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CAPScall of the Week: First Merchants Corporation (FRME)

First Merchants Corporation (NASDAQ:FRME)For years, satirical late-night TV host Stephen Colbert has been running a series on his show called “Better Know a District,” which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That’s why I’ve made it a weekly tradition to examine one seldom-followed company within the Motley Fool CAPS database and make a CAPScall of outperform or underperform on that company.

For this week’s round of “Better Know a Stock,” I’m going to take a closer look at First Merchants Corporation (NASDAQ:FRME).

What First Merchants Corporation (NASDAQ:FRME) does

First Merchants Corporation (NASDAQ:FRME) is a financial holding company that provides community and commercial banking services primarily throughout Indiana, but also in Ohio. As of the first-quarter, First Merchants Corporation (NASDAQ:FRME) had $4.3 billion in total assets with total loans outstanding equaling $2.9 billion.

Source: Daniel X. O’Neil, Flickr.

In its first-quarter results, First Merchants Corporation (NASDAQ:FRME) reported EPS of $0.38, down from $0.46 in the previous year in spite of an 8.1% increase in commercial real estate loans and a 9.2% increase in total non-maturity deposits. The drop in income can be explained by a one-time $9.1 million benefit last year from its acquisition of the failed bank, SCB of Shelbyville, from the FDIC. Net interest margin for the quarter dipped six basis points to 3.9% and return on average assets fell to 1.04% from 1.26% in the year-ago quarter.

Who it competes against
Now here’s the sad news for any bank: It competes against far, far too many foes. The smartest move for regional banks like First Merchants Corporation (NASDAQ:FRME) is to merge or expand outside the box, otherwise regional downturns or low interest rates have the potential to sap earnings potential.

First Merchants’ biggest competitor is Old National Bancorp (NYSE:ONB), the largest bank by assets in Indiana ($9.4 billion in assets). Old National Bancorp (NYSE:ONB) has been exercising its regional flexibility of late by closing more than a dozen Indiana-based branches and purchasing some 20 offices from Bank of America Corp (NYSE:BAC) in Michigan.

The thought process here might be twofold for Old National Bancorp (NYSE:ONB). First, Indiana has seen much of its recovery, so trying to pry customers and enterprises away from their current financial institution could be difficult. Second, and on the flipside, Michigan really hasn’t seen much of an economic recovery and could represent a unique stepping stone for Old National to expand its presence. Regional banks like this really do have the upper hand over money center banks like Bank of America Corp (NYSE:BAC) when it comes to creating customer loyalty, so the more expansive they can become, the better chance they have of diversifying their asset portfolio.

Historically low lending rates are another point of contention for First Merchants and really any other bank operating in the area — including large money center banks. Take national bank Wells Fargo & Co (NYSE:WFC), for example, which has branches set up throughout Indiana. Even though it has traditionally been the safest of all large banks, it’s struggled to generate income because of low lending rates that act as a deterrent to deposit growth and profitability from loans. In its second-quarter results, released just two weeks ago, Wells Fargo & Co (NYSE:WFC) delivered a 45 basis point contraction in net interest margin to 3.46% from the year-ago period.

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