,270
2003............... 5,863
After 2003 ........ 1,275
--------
$437,512
========
================================================================================
NOTE 8
================================================================================
Borrowings
================================================================================
1998 1997
================================================================================
Borrowings at December 31:
Securities sold under repurchase agreements ....... $ 48,836 $ 15,398
Federal funds purchased ........................... 17,070 4,070
U. S. Treasury demand notes ....................... 2,226 7,361
Federal Home Loan Bank advances ................... 43,268 20,700
-------- --------
Total borrowings .............................. $111,400 $ 47,529
======== ========
Securities sold under repurchase agreements consist of obligations of the
Banks to other parties. The obligations are secured by U.S. Treasury, Federal
agency obligations and corporate asset-backed securities. The maximum amount of
outstanding agreements at any month-end during 1998 and 1997 totaled $78,302,000
and $33,802,000, and the average of such agreements totaled $36,506,000 and
$31,327,000.
Maturities of Federal Home Loan Bank advances and securities sold under
repurchase agreements as of December 31, 1998 are as follows:
Federal Home Loan Securities Sold Under
Bank Advances Repurchase Agreements
- --------------------------------------------------------------------------------------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
AMOUNT INTEREST RATE AMOUNT INTEREST RATE
- --------------------------------------------------------------------------------------------------------
Maturities in years ending December 31
1999 ................................. $19,150 5.45% $20,836 5.07%
2000 ................................. 2,850 5.84 11,700 5.69
2001 ................................. 6,000 5.44 2,500 5.73
2002 ................................. 150 7.07
2003 ................................. 3,000 5.26 13,800 5.80
After 2003............................. 12,118 6.26
------- ---- ------- ----
Total ............................... $43,268 5.69 $48,836 5.46
======= ==== ======= ====
The terms of a security agreement with the FHLB require the Corporation to
pledge, as collateral for advances, qualifying first mortgage loans and all
otherwise unpledged investment securities in an amount equal to at least 160
percent of these advances. Advances are subject to restrictions or penalties in
the event of prepayment.
38
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 9
================================================================================
Loan Servicing
Mortgage loans serviced for others are not included in the accompanying
consolidated balance sheet. The loans are serviced primarily for the Federal
Home Loan Mortgage Corporation and the unpaid balances totaled $15,541,000 and
$11,877,000 at December 31, 1998 and 1997.
The Corporation has adopted SFAS No. 122, Accounting for Mortgage Servicing
Rights. The adoption of this statement has had no material impact on the
Corporation's financial condition and results of operations for all years
presented.
================================================================================
NOTE 10
================================================================================
Income Tax
==================================================================================================
1998 1997 1996
==================================================================================================
Income tax expense, for the year ended December 31:
Currently payable:
Federal ..................................... $ 6,090 $ 5,702 $ 4,903
State ....................................... 2,007 1,894 1,655
Deferred:
Federal ..................................... 38 (21) 336
State ....................................... (10) (14) 65
------- ------- -------
Total income tax expense ................. $ 8,125 $ 7,561 $ 6,959
======= ======= =======
Reconciliation of federal statutory to actual tax expense:
Federal statutory income tax at 34% ............ $ 7,998 $ 7,458 $ 6,834
Tax-exempt interest ............................ (1,311) (1,257) (1,140)
Graduated tax rates ............................ 173
Effect of state income taxes ................... 1,318 1,241 1,135
Other .......................................... (53) 119 130
------- ------- -------
Actual tax expense ....................... $ 8,125 $ 7,561 $ 6,959
======= ======= =======
Tax expense (benefit) applicable to security gains and losses for the years
ended December 31, 1998, 1997 and 1996, was $47,600, $(5,700) and $60,000,
respectively.
A cumulative net deferred tax asset is included in other assets. The components
of the asset are as follows:
================================================================================
1998 1997
================================================================================
Deferred tax asset at December 31:
Assets:
Differences in accounting for loan losses ............... $3,042 $2,692
Deferred compensation ................................... 344 313
Differences in accounting for pensions
and other employee benefits .......................... 84 183
------ ------
Total assets ...................................... 3,470 3,188
------ ------
Liabilities:
Differences in depreciation methods ..................... 968 1,012
Differences in accounting for loans and securities ...... 206 125
Differences in accounting for loan fees ................. 228 28
Net unrealized gain on securities available for sale .... 1,444 1,023
State income tax ........................................ 141 146
Other ................................................... 91 69
------ ------
Total liabilities ................................. 3,078 2,403
------ ------
Net deferred tax asset ............................ $ 392 $ 785
====== ======
39
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 11
================================================================================
Commitments and Contingent Liabilities
In the normal course of business, there are outstanding commitments and
contingent liabilities, such as commitments to extend credit and standby letters
of credit, which are not included in the accompanying financial statements. The
Banks' exposure to credit loss in the event of nonperformance by the other party
to the financial instruments for commitments to extend credit and standby
letters of credit is represented by the contractual or notional amount of those
instruments. The Banks use the same credit policies in making such commitments
as they do for instruments that are included in the consolidated balance sheet.
=============================================
1998 1997
=============================================
Commitments
to extend credit $185,879 $138,828
Standby letters
of credit 4,310 4,649
- ---------------------------------------------
Financial instruments whose contract amount represents credit risk as of
December 31, were as follows: Commitments to extend credit are agreements to
lend to a customer, as long as there is no violation of any condition
established in the contract. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Banks evaluate each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Banks upon extension
of credit, is based on management's credit evaluation. Collateral held varies,
but may include accounts receivable, inventory, property and equipment, and
income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Banks
to guarantee the performance of a customer to a third party.
The Corporation and subsidiaries are also subject to claims and lawsuits
which arise primarily in the ordinary course of business. It is the opinion of
management that the disposition or ultimate resolution of such claims and
lawsuits will not have a material adverse effect on the consolidated financial
position of the Corporation.
================================================================================
NOTE 12
================================================================================
Year 2000
Like all entities, the Corporation and subsidiaries are exposed to risks
associated with the Year 2000 Issue, which affects computer software and
hardware; transactions with customers, vendors and entities; and equipment
dependent upon microchips. The Company has begun, but not yet completed, the
process of remediating potential Year 2000 problems. It is not possible for any
entity to guarantee the results of its own remediation efforts or to accurately
predict the impact of the Year 2000 Issue on third parties with which the
Company and subsidiaries do business. If remediation efforts of the Company or
third parties with which the Company and subsidiaries do business are not
successful, the Year 2000 Issue could have negative effects on the Company's
financial condition and results of operations in the near term.
================================================================================
NOTE 13
================================================================================
Stockholders' Equity
National and state banking laws restrict the maximum amount of dividends
that a bank may pay in any calendar year. National and state banks are limited
to the bank's retained net income (as defined) for the current year plus those
for the previous two years. The amount at December 31, 1998, available for 1999
dividends to the Corporation is $23,878,000. The subsidiaries restrict dividends
to a lesser amount because of the need to maintain an adequate capital
structure.
Total stockholders' equity for all subsidiaries at December 31, 1998, was
$129,067,000, of which $105,189,000 was restricted from dividend distribution to
the Corporation.
The Corporation has a Dividend Reinvestment and Stock Purchase Plan,
enabling stockholders to elect to have their cash dividends on all shares held,
automatically reinvested in additional shares of the Corporation's common stock.
In addition, stockholders may elect to make optional cash payments up to an
aggregate of $2,500 per quarter for the purchase of additional shares of common
stock. The stock is credited to participant accounts at fair market value.
Dividends are reinvested on a quarterly basis. At December 31, 1998, there were
543,913 shares of common stock reserved for purchase under the plan.
On August 11, 1998, the Board of Directors of the Corporation declared a
three-for-two stock split on its common shares. The new shares were distributed
on October 23, 1998, to holders of record on October 16, 1998.
40
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 14
================================================================================
Regulatory Capital
The Corporation and Banks are subject to various regulatory capital
requirements administered by the federal banking agencies and are assigned to a
capital category. The assigned capital category is largely determined by three
ratios that are calculated according to the regulations: total risk adjusted
capital, Tier 1 capital, and Tier 1 leverage ratios. The ratios are intended to
measure capital relative to assets and credit risk associated with those assets
and off-balance sheet exposures of the entity. The capital category assigned to
an entity can also be affected by qualitative judgments made by regulatory
agencies about the risk inherent in the entity's activities that are not part of
the calculated ratios.
There are five capital categories defined in the regulations, ranging from
well capitalized to critically undercapitalized. Classification of a bank in any
of the undercapitalized categories can result in actions by regulators that
could have a material effect on a bank's operations.
At December 31, 1998, the management of the Corporation believes that it
meets all capital adequacy requirements to which it is subject. The most recent
notifications from the regulatory agencies categorized the Corporation and Banks
as well capitalized under the regulatory framework for prompt corrective action.
To be categorized as well capitalized, the Corporation and Banks must maintain a
minimum total capital to risk-weighted assets, Tier I capital to risk-weighted
assets and Tier I capital to average assets of 10 percent, 6 percent and 5
percent, respectively. There have been no conditions or events since that
notification that management believes have changed this categorization.
Actual and required capital amounts and ratios are as follows:
====================================================================================================================================
1998 1997
====================================================================================================================================
REQUIRED FOR REQUIRED FOR
ACTUAL ADEQUATE CAPITAL (1) ACTUAL ADEQUATE CAPITAL (1)
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------------------------------
December 31
Total Capital (1) (to risk-weighted assets)
Consolidated............................... $133,762 16.9% $ 63,206 8.0% $125,762 17.9% $ 56,166 8.0%
First Merchants ........................... 79,685 15.7 40,678 8.0 75,539 17.4 34,756 8.0
Pendleton ................................. 13,486 18.5 5,844 8.0 12,256 17.4 5,628 8.0
First United .............................. 8,069 18.5 3,484 8.0 7,570 18.2 3,332 8.0
Randolph County ........................... 10,574 18.2 4,640 8.0 10,278 15.1 5,448 8.0
Union County .............................. 19,375 16.4 9,451 8.0 18,075 17.0 8,498 8.0
Tier I Capital (1) (to risk-weighted assets)
Consolidated............................... $126,350 16.0% $ 31,603 4.0% $118,984 16.9% $ 28,083 4.0%
First Merchants ........................... 75,752 14.9 20,338 4.0 71,900 16.6 17,378 4.0
Pendleton ................................. 12,701 17.4 2,922 4.0 11,506 16.4 2,814 4.0
First United .............................. 7,599 17.5 1,742 4.0 7,133 17.1 1,666 4.0
Randolph County ........................... 9,848 17.0 2,320 4.0 9,548 14.0 2,724 4.0
Union County .............................. 17,966 15.2 4,726 4.0 16,852 15.9 4,249 4.0
Tier I Capital (1) (to average assets)
Consolidated............................... $126,350 11.9% $ 42,464 4.0% $118,984 11.9% $ 40,010 4.0%
First Merchants ........................... 75,752 10.8 27,981 4.0 71,900 11.7 24,548 4.0
Pendleton ................................. 12,701 12.4 4,092 4.0 11,506 11.8 3,897 4.0
First United .............................. 7,599 11.5 2,646 4.0 7,133 11.5 2,481 4.0
Randolph County ........................... 9,848 13.0 3,042 4.0 9,548 14.0 2,733 4.0
Union County .............................. 17,966 8.6 8,362 4.0 16,852 9.1 7,438 4.0
(1) As defined by regulatory agencies
continued 41
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 15
================================================================================
Employee Benefit Plans
The Corporation's defined-benefit pension plans cover substantially all of
the Banks' employees. The benefits are based primarily on years of service and
employees' pay near retirement. Contributions are intended to provide not only
for benefits attributed to service-to-date, but also for those expected to be
earned in the future.
The table below sets forth the plans' funded status and amounts recognized
in the consolidated balance sheet at December 31:
December 31
================================================================================
1998 1997
================================================================================
Change in benefit obligation
Benefit obligation at beginning of year ........... $ 14,454 $ 13,060
Service cost ...................................... 688 624
Interest cost ..................................... 1,044 956
Actuarial gain .................................... 793 388
Benefits paid ..................................... (660) (574)
-------- --------
Benefit obligation at end of year ................. 16,319 14,454
-------- --------
Change in plan assets
Fair value of plan assets at beginning of year .... 18,865 15,188
Actual return of plan assets ...................... 1,038 4,251
Benefits paid ..................................... (660) (574)
-------- --------
Fair value of plan assets at end of year .......... 19,243 18,865
-------- --------
Funded status ..................................... 2,924 4,411
Unrecognized net actuarial gain ................... (2,579) (4,169)
Unrecognized prior service cost ................... (144) (156)
Unrecognized transition asset ..................... (480) (617)
-------- --------
Accrued benefit cost .............................. $ (279) $ (531)
======== ========
==============================================================================================
1998 1997 1996
==============================================================================================
Pension expense (benefit) includes the following components:
Service cost-benefits earned during the year ............ $ 688 $ 624 $ (537
Interest cost on projected benefit obligation ........... 1,044 956 921
Actual return on plan assets ............................ (1,038) (4,251) (1,966)
Net amortization and deferral ........................... (946) 2,810 699
------- ------- -------
Total pension expense (benefit) ...................... $ (252) $ 139 $ 191
======= ======= =======
==============================================================================================
1998 1997 1996
==============================================================================================
Assumptions used in the accounting as of December 31 were:
Discount rate ........................................... 6.77% 7.40% 7.50%
Rate of increase in compensation ........................ 4.00% 4.50% 4.50%
Expected long-term rate of return on assets ............. 9.00% 9.00% 8.75%
Randolph County employees participated in a defined-benefit pension plan,
which is included in the above disclosures. This plan was merged with the
Corporation's plan as of December 31, 1996. Randolph County's plan assumptions
used in the accounting were different than the Corporation's plan assumptions.
However, the differences do not have a material impact on the disclosures
presented.
In 1989, stockholders approved the 1989 Stock Option Plan, reserving
253,125 shares of Corporation common stock for the granting of options to
certain employees. The exercise price of the shares may not be less than the
fair market value of the shares upon grant of the option. Options become 100
percent vested when granted and are fully exercisable generally six months after
the date of grant, for a period of ten years. There were no shares available for
grant at December 31, 1998.
42 continued
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 15
================================================================================
Employee Benefit Plans continued
On March 31, 1994, stockholders approved the 1994 Stock Option Plan,
reserving 472,500 shares of Corporation common stock for the granting of options
to certain employees and non-employee directors. The exercise price of the
shares may not be less than the fair market value of the shares upon the grant
of the option. Options become 100 percent vested when granted and are fully
exercisable generally six months after the date of the grant, for a period of
ten years. There were 34,829 shares available for grant at December 31, 1998.
The table below is a summary of the status of the Corporation's stock
option plans and changes in those plans as of and for the years ended December
31, 1998, 1997 and 1996. The number of shares and prices have been restated to
give effect to the Corporation's 1998 stock split.
Year Ended December 31,
==============================================================================================================================
1998 1997 1996
==============================================================================================================================
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
- ------------------------------------------------------------------------------------------------------------------------------
Outstanding, beginning of year ... 447,577 $14.98 408,127 $12.89 334,532 $12.05
Granted .......................... 97,645 28.64 96,375 20.91 79,950 16.18
Exercised ........................ (67,628) 12.99 (56,925) 9.99 (6,355) 10.11
Cancelled ........................ (862) 28.71
------- ------- -------
Outstanding, end of year ......... 476,732 $18.04 447,577 $14.98 408,127 $12.89
======= ======= =======
Options exercisable at year end .. 376,949 348,652 324,925
Weighted-average fair value of
options granted during the year $ 5.95 $ 4.21 $ 3.39
As of December 31, 1998, other information by exercise price range for options
outstanding and exercisable is as follows:
OUTSTANDING EXERCISABLE
- ---------------------------------------------------------------------------- ------------------------------
EXERCISE PRICE NUMBER WEIGHTED-AVERAGE WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
RANGE OF SHARES EXERCISE PRICE REMAINING CONTRACTURAL LIFE OF SHARES EXERCISE PRICE
- ---------------------------------------------------------------------------- ------------------------------
$ 6.07 - $14.39 166,589 $11.72 4.4 years 166,589 $11.72
15.39 - 20.92 213,360 18.16 7.7 years 207,360 18.17
24.67 - 30.44 96,783 28.63 9.6 years 3,000 26.13
------- -------
476,732 $18.04 6.9 years 376,949 $15.38
======= =======
- ------------------------------------------------------------------------------------------------------------------
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. The exercise price of each option was
equal to the market price of the Corporation's stock on the date of grant;
therefore, no compensation expense was recognized.
Although the Corporation has elected to follow APB No. 25, SFAS No. 123
requires pro forma disclosures of net income and earnings per share as if the
Corporation had accounted for its employee stock options under that Statement.
The fair value of each option grant was estimated on the grant date using an
option-pricing model with the following assumptions:
================================================================================
1998 1997 1996
================================================================================
Risk-free interest rates ............ 5.45% 6.54% 6.66%
Dividend yields ..................... 3.25% 3.37% 3.41%
Volatility factors of expected
market price common stock ....... 17.19% 11.20% 12.00%
Weighted-average expected
life of the options ............. 8.50 years 8.50 years 8.50 years
- --------------------------------------------------------------------------------
continued
43
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 15
================================================================================
Employee Benefit Plans continued
Under SFAS No. 123, compensation cost is recognized in the amount of the
estimated fair value of the options and amortized to expense over the options'
vesting period. The pro forma effect on net income and earnings per share of
this statement are shown on the right:
================================================================================
1998 1997 1996
================================================================================
Net Income
As reported ............. $15,399 $14,373 $13,142
Pro Forma ............... 14,650 13,948 12,852
Earnings per share
Basic:
As reported ............. $ 1.53 $ 1.44 $ 1.33
Pro forma ............... 1.46 1.40 1.30
Diluted:
As reported ............. $ 1.51 $ 1.43 $ 1.32
Pro forma ............... 1.44 1.38 1.29
In 1994, the stockholders approved the 1994 Employee Stock Purchase Plan,
enabling eligible employees to purchase the Corporation's common stock. A total
of 253,125 shares of the Corporation's common stock are reserved for issuance
persuant to the plan. The price of the stock to be paid by the employees is
determined by the Corporation's compensation committee, but may not be less than
85 percent of the lesser of the fair market value of the Corporation's common
stock at the beginning or at the end of the offering period. Common stock
purchases are made annually and are paid through advance payroll deductions of
up to 20 percent of eligible compensation. Participants under the plan purchased
21,706 shares in 1998 at $17.71 per share. The fair market value per share on
the purchase date was $30.44.
At December 31, 1998, there were 162,977 shares of Corporation common stock
reserved for purchase under the plan, and $444,000 has been withheld from
compensation, plus interest, toward the purchase of shares after June 30, 1999,
the end of the annual offering period.
The Corporation's Employee Stock Purchase Plan is accounted for in
accordance with APB No. 25. Although the Corporation has elected to follow APB
No. 25, SFAS No. 123 requires pro forma disclosures of net income and earnings
per share as if the Corporation had accounted for the purchased shares under
that statement. The pro forma disclosures are included in the table above and
were estimated using an option pricing model with the following assumptions for
1998, 1997 and 1996, respectively: dividend yield of 3.25, 3.37 and 3.41
percent; an expected life of one year for all years; expected volatility of
17.19, 11.20 and 12.00 percent; and risk-free interest rates of 5.41, 6.54 and
6.66 percent. The fair value of those purchase rights granted in 1998, 1997 and
1996 was $12.69, $5.03 and $4.68, respectively.
The Banks have retirement savings 401(k) plans in which substantially all
employees may participate. The Banks match employees' contributions at the rate
of 25-50 percent for the first 5-6 percent of base salary contributed by
participants. The Banks' expense for the plans was $108,000 for 1998, $110,000
for 1997, and $92,000 for 1996.
================================================================================
NOTE 16
================================================================================
Net Income Per Share
Year Ended December 31,
============================================================================================================
1998 1997
============================================================================================================
WEIGHTED-AVERAGE PER SHARE WEIGHTED-AVERAGE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
- ------------------------------------------------------------------------------------------------------------
Basic net income per share:
Net income available to
common stockholders .......... $15,399 10,045,502 $ 1.53 $14,373 9,950,303 $ 1.44
====== ======
Effect of dilutive stock options . 155,568 135,157
------- ---------- ------- ----------
Diluted net income per share:
Net income available to
common stockholders
and assumed conversions ...... $15,399 10,201,070 $ 1.51 $14,373 10,085,460 $ 1.43
======= ========== ====== ======= ========== ======
=====================================================================
1996
=====================================================================
WEIGHTED-AVERAGE PER SHARE
INCOME SHARES AMOUNT
- ---------------------------------------------------------------------
Basic net income per share:
Net income available to
common stockholders .......... $13,142 9,871,751 $ 1.33
======
Effect of dilutive stock options . 99,556
------- ---------
Diluted net income per share:
Net income available to
common stockholders
and assumed conversions ...... $13,142 9,971,307 $ 1.32
======= ========= ======
44
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 17
================================================================================
Fair Values of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument:
Cash and Cash Equivalents
The fair value of cash and cash equivalents approximates carrying value.
Interest-Bearing Time Deposits
The fair value of interest-bearing time deposits approximates carrying value.
Investment Securities
Fair values are based on quoted market prices.
Mortgage Loans Held for Sale
The fair value of mortgages held for sale approximates carrying values.
Loans
For both short-term loans and variable-rate loans that reprice frequently and
with no significant change in credit risk, fair values are based on carrying
values. The fair value for other loans is estimated using discounted cash flow
analyses, using interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality.
Interest Receivable/Payable
The fair values of interest receivable/payable approximate carrying values.
Federal Reserve and Federal Home Loan Bank Stock
The fair value of FRB and FHLB stock is based on the price at which it may be
resold to the FRB and FHLB.
Deposits
The fair values of noninterest-bearing demand accounts, interest-bearing demand
accounts and savings deposits are equal to the amount payable on demand at the
balance sheet date. The carrying amounts for variable rate, fixed-term
certificates of deposit approximate their fair values at the balance sheet date.
Fair values for fixed-rate certificates of deposit and other time deposits are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated expected
monthly maturities on such time deposits.
Federal Funds Purchased and U.S. Treasury Demand Notes
These financial instruments are short-term borrowing arrangements. The rates at
December 31, 1998 and 1997, approximate market rates, thus the fair value
approximates carrying value.
Securities Sold Under Repurchase Agreements and Federal Home Loan Bank Advances
The fair value of the these borrowings is estimated using a discounted cash flow
calculation, based on current rates for similar debt.
Off-Balance Sheet Commitments
Loan commitments and letters-of-credit generally have short-term, variable-rate
features and contain clauses which limit the Banks' exposure to changes in
customer credit quality. Accordingly, their carrying values, which are
immaterial at the respective balance sheet dates, are reasonable estimates of
fair value.
The estimated fair values of the Corporation's financial instruments are as
follows:
====================================================================================================================================
1998 1997
====================================================================================================================================
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Assets at December 31:
Cash and cash equivalents ....................................... $ 71,223 $ 71,223 $ 42,177 $ 42,177
Interest-bearing time deposits .................................. 855 855 385 385
Investment securities available for sale ........................ 308,507 308,507 212,040 212,040
Investment securities held to maturity .......................... 20,854 21,184 35,332 35,429
Mortgage loans held for sale .................................... 776 776 471 471
Loans ........................................................... 742,972 751,589 703,313 704,335
FRB and FHLB stock .............................................. 3,723 3,723 3,373 3,373
Interest receivable ............................................. 9,173 9,173 8,968 8,968
Liabilities at December 31:
Deposits ........................................................ 926,844 928,712 843,812 845,277
Borrowings:
Securities sold under repurchase agreements .................. 48,836 43,903 15,398 15,398
Federal funds purchased ...................................... 17,070 17,070 4,070 4,070
U.S. Treasury demand notes ...................................... 2,226 2,226 7,361 7,361
FHLB advances ................................................ 43,268 43,425 20,700 21,114
Interest payable ................................................ 3,614 3,614 3,615 3,615
45
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 18
================================================================================
Condensed Financial Information (Parent Company Only)
Presented below is condensed financial information as to financial
position, results of operations, and cash flows of the Corporation:
CONDENSED BALANCE SHEET
December 31,
================================================================================
1998 1997
================================================================================
Assets
Cash .............................................. $ 84 $ 318
Loans to affiliates ............................... 1,500
Security purchased with agreement
to resell to an affiliate ...................... 2,000
Investment securities available for sale .......... 250 250
Investment in subsidiaries ........................ 129,067 118,732
Goodwill .......................................... 535 553
Other assets ...................................... 329 230
-------- --------
Total assets ................................... $131,765 $122,083
======== ========
Liabilities' ......................................... $ 268 $ 114
Stockholders' Equityi ................................ 131,497 121,969
-------- --------
Total liabilities and stockholders' equity ..... $131,765 $122,083
======== ========
CONDENSED STATEMENT OF INCOME Year Ended December 31,
===============================================================================================================
1998 1997 1996
===============================================================================================================
Income
Dividends from subsidiaries ............................... $ 7,772 $ 6,903 $ 5,420
Other income .............................................. 105 101 25
-------- -------- --------
Total income ........................................... 7,877 7,004 5,445
-------- -------- --------
Expenses
Amortization of core deposit intangibles,
goodwill, and fair value adjustments .................... 45 45 43
Business combination expenses ............................. 36 258
Other expenses ............................................ 500 591 269
-------- -------- --------
Total expenses ......................................... 581 636 570
-------- -------- --------
Income Before Income Tax Benefit and Equity in
Undistributed Income of Subsidiariesi ....................... 7,296 6,368 4,875
Income tax benefit ........................................ (201) (193) (100)
-------- -------- --------
Income Before Equity in Undistributed Income of Subsidiaries. 7,497 6,561 4,975
Equity in undistributed income of subsidiaries ........... 7,902 7,812 8,167
-------- -------- --------
Net Income ................................................. $ 15,399 $ 14,373 $ 13,142
======== ======== ========
continued
46
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
(Table Dollar Amounts in Thousands, Except Share Data)
================================================================================
NOTE 18
================================================================================
Condensed Financial Information (Parent Company Only) continued
CONDENSED STATEMENT OF CASH FLOWS Year Ended December 31,
===================================================================================================================================
1998 1997 1996
===================================================================================================================================
Operating Activities:
Net income .......................................................... $ 15,399 $ 14,373 $ 13,142
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization ...................................................... 18 17 20
Equity in undistributed income of subsidiaries .................... (7,902) (7,812) (8,167)
Security gains .................................................... (19)
Net change in:
Other assets ................................................... (131) 25 567
Other liabilities .............................................. 126 16 (337)
-------- -------- --------
Net cash provided by operating activities ................... 7,510 6,619 5,206
-------- -------- --------
Investing Activities:
Security purchased with an agreement to resell to an affiliate ...... 2,000 (1,000) (1,000)
Net change in loans ................................................. (1,500)
Proceeds from sales of securities available for sale ................ 8 103
Investment in subsidiary ............................................ (1,729)
Other investing activities .......................................... (78)
-------- -------- --------
Net cash used by investing activities ....................... (1,229) (992) (975)
-------- -------- --------
Financing Activities:
Cash dividends ...................................................... (7,772) (6,902) (5,369)
Stock issued under employee benefit plans ........................... 385 291 298
Stock issued under dividend reinvestment
and stock purchase plan ........................................... 679 726 558
Stock options exercised ............................................. 271 163 64
Stock redeemed ...................................................... (72)
Cash paid in lieu of issuing fractional shares ...................... (6) (2)
-------- -------- --------
Net cash used by financing activities ....................... (6,515) (5,722) (4,451)
-------- -------- --------
Net change in cash .................................................. (234) (95) (220)
Cash, beginning of year ................................................ 318 413 633
-------- -------- --------
Cash, end of year ................................................... $ 84 $ 318 $ 413
======== ======== ========
================================================================================
NOTE 19
================================================================================
Quarterly Results of Operations (Unaudited)
The following table sets forth certain quarterly results for the years ended
December 31, 1998 and 1997:
- ------------------------------------------------------------------------------------------------------------------------------------
QUARTER INTEREST INTEREST NET INTEREST PROVISION FOR NET AVERAGE SHARES OUTSTANDING NET INCOME PER SHARE
ENDED INCOME EXPENSE INCOME LOAN LOSSES INCOME BASIC DILUTED BASIC DILUTED
- ------------------------------------------------------------------------------------------------------------------------------------
1998:
March ........ $19,122 $8,970 $10,152 $411 $3,824 10,005,041 10,186,400 $.38 $.38
June ......... 19,736 9,431 10,305 411 3,798 10,024,931 10,210,374 .38 .37
Sept ......... 20,145 9,687 10,458 446 3,891 10,071,921 10,222,876 .39 .38
Dec .......... 20,725 9,962 10,763 716 3,886 10,080,117 10,217,407 .38 .38
------- ------- ------- ------ ------- ----- -----
$79,728 $38,050 $41,678 $1,984 $15,399 10,045,502 10,201,070 $1.53 $1.51
======= ======= ======= ====== ======= ===== =====
1997:
March ........ $17,884 $8,343 $9,541 $287 $3,429 9,907,518 10,039,461 $.35 $.34
June ......... 18,980 8,901 10,079 290 3,707 9,928,085 10,054,069 .37 .37
Sept ......... 19,042 9,132 9,910 375 3,536 9,974,990 10,101,611 .35 .35
Dec .......... 19,569 9,349 10,220 345 3,701 9,990,621 10,146,708 .37 .37
------- ------- ------- ------ ------- ----- -----
$75,475 $35,725 $39,750 $1,297 $14,373 9,950,303 10,085,460 $1.44 $1.43
======= ======= ======= ====== ======= ===== =====
47
Stockholder
INFORMATION
[GRAPHIC]
First Merchants Corporation
currently provides services
through offices located in
Delaware, Fayette, Hamilton,
Henry, Madison, Wayne, Randolph
and Union counties in Indiana
and Butler county in Ohio.
[LOGO]
First Merchants
Corporation
Corporate Office
200 East Jackson Street
Muncie, Indiana 47305-2814
765-747-1500
http://firstmerchants.com
48
First Merchants Corporation of Muncie, Indiana, was organized in September,
1982, as the bank holding company for The Merchants National Bank, now First
Merchants Bank, N.A., an institution which has served Muncie and the surrounding
communities since 1893.
In November 1988, First Merchants acquired Pendleton Banking Company of
Pendleton, Indiana, a commercial bank which was organized in 1872.
In July 1991, the Corporation acquired First United Bank of Middletown, Indiana,
which was established in 1882.
In August 1996, First Merchants Corporation acquired Union County National Bank,
established in 1872 and based in Liberty, Indiana.
In October 1996, the Corporation acquired The Randolph County Bank of
Winchester, Indiana, which was founded in 1865.
In April 1998, the Corporation acquired the Muncie office of Insurance & Risk
Management, Inc., renamed First Merchants Insurance Services, Inc.
Subsidiaries of First Merchants Corporation conduct a full range of banking
operations, including commercial, industrial, consumer and real estate lending,
deposit and investment services, and other banking services. First Merchants
Bank, with more than one billion dollars in fiduciary assets at market value,
operates one of the ten largest trust departments in Indiana.
First Merchants Corporation is committed to the sound management of its
subsidiaries and to leading its east central Indiana marketplace in meeting
customer banking needs and expectations.
[PHOTO]
Annual
MEETING
The Annual Meeting of Stockholders of
First Merchants Corporation
will be held...
Wednesday, April 14, 1999 o 3:30 p.m.
Horizon Convention Center
401 South High Street
Muncie, Indiana 47305
49
=======================
STOCKHOLDER INFORMATION
=======================
Stock PRICE
&
Dividend
INFORMATION
================================================================================
PRICE PER SHARE
================================================================================
QUARTER HIGH LOW DIVIDENDS DECLARED
1998 1997 1998 1997 1998 1997
--------------- ---------------- --------------
First Quarter ........ $27.67 $20.00 $24.50 $16.83 $.187 $.160
Second Quarter ....... 31.83 20.50 25.67 18.50 .187 .160
Third Quarter ........ 30.83 21.58 24.00 20.00 .200 .187
Fourth Quarter ....... 28.75 25.33 21.50 21.42 .200 .187
The table above lists per share prices and dividend payments during 1998 and
1997.
Prices are as reported by the National Association of Securities Dealers.
Automated Quotation - National Market System.
Numbers rounded to nearest cent when applicable.
Restated for 3-for-2 stock split distributed October, 1998.
- --------------------------------------------------------------------------------
==================
STOCK INFORMATION
==================
Common Stock Listing
First Merchants Corporation common stock is traded over-the-counter on the
NASDAQ National Market System. Quotations are carried in many daily papers. The
NASDAQ symbol is FRME (Cusip #320817-10-9). At the close of business on December
31, 1998, the number of shares outstanding was 10,086,083. There were 1,555
stockholders of record on that date.
==============
Market Makers
==============
The following firms make a market in First Merchants Corporation stock:
Robert W. Baird & Co., Inc.
Keefe, Bruyette & Woods, Inc.
Knight Securities, L.P.
Herzog, Heine, Geduld, Inc.
Howe, Barnes & Johnson, Inc.
McDonald Investments Inc.
NatCity Investments, Inc.
Troster Securities, L.P.
General Stockholder Inquiries
Stockholders and interested investors may obtain information about the
Corporation upon written request or by calling:
Mr. Douglas B. Harris
Vice President
Investor Services & Bank Investments
First Merchants Corporation
P. O. Box 792
Muncie, Indiana 47308-0792
765-741-7278
1-800-262-4261 Ext. 7278
Stock Transfer Agent and Registrar
First Merchants Bank, N.A.
Corporate Trust Department
P. O. Box 792
Muncie, Indiana 47308-0792
Form 10-k and Financial Information
First Merchants Corporation, upon request and without charge, will furnish
stockholders, security analysts and investors a copy of Form 10-k filed with the
Securities and Exchange Commission.
Please contact:
Mr. James L. Thrash
Senior Vice President
and Chief Financial Officer
First Merchants Corporation
P. O. Box 792
Muncie, Indiana 47308-0792
765-747-1390
1-800-262-4261 Ext. 1390