CAPScall of the Week: First Merchants Corporation (FRME)

The call
After carefully reviewing the prospects for First Merchant, I’ve decided to make a CAPScall of outperform on the company.

All states were hit particularly hard during the recession, but those banks that stuck to traditional banking practices like loans and deposits, and that maintained conservatively liquid positions, are now being rewarded. First Merchant is one such bank that did a really good job of seizing the opportunities presented to it. It nabbed SCB for a bargain basement price after the bank failed, then, earlier this year, agreed to merge with CFS Bancorp, Inc. (NASDAQ:CITZ) for the sum of 0.65 First Merchant shares for each CFS Bancorp, Inc. (NASDAQ:CITZ) share. The combined bank will offer the second-highest asset total in Indiana at $5.4 billion and will have close to 100 branches.

On a comparative basis, First Merchant is also much more attractive than many of banking’s major players from a valuation perspective. To begin with, First Merchants Corporation (NASDAQ:FRME) net interest margin of 3.9%, while a bit lower than the previous year, is still much higher than many of its larger foes — including Wells Fargo & Co (NYSE:WFC). Even its return on average assets has hovered a clean 10-20 basis points consistently above the average for national banks. As icing on the cake, net charge-offs as a percentage of loans was nearly halved to 0.40% from 0.78% in the previous year, marking a significant improvement in credit quality.

All of these figure help to make my case for a bank trading at just 15% more than its book value and close to 13 times forward earnings. I see considerable upside here over the long run if First Merchant stays the course and sticks to conservative banking practices and small but earnings-accretive acquisitions.

The article CAPScall of the Week: First Merchants originally appeared on Fool.com and is written by Sean Williams.

Fool contributor Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.The Motley Fool owns shares of, and recommends, Bank of America and Wells Fargo.

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