First Merchants Corporation (FRME) Q3 2026 earnings review
First Merchants lending margins rise, but problem loans keep climbing
First Merchants, an Indiana regional bank, grew its lending spread while continuing to clean up troubled business loans. Net interest margin — the gap between loan yields and deposit costs — rose 0.06 percentage points to 3.44%, above what the company's own plan pointed to, lifting profit per share 11% to $1.09. Chief executive Mark Hardwick, who will hand the role to president Mike Stewart at year-end, said bad loans stabilized after the bank wrote off $29 million on two commercial borrowers reserved for last quarter.
| Organic loan growth (owned a year ago) | +3.5% total loans +14.8% with First Savings |
|---|---|
| Profit per share, excluding one-offs | $1.10 +11% from a year ago |
| Net interest margin (lending spread) | 3.44% up 0.06 percentage points from Q2 |
| Problem (classified) business loans | $420.1M up from $393.3M in Q2 |
⚖️ Verdict: ⚪ Neutral
The story is unchanged because core lending profit improved while underlying credit and cost pressures persisted. The bank proved its margin gains do not rely on temporary acquisition accounting, and strong deposit inflows allowed it to pay down expensive wholesale debt. The bad news: total bad loans stayed flat only because write-offs matched $41 million of fresh non-paying loans, problem commercial loans climbed again, and operating costs topped the bank's quarterly target.
The question now is whether commercial loan downgrades are finally peaking or spreading across the broader business portfolio. If the new non-paying loans were the last of an internal review, low loan-loss provisions will let higher lending margins flow straight to profit; if downgrades continue, the bank will have to rebuild its depleted loss reserves. Fourth-quarter problem loan additions and the credit review update will settle it.
🐂 Bull Case
Lending Margin Rose Without Extra Acquisition Help
First Merchants earns most of its profit from net interest margin (NIM), the gap between what it earns on loans and bonds and what it pays on deposits. That margin rose 0.06 percentage points from last quarter to 3.44% on a tax-equivalent basis, beating the 3.38% to 3.40% second-half plan.
- Margin excluding acquisition accounting: 3.36%, up 0.06 percentage points from last quarter
- Average loan yield: 6.23%, up 0.12 percentage points from last quarter, with new and renewed loans at 6.34%
- Bond portfolio: $3.1 billion, down $168 million from last quarter as low-yielding bonds paid down
- Acquisition accounting benefit: 0.08 percentage points ($4.0 million), unchanged from last quarter
Skeptics worried that recent margin gains relied on temporary accounting boosts from buying First Savings Bank in February. This quarter answered that concern because the underlying margin grew at the exact same 0.06-point pace as the headline figure. The bank let low-yielding bonds mature and reinvested the cash into higher-rate loans, which more than covered a 0.09-point rise in deposit costs.
What to watch: the underlying margin and average loan yields in the fourth quarter. With 69% of the loan book tied to floating interest rates, a drop in loan yields would show that central bank rate cuts are squeezing lending spreads faster than deposit costs can fall.
Deposit Inflows Outpaced Loans and Eased Funding
A bank's loan growth depends on gathering enough customer deposits to fund those loans without relying on expensive wholesale borrowing. Total loans grew 14.8% from a year ago to $15.6 billion, while loans from businesses owned a year ago rose 3.5%. In the third quarter, total deposits grew $175.6 million (4.2% annualized) to $16.9 billion, more than double the $70.2 million (1.8% annualized) increase in loans.
Home mortgages and home equity lines grew at a 9.5% annualized rate, while Michigan loans reached $2.9 billion, offsetting a 0.5% annualized dip in commercial lending. Because deposit inflows beat loan demand, the bank cut its loan-to-deposit ratio to 92.2% and paid down $510 million in Federal Home Loan Bank borrowings.
What to watch: commercial loan balances and total deposit costs in the fourth quarter. Management noted that consumer loan pipelines softened at quarter-end, so overall growth now requires business borrowers to start drawing on their credit lines again.
🐻 Bear Case
Troubled Business Loans Keep Rising
"We made meaningful progress resolving the two commercial credits identified last quarter, and nonperforming assets remained stable," chief executive Mark Hardwick said. Nonperforming assets — loans no longer paying interest plus foreclosed property — ended the quarter at $119.0 million, or 0.57% of total assets, compared with $119.8 million last quarter.
- Loan write-offs: $29.4 million, including $18.5 million for a wireless retailer and $10.5 million for a roofing company
- New nonaccrual loans (stopped paying interest): $41.0 million, led by an $18.4 million parts distributor and a $4.3 million digital marketer
- Classified loans (problem loans still paying): $420.1 million, or 2.69% of loans, up from $393.3 million (2.53%) last quarter
- Loans 90+ days past due and still accruing interest: $12.7 million, up from $9.7 million last quarter
Hardwick's claim of stability misses the flow underneath. The bad-loan balance stayed flat only because the bank wrote off $30.9 million of existing bad loans while $41.0 million of fresh ones took their place. Problem loans are spreading beyond the two borrowers flagged in the summer, even inside the $936 million shared national credit book (large loans shared with other banks) and the $810.5 million sponsor finance book (loans to private-equity-backed firms).
What to watch: new nonaccrual loan additions and classified loan balances in the fourth quarter. Now that the bank has used the reserves set aside last quarter — dropping its loan loss allowance from 1.56% to 1.38% of loans — another wave of downgrades would force it to rebuild reserves out of quarterly profit.
Bond Losses Cut Tangible Book Value
First Merchants holds $3.1 billion of municipal and mortgage bonds that lose market value when long-term interest rates rise. The bank said the portfolio shrank during the quarter due to "principal paydowns and maturities, and a decline in the securities portfolio valuation due to increases in interest rates".
Paper losses on bonds available for sale jumped from $171.3 million in June to $290.7 million in September, while losses on bonds held to maturity rose from $254.0 million to $377.7 million. That $668.4 million combined paper loss, up 57.2% in three months by our math, reduced tangible common book value per share (net asset value excluding goodwill) by 3.2% from last quarter to $28.86.
What to watch: unrealized bond losses and the tangible common equity ratio (now 8.83%) next quarter. If long-term bond yields keep climbing, paper losses will continue to erode book value per share even if quarterly earnings stay high.
Operating Costs Topped the Bank's Target
After finishing the computer system integration of First Savings Bank in May, finance chief Michele Kawiecki told investors that quarterly operating expenses would run between $111 million and $114 million for the rest of 2026. In the third quarter, total noninterest expense reached $116.3 million, or $115.4 million excluding $0.9 million of acquisition costs.
Underlying operating costs rose $3.9 million from last quarter, which the company said was "primarily driven by a $1.4 million increase in marketing expense, a $0.7 million increase in employee health insurance costs, and a $0.6 million increase in premises expense". Marketing costs rose 0.6 percentage points as a share of revenue from last quarter by our math, pushing the adjusted efficiency ratio (operating costs as a share of revenue) up 0.91 percentage points to 54.13%.
What to watch: fourth-quarter operating expenses excluding acquisition charges. With merger cost savings already completed, another reading above $114 million would show that everyday inflation and hiring are eating into the deal's cost benefits.
👓 Other Themes
Chief Executive Mark Hardwick Will Retire
First Merchants announced a planned leadership handover alongside its results: "President Mike Stewart will succeed Mark Hardwick as Chief Executive Officer upon Mr. Hardwick’s retirement at year-end 2026." Hardwick spent 29 years at the Indiana lender, while Stewart has been with the bank for 18 years overseeing its commercial, private wealth, and consumer divisions, pointing to continuity in strategy.
💲 Other KPIs
Fee income rose 2.2% from last quarter and 17.0% from a year ago. Higher deposit service charges ($9.8 million) and wealth management fees ($9.8 million) led the gain, while mortgage loan sale gains held at $7.4 million. That run rate sits well above the $33.4 million quarterly pace implied by the full-year outlook.
Diluted share count fell 0.3% from last quarter as the bank bought back 287,431 shares for $12.0 million ($50.3 million year-to-date). Compared with a year ago, share count is up 8.6% because First Merchants issued stock to buy First Savings in February, which is why 20.5% net profit growth translated into 11.2% per-share growth.
The bank's total regulatory capital ratio — its cushion against loan losses — rose 0.60 percentage points from last quarter and 0.54 points from a year ago. First Merchants issued $100 million of subordinated debt in late September, lifting regulatory capital well above its 12.50% internal target while Common Equity Tier 1 capital reached 11.22%.
🔮 Guidance
Unchanged. The bank kept its long-term floor for tangible common equity at 8.00% of tangible assets. Actual tangible common equity slipped 0.16 percentage points from last quarter to 8.83% because higher interest rates reduced the market value of the bond portfolio, though it remains 0.83 percentage points above the target.
Unchanged. Management's internal target for core bank capital stays at 10.00%. The actual ratio edged up 0.06 percentage points from last quarter to 11.22% as retained earnings outpaced share buybacks and slow loan growth, keeping the bank 1.22 percentage points above its floor for a第五 straight quarter.
Unchanged. The target for total regulatory capital remains 12.50%. Completing a $100 million subordinated debt offering in September pushed the actual ratio to 13.58%, up from 12.98% in June and 1.08 percentage points above the bank's target.
Updated for the rolling 12-month window. The presentation projects $271.4 million of scheduled bond principal and interest payments over the next year at an average yield of 2.11%. Moving that cash into new loans yielding 6.34% would add about $11.5 million of annual interest income by our math.
❓ Key Questions
Why did new nonaccrual loans stay high at $41 million?
Management said last quarter's credit problems were isolated to two borrowers, yet $41.0 million of new loans stopped paying interest this quarter and problem (classified) loans rose by $26.8 million. Investors need to know if credit weakness is spreading across the commercial book.
Is the wireless retailer loan now fully resolved?
The bank wrote off $18.5 million on its $28.1 million loan to an authorized wireless retailer and $10.5 million on a $13.7 million roofing loan. Management has not said whether the remaining $12.8 million combined balance still carries loss risk.
Will fourth-quarter operating costs return to the $111–114 million plan?
Operating expenses excluding acquisition charges reached $115.4 million in the third quarter, topping the $111 million to $114 million run-rate target set on last quarter's call. The call needs to clarify whether higher marketing and health insurance costs are permanent.
How will falling interest rates affect the 3.44% lending margin?
Roughly 69% of First Merchants' $15.6 billion loan book carries a floating interest rate tied to benchmarks like SOFR. With the earnings release providing no updated rate-sensitivity table or margin outlook, management needs to quantify the impact of central bank rate cuts.