UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549


_______________________________


FORM 10-K





[Mark One]


[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended December 31, 2015


OR


[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the transition period from __________to_________


Commission file number 0-17071


FIRST MERCHANTS CORPORATION


(Exact name of registrant as specified in its charter)


Indiana35-1544218(State or other jurisdiction ofincorporation or organization)(I.R.S. Employer Identification No.)


200 East JacksonMuncie, Indiana47305-2814(Address of principal executive offices)(Zip Code)





Registrant’s telephone number, including area code: (765)747-1500


Securities registered pursuant to Section 12(b) of the Act:


Title of Each ClassName of each exchange on which registeredCommon Stock, $0.125 stated value per shareThe NASDAQ Stock Market





Securities registered pursuant to Section 12(g) of the Act:


None


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [  ] No [X]


Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X]


Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of 1934  during  the  preceding  12 months  (or for such  shorter  period  that the registrant was required to file such reports),  and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) Yes [X] No [ ]


Indicate  by check  mark if disclosure of delinquent filers  pursuant to Item 405 of Regulation S-K is not contained  herein,  and will not be contained, to the best of  registrant’s  knowledge,  in  definitive  proxy  or  information statements  incorporated  by  reference  in Part  III of this  Form  10-K or any amendment to this Form 10-K. [X]


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer [X] Accelerated filer[  ] Non-accelerated filer [  ] Small Reporting Company [  ]


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [  ] No[X]


The aggregate market value (not necessarily a reliable indication of the price at which more than a limited number of shares would trade) of the voting stock held by non-affiliates of the registrant was $934,269,000 as of the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2015).





As of February 23, 2016 there were 40,671,228 outstanding common shares, without par value, of the registrant.





DOCUMENTS INCORPORATED BY REFERENCE





DocumentsPart of Form 10-K into which incorporatedPortions of the Registrant’s DefinitivePart III (Items 10 through 14)Proxy Statement for Annual Meeting ofShareholders to be held May 2, 2016








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Table of Contents
 TABLE OF CONTENTS





FIRST MERCHANTS CORPORATION











Statement Regarding Forward-Looking Statements3PART IItem 1.Business4Item 1A.Risk Factors21Item 1B.Unresolved Staff Comments24Item 2.Properties25Item 3.Legal Proceedings25Item 4.Mine Safety Disclosures25Supplemental Information - Executive Officers of the Registrant26PART IIItem 5.Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities27Item 6.Selected Financial Data29Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations30Item 7A.Quantitative and Qualitative Disclosure about Market Risk46Item 8.Financial Statements and Supplementary Data47Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure102Item 9A.Controls and Procedures102Item 9B.Other Information103PART IIIItem 10.Directors, Executive Officers and Corporate Governance104Item 11.Executive Compensation104Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters104Item 13.Certain Relationships, Related Transactions and Director Independence104Item 14.Principal Accountant Fees and Services104PART IVItem 15.Exhibits and Financial Statement Schedules105








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 FORWARD-LOOKING STATEMENTS





First Merchants Corporation (the “Corporation”) from time to time includes forward-looking statements in its oral and written communication. The Corporation may include forward-looking statements in filings with The Securities and Exchange Commission (“SEC”), such as its Annual Reports on Form 10-K and its Quarterly Reports on Form 10-Q, in other written materials and oral statements made by senior management to analysts, investors, representatives of the media and others. The Corporation intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and the Corporation is including this statement for purposes of these safe harbor provisions. Forward-looking statements can often be identified by the use of words like “believe”, “continue”, “pattern”, “estimate”, “project”, “intend”, “anticipate”, “expect” and similar expressions or future or conditional verbs such as “will”, “would”, “should”, “could”, “might”, “can”, “may” or similar expressions. These forward-looking statements include:





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|• | statements of the Corporation’s goals, intentions and expectations;

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|• | statements regarding the Corporation’s business plan and growth strategies;

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|• | statements regarding the asset quality of the Corporation’s loan and investment portfolios; and

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|• | estimates of the Corporation’s risks and future costs and benefits.




These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, those discussed in Item 1A, “RISK FACTORS”.





Because of these and other uncertainties, the Corporation’s actual future results may be materially different from the results indicated by these forward-looking statements. In addition, the Corporation’s past results of operations do not necessarily indicate its future results.





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 PART I: ITEM 1. BUSINESS





PART I





ITEM 1. BUSINESS





GENERAL





First Merchants Corporation (the “Corporation”) is a financial holding company headquartered in Muncie, Indiana and was organized in September 1982. The Corporation’s Common Stock is traded on NASDAQ’s Global Select Market System under the symbol FRME. The Corporation has one full-service bank charter, First Merchants Bank, National Association (the “Bank”), which opened for business in Muncie, Indiana, in March 1893. The Bank also operates Lafayette Bank and Trust, Ameriana Bank, Ameriana Financial Services and First Merchants Trust Company as divisions of First Merchants Bank, N.A.  The Bank includes 116 banking locations in twenty-seven Indiana, two Illinois and two Ohio counties. In addition to its branch network, the Corporation’s delivery channels include ATMs, check cards, remote deposit capture, interactive voice response systems and internet technology. The Corporation’s business activities are currently limited to one significant business segment, which is community banking.





Through the Bank, the Corporation offers a broad range of financial services, including accepting time deposits, savings and demand deposits; making consumer, commercial, agri-business and real estate mortgage loans; renting safe deposit facilities; providing personal and corporate trust services; providing full-service brokerage; and providing other corporate services, letters of credit and repurchase agreements.





The Corporation operated First Merchants Insurance Services, Inc., operating as First Merchants Insurance Group, a full-service property, casualty, personal lines, and employee benefit insurance agency headquartered in Muncie, Indiana.  On June 12, 2015, the Corporation sold all of its stock in First Merchants Insurance Services, Inc. to USI Insurance Services LLC.





All inter-company transactions are eliminated during the preparation of consolidated financial statements.





As of December 31, 2015 , the Corporation had consolidated assets of $6.8 billion, consolidated deposits of $5.3 billion and stockholders’ equity of $851 million.  As of December 31, 2015 , the Corporation and its subsidiaries had 1,529 full-time equivalent employees.





AVAILABLE INFORMATION





The Corporation makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, available on its website at https://www.firstmerchants.com without charge, as soon as reasonably practicable, after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. These documents can also be read and copied at the Securities and Exchange Commission’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.  Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the public reference room. SEC filings are also available to the public at the Securities and Exchange Commission’s website at http://www.sec.gov. Additionally, the Corporation will also provide without charge, a copy of its Annual Report on Form 10-K to any shareholder by mail. Requests should be sent to Cynthia Holaday, Shareholder Relations, First Merchants Corporation, P.O. Box 792, Muncie, IN 47308-0792.





ACQUISITION AND DIVESTITURE POLICY





The Corporation anticipates that it will continue its policy of geographic expansion of its banking business through the acquisition of banks whose operations are consistent with its banking philosophy.  Management routinely explores opportunities to acquire financial institutions and other financial services-related businesses and to enter into strategic alliances to expand the scope of its services and its customer base.





On December 31, 2015, the Corporation acquired 100 percent of Ameriana Bancorp ("Ameriana").  Ameriana was headquartered in New Castle, Indiana and had 13 full service banking centers in east central and central Indiana.  Pursuant to the merger agreement, shareholders of Ameriana received .9037 shares of the Corporation's common stock for each share of Ameriana Bancorp common stock held.  The Corporation issued approximately 2.8 million shares of common stock, which was valued at approximately $70.4 million.





On June 12, 2015, the Corporation sold all of its stock in First Merchants Insurance Services, Inc., an Indiana corporation ("FMIG"), to USI Insurance Services LLC, a Delaware limited liability company ("USI").  The sale price was $18.0 million, of which $16.0 million was paid at closing with the remaining $2.0 million paid through a two-year promissory note.  The sale of FMIG generated a gain on sale of $8.3 million.





On April 17, 2015, the Corporation acquired 100 percent of C Financial Corporation ("C Financial").  C Financial was headquartered in Columbus, Ohio and had 6 full service banking centers serving the Columbus, Ohio market.  Pursuant to the merger agreement, shareholders of C Financial received $6.738 in cash for each share of C Financial stock held, resulting in a total purchase price of $14.5 million.





On November 7, 2014, the Corporation acquired 100 percent of Community Bancshares, Inc. ("Community").  Community was headquartered in Noblesville, Indiana and had 10 full-service banking centers serving central Indiana.  Pursuant to the merger agreement, each outstanding share of common stock of Community was converted into the right to receive either (a) 4.0926 shares of the Corporation's common stock, plus cash in lieu of fractional shares; or (b) $85.94 in cash, based upon shareholder elections.  The Corporation paid $14.2 million in cash and issued approximately 1.6 million shares of common stock, valued at approximately $35.0 million, for a total purchase price of approximately $49.2 million.














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Effective November 12, 2013, the Corporation acquired 100 percent of CFS Bancorp ("CFS") in an all stock transaction.  CFS was headquartered in Munster, Indiana and had 20 banking centers in northwestern Indiana and northeastern Illinois.  Pursuant to the merger agreement, the shareholders of CFS received 0.65 percent of a share of the Corporation's common stock for each share of CFS Bancorp common stock held.  The Corporation issued approximately 7.1 million shares of common stock, which was valued at approximately $135.6 million.





Effective February 10, 2012, the Bank assumed substantially all of the deposits and certain other liabilities and acquired certain assets of SCB Bank ("SCB"), a federal savings bank headquartered in Shelbyville, Indiana, from the Federal Deposit Insurance Corporation ("FDIC"), as receiver for SCB, pursuant to the terms of the Purchase and Assumption Agreement - Modified Whole Bank; All Deposits, entered into by the Bank, the FDIC as receiver of SCB and the FDIC.





Details of the acquisitions can be found in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





COMPETITION





The Bank is located in Indiana, Ohio and Illinois counties where other financial services companies provide similar banking services. In addition to the competition provided by the lending and deposit gathering subsidiaries of national manufacturers, retailers, insurance companies and investment brokers, the Bank competes vigorously with other banks, thrift institutions, credit unions and finance companies located within its service areas.





REGULATION AND SUPERVISION OF FIRST MERCHANTS CORPORATION AND SUBSIDIARIES





Bank Holding Company Regulation





The Corporation is registered as a bank holding company and has elected to be a financial holding company. It is subject to the supervision of, and regulation by the Board of Governors of the Federal Reserve System (“Federal Reserve”) under the Bank Holding Company Act of 1956 (the “BHC Act”), as amended. Bank holding companies are required to file periodic reports with and are subject to periodic examination by the Federal Reserve. The Federal Reserve has issued regulations under the BHC Act requiring a bank holding company to serve as a source of financial and managerial strength to the Bank. Thus, it is the policy of the Federal Reserve that a bank holding company should stand ready to use its resources to provide adequate capital funds to the Bank during periods of financial stress or adversity. Additionally, under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” (as defined in the FDICIA section of this Form 10-K) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency. Under the BHC Act, the Federal Reserve has the authority to require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the determination that such activity constitutes a serious risk to the financial stability of any bank subsidiary.





The BHC Act requires the Corporation to obtain the prior approval of the Federal Reserve before:





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|• | acquiring direct or indirect control or ownership of any voting shares of any bank or bank holding company if, after such acquisition, the bank holding company will directly or indirectly own or control more than 5 percent of the voting shares of the bank or bank holding company;

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|• | merging or consolidating with another bank holding company; or

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|• | acquiring substantially all of the assets of any bank.




The BHC Act generally prohibits bank holding companies that have not become financial holding companies from (i) engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries, and (ii) acquiring or retaining direct or indirect control of any company engaged in the activities other than those activities determined by the Federal Reserve to be closely related to banking or managing or controlling banks.





Capital Adequacy Guidelines for Bank Holding Companies





In July 2013, the United States banking regulators adopted new capital rules which modified the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions.  These rules are commonly known as "Basel III".  Basel III was effective for the Corporation on January 1, 2015.  Basel III addresses the components of capital and other issues affecting the numerator in banking institutions' regulatory capital ratios.  Basel III also implements the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies' rules.  Certain of the Basel III rules came into effect for the Corporation and the Bank on January 1, 2015, and the balance of the rules are subject to a phase-in period which will continue through 2019.





Basel III introduced a new capital measure "Common Equity Tier 1" ("CET1").  Basel III specifies that Tier 1 capital consists of CET1 and "Additional Tier 1 Capital" instruments meeting specified requirements.  CET1 capital consists of common stock instruments that meet the eligibility criteria, retained earnings, accumulated other comprehensive income and common equity Tier 1 minority interest.  Basel III also defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1, and not to the other components of capital.





Basel III requires the Corporation to maintain minimum amounts and ratio of common equity tier 1 capital to risk weighted assets, as defined in the regulation.  Under Basel III, in order to avoid limitations on capital distributions, including dividends, the Corporation must hold a capital conservation buffer above the adequately capitalized common equity tier 1 capital to risk-weighted assets ratio.  The capital conservation buffer is being phased in from zero percent to 2.50 percent by 2019.








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When fully phased-in on January 1, 2019, Basel III will require banking organizations to maintain:


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|• | a minimum ratio of CET1 to risk-weighted assets of a least 4.5 percent, plus a 2.5 percent "capital conservation buffer" (which is added to the 4.5 percent CET1 as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0 percent upon full implementation)

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|• | a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0 percent, plus the 2.5 percent capital conservation buffer (which is added to the 6.0 percent Tier 1 capital ratio as that buffer is phased-in, effectively resulting in a minimum Tier 1 capital ratio of 8.5 percent upon full implementation);

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|• | a minimum ratio of total capital (Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0 percent, plus the 2.5 percent capital conservation buffer (which is added to the 8.0 percent total capital ratio as that buffer is phased-in, effectively resulting in a minimum total capital ratio of 10.5 percent upon full implementation); and

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|• | a minimum leverage ratio of 4.0 percent, calculated as the ratio of Tier 1 capital to adjusted average consolidated assets.

Basel III also provides for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to have any current applicability to the Corporation or the Bank.


The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.





Basel III provides for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10 percent of CET1 or all such categories in the aggregate exceed 15 percent of CET1. Under Basel III, the Corporation and the Bank were given a one-time election (the “Opt-out Election”) to filter out certain accumulated other comprehensive income (“AOCI”) components. The AOCI Opt-out Election was made on the March 31, 2015 Call Report and FR Y-9C for the Bank and the Corporation, respectively.


Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a five-year period (20 percent per year). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625 percent level and be phased-in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5 percent on January 1, 2019).


Basel III permits banks with less than $15 billion in assets to continue to treat trust preferred securities as Tier 1 capital. This treatment is permanently grandfathered as Tier 1 capital even if the Corporation should ever exceed $15 billion in assets due to organic growth. Should the Corporation exceed $15 billion in assets as the result of a merger or acquisition, then the Tier 1 treatment of its outstanding trust preferred securities will be phased out, but those securities will still be treated as Tier 2 capital. Basel III permits banks with less than $250 billion in assets to choose to continue excluding unrealized gains and losses on certain securities holdings for purposes of calculating regulatory capital.  The rules limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of a specified amount of CET1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements.


Historically, the regulation and monitoring of a bank and bank holding company's liquidity has been addressed as a supervisory matter, without minimum required formulaic measures. The Basel III liquidity framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, is now required by regulation. One test, referred to as the liquidity coverage ratio (“LCR”), is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements are expected to incent banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source. The NSFR will be subject to an observation period through mid-2016 and, subject to any revisions resulting from the analyses conducted and data collected during the observation period, implemented as a minimum standard by January 1, 2018. These new standards are subject to further rulemaking and their terms may well change before implementation. The federal banking agencies have not proposed rules implementing the Basel III liquidity framework and have not determined to what extent they will apply to U.S. banks that are not large, internationally active banks.





The following are the Corporation’s regulatory capital ratios as of December 31, 2015 :


CorporationRegulatory Minimum RequirementTotal risk-based capital to risk-weighted assets14.94%8.00%Tier 1 capital to risk-weighted assets12.51%6.00%Common equity tier 1 capital to risk-weighted assets11.49%4.50%Tier 1 capital to average assets10.85%4.00%


























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Bank Regulation





The Bank is supervised, regulated and examined by the Office of the Comptroller of the Currency (the “OCC”). The OCC has the authority to issue cease-and-desist orders if it determines that activities of the Bank regularly represent an unsafe and unsound banking practice or a violation of law. Federal law extensively regulates various aspects of the banking business such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. Current federal law also requires banks, among other things, to make deposited funds available within specified time periods.





Bank Capital Requirements





Capital adequacy is an important indicator of financial stability and performance.  The Corporation and the Bank 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 four ratios that are calculated according to the regulations: total risk-based capital, tier 1 risk-based capital, common equity 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.  Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the regulations.  Banks with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual levels.  The appropriate federal regulatory agency may also downgrade a bank to the next lower capital category upon a determination that the bank is in an unsafe or unsound practice.  Banks are required to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category.





Basel III was effective for the Bank on January 1, 2015.  Basel III requires the Bank to maintain minimum amounts and ratio of common equity tier 1 capital to risk weighted assets, as defined in the regulation.  Under Basel III, the Bank elected to opt-out of including accumulated other comprehensive income in regulatory capital.  As of December 31, 2015 , the Bank met all capital adequacy requirements to be considered well capitalized.





FDIC Improvement Act of 1991





The FDICIA requires, among other things, federal bank regulatory authorities to take “prompt corrective action” with respect to banks, which do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The Federal Deposit Insurance Corporation (“FDIC”) has adopted regulations to implement the prompt corrective action provisions of FDICIA.





Basel III revised the "prompt corrective action" regulations by:


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|• | introducing CET1 ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being 6.5 percent for well-capitalized status;

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|• | increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 risk-based capital ratio for well-capitalized status being 8.0 percent; and

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|• | eliminating a provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0 percent leverage ratio and still be well-capitalized.




The FDICIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.”  “Undercapitalized” banks are subject to growth limitations and are required to submit a capital restoration plan. A bank’s compliance with such plan is required to be guaranteed by the bank’s parent holding company. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. “Significantly undercapitalized” banks are subject to one or more restrictions, including an order by the FDIC to sell sufficient voting stock to become "adequately capitalized", requirements to reduce total assets and cease receipt of deposits from correspondent banks, and restrictions on compensation of executive officers. “Critically undercapitalized” institutions may not, beginning 60 days after becoming “critically undercapitalized,” make any payment of principal or interest on certain subordinated debt or extend credit for a highly leveraged transaction or enter into any transaction outside the ordinary course of business. In addition, “critically undercapitalized” institutions are subject to appointment of a receiver or conservator.





As of December 31, 2015 , the Bank was “well capitalized” based on the “prompt corrective action” ratios described above. It should be noted that a bank’s capital category is determined solely for the purpose of applying the OCC’s “prompt corrective action” regulations and that the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects.





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Volcker Rule





In December 2013, United States banking regulators adopted final rules implementing the Volcker Rule under the Dodd-Frank Act.  The Volcker Rule places certain limitations on the trading activity of insured depository institutions and their affiliates subject to certain exceptions.  The restricted trading activity includes purchasing or selling certain types of securities or instruments in order to benefit from short-term price movements or to realize short-term profits.  Exceptions to the Volcker Rule include trading in certain U.S. Government or other municipal securities and trading conducted in certain capacities as a broker or other agent, as a fiduciary on behalf of customers, to satisfy a debt previously contracted, repurchase and securities lending agreements and risk-mitigating hedging activities.  The Volcker Rule also prohibits banking institutions from having an ownership interest in a hedge fund or private equity fund.  The implementation of the new Volcker Rule did not have a material impact on the Corporation or the Bank.





LEGISLATIVE AND REGULATORY INITIATIVES TO ADDRESS FINANCIAL AND ECONOMIC CRISES





Small Business Lending Program





In 2010, Congress established the Small Business Lending Fund (“SBLF”) under the Small Business Jobs Act of 2010 encouraging lending to small business by providing capital to qualified community banks with assets of less than $10 billion.  On September 22, 2011, the Corporation became a participant in SBLF by entering into a Securities Purchase Agreement (the “Purchase Agreement”) with the U.S. Department of Treasury ("Treasury"), pursuant to which the Corporation issued 90,782.94 shares of the Corporation’s Senior Non-Cumulative Perpetual


Preferred Stock, Series B (the “Series B Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total purchase price of $90,782,940.





The Series B Preferred Stock was entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1, beginning October 1, 2011.  The dividend rate was based on the level of the Bank's lending to small businesses.  The Series B Preferred Stock was non-voting, except in limited circumstances, and was issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.





On January 3, 2013, the Corporation redeemed 22,695.94 shares of the Series B Preferred Stock held by the Treasury at an aggregate redemption price of $22,695,940 plus accrued but unpaid dividends.  On July 2, 2013, the Corporation redeemed an additional 34,044 shares of the Series B Preferred Stock held by the Treasury at an aggregate redemption price of $34,044,000 plus accrued but unpaid dividends.  On November 22, 2013, the Corporation redeemed the final 34,043 shares of the Series B Preferred Stock held by the Treasury at an aggregate redemption price of $34,043,000 plus accrued but unpaid dividends.  This redemption resulted in all of the outstanding shares of Series B Preferred Stock having been redeemed and the Corporation ending its participation in the SBLF program.





Dodd-Frank Wall Street Reform and Consumer Protection Act





On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. The Dodd-Frank Act has had a broad impact on the financial services industry, including significant regulatory and compliance changes. Many of the requirements called for in the Dodd-Frank Act are being implemented over time and continue to be subject to various federal agencies implementing regulations over the course of several years. Although many of the required regulations have been promulgated, there are additional regulations yet to be finalized.  The changes resulting from the Dodd-Frank Act may materially impact the profitability of the Corporation’s business activities, require changes to certain business practices, impose more stringent capital, liquidity and leverage requirements or otherwise adversely affect the business. At a minimum, the Dodd-Frank Act is likely to:





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|• | increase the cost of operations due to greater regulatory oversight, supervision and examination of banks and bank holding companies, including higher deposit insurance premiums;

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|• | limit the Corporation’s ability to raise additional capital through the use of trust preferred securities as new issuances of these securities may no longer be included as Tier 1 capital;

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|• | reduce the flexibility to generate or originate certain revenue-producing assets based on increased regulatory capital standards; and

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|• | limit the ability to expand consumer product and service offerings due to anticipated stricter consumer protection laws and regulations.




The Corporation’s management is currently taking steps to best prepare for the implementation and to minimize the adverse impact on the business, financial condition and results of operation.





Deposit Insurance





The Bank is insured up to regulatory limits by the FDIC; and, accordingly, is subject to deposit insurance assessments to maintain the Deposit Insurance Fund administered by the FDIC.  The FDIC has adopted regulations establishing a permanent risk-related deposit insurance assessment system. Under this system, the FDIC places each insured bank in one of four risk categories based on (i) the bank’s capital evaluation, and (ii) supervisory evaluations provided to the FDIC by the bank’s primary federal regulator. Each insured bank’s annual assessment rate is then determined by the risk category in which it is classified by the FDIC.


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When Dodd-Frank became effective, it permanently raised the previous Standard Maximum Deposit Insurance Amount (“SMDIA") to $250,000. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category.





As of January 1, 2013, noninterest-bearing transaction deposit accounts are no longer insured separately from other accounts at the same FDIC-insured institution. Instead, noninterest-bearing transaction accounts will be added to other accounts, and the aggregate balance insured up to at least the Standard Maximum Deposit Insurance Amount of $250,000, at each institution.





DIVIDEND LIMITATIONS





National banking laws restrict the amount of dividends that an affiliate bank may declare in a year without obtaining prior regulatory approval. National banks are limited to the bank’s retained net income (as defined) for the current year plus those for the previous two years. At December 31, 2015 , the Corporation’s affiliates (including the Bank and other affiliates) had a total of $29,812,000 retained net profits available for 2016 dividends to the Corporation without prior regulatory approval.





BROKERED DEPOSITS





Under FDIC regulations, no FDIC-insured depository institution can accept brokered deposits unless it (i) is well capitalized, or (ii) is adequately capitalized and received a waiver from the FDIC. In addition, these regulations prohibit any depository institution that is not well capitalized from (a) paying an interest rate on deposits in excess of 76 basis points over certain prevailing market rates or (b) offering “pass through” deposit insurance on certain employee benefit plan accounts unless it provides certain notice to affected depositors.





INTERSTATE BANKING AND BRANCHING





Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Riegle-Neal”), subject to certain concentration limits, required regulatory approvals and other requirements, (i) financial holding companies such as the Corporation are permitted to acquire banks and bank holding companies located in any state; (ii) any bank that is a subsidiary of a bank holding company is permitted to receive deposits, renew time deposits, close loans, service loans and receive loan payments as an agent for any other bank subsidiary of that holding company; and (iii) banks are permitted to acquire branch offices outside their home states by merging with out-of-state  banks, purchasing  branches in other states, and establishing de novo branch offices in other states.





FINANCIAL SERVICES MODERNIZATION ACT





The Gramm-Leach-Bliley Act of 1999 (the “Financial Services Modernization Act”) establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the existing BHC Act. Under this legislation, bank holding companies would be permitted to conduct essentially unlimited securities and insurance activities as well as other activities determined by the Federal Reserve Board to be financial in nature or related to financial services. As a result, the Corporation is able to provide securities and insurance services. Furthermore, under this legislation, the Corporation is able to acquire, or be acquired, by brokerage and securities firms and insurance underwriters. In addition, the Financial Services Modernization Act broadens the activities that may be conducted by national banks through the formation of financial subsidiaries. Finally, the Financial Services Modernization


Act modifies the laws governing the implementation of the Community Reinvestment Act and addresses a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.





A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, is well managed and has at least a satisfactory rating under the Community Reinvestment Act, by filing a declaration that the bank holding company wishes to become a financial holding company. No regulatory approval is required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. The Federal Reserve Bank of Chicago approved the Corporation’s application to become a Financial Holding Company effective September 13, 2000.





USA PATRIOT ACT





As part of the USA Patriot Act, signed into law on October 26, 2001, Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the “Act”). The Act authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to financial institutions such as banks, bank holding companies, broker-dealers and insurance companies. Among its other provisions, the Act requires each financial institution: (i) to establish an anti-money laundering program; (ii) to establish due diligence policies, procedures and controls that are reasonably designed to detect and report instances of money laundering in United States private banking accounts and correspondent accounts maintained for non-United States persons or their representatives; and (iii) to avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign shell bank that does not have a physical presence in any country. In addition, the Act expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours.





Treasury regulations implementing the due diligence requirements were issued in 2002. These regulations required minimum standards to verify customer identity, encouraged cooperation among financial institutions, federal banking agencies, and law enforcement authorities regarding possible money laundering or terrorist activities, prohibited the anonymous use of “concentration accounts,” and required all covered financial institutions to have in place an anti-money laundering compliance program.





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The Act also amended the Bank Holding Company Act and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing an application under these acts.





THE SARBANES-OXLEY ACT





The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”), which became law on July 30, 2002, added new legal requirements for public companies affecting corporate governance, accounting and corporate reporting. The Sarbanes-Oxley Act provides for, among other things:





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|• | a prohibition on personal loans made or arranged by the issuer to its directors and executive officers (except for loans made by a bank subject to Regulation O);

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|• | independence requirements for audit committee members;

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|• | independence requirements for company auditors;

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|• | certification of financial statements on Forms 10-K and 10-Q reports by the chief executive officer and the chief financial officer;

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|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | the forfeiture by the chief executive officer and chief financial officer of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by such officers in the twelve-month period following initial publication of any financial statements that later require restatement due to corporate misconduct;

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|- | ---------------------------------------------
|• | disclosure of off-balance sheet transactions;

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|• | two-business day filing requirements for insiders filing Form 4s;

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|• | disclosure of a code of ethics for financial officers and filing a Form 8-K for a change in or waiver of such code;

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|• | the reporting of securities violations “up the ladder” by both in-house and outside attorneys;

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|• | restrictions on the use of non-GAAP financial measures in press releases and SEC filings;

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|- | ---------------------------------------------------------
|• | the formation of a public accounting oversight board; and

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|- | -----------------------------------------------------------------------
|• | various increased criminal penalties for violations of securities laws.




The SEC was delegated the task of enacting rules to implement various provisions. In addition, each of the national stock exchanges developed new corporate governance rules, including rules strengthening director independence requirements for boards, the adoption of corporate governance codes and charters for the nominating, corporate governance and audit committees.





ADDITIONAL MATTERS





The Corporation and the Bank are subject to the Federal Reserve Act, which restricts financial transactions between banks and affiliated companies. The statute limits credit transactions between banks, affiliated companies and its executive officers and its affiliates. The statute prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices. It also restricts the types of collateral security permitted in connection with the bank’s extension of credit to an affiliate. Additionally, all transactions with an affiliate must be on terms substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated parties.





In addition to the matters discussed above, the Bank is subject to additional regulation of its activities, including a variety of consumer protection regulations affecting its lending, deposit and collection activities and regulations affecting secondary mortgage market activities.





The earnings of financial institutions are also affected by general economic conditions and prevailing interest rates, both domestic and foreign, and by the monetary and fiscal policies of the United States Government and its various agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States Government obligations, varying the discount rate on financial institution borrowings, varying reserve requirements against financial institution deposits, and restricting certain borrowings by financial institutions and their subsidiaries. The monetary policies of the Federal Reserve have had a significant effect on the operating results of the Bank in the past and are expected to continue to do so in the future.





Additional legislation and administrative actions affecting the banking industry may be considered by the United States Congress, state legislatures and various regulatory agencies, including those referred to above. It cannot be predicted with certainty whether such legislation or administrative action will be enacted or the extent to which the banking industry, the Corporation or the Bank would be affected.








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STATISTICAL DATA





The following tables set forth statistical data on the Corporation and its subsidiaries.





DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS’ EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL





The daily average balance sheet amounts, the related interest income or interest expense, and average rates earned or paid are presented in the following table:


Average BalanceInterestIncome /ExpenseAverageRateAverage BalanceInterestIncome /ExpenseAverageRateAverage BalanceInterestIncome /ExpenseAverageRate(Dollars in Thousands)201520142013Assets:Interest-bearing deposits$61,373$1600.26%$53,231$1240.23%$74,964$1580.21%Federal reserve and federal home loan bank stock37,4951,9675.2542,1422,1245.0433,6201,4884.43Investment securities:(1)Taxable703,01917,8852.54763,45019,8822.60617,52415,2142.46Tax-Exempt(2)483,10326,0345.39396,43522,1275.58282,58416,6605.90Total investment securities1,186,12243,9193.701,159,88542,0093.62900,10831,8743.54Loans held for sale3,72547512.756,6814857.2616,1377704.77Loans:(3)Commercial3,187,239142,6964.482,919,020133,5674.582,391,221113,6134.75Real estate mortgage457,01319,4574.26429,38419,8124.61277,52012,3754.46Installment406,16318,1774.48361,48418,1755.03308,23315,9945.19Tax-Exempt(2)125,6995,3224.2313,5115043.7315,4446053.92Total loans4,179,839186,1274.453,730,080172,5434.633,008,555143,3574.76Total earning assets5,464,829232,1734.25%4,985,338216,8004.35%4,017,247176,8774.40%Net unrealized gain on securities available for sale11,8008,9214,521Allowance for loan losses(62,975)(67,969)(68,806)Cash and cash equivalents98,05187,06873,161Premises and equipment82,71075,20257,228Other assets491,272482,794372,060Total assets$6,085,687$5,571,354$4,455,411Liabilities:Interest-bearing deposits:NOW accounts$1,109,829$1,3740.12%$1,066,402$1,1100.10%$880,323$9410.11%Money market deposit accounts840,0841,7680.21776,7121,5720.20603,0121,2870.21Savings  deposits614,6756720.11533,0806190.12377,1064210.11Certificates and other time deposits1,121,65111,0410.981,042,5398,3770.80807,7647,4040.92Total interest-bearing deposits3,686,23914,8550.403,418,73311,6780.342,668,20510,0530.38Borrowings480,7949,9392.07492,12810,1642.07400,5806,5161.63Total interest-bearing liabilities4,167,03324,7940.603,910,86121,8420.563,068,78516,5690.54Noninterest-bearing deposits1,120,264945,222797,435Other liabilities44,66639,97648,936Total liabilities5,331,9634,896,0593,915,156Stockholders' Equity753,724675,295540,255Total Liabilities and Stockholders' Equity$6,085,68724,7940.45$5,571,35421,8420.44$4,455,41116,5690.41Net Interest Income$207,379$194,958$160,308Net Interest Margin3.80%3.91%3.99%


























______________________________





(1) Average balance of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustment.





(2) Tax-exempt securities and loans are presented on a fully taxable equivalent basis, using a marginal tax rate of 35 percent for 2015, 2014 and 2013. These totals equal $10,975, $7,921 and $6,043,


respectively.





(3) Non-accruing loans have been included in the average balances.





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ANALYSIS OF CHANGES IN NET INTEREST INCOME





The following table presents net interest income components on a tax-equivalent basis and reflects changes between periods attributable to movement in either the average balance or average interest rate for both earning assets and interest-bearing liabilities. The volume differences were computed as the difference in volume between the current and prior year multiplied by the interest rate from the prior year.  The interest rate changes were computed as the difference in rate between the current and prior year multiplied by the volume from the prior year.  Volume/rate variances have been allocated on the basis of the absolute relationship between volume variances and rate variances.


2015 Compared to 2014Increase (Decrease) Due To2014 Compared to 2013Increase (Decrease) Due To2013 Compared to 2012Increase (Decrease) Due To(Dollars in Thousands, Fully Taxable Equivalent Basis)VolumeRateTotalVolumeRateTotalVolumeRateTotalInterest Income:Interest-bearing deposits$20$16$36$(49)$15$(34)$33$25$58Federal Reserve and Federal Home Loan Bank stock(241)84(157)411225636354580Investment securities9619491,9109,39374210,135(800)(28)(828)Loans held for sale(274)264(10)(576)291(285)(216)(38)(254)Loans20,315(6,721)13,59433,894(4,423)29,4719,718(13,591)(3,873)Totals20,781(5,408)15,37343,073(3,150)39,9238,770(13,587)(4,817)Interest Expense:NOW accounts47217264194(25)16977(143)(66)Money market deposit accounts13264196354(69)285248(331)(83)Savings deposits91(38)531801819872(179)(107)Certificates and other time deposits6721,9922,6641,966(993)973(1,477)(3,014)(4,491)Borrowings(234)9(225)1,6731,9753,648(237)(2,060)(2,297)Totals7082,2442,9524,3679065,273(1,317)(5,727)(7,044)Change in net interest income (fully taxable equivalent basis)$20,073$(7,652)12,421$38,706$(4,056)34,650$10,087$(7,860)2,227Tax equivalent adjustment using marginal rate of 35% for 2015, 2014, and 2013(3,054)(1,878)(298)Change in net interest income$9,367$32,772$1,929








INVESTMENT SECURITIES





Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities are generally evaluated for OTTI under Accounting Standards Codification (“ASC”) 320, Investments – Debt and Equity Securities . However, certain purchased beneficial interest, including certain non-agency government-sponsored mortgage-backed securities, asset-backed securities and collateralized debt obligations are evaluated using the model outlined in ASC 325-10 , Investments - Other .





In determining OTTI under ASC 320, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Corporation has the intent to sell the debt security or more likely than not, will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.





When OTTI occurs, the amount of OTTI recognized in the income statement depends on whether the Corporation intends to sell the security or it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis, less any recognized credit loss. If the intent is to sell, or it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis, less any recognized credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis, less any recognized credit loss, and its fair value at the balance sheet date. If the intent is not to sell the security and it is not more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis less any recognized credit loss, the OTTI has been separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable income taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.





The Corporation’s management has evaluated all securities with unrealized losses for OTTI as of December 31, 2015 .  The evaluations are based on the nature of the securities, the extent and duration of the loss and the intent and ability of the Corporation to hold these securities either to maturity or through the expected recovery period.





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In determining the fair value of the investment securities portfolio, the Corporation utilizes a third party for portfolio accounting services, including market value input, for those securities classified as Level I and Level II in the fair value hierarchy.  The Corporation has obtained an understanding of what inputs are being used by the vendor in pricing the portfolio and how the vendor classified these securities based upon these inputs.  From these discussions, the Corporation’s management is comfortable that the classifications are proper.  The Corporation has gained trust in the data for two reasons:  (a) independent spot testing of the data is conducted by the Corporation through obtaining market quotes from various brokers on a periodic basis; and (b) actual gains or loss resulting from the sale of certain securities has proven the data to be accurate over time.   Fair value of securities classified as Level 3 in the valuation hierarchy were determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.





The Corporation continues to evaluate the portfolio for OTTI on an ongoing basis.  In 2015, the Corporation sold its remaining trust preferred security which had no remaining book value as a result of OTTI of approximately $500,000 taken in 2009.





The amortized cost, gross unrealized gains, gross unrealized losses and approximate market value of the investment securities at the dates indicated were:


(Dollars in Thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesFair ValueAvailable for sale at December 31, 2015U.S. Government-sponsored agency securities$100$4$104State and municipal291,73014,241$60305,911U.S. Government-sponsored mortgage-backed securities342,5504,234518346,266Corporate obligations3131Equity securities3,9123,912Certificates of deposit2,1762,176Total available for sale640,49918,479578658,400Held to maturity at December 31, 2015State and municipal219,7676,98215226,734U.S. Government-sponsored mortgage-backed securities398,8327,601787405,646Total held to maturity618,59914,583802632,380Total Investment Securities$1,259,098$33,062$1,380$1,290,780








Amortized CostGross Unrealized GainsGross Unrealized LossesFair ValueAvailable for sale at December 31, 2014U.S. Government-sponsored agency securities$100$9$109State and municipal216,91511,801$123228,593U.S. Government-sponsored mortgage-backed securities310,4608,771127319,104Corporate obligations3131Equity securities1,7061,706Total available for sale529,21220,581250549,543Held to maturity at December 31, 2014State and municipal204,4435,71696210,063U.S. Government-sponsored mortgage-backed securities426,64511,527512437,660Total held to maturity631,08817,243608647,723Total Investment Securities$1,160,300$37,824$858$1,197,266








Amortized CostGross Unrealized GainsGross Unrealized LossesFair ValueAvailable for sale at December 31, 2013U.S. Treasury$15,914$80$21$15,973U.S. Government-sponsored agency securities3,55012173,545State and municipal231,0053,8783,896230,987U.S. Government-sponsored mortgage-backed securities279,2993,9261,973281,252Corporate obligations6,3743,6362,738Equity securities1,7061,706Total available for sale537,8487,8969,543536,201Held to maturity at December 31, 2013State and municipal145,9416291145,912U.S. Government-sponsored mortgage-backed securities413,4375,2203,722414,935Total held to maturity559,3785,2823,813560,847Total Investment Securities$1,097,226$13,178$13,356$1,097,048


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The cost and yields for Federal Reserve and Federal Home Loan Bank stock are included in the table below.


201520142013(Dollars in Thousands)CostYieldCostYieldCostYieldFederal Reserve and Federal Home Loan Bank stock at December 31:Federal Reserve Bank stock$19,4566.0%$18,9496.0%$13,2876.0%Federal Home Loan Bank stock18,1775.3%22,4045.1%25,7032.0%Total$37,6335.7%$41,3535.5%$38,9903.4%








Federal Reserve and Federal Home Loan Bank stock have been reviewed for impairment and the analysis reflected no impairment.  The Corporation’s Federal Home Loan Bank stock is primarily in the Federal Home Loan Bank of Indianapolis and it continued to produce sufficient financial results to pay dividends.





There were no issuers included in the investment security portfolio at December 31, 2015 , 2014 or 2013 where the aggregate carrying value of any one issuer exceeded 10 percent of the Corporation's stockholders' equity at those dates. The term "issuer" excludes the U.S. Government and its sponsored agencies and corporations.





The maturity distribution and average yields for the securities portfolio at December 31, 2015 were:


Within 1 Year1-5 Years5-10 Years(Dollars in Thousands)AmountYield(1)AmountYield(1)AmountYield(1)Securities available for sale December 31, 2015U.S. Government-sponsored agency securities$1044.9%State and municipal4,6006.0%$14,2955.1%$55,3445.5%Corporate obligations31—%$4,7046.0%$14,2955.1%$55,3755.5%








Due After Ten YearsEquity, Certificates of Deposits, and U.S. Government-SponsoredMortgage - BackedSecuritiesTotalAmountYield(1)AmountYield(1)AmountYield(1)U.S. Government-sponsored agency securities$1044.9%State and municipal$231,6725.0%305,9115.1%Equity securities$3,9121.9%3,9121.9%Corporate obligations31—%U.S. Government-sponsored mortgage-backed securities346,2662.8%346,2662.8%Certificates of deposit2,176—%2,176—%$231,6725.0%$352,3542.8%$658,4004.0%








Within 1 Year1-5 Years5-10 YearsAmountYield(1)AmountYield(1)AmountYield(1)Securities held to maturity at December 31, 2015State and municipal$4,1442.4%$28,0545.8%$81,4836.1%U.S. Government-sponsored mortgage-backed securities$4,1442.4%$28,0545.8%$81,4836.1%








Due After Ten YearsEquity, Certificates of Deposits, and U.S. Government-SponsoredMortgage - BackedSecuritiesTotalAmountYield(1)AmountYield(1)AmountYield(1)State and municipal$106,0864.8%$219,7675.4%U.S. Government-sponsored mortgage-backed securities$398,8322.9%398,8322.9%$106,0864.8%$398,8322.9%$618,5993.7%





_ ______________________________





(1) Interest yields are presented on a fully taxable equivalent basis using a 35 percent tax rate.


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The following tables show the Corporation’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2015 and 2014 :


Less than12 Months12 Months or LongerTotalFairValueGrossUnrealizedLossesFairValueGrossUnrealizedLossesFairValueGrossUnrealizedLossesTemporarily Impaired Available for Sale Securities at December 31, 2015State and municipal$7,558$60$7,558$60U.S. Government-sponsored mortgage-backed securities83,396445$2,101$7385,497518Total Temporarily Impaired Available for Sale Securities90,9545052,1017393,055578Temporarily Impaired Held to Maturity Securities at December 31, 2015State and municipal1,982151,98215U.S. Government-sponsored mortgage-backed securities69,64151912,90626882,547787Total Temporarily Impaired Held to Maturity Securities69,64151914,88828384,529802Total Temporarily Impaired Investment Securities$160,595$1,024$16,989$356$177,584$1,380








Less than12 Months12 Months or LongerTotalFairValueGrossUnrealizedLossesFairValueGrossUnrealizedLossesFairValueGrossUnrealizedLossesTemporarily Impaired Available for Sale Securities at December 31, 2014State and municipal$1,256$7$9,850$116$11,106$123U.S. Government-sponsored mortgage-backed securities2,186135,4471147,633127Total Temporarily Impaired Available for Sale Securities3,4422015,29723018,739250Temporarily Impaired Held to Maturity Securities at December 31, 2014State and municipal5,119962505,36996U.S. Government-sponsored mortgage-backed securities9,7918238,49143048,282512Total Temporarily Impaired Held to Maturity Securities14,91017838,74143053,651608Total Temporarily Impaired Investment Securities$18,352$198$54,038$660$72,390$858








LOAN PORTFOLIO





The following table shows the composition of the Corporation’s loan portfolio, including purchased credit impaired loans, for the years indicated:


20152014201320122011(Dollars in Thousands)Amount%Amount%Amount%Amount%Amount%Loans at December 31:Commercial and industrial loans$1,057,07522.5%$896,68822.8%$761,70521.0%$622,57921.5%$532,52319.6%Agricultural production financing and other loans to farmers97,7112.1104,9272.7114,3483.1112,5273.9104,5263.9Real estate loans:Construction366,7047.8207,2215.3177,0824.998,6393.481,7803.0Commercial and farmland1,802,92138.51,672,66142.61,611,80944.41,266,68243.61,194,23044.0Residential786,10516.7647,31516.5616,38517.0473,53716.3481,49317.7Home equity348,6137.4286,5297.3255,2237.0203,4067.0191,6317.1Individuals' loans for household and other personal expenditures74,7171.673,4001.969,7831.975,7482.684,1723.1Lease financing receivables, net of unearned income5881,1061,5452,5900.13,5550.1Other loans159,3883.435,0180.924,5290.746,5011.639,5051.5Loans4,693,822100.0%3,924,865100.0%3,632,409100.0%2,902,209100.0%2,713,415100.0%Allowance for loan losses(62,453)(63,964)(67,870)(69,366)(70,898)Net Loans$4,631,369$3,860,901$3,564,539$2,832,843$2,642,517








Residential Real Estate Loans Held for Sale at December 31, 2015, 2014, 2013, 2012, and 2011 were $9,894,000, $7,235,000, $5,331,000, $22,300,000, and $17,864,000, respectively.





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At December 31, 2015, loans of $331.0 million with an estimated fair value discount of $11.3 million were acquired in the Ameriana transaction. The April 17, 2015 acquisition of C Financial included loans of $113.2 million with a fair value discount of $2.6 million. The assets acquired in the November 7, 2014 Community transaction included $153.9 million in loans which were acquired at a fair value discount of $8.8 million. The November 12, 2013 CFS acquisition included loans of $639.6 million and a fair value discount of $36.5 million.  In 2012, the Bank acquired $113.0 million of loans at a fair value discount of $19.2 million as part of the SCB transaction.





The majority of the portfolio is comprised of loans secured by commercial and farmland real estate, commercial and industrial loans and loans secured by residential real estate.  Commercial and farmland real estate loans made up 38.5 percent and 42.6 percent of loans at December 31, 2015 and 2014, respectively. Commercial and industrial loans made up 22.5 percent and 22.8 percent of loans and residential real estate loans, including home equity, made up 24.1 percent and 23.8 percent of loans at December 31, 2015 and 2014, respectively. Loans are generated from customers primarily in central and northwest Indiana, northeast Illinois and central Ohio and are typically secured by specific items of collateral, including real property, consumer assets, and business assets.





LOAN MATURITIES





Presented in the table below are the maturities of loans (excluding residential real estate, home equity, individuals’ loans for household and other personal expenditures and lease financing) outstanding as of December 31, 2015. Also presented are the amounts due after one year, classified according to the sensitivity to changes in interest rates.


(Dollars in Thousands)MaturingWithin 1 YearMaturing1-5 YearsMaturing Over5 YearsTotalCommercial and industrial loans$815,885$165,483$75,707$1,057,075Agriculture production financing and other loans to farmers89,3427,49787297,711Real estate loans:Construction329,87224,47012,362366,704Commercial and farmland764,768813,561224,5921,802,921Other loans4,4345,727149,227159,388Total$2,004,301$1,016,738$462,760$3,483,799








(Dollars in Thousands)Maturing1-5 YearsMaturing Over5 YearsLoans maturing after one year with:Fixed rate$679,528$399,426Variable rate337,21063,334Total$1,016,738$462,760








NON-PERFORMING ASSETS





The table below summarizes non-performing assets and impaired loans for the years indicated:


December 31,December 31,December 31,December 31,December 31,(Dollars in Thousands)20152014201320122011Non-performing assets:Non-accrual loans$31,389$48,789$56,402$53,399$69,592Renegotiated loans1,9231,9923,04812,68114,308Non-performing loans (NPL)33,31250,78159,45066,08083,900Other real estate owned17,25719,29322,24613,26316,289Non-performing assets (NPA)50,56970,07481,69679,343100,18990+ days delinquent and still accruing9074,6631,3502,037580NPAs & 90+ days delinquent$51,476$74,737$83,046$81,380$100,769Impaired loans$97,527$116,223$119,755$79,179$79,775








Loans are reclassified to a non-accruing status when, in management’s judgment, the collateral value and financial condition of the borrower do not justify accruing interest. Interest previously recorded, but not deemed collectible, is reversed and charged against current income.  Payments subsequently received on non-accrual loans are applied to principal.





At December 31, 2015, non-accrual loans and other real estate owned of $31,389,000 and $17,257,000 include assets acquired from Ameriana of $2,229,000 and $5,719,000, respectively.  At December 31, 2014, non-accrual loans and other real estate owned of $48,789,000 and $19,293,000 included assets acquired from Community of $5,674,000 and $6,662,000, respectively.   At December 31, 2013, non-accrual loans and other real estate owned of $56,402,000 and $22,246,000 include assets acquired from CFS of $22,703,000 and $12,899,000, respectively. At December 31, 2012, non-accrual loans and other real estate owned of $53,399,000 and $13,263,000 include assets acquired from SCB of $4,219,000 and $160,000, respectively.





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Renegotiated loans are loans for which concessions are granted to the borrower due to deterioration in the financial condition of the borrower, resulting in the inability of the borrower to meet the original contractual terms of the loans. These concessions may include interest rate reductions, principal forgiveness, extensions of maturity date or other actions intended to minimize losses.  Certain loans restructured may be excluded from restructured loan disclosures in years subsequent to the restructuring if the loans are in compliance with their modified terms. A non-accrual loan that is restructured may remain non-accrual for a period of approximately six months until the borrower can demonstrate their ability to meet the restructured terms. A borrower's performance prior to the restructuring, as well as after, will be considered in assessing whether the borrower can meet the new terms resulting in the loan being returned to accruing status in a shorter or longer period of time than the standard six months. If the borrower’s performance under the modified terms is not reasonably assured, the loan will remain non-accrual.





For the year ended December 31, 2015, interest income of $648,000 was recognized on the non-accruing and renegotiated loans listed in the table above, whereas interest income of $2,057,000 would have been recognized under their original loan terms.





At December 31, 2015, the commercial impaired loan total of $97,527,000 included $11,365,000 and $1,841,000 in loans acquired from Ameriana and C Financial, respectively.  At December 31, 2014, the commercial impaired loan total of $116,223,000 included $17,027,000 in loans acquired from Community.  At December 31, 2013, the commercial impaired loan total of $119,755,000 included $69,448,000 in loans acquired from CFS.  At December 31, 2012, the commercial impaired loan total of $79,179,000 included $17,334,000 in loans acquired from SCB. Commercial impaired loans include non-accrual loans, loans accounted for under ASC 310-30, and loans risk graded as substandard, doubtful and loss that were still accruing but deemed impaired according to the guidance set forth in ASC 310.  Also included in impaired loans are accruing loans that are contractually past due 90 days or more and troubled debt restructurings.  A loan is deemed impaired under ASC 310 when, based on current information or events, it is probable that all amounts due of principal and interest according to the contractual terms of the loan agreement will not be collected.  A specific allowance for losses was not deemed necessary for a subset of the impaired loans totaling $90,975,000, but a specific allowance of $1,842,000 was recorded for the remaining balance of $6,552,000 and is included in the Corporation’s allowance for loan losses at December 31, 2015. Specific reserves totaling $153,000 were recorded on loans acquired from CFS and Community. No specific allowance was recorded on loans acquired in SCB, C Financial or Ameriana transactions. The average balance of the aforementioned total impaired loans for 2015 was $103,368,000.





An allowable method for determining impairment is estimating the fair value of collateral on collateral dependent loans.  This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.  The fair value of real estate is generally based on appraisals by qualified licensed appraisers.  The appraisers determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a discounted cash flow analysis. Fair value on other collateral such as business assets is typically ascertained by assessing, either singularly or some combination of, asset appraisals, accounts receivable aging reports, inventory listings and  or customer financial statements.   Both appraised values and values based on borrower’s financial information are discounted as considered appropriate based on age and quality of the information and current market conditions.





In addition to the impaired loans discussed above, management also identified loans totaling $240,948,000 as of December 31, 2015 that were deemed to be criticized, but not impaired.  These loans are not included in the table above, or the impaired loan table in the footnotes to the consolidated financial statements.  A criticized loan is a loan in which there are concerns regarding the borrower’s ability to comply with the repayment terms.





See additional information regarding loan credit quality in Note 5. LOANS AND ALLOWANCE, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





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SUMMARY OF LOAN LOSS EXPERIENCE





The following table summarizes the loan loss experience for the years indicated:


(Dollars in Thousands)20152014201320122011Allowance for loans losses:Balances, January 1$63,964$67,870$69,366$70,898$82,977Charge offs:Commercial(1)2,3567,2466,1178,3119,818Commercial real estate(2)1,4376,6087,49312,32229,807Consumer6206576231,1301,441Residential3,8592,8693,8865,4757,407Finance leases21534Total Charge Offs8,27217,38218,13427,27248,473Recoveries:Commercial(3)1,9115,4354,5861,7448,828Commercial real estate(4)2,5453,2973,5523,6522,811Consumer352377556695942Residential1,5361,7831,2921,1131,176Finance leases24427Total Recoveries6,34410,9169,9907,20613,764Net charge offs1,9286,4668,14420,06634,709Provisions for loan losses4172,5606,64818,53422,630Balance at December 31$62,453$63,964$67,870$69,366$70,898Ratio of net charge offs during the period to average loans outstanding during the period0.05%0.17%0.27%0.71%1.26%








See the information regarding the analysis of loan loss experience in the “Provision and Allowance for Loan Losses” section


of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.




























































































_______________________________





(1) Category includes the charge offs for commercial and industrial, agricultural production financing and other loans to farmers and other non-consumer loans.





(2) Category includes the charge offs for construction, commercial and farmland.





(3) Category includes the recoveries for commercial and industrial, agricultural production financing and other loans to farmers and other non-consumer loans.





(4) Category includes the recoveries for construction, commercial and farmland.


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ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES





Presented below is an analysis of the composition of the allowance for loan losses and percent of loans in each category to total loans as of December 31, 2015, 2014, 2013, 2012, and 2011.


20152014201320122011(Dollars in Thousands)AmountPercentAmountPercentAmountPercentAmountPercentAmountPercentBalance at December 31:Commercial$26,47828.0%$28,82426.4%$27,17624.8%$25,91326.9%$17,73124.9%Commercial real estate22,14546.219,32747.923,10249.326,70347.137,91947.1Consumer2,6891.62,6581.92,5151.92,5932.62,9023.1Residential11,13924.213,15223.815,07724.014,15723.312,34324.8Finance leases230.130.1Totals$62,453100.0%$63,964100.0%$67,870100.0%$69,366100.0%$70,898100.0%








Loan concentrations are considered to exist when there are amounts loaned to multiple borrowers engaged in similar activities, which would cause them to be similarly impacted by economic or other conditions.  As of December 31, 2015, the only concentrations of commercial loans within a single industry (as segregated by North American Industry Classification System “NAICS code”) in excess of 10 percent of loans were Lessors of Nonresidential Buildings and Lessors of Residential Buildings and Dwellings.





LOAN LOSS CHARGE OFF PROCEDURES





The Corporation maintains an allowance to cover probable credit losses in its loan portfolio. The allowance is increased by the provision for loan losses and decreased by charge offs less recoveries. All charge offs are approved by the senior loan officers or loan committees, depending on the amount of the charge off, and are reported to the Board of Directors. Loans are charged off when a determination is made that all or a portion of a loan is uncollectible.





PROVISION FOR LOAN LOSSES





In banking, loan losses are a cost of doing business. Although management emphasizes the early detection and charge off of loan losses, it is inevitable that certain losses, which have not been specifically identified, exist in the portfolio. Accordingly, the provision for loan losses is charged to earnings on an anticipatory basis, and recognized loan losses net of recoveries are deducted from the established allowance. Over time, all net loan losses are charged to earnings. During the year, an estimate of the expected losses for the year serves as a starting point in determining the appropriate level of the provision for loan losses. Based on management’s judgment as to the appropriate level of the allowance for loan losses, the amount provided in any period may be greater or less than net loan losses for the same period. The determination of the provision for loan losses in any period is based on management’s continuing review and evaluation of the loan portfolio, and its judgment as to the impact of current economic conditions on the portfolio. The evaluation by management includes consideration of past loan loss experience, changes in the composition of the loan portfolio, and the current condition and amount of loans outstanding. See additional information in the “Provision and Allowance For Loan Losses” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





DEPOSITS





The average balances, interest expense and average rates on deposits for the years ended December 2015, 2014 and 2013 are presented in the Part I. Item I. Business section titled "DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY, INTEREST RATES AND INTEREST DIFFERENTIAL" of this Annual Report on Form 10-K.





As of December 31, 2015 , certificates of deposit and other time deposits of $100,000 or more mature as follows:


(Dollars in Thousands)Maturing 3Months or LessMaturing 3-6MonthsMaturing 6-12 MonthsMaturing Over12 MonthsTotalCertificates of deposit and other time deposits$90,182$46,117$75,925$111,474$323,698Percent28%14%24%34%100%








RETURN ON EQUITY AND ASSETS





See the information regarding return on equity and assets presented within Part II: Item 6. SELECTED FINANCIAL DATA of this Annual Report on Form 10-K.





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SHORT-TERM BORROWINGS





Borrowings maturing in one year or less are included in the following table:


(Dollars in Thousands)201520142013Balance at December 31:Federal funds purchased$49,721$15,381$125,645Securities sold under repurchase agreements (short-term portion)155,325124,539148,672Federal Home Loan Bank advances  (short-term portion)91,44130,70126,272Subordinated debentures and term loans (short-term portion)183108105Total short-term borrowings$296,670$170,729$300,694








Securities sold under repurchase agreements are categorized as borrowings maturing within one year and are secured by U.S. Treasury and U.S. Government-Sponsored Enterprise obligations, certain municipal securities and mortgage loans.





Pertinent information with respect to short-term borrowings is summarized below:


(Dollars in Thousands)201520142013Weighted Average Interest Rate on Outstanding Balance at December 31:Federal funds purchased0.5%0.3%0.3%Securities sold under repurchase agreements (short-term portion)0.3%0.3%0.5%Federal Home Loan Bank advances (short-term portion)1.1%2.0%1.1%Subordinated debentures and term loans (short-term portion)Total short-term borrowings0.6%0.6%0.5%Weighted Average Interest Rate During the Year:Federal funds purchased0.4%0.4%0.4%Securities sold under repurchase agreements (short-term portion)0.3%0.4%0.6%Federal Home Loan Bank advances (short-term portion)1.1%0.9%0.8%Subordinated debentures and term loans (short-term portion)Total short-term borrowings0.5%0.6%0.6%Highest Amount Outstanding at Any Month End During the Year:Federal funds purchased$101,249$121,192$125,645Securities sold under repurchase agreements (short-term portion)163,128155,941151,813Federal Home Loan Bank advances (short-term portion)128,557190,70976,272Subordinated debentures and term loans (short-term portion)234470459Total short-term borrowings$393,168$468,312$354,189Average Amount Outstanding During the year:Federal funds purchased$20,767$44,674$26,789Securities sold under repurchase agreements (short-term portion)143,491130,910140,126Federal Home Loan Bank advances (short-term portion)62,47196,28422,807Subordinated debentures and term loans (short-term portion)174232187Total short-term borrowings$226,903$272,100$189,909





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ITEM 1A. RISK FACTORS





RISK FACTORS





There are a number of factors, including those specified below, that may adversely affect the Corporation’s business, financial results or stock price. Additional risks that the Corporation currently does not know about or currently views as immaterial may also impair the Corporation’s business or adversely impact its financial results or stock price.





INDUSTRY AND CORPORATE RISK FACTORS





The Corporation’s business and financial results are significantly affected by general business and economic conditions.





The Corporation’s business activities and earnings are affected by general business conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, and the strength of the United States economy and the state and local economies in which the Corporation operates. For example, a prolonged economic downturn, continued increase in unemployment, or other events that affect household and/or corporate incomes could result in deterioration of credit quality, an increase in the allowance for loan losses, or reduced demand for loan or fee-based products and services. Changes in the financial performance and condition of the Corporation’s borrowers could negatively affect repayment of those borrowers’ loans. In addition, changes in securities market conditions and monetary fluctuations could adversely affect the availability and terms of funding necessary to meet the Corporation’s liquidity needs.





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|• | Changes in the domestic interest rate environment could reduce the Corporation’s net interest income.




The operations of financial institutions, such as the Corporation, are dependent to a large degree on net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings. An institution’s net interest income is significantly affected by market rates of interest, which in turn are affected by prevailing economic conditions, by the fiscal and monetary policies of the federal government and by the policies of various regulatory agencies. Like all financial institutions, the Corporation’s balance sheet is affected by fluctuations in interest rates. Volatility in interest rates can also result in the flow of funds away from financial institutions into direct investments. Direct investments, such as U.S. Government and corporate securities and other investment vehicles, including mutual funds, generally pay higher rates of return than financial institutions, because of the absence of federal insurance premiums and reserve requirements.





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|• | Changes in the laws, regulations and policies governing banks and financial services companies could alter the Corporation’s business environment and adversely affect operations.




The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its fiscal and monetary policies determine in a large part the Corporation’s cost of funds for lending and investing and the return that can be earned on those loans and investments, both of which affect the Corporation’s net interest margin. Federal Reserve Board policies can also materially affect the value of financial instruments that the Corporation holds, such as debt securities. The Corporation and the Bank are heavily regulated at the federal and state levels. This regulation is to protect depositors, federal deposit insurance funds and the banking system as a whole. Congress and state legislatures and federal and state agencies continually review banking laws, regulations and policies for possible changes. Changes in statutes, regulations or policies could affect the Corporation in substantial and unpredictable ways, including limiting the types of financial services and products that the Corporation offers and/or increasing the ability of non-banks to offer competing financial services and products.  See a description of recent legislation in the “REGULATION AND SUPERVISION OF FIRST MERCHANTS CORPORATION AND SUBSIDIARIES” section of Item 1: Business of this Annual Report on Form 10-K.





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|• | The banking and financial services industry is highly competitive, and competitive pressures could intensify and adversely affect the Corporation’s financial results.




The Corporation operates in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. The Corporation competes with other banks, savings and loan associations, mutual savings banks, finance companies, mortgage banking companies, credit unions and investment companies. In addition, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks. Many of the Corporation’s competitors have fewer regulatory constraints and some have lower cost structures. Also, the potential need to adapt to industry changes in information technology systems, on which the Corporation and financial services industry are highly dependent, could present operational issues and require capital spending.





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|• | Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.




Geopolitical conditions may also affect the Corporation’s earnings. Acts or threats of terrorism and political or military actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general economic or industry conditions.


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|• | The Corporation’s allowance for loan losses may not be adequate to cover actual losses.




The Corporation maintains an allowance for loan losses to provide for loan defaults and non-performance.  The allowance for loan losses represents management’s estimate of probable losses inherent in the Corporation’s loan portfolio. The Corporation’s allowance consists of three components:  probable losses estimated from individual reviews of specific loans, probable losses estimated from historical loss rates, and probable losses resulting from economic, environmental, qualitative or other deterioration above and beyond what is reflected in the first two components of the allowance. The process for determining the adequacy of the allowance for loan losses is critical to the Corporation’s financial results. It requires management to make difficult, subjective and complex judgments, as a result of the need to make estimates about the effect of matters that are uncertain.  Therefore, the allowance for loan losses, considering current factors at the time, including economic conditions and ongoing internal and external examination processes, will increase or decrease as deemed necessary to ensure the allowance for loan losses remains adequate. In addition, the allowance as a percentage of charge offs and nonperforming loans will change at different points in time based on credit performance, loan mix and collateral values.





The Corporation may suffer losses in its loan portfolio despite its underwriting practices.





The Corporation seeks to mitigate the risks inherent in its loan portfolio by adhering to specific underwriting practices. The Corporation’s strategy for credit risk management includes conservative credit policies and underwriting criteria for all loans, as well as an overall credit limit for each customer significantly below legal lending limits. The strategy also emphasizes diversification on a regional geographic, industry and customer level, regular credit quality reviews and management reviews of large credit exposures and loans experiencing deterioration of credit quality. There is a continuous review of the loan portfolio, including an internally administered loan “watch” list and an independent loan review. The evaluation takes into consideration identified credit problems, as well as the possibility of losses inherent in the loan portfolio that are not specifically identified. Although the Corporation believes that its underwriting criteria are appropriate for the various kinds of loans it makes, the Corporation may incur losses on loans due to the factors previously discussed.





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|• | The Corporation faces operational risks because the nature of the financial services business involves a high volume of transactions.




The Corporation operates in diverse markets and relies on the ability of its employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from the Corporation’s operations, including, but not limited to, the risk of fraud by employees or persons outside of the Corporation, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, the Corporation could suffer financial loss, face regulatory action and suffer damage to its reputation.





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|• | A natural disaster could harm the Corporation’s business.




Natural disasters could harm the Corporation’s operations directly through interference with communications, as well as through the destruction of facilities and operational, financial and management information systems. These events could prevent the Corporation from gathering deposits, originating loans and processing and controlling its flow of business.





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|• | The Corporation faces systems failure risks as well as security risks, including “hacking” and “identity theft”.




The computer systems and network infrastructure the Corporation uses could be vulnerable to unforeseen problems. The Corporation’s operations are dependent upon the ability to protect computer equipment against damage from fire, power loss or telecommunication failure. Any damage or failure that causes an interruption in operations could adversely affect the business and financial results. In addition, computer systems and network infrastructure present security risks, and could be susceptible to hacking or identity theft which could cause significant damage and cost to the Corporation, the severity of which is difficult to predict.





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|• | The Corporation relies on dividends from its subsidiaries for its liquidity needs.




The Corporation is a separate and distinct legal entity from its bank and non-bank subsidiaries. The Corporation receives substantially all of its cash from dividends paid by its subsidiaries. These dividends are the principal source of funds to pay dividends on the Corporation’s stock and interest and principal on its debt. Various federal and state laws and regulations limit the amount of dividends that the bank subsidiaries may pay to the Corporation.


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|• | The Corporation’s reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates.




The Corporation’s accounting policies and methods are fundamental to how it records and reports its financial condition and results of operations. The Corporation’s management must exercise judgment in selecting and applying many of these accounting policies and methods, so they comply with Generally Accepted Accounting Principles and reflect management’s judgment of the most appropriate manner to report the Corporation’s financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in the Corporation reporting materially different results than would have been reported under a different alternative. Certain accounting policies are critical to presenting the Corporation’s financial condition and results, and require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include:  the allowance for loan losses; the valuation of investment securities; the valuation of goodwill and intangible assets; and pension accounting. Because of the uncertainty of estimates involved in these matters, the Corporation may be required to do one or more of the following:  significantly increase the allowance for loan losses and/or sustain loan losses that are significantly higher than the reserve provided; recognize significant provision for impairment of its investment securities; recognize significant impairment on its goodwill and intangible assets; or significantly increase its pension liability. As part of its function of assisting the Corporation’s Board of Directors in discharging its responsibility of ensuring all types of risk to the organization are properly being managed, mitigated and monitored by management, the Audit Committee of the Board of Directors oversees management’s accounting policies and methods.  For more information, refer to Note 1.  NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, in the Notes to Consolidated Financial Statements included as item 8 of this Annual Report on Form 10-K.





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|• | A write-down of all or part of the Corporation’s goodwill could materially reduce its net income and net worth.




At December 31, 2015 , the Corporation had goodwill of $243,129,000 recorded on its consolidated balance sheet. Under ASC 340-20, Other Assets and Deferred Costs , the Corporation is required to evaluate goodwill for impairment on an annual basis, as well as on an interim basis, if events or changes indicate that the asset may be impaired. An impairment loss must be recognized for any excess of carrying value over the fair value of goodwill.  The fair value is determined based on internal valuations using management’s assumptions of future growth rates, future attrition, discount rates, multiples of earnings or other relevant factors. The resulting estimated fair value could result in material write-downs of goodwill and recording of impairment losses. Such a write-down could materially reduce the Corporation’s net income and overall net worth. The Corporation also cannot predict the occurrence of certain future events that might adversely affect the fair value of goodwill. Such events include, but are not limited to, strategic decisions made in response to economic and competitive conditions, the effect of the economic environment on the Corporation’s customer base, or a material negative change in its relationship with significant customers.





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|• | Changes in accounting standards could materially impact the Corporation’s financial statements.




From time to time, the Financial Accounting Standards Board changes the financial accounting and reporting standards that govern the preparation of the Corporation’s financial statements. These changes can be hard to predict and can materially impact how the Corporation records and reports its financial condition and results of operations. In some cases, the Corporation could be required to apply a new or revised standard retroactively; resulting in the restating of prior period financial statements.





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|• | Significant legal actions could subject the Corporation to substantial uninsured liabilities.




The Corporation is from time to time subject to claims related to its operations. These claims and legal actions, including supervisory actions by the Corporation’s regulators, could involve large monetary claims and significant defense costs. To protect itself from the cost of these claims, the Corporation maintains insurance coverage in amounts and with deductibles that it believes are appropriate for its operations. However, the Corporation’s insurance coverage may not cover all claims against the Corporation or continue to be available to the Corporation at a reasonable cost. As a result, the Corporation may be exposed to substantial uninsured liabilities, which could adversely affect the Corporation’s results of operations and financial condition





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|• | Negative publicity could damage the Corporation’s reputation and adversely impact its business and financial results.




Reputation risk, or the risk to the Corporation’s earnings and capital from negative publicity, is inherent in the Corporation’s business.  Negative publicity can result from the Corporation’s actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and actions taken by government regulators and community organizations in response to those activities. Negative publicity can adversely affect the Corporation’s ability to keep and attract customers and can expose the Corporation to litigation and regulatory action. Although the Corporation takes steps to minimize reputation risk in dealing with customers and other constituencies, the Corporation is inherently exposed to this risk.





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|• | Acquisitions may not produce revenue enhancements or cost savings at levels or within timeframes originally anticipated and may result in unforeseen integration difficulties.




The Corporation regularly explores opportunities to acquire banks, financial institutions, or other financial services businesses or assets. The Corporation cannot predict the number, size or timing of acquisitions. Difficulty in integrating an acquired business or company may cause the Corporation not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of the Corporation’s business or the business of the acquired company, or otherwise adversely affect the Corporation’s ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also, the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected.


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|• | The Corporation may not be able to pay dividends in the future in accordance with past practice.




The Corporation has traditionally paid a quarterly dividend to common stockholders. The payment of dividends is subject to legal and regulatory restrictions. Any payment of dividends in the future will depend, in large part, on the Corporation’s earnings, capital requirements, financial condition and other factors considered relevant by the Corporation’s Board of Directors.





|  |                                               
|- | ----------------------------------------------
|• | The Corporation’s stock price can be volatile.




The Corporation’s stock price can fluctuate widely in response to a variety of factors, including:  actual or anticipated variations in the Corporation’s quarterly operating results; recommendations by securities analysts; significant acquisitions or business combinations; strategic partnerships, joint ventures or capital commitments; operating and stock price performance of other companies that investors deem comparable to the Corporation; new technology used or services offered by the Corporation’s competitors; news reports relating to trends, concerns and other issues in the banking and financial services industry, and changes in government regulations. General market fluctuations, industry factors and general economic and political conditions and events, including terrorist attacks, economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations, could also cause the Corporation’s stock price to decrease, regardless of the Corporation’s operating results.





ITEM 1B. UNRESOLVED STAFF COMMENTS.





None.





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 PART I: ITEM 2., ITEM 3. AND ITEM 4.





ITEM 2.  PROPERTIES.





The headquarters of the Corporation and the Bank is located at 200 East Jackson Street, Muncie, Indiana. The building is owned by the Bank.





The Bank conducts business through numerous facilities owned and leased.  Of the 116 banking offices operated by the Bank, 91 are owned and 25 are leased from non-affiliated third parties.





None of the properties owned by the Corporation are subject to any major encumbrances.  The net investment of the Corporation and subsidiaries in real estate and equipment at December 31, 2015 was $97,648,000 .





ITEM 3. LEGAL PROCEEDINGS .





There is no pending legal proceeding, other than ordinary routine litigation incidental to the business of the Corporation or its subsidiaries, of a material nature to which the Corporation or its subsidiaries is a party or of which any of their properties are subject. Further, there is no material legal proceeding in which any director, officer, principal shareholder, or affiliate of the Corporation, or any associate of any such director, officer or principal shareholder, is a party, or has a material interest, adverse to the Corporation or any of its subsidiaries.





None of the routine legal proceedings, individually or in the aggregate, in which the Corporation or its affiliates are involved are expected to have a material adverse impact on the financial position or the results of operations of the Corporation.





ITEM 4. MINE SAFETY DISCLOSURES.





Not applicable.


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 SUPPLEMENTAL INFORMATION





SUPPLEMENTAL INFORMATION - EXECUTIVE OFFICERS OF THE REGISTRANT





The names, ages, and positions with the Corporation and the Bank of all executive officers of the Corporation and all persons chosen to become executive officers are listed below. The officers are elected by the Board of Directors of the Corporation for a term of one year or until the election of their successors. There are no arrangements between any officer and any other person pursuant to which he or she was selected as an officer.





Michael C. Rechin , 57, President and Chief Executive Officer, Corporation


President and Chief Executive Officer of the Corporation since April 2007; Chief Operating Officer of the Corporation from November 2005 to April 2007; Executive Vice President, Corporate Banking National City Bank from 1995 to November 2005.





Mark K. Hardwick , 45, Executive Vice President and Chief Financial Officer, Corporation


Executive Vice President and Chief Financial Officer of the Corporation since December 2005; Senior Vice President and Chief Financial Officer of the Corporation from April 2002 to December 2005; Corporate Controller of the Corporation from November 1997 to April 2002.





Michael J. Stewart , 50, Executive Vice President and Chief Banking Officer, Corporation


Executive Vice President and Chief Banking Officer of the Corporation since February 2008; Executive Vice President from December 2006 to February 2008 of National City Corp;  Executive Vice President and Chief Credit Officer of National City Bank of Indiana from December 2002 to December 2006.





John J. Martin , 49, Executive Vice President and Chief Credit Officer, Corporation


Executive Vice President and Chief Credit Officer of the Corporation since March 2013; Senior Vice President and Chief Credit Officer of the Corporation from June 2009 to March 2013; First Vice President and Deputy Chief Credit Officer of the Corporation from July 2008 to June 2009; First Vice President and Senior Manager of Lending Process of the Corporation from January 2008 to July 2008; Senior Vice President and Regional Senior Credit Officer of National City Bank from May 2000 to December 2007.





Stephan H. Fluhler , 47, Senior Vice President, Chief Information Officer, Corporation


Senior Vice President and Chief Information Officer of the Corporation since May 2014; Chief Technology Officer of the Corporation from 2004 to May 2014; Director of Technology Services and Change Management of the Corporation from December 2003 to 2004.





Kimberly J. Ellington , 56, Senior Vice President and Director of Human Resources, Corporation


Senior Vice President and Director of Human Resources of the Corporation since 2004; Vice President and Director of Human Resources of the Corporation from 1999 to 2004.





Jeffrey B. Lorentson , 52, Senior Vice President and Chief Risk Officer, Corporation


Senior Vice President and Chief Risk Officer of the Corporation since June 2007; Corporate Controller of First Indiana Bank from June 2006 to June 2007; First Vice President and Corporate Controller of the Corporation from 2003 to 2006; Vice President and Corporate Controller of the Corporation from 2002 to 2003.





Michele Kawiecki , 43, Senior Vice President and Director of Finance, Corporation


Senior Vice President and Director of Finance of the Corporation since March 2015; Senior Vice President of Capital Management and Assistant Treasurer of UMB Financial Corporation from May 2011 to March 2015; Director of Corporate Development and Enterprise Project Management at UMB Financial Corporation from May 2008 to May 2011; Chief Risk Officer at UMB Financial Corporation from February 2004 to May 2008.











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 PART II: ITEM 5. AND ITEM 6.





PART II





ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.





PERFORMANCE GRAPH





The following graph compares the cumulative 5-year total return to shareholders on First Merchants Corporation’s common stock relative to the cumulative total returns of the Russell 2000 index, the SNL Bank $1B - $5B index, and the SNL Bank $5B - $10B index. The graph assumes that the value of the investment in the Corporation’s common stock and in each of the indexes (including reinvestment of dividends) was $100 on December 31, 2010 and tracks it through December 31, 2015 .














Period EndingIndex12/31/201012/31/201112/31/201212/31/201312/31/201412/31/2015First Merchants Corporation$100.00$96.07$169.64$262.43$266.42$302.62Russell 2000100.0095.82111.49154.78162.35155.18SNL Bank $1B-$5B100.0091.20112.45163.52170.98191.39SNL Bank $5B-$10B100.0099.24116.73180.10185.52211.33








The stock price performance included in this graph is not necessarily indicative of future stock price performance.


























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STOCK INFORMATION





Price Per ShareHIGHLOWDividends Declared(1)Quarter201520142015201420152014First quarter$23.95$22.66$21.37$19.74$0.08$0.05Second quarter25.3822.8022.0919.380.110.08Third quarter26.7722.1024.6119.460.110.08Fourth quarter27.6023.3924.7419.940.110.08








Numbers rounded to nearest cent when applicable.





The table above lists per share prices and dividend payments during 2015 and 2014 . Prices are as reported by the National Association of Securities Dealers Automated Quotation – Global Select Market System.





COMMON STOCK LISTING





First Merchants Corporation common stock is traded over-the-counter on the NASDAQ Global Select Market System. Quotations are carried in many daily papers. The NASDAQ symbol is FRME (Cusip #320817-10-9).  At the close of business on February 23, 2016, the number of shares outstanding was 40,671,228.  There were 3,841 stockholders of record on that date.





PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASES





The following table presents information relating to our purchases of equity securities during the three months ended December 31, 2015, as follows


PeriodTotal Numberof SharesPurchasedAveragePrice Paidper ShareTotal Number of SharesPurchased as part of Publicly announced Plans or ProgramsMaximum Number of Sharesthat may yet be PurchasedUnder the Plans or ProgramsOctober, 2015184$25.88November, 2015December, 2015








The shares were purchased in connection with the exercise of certain outstanding stock options or restricted stock.





EQUITY COMPENSATION PLAN INFORMATION





The following table provides information about the Corporation’s common stock that may be issued under equity compensation plans as of December 31, 2015 .


Plan CategoryNumber of securities to beissued upon exercise ofoutstanding options,warrants and rightsWeighted-averageexercised price ofoutstanding optionswarrants and rightsNumber of securities remainingavailable for future issuanceunder equity compensationsplans (excluding securitiesreflected in first column)Equity compensation plans approved by stockholders442,373$19.98654,150Total442,373$19.98654,150


















































_______________________________





(1) The “DIVIDEND LIMITATIONS” section of “BUSINESS” included as Item 1 of this Annual Report on Form 10-K, the “CAPITAL” and “LIQUIDITY” sections of “Management's Discussion & Analysis of Financial Condition and Results of Operations” included as Item 7 of this Annual Report on Form 10-K and Note 16. STOCKHOLDERS’ EQUITY  to the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K include discussions regarding dividend restrictions.





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ITEM 6. SELECTED FINANCIAL DATA.





(Dollars in Thousands, Except Share Data)20152014201320122011Operations(1) (2) (3) (4) (5)Net interest income fully taxable equivalent (FTE) basis$207,379$194,958$160,308$158,081$149,114Less tax equivalent adjustment10,9757,9216,0435,7455,759Net interest income196,404187,037154,265152,336143,355Provision for loan losses4172,5606,64818,53422,630Net interest income after provision for loan losses195,987184,477147,617133,802120,725Total other income72,53166,40056,01664,50749,301Total other expenses177,469168,592143,219137,115135,938Income before income tax expense (benefit)91,04982,28560,41461,19434,088Income tax expense (benefit)25,66522,12315,88416,0728,836Net income65,38460,16244,53045,12225,252Loss on Capital Purchase Program unamortized discount(1,401)Loss on extinguishment of trust preferred securities(10,857)Preferred stock dividends and discount accretion(2,380)(4,539)(3,981)Net income available to common stockholders$65,384$60,162$42,150$40,583$9,013Per Share DataBasic net income available to common stockholders$1.73$1.66$1.42$1.42$0.34Diluted net income available to common stockholders1.721.651.411.410.34Cash dividends paid - common0.410.290.180.100.04December 31 book value - common20.9119.2917.6716.0814.83December 31 tangible book value - common14.6813.6512.1710.959.64December 31 market value (bid price) - common25.4222.7522.7214.848.47Average Balances(1) (2) (3) (4) (5)Total assets$6,085,687$5,571,354$4,455,411$4,245,996$4,143,850Total loans(6)4,179,8393,730,0803,008,5552,819,8162,748,684Earning assets5,464,8294,985,3384,017,2473,833,1743,744,027Total deposits4,806,5034,363,9553,465,6403,263,0203,175,762Total stockholders' equity753,724675,295540,255535,497478,440Year-End Balances(1) (2) (3) (4) (5)Total assets$6,761,003$5,824,127$5,437,262$4,304,821$4,173,076Total loans(6)4,703,7163,932,1003,637,7402,924,5092,731,279Allowance for loan losses62,45363,96467,87069,36670,898Total deposits5,289,6474,640,6944,231,4683,346,3833,134,655Total stockholders' equity850,509726,827634,923552,236514,467Financial Ratios(1) (2) (3) (4) (5)Return on average assets1.07%1.08%0.95%0.96%0.22%Return on average stockholders' equity8.678.917.807.581.88Average earning assets to total assets89.8089.4890.1790.2890.35Allowance for loan losses as % of total loans1.331.631.872.372.60Dividend payout ratio23.8417.5812.777.0911.76Average stockholders' equity to average assets12.3912.1212.1312.6111.55Tax equivalent yield on earning assets4.254.354.404.744.99Cost of supporting liabilities0.450.440.410.621.01Net interest margin on earning assets3.803.913.994.123.98





(1) Effective February 10, 2012, the Bank assumed substantially all of the deposits and certain other liabilities and acquired certain assets of SCB Bank, a federal savings bank headquartered in Shelbyville, Indiana, from the Federal Deposit Insurance Corporation ("FDIC"), as receiver for SCB Bank, pursuant to the terms of the Purchase and Assumption Agreement - Modified Whole Bank; All Deposits (the “Agreement”), entered into by the Bank, the FDIC as receiver of SCB Bank and the FDIC.   Under the terms of the Agreement, the Bank acquired $147.7 million in assets, including approximately $11.9 million of cash and cash equivalents, $18.9 million of marketable securities, $1.8 million in Federal Home Loan Bank stock, $113.0 million in loans and $2.1 million of premises and other assets.   The asset balances are book balances and do not reflect the fair value discount of $29.0 million from book value. The Bank assumed approximately $135.7 million of liabilities, including $125.9 million in customer deposits, $9.6 million of other borrowings and $402,000 in other liabilities.  The bid accepted by the FDIC included no deposit premium.





(2) Effective November 12, 2013, the Corporation acquired 100 percent of CFS Bancorp, Inc. ("CFS") in an all stock transaction.  CFS was headquartered in Munster, Indiana and had 20 banking centers in northwestern Indiana and northeastern Illinois.  Pursuant to the merger agreement, the shareholders of CFS received 0.65 percent of a share of the Corporation's common stock for each share of CFS common stock held.  The Corporation issued approximately 7.1 million shares of common stock, which was valued at approximately $135.6 million.   The Corporation acquired approximately $1.1 billion of assets, including $603 million of loans.  Additionally, the Corporation assumed approximately $997 million of liabilities, including $955 million of deposits.





(3) Effective November 7, 2014, the Corporation acquired 100 percent of Community Bancshares, Inc. ("Community").  Community was headquartered in Noblesville, IN and had 10 banking centers serving central Indiana.  Pursuant to the merger agreement, each outstanding share of common stock of Community was converted into the right to receive either (a) 4.0926 shares of First Merchants' common stock, plus cash in lieu of fractional shares; or (b) $85.94 in cash, based upon shareholder elections.  The Corporation paid $14.2 million in cash and issued approximately 1.6 million shares of common stock, valued at $35.0 million, for a total purchase price of approximately $49.2 million.  The details of the acquisition can be found in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





(4) Effective April 17, 2015, the Corporation acquired 100 percent of C Financial Corporation ("C Financial"). C Financial was headquartered in Columbus, Ohio and had 6 full service banking centers serving the Columbus, Ohio market.  Pursuant to the merger agreement, shareholders of C Financial received $6.738 in cash for each share of C Financial stock held, resulting in a total purchase price of $14.5 million.  The details of the acquisition can be found in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





(5) Effective December 31, 2015, the Corporation acquired 100 percent of Ameriana Bancorp, Inc. ("Ameriana").  Ameriana was headquartered in New Castle, Indiana and had 13 full service banking centers in east central and central Indiana.  Pursuant to the merger agreement, shareholders of Ameriana received .9037 shares of the Corporation's common stock for each share of Ameriana Bancorp common stock held.  The Corporation issued approximately 2.8 million shares of common stock, which was valued at approximately $70.4 million.  The details of the acquisition can be found in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





(6) Includes loans held for sale.


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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.





CRITICAL ACCOUNTING POLICIES





Generally accepted accounting principles require management to apply significant judgment to certain accounting, reporting and disclosure matters. Management must use assumptions and estimates to apply those principles where actual measurement is not possible or practical. For a complete discussion of the Corporation’s significant accounting policies, see Note 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K for additional detail.





RESULTS OF OPERATIONS – 2015





Net income available to stockholders was $65.4 million, or $1.72 per fully diluted common share, an increase of $5.2 million, compared to $60.2 million, or $1.65 per fully diluted common share in 2014.   Included in the 2015 results were $9.8 million, or $0.17 per share, of non-recurring acquisition, merger and system conversion expenses related to our 2014 and 2015 acquisitions and our on-line banking system conversion.  Details of the December 31, 2015 Ameriana acquisition, the April 17, 2015 C Financial acquisition and the November 7, 2014 Community acquisition are included in Note 2. ACQUISITIONS AND DIVESTITURES, included within the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





As of December 31, 2015, total assets equaled $6.8 billion, an increase of $936.9 million from December 31, 2014.  Loans and investments, the Corporation’s primary earning assets, totaled $6.0 billion, an increase of $868.0 million from the prior year’s total of $5.1 billion.  Investments increased $96.4 million and loans increased $769.0 million.  Of the increase in loans, organic growth accounted for $338.7 million, or 8.6 percent.  The Corporation acquired $110.6 million in loans as a result of the C Financial acquisition and $319.7 million in loans as a result of the Ameriana acquisition.   Additional details of these changes are included within the "Earning Assets" section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





The Corporation’s allowance for loan losses totaled $62.5 million as of December 31, 2015.  The allowance provides 199.0 percent coverage of all non-accrual loans and 1.33 percent of total loans.  Details of the Allowance for Loan Losses and non-performing loans are discussed within the “Loan Quality” and “Provision and Allowance for Loan Losses” sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





The Corporation recognized increases in premises and equipment and cash surrender value of life insurance of $20.0 million and $31.1 million, respectively, primarily as a result of the C Financial and Ameriana acquisitions.  In addition, the excess of purchase price over net tangible assets acquired was allocated to core deposit intangibles of $4.2 million and goodwill of $48.9 million.  These increases were offset by a decrease in core deposit intangibles and goodwill of $742,000 and $8.5 million, respectively, triggered by the Corporation's sale of FMIG.





At December 31, 2015, other real estate owned totaled $17.3 million, a decrease of $2.0 million, or 10.6 percent, from the December 31, 2014 balance of $19.3 million.  Included in the December 31, 2015 balance was $5.7 million acquired in the Ameriana acquisition on December 31, 2015.





Taxes, both current and deferred, increased in 2015 by $5.0 million.  Details related to the change in taxes are discussed within the “Income Taxes” section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K and in Note 22. INCOME TAX of the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





Deposits increased $649.0 million from December 31, 2014, and borrowings increased $156.6 million during the same period.  Deposits increased from the C Financial and Ameriana acquisitions by $105.3 million and $382.5 million, respectively.  As part of the Ameriana acquisition, the Corporation assumed approximately $24.9 million of Federal Home Loan Bank Advances.  The C Financial acquisition resulted in an additional $19.0 million of Federal Home Loan Bank advances at acquisition, of which, approximately $7.4 million matured during 2015 and $11.6 million remained at December 31, 2015.  Additional details related to the change are discussed within the “Deposits and Borrowings” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





The Corporation was able to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized” as discussed in the “CAPITAL” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





RESULTS OF OPERATIONS – 2014





Net income available to stockholders was $60.2 million, or $1.65 per fully diluted common share, an increase of $18.0 million compared to $42.2 million, or $1.41 per fully diluted common share in 2013.   On November 12, 2013, the Corporation acquired CFS Bancorp, Inc. ("CFS"), and on November 7, 2014, the Corporation acquired Community Bancshares, Inc. ("Community").





As of December 31, 2014, total assets equaled $5.8 billion, an increase of $386.9 million from December 31, 2013.  Loans and investments, the Corporation’s primary earning assets, totaled $5.1 billion, an increase of $379.4 million from the prior year’s total of $4.7 billion.  Investments increased $85.1 million and total loans increased $294.3 million.  The Corporation acquired $145.1 million in loans as a result of the Community acquisition.








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The Corporation’s allowance for loan losses totaled $64.0 million as of December 31, 2014.  The allowance provides 131.1 percent coverage of all non-accrual loans and 1.63 percent of total loans.  Details of the Allowance for Loan Losses and non-performing loans are discussed within the “Loan Quality” and “Provision and Allowance for Loan Losses” sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





The Corporation recognized increases in goodwill and core deposit intangible of $13.8 million and $4.7 million, respectively, as a result of the Community acquisition.





At December 31, 2014, other real estate owned totaled $19.3 million, a decrease of $2.9 million from the December 31, 2013 balance of $22.2 million.  Included in the December 31, 2014 balance was $6.7 million acquired in the Community acquisition.





Taxes, both current and deferred, decreased in 2014 by $14.7 million.  Details related to the change in taxes are discussed within the “Income Taxes” section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K and in Note 22. INCOME TAX of the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





Other assets of $20.8 million at December 31, 2014, decreased $8.2 million from December 31, 2013.  Included in the decrease was an $11.1 million decrease in prepaid pension expense.  Additional details related to the prepaid pension expense are discussed in Note 21. PENSION AND OTHER POST RETIREMENT BENEFIT PLANS, of the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





Deposits increased $409.2 million from December 31, 2013, while borrowings decreased $111.3 million during the same period.  As part of the Community acquisition, the Bank acquired deposits of $228.4 million.





As part of the Community acquisition, the Corporation issued approximately 1.6 million shares of common stock valued at $35.0 million.  Additional details of this transaction are discussed in Note 16. STOCKHOLDERS' EQUITY of the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





The Corporation was able to maintain all regulatory capital ratios in excess of the regulatory definition of “well-capitalized” as discussed in the “CAPITAL” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





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Net Interest Income





Net interest income is the primary source of the Corporation’s earnings.  Net interest margin is a function of net interest income and the level of average earning assets.  The following table presents the Corporation’s interest income, interest expense, and net interest income as a percent of average earning assets for the three-year period ending in 2015 .


Average BalanceInterest Income /ExpenseAverageRateAverage BalanceInterest Income /ExpenseAverageRateAverage BalanceInterest Income /ExpenseAverageRate(Dollars in Thousands)201520142013Assets:Interest-bearing deposits$61,373$1600.26%$53,231$1240.23%74,9641580.21%Federal reserve and federal home loan bank stock37,4951,9675.2542,1422,1245.0433,6201,4884.43Investment securities:(1)Taxable703,01917,8852.54763,45019,8822.60617,52415,2142.46Tax-Exempt(2)483,10326,0345.39396,43522,1275.58282,58416,6605.90Total investment securities1,186,12243,9193.701,159,88542,0093.62900,10831,8743.54Loans held for sale3,72547512.756,6814857.2616,1377704.77Loans:(3)Commercial3,187,239142,6964.482,919,020133,5674.582,391,221113,6134.75Real estate mortgage457,01319,4574.26429,38419,8124.61277,52012,3754.46Installment406,16318,1774.48361,48418,1755.03308,23315,9945.19Tax-Exempt(2)125,6995,3224.2313,5115043.7315,4446053.92Total loans4,179,839186,1274.453,730,080172,5434.633,008,555143,3574.76Total earning assets5,464,829232,1734.25%4,985,338216,8004.35%4,017,247176,8774.40%Net unrealized gain on securities available for sale11,8008,9214,521Allowance for loan losses(62,975)(67,969)(68,806)Cash and cash equivalents98,05187,06873,161Premises and equipment82,71075,20257,228Other assets491,272482,794372,060Total assets$6,085,687$5,571,354$4,455,411Liabilities:Interest-bearing deposits:NOW accounts$1,109,829$1,3740.12%$1,066,402$1,1100.10%$880,323$9410.11%Money market deposit accounts840,0841,7680.21776,7121,5720.20603,0121,2870.21Savings  deposits614,6756720.11533,0806190.12377,1064210.11Certificates and other time deposits1,121,65111,0410.981,042,5398,3770.80807,7647,4040.92Total interest-bearing deposits3,686,23914,8550.403,418,73311,6780.342,668,20510,0530.38Borrowings480,7949,9392.07492,12810,1642.07400,5806,5161.63Total interest-bearing liabilities4,167,03324,7940.603,910,86121,8420.563,068,78516,5690.54Noninterest-bearing deposits1,120,264945,222797,435Other liabilities44,66639,97648,936Total liabilities5,331,9634,896,0593,915,156Stockholders' Equity753,724675,295540,255Total Liabilities and Stockholders' Equity$6,085,68724,7940.45$5,571,35421,8420.44$4,455,41116,5690.41Net Interest Income$207,379$194,958$160,308Net Interest Margin3.80%3.91%3.99%








(1) Average balance of securities is computed based on the average of the historical amortized cost balances without the effects of the fair value adjustment.





(2) Tax-exempt securities and loans are presented on a fully taxable equivalent basis, using a marginal tax rate of 35 percent for 2015, 2014 and 2013. These totals equal $10,975, $7,921 and $6,043,


respectively.





(3) Non-accruing loans have been included in the average balances.





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In 2015, asset yields decreased 10 basis points on a fully taxable equivalent basis (FTE).  Interest costs increased 1 basis point, resulting in a net decrease in net interest margin of 11 basis points when compared to 2014.  Average earning assets increased $479,491,000 primarily due to a larger loan portfolio.  In November 2014, the Corporation acquired Community and average earning assets only included approximately six weeks of averages related to the acquisition, but an entire year in 2015.  In addition, the Corporation acquired C Financial in April 2015.  Additional details of these acquisitions are discussed in Note 2. ACQUISITIONS AND DIVESTITURES, included within the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





In 2014, asset yields decreased 5 basis points FTE and interest cost increased 3 basis points, resulting in an 8 basis points decrease in net interest margin compared to 2013.  In 2013, average earning assets only included approximately six weeks of averages related to assets acquired from CFS; however, 2014 included an entire year of averages.  Average earning assets increased $968,091,000 and were a result of larger loan and investment portfolios, which has positive volume variances of $33,894,000 and $9,393,000, respectively.  In addition, a low interest rate environment produced a negative rate variance of $5,934,000 (FTE), resulting in a net increase of $32,772,000 (FTE) in net interest income.





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.  In addition, annualized amounts are computed utilizing a 30/360 day basis.





Non-Interest Income





Non-interest income increased $6.1 million, or 9.2 percent, in 2015 compared to 2014.  The June 12, 2015 sale of FMIG resulted in an $8.3 million pre-tax gain, but also a $3.3 million decrease in insurance commissions when compared to 2014.  Additionally, the acquisitions of Community on November 7, 2014 and C Financial on April 17, 2015 resulted in a larger customer base that contributed to increases in gains on sale of mortgage loans and electronic card interchange fees of $1.6 million and $1.3 million, respectively.  Additional details related to the sale of FMIG and the acquisition of Community and C Financial can be found in Note 2. ACQUISITIONS AND DIVESTITURES, included within the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.  Finally, as detailed in Note 12. BORROWINGS, included within the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K, the Corporation completed the cancellation of $5 million of subordinated debentures at a gain of $1.3 million.





Offsetting these increases were decreases from 2014 to 2015 in gains on the sale of other real estate owned, gains on the sale of investment securities, and earnings on cash surrender value of life insurance of $2.4 million, $911,000 and $740,000, respectively.  The decreases in gains on the sales of other real estate owned and investment securities were volume driven while the decrease in earnings on cash surrender value of life insurance was a result of 2014 including an $846,000 death benefit from Bank Owned Life Insurance.





In 2014, non-interest income increased $10.4 million, or 18.5 percent in comparison to 2013.  The November 12, 2013 acquisition of CFS was the largest contributing factor to the year-over-year increase.





Significant increases realized during 2014 when compared to 2013 included service charge income, other customer fees (primarily electronic card interchange fees and investment brokerage fees) and other income, including gains on sale of other real estate owned, totaling $3.3 million, $3.8 million and $1.5 million, respectively.  Additionally, gains on the sale of investment securities increased $3.1 million from 2013 to 2014.  Additional details on investment securities can be found in Note 4. INVESTMENT SECURITIES, included within the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.  Finally, 2014 earnings on cash surrender value of life insurance increased $1.0 million from the previous year, primarily due to receipt of an $846,000 death benefit from Bank Owned Life Insurance during the period.





Partially offsetting the year-over-year increases from 2013 to 2014 was a $2.6 million decrease in net gains recognized on the sale of mortgage loans.  Mortgage origination and refinance volumes decreased from 2013 levels as a result of interest rate and economic factors.





The Community acquisition resulted in $201,000 of non-interest income during the last seven weeks of 2014.





Non-Interest Expenses





Non-interest expenses increased $8.9 million, or 5.3 percent, in 2015 compared to 2014.  The Community and C Financial acquisitions along with the December 31, 2015 acquisition of Ameriana were the most significant factors in the year-over-year increase.  During 2015, the Corporation recorded $9.8 million of one-time expenses that were primarily merger, integration and system conversion related.





Additionally in 2015, salaries and employee benefits increased $5.4 million, or 5.6 percent, over 2014.  The increase was driven by the addition of Community and C Financial employees as well as severance expenses associated with the Ameriana acquisition.  Also, as a result of the increased franchise size resulting from the acquisitions, the Corporation experienced increases in equipment and net occupancy expenses of $1.5 million and $837,000, respectively.  Finally, as a result of one-time merger and integration expenses, professional and other outside services and other expenses increased by $1.7 million and $1.4 million, respectively.





Offsetting these increases was a $1.9 million decrease, from 2014 to 2015, in other real estate owned and foreclosure expenses as a result of continued improvement in asset quality trends.





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In 2014, non-interest expenses increased $25.4 million, or 17.7 percent, compared to 2013.  As with non-interest income, the CFS acquisition was the most significant factor in the year-over-year increase.





Salaries and employee benefits increased $11.1 million, or 13.0 percent, in 2014 compared to 2013 due to the addition of CFS employees since the acquisition.  The Corporation also experienced a $3.5 million increase in net occupancy expense, as 20 banking center locations were added as a result of the CFS acquisition.  In addition to the non-interest expense increases associated with operating a larger organization, 2014 included $1.5 million of non-recurring expenses associated with the CFS acquisition.





The Community acquisition resulted in $2.2 million of one-time expenses in 2014 and also added $646,000 of non-interest expense in the last seven weeks of 2014.





Income Tax Expense





Income tax expense in 2015 was $25,665,000 on pre-tax income of $91,049,000, or 28.2 percent.  For the same period in 2014, income tax expense was $22,123,000 on pre-tax income of $82,285,000, or 26.9 percent.  The increase in the effective tax rate in 2015 when compared to 2014 was primarily a result of a permanent book-to-tax basis difference associated with the gain on sale of FMIG.   Details of the FMIG sale are included in Note 2.  ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





Additional income tax expense details are discussed within the “INCOME TAXES” section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K and in Note 22. INCOME TAX, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





CAPITAL





Capital adequacy is an important indicator of financial stability and performance.  The Corporation and the Bank 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 four ratios that are calculated according to the regulations: total risk-based capital, tier 1 risk-based capital, common equity 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.  Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the regulations.  Banks with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual levels.  The appropriate federal regulatory agency may also downgrade a bank to the next lower capital category upon a determination that the bank is in an unsafe or unsound practice.  Banks are required to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category.





Basel III was effective for the Corporation on January 1, 2015.  Basel III requires the Corporation and the Bank to maintain minimum amounts and ratio of common equity tier 1 capital to risk weighted assets, as defined in the regulation.  Under the new Basel III rules, in order to avoid limitations on capital distributions, including dividends, the Corporation must hold a capital conservation buffer above the adequately capitalized common equity tier 1 capital to risk-weighted assets ratio.  The capital conservation buffer is being phased in from zero percent to 2.50 percent by 2019.  Under Basel III, the Corporation and Bank elected to opt-out of including accumulated other comprehensive income in regulatory capital.  Regulatory capital ratios at December 31, 2015 , were calculated under Basel III while regulatory capital ratios at December 31, 2014, were calculated under Basel I.





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As of December 31, 2015 , the Bank met all capital adequacy requirements to be considered well capitalized.  There is no threshold for well capitalized status for bank holding companies.  The Corporation's and Bank's actual and required capital ratios as of December 31, 2015 and December 31, 2014 were as follows:


Prompt Corrective Action ThresholdsActualAdequately CapitalizedWell CapitalizedDecember 31, 2015AmountRatioAmountRatioAmountRatioTotal risk-based capital to risk-weighted assetsFirst Merchants Corporation$783,77614.94%$419,8098.00%N/AN/AFirst Merchants Bank739,79313.98423,2428.00$529,05210.00%Tier 1 capital to risk-weighted assetsFirst Merchants Corporation$656,32312.51%$314,8576.00%N/AN/AFirst Merchants Bank677,34012.80317,4316.00$423,2428.00%Common equity tier 1 capital to risk-weighted assetsFirst Merchants Corporation$603,06311.49%$236,1434.50%N/AN/AFirst Merchants Bank677,34012.80238,0744.50$343,8846.50%Tier 1 capital to average assetsFirst Merchants Corporation$656,32310.85%$242,0014.00%N/AN/AFirst Merchants Bank677,34011.22241,4234.00$301,7795.00%








Prompt Corrective Action ThresholdsActualAdequately CapitalizedWell CapitalizedDecember 31, 2014AmountRatioAmountRatioAmountRatioTotal risk-based capital to risk-weighted assetsFirst Merchants Corporation$685,50715.34%$357,5818.00%N/AN/AFirst Merchants Bank653,16914.64356,8848.00$446,10510.00%Tier 1 capital to risk weighted assetsFirst Merchants Corporation$564,53512.63%$178,7914.00%N/AN/AFirst Merchants Bank597,30513.39178,4424.00$267,6636.00%Tier 1 capital to average assetsFirst Merchants Corporation$564,53510.15%$222,5334.00%N/AN/AFirst Merchants Bank597,30510.56226,3394.00$282,9535.00%








Tier I regulatory capital consists primarily of total stockholders’ equity and subordinated debentures issued to business trusts categorized as qualifying borrowings, less non-qualifying intangible assets and unrealized net securities gains or losses.





On November 7, 2014, the Corporation acquired 100 percent of Community and pursuant to the merger agreement, each outstanding share of common stock of Community was converted into the right to receive either (a) 4.0926 shares of First Merchants' common stock, plus cash in lieu of fractional shares; or (b) $85.94 in cash, based upon shareholder elections.  The Corporation paid $14.2 million in cash and issued approximately 1.6 million shares of common stock, valued at approximately $35.0 million, for a total purchase price of approximately $49.2 million.





On December 31, 2015, the Corporation acquired 100 percent of Ameriana and pursuant to the merger agreement, each Ameriana shareholder received 0.9037 of a share of First Merchants common stock for each outstanding share of Ameriana Bancorp common stock held.  The Corporation issued approximately 2.8 million shares of common stock, which was valued at approximately $70.4 million.





Management believes that all of the above capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation. Additionally, management believes the following tables are also meaningful when considering performance measures of the Corporation.





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The Corporation had a strong capital position as evidenced by the tangible common equity to tangible assets ratio of 9.17% percent at December 31, 2015 , and 9.16% percent at December 31, 2014 .


Tangible Common Equity to Tangible Assets (non-GAAP)(Dollars in Thousands, Except Per Share Amounts)December 31, 2015December 31, 2014Total Stockholders' Equity (GAAP)$850,509$726,827Less:  Cumulative preferred stock (GAAP)(125)(125)Less:  Intangible assets, net of tax (GAAP)(253,486)(212,669)Tangible common equity (non-GAAP)$596,898$514,033Total assets (GAAP)$6,761,003$5,824,127Less: Intangible assets, net of tax (GAAP)(253,486)(212,669)Tangible assets (non-GAAP)6,507,5175,611,458Tangible common equity to tangible assets (non-GAAP)9.17%9.16%








The following table details and reconciles tangible earnings per share, return on tangible capital and tangible assets to traditional GAAP measures for the periods ended December 31, 2015 and 2014 .


(Dollars in Thousands, Except Per Share Amounts)December 31, 2015December 31, 2014Average goodwill (GAAP)$206,032$191,033Average core deposit intangible (GAAP)14,85913,323Average deferred tax on CDI (GAAP)(5,610)(5,002)Intangible adjustment (non-GAAP)$215,281$199,354Average stockholders' equity (GAAP)$753,724$675,295Average cumulative preferred stock (GAAP)(125)(125)Intangible adjustment (non-GAAP)(215,281)(199,354)Average tangible capital (non-GAAP)$538,318$475,816Average assets (GAAP)$6,085,687$5,571,354Intangible adjustment (non-GAAP)(215,281)(199,354)Average tangible assets (non-GAAP)$5,870,406$5,372,000Net income available to common stockholders (GAAP)$65,384$60,162CDI amortization, net of tax (GAAP)1,7201,395Tangible net income available to common stockholders (non-GAAP)$67,104$61,557Per Share Data:Diluted net income available to common stockholders (GAAP)$1.72$1.65Diluted tangible net income available to common stockholders (non-GAAP)$1.76$1.68Ratios:Return on average GAAP capital (ROE)8.67%8.91%Return on average tangible capital12.47%12.94%Return on average assets (ROA)1.07%1.08%Return on average tangible assets1.14%1.15%








Return on average tangible capital is tangible net income available to common stockholders (annualized) expressed as a percentage of average tangible capital.  Return on average tangible assets is tangible net income available to common stockholders (annualized) expressed as a percentage of average tangible assets.





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LOAN QUALITY/PROVISION AND ALLOWANCE FOR LOAN LOSSES





The Corporation's primary lending focus is small business and middle market commercial, commercial real estate, residential real estate and  consumer, which results in portfolio diversification.  Commercial loans are individually underwritten and judgmentally risk rated.  They are periodically monitored and prompt corrective actions are taken on deteriorating loans.  Retail loans are typically underwritten with statistical decision-making tools and are managed throughout their life cycle on a portfolio basis.





Loan Quality





The quality and amount of non-performing loans may increase or decrease going forward as a result of acquisitions, organic portfolio growth,  problem loan recognition and resolution through collections, sales or charge offs.  The performance of any loan can be affected by external factors such as economic conditions, or internal factors specific to a particular borrower, such as the actions of a customer's management.





At December 31, 2015, non-performing loans totaled $33,312,000 and included $2,229,000 of non-accrual loans acquired in the Ameriana        transaction. The acquired non-accruals were offset by a $19,629,000 decrease in non-accruals in the existing portfolio, contributing to a $17,469,000 decrease in non-performing loans from December 31, 2014.  Non-accrual loans totaled $31,389,000 at December 31, 2015.  The Corporation’s coverage ratio of allowance for loan losses to non-accrual loans increased from 131.1 percent at December 31, 2014 to 199.0 percent at December 31, 2015.  See additional information in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





Other real estate owned totaling $17,257,000 at December 31, 2015, declined $2,036,000 during the twelve month period despite the addition of $5,719,000 of real estate assets acquired in the Ameriana acquisition.  For other real estate owned, current appraisals are obtained to determine fair value as management continues to aggressively market these real estate assets.





Accruing loans delinquent 90+ days at December 31, 2015 decreased $3,756,000 to $907,000 from the December 31, 2014 balance of $4,663,000.  Commercial and industrial loans 90+ days delinquent and accruing decreased to zero at December 31, 2015 from the December 31, 2014 balance of $2,985,000.  Renegotiated loans decreased $69,000 as the amount of new troubled debt restructurings during the period was outpaced by the continued performance of troubled debt restructurings from prior periods.





Commercial impaired loans include all non-accrual loans, loans accounted for under ASC 310 as well as substandard, doubtful and loss grade loans that were still accruing but deemed impaired according to guidance set forth in ASC 310.  Also included in impaired loans are accruing loans that are contractually past due 90 days or more and troubled debt restructurings.





A loan is deemed impaired when, based on current information or events, it is probable that all amounts due of principal and interest according to the contractual terms of the loan agreement will not be collected substantially within the contractual terms of the note.  At December 31, 2015 , commercial impaired loans totaled $97,527,000, a decrease of $18,696,000 from December 31, 2014. Included in the December 31, 2015 balance of commercial impaired loans was $13,206,000 in loans acquired in the Ameriana and C Financial transactions.  At December 31, 2015 , a specific allowance for losses was not deemed necessary for commercial impaired loans totaling $90,975,000 as there was no identified loss on these credits.  An allowance of $1,842,000 was recorded for the remaining balance of these impaired loans totaling $6,552,000 and is included in the Corporation’s allowance for loan losses.





At December 31, 2015, non-performing assets, which includes non-accrual loans, renegotiated loans, and other real estate owned, plus loans 90-days delinquent, totaled $51,476,000; a decrease of $23,261,000 from December 31, 2014 as noted in the table below.


December 31,December 31,(Dollars in Thousands)20152014Non-performing assets:Non-accrual loans$31,389$48,789Renegotiated loans1,9231,992Non-performing loans (NPL)33,31250,781Other real estate owned17,25719,293Non-performing assets (NPA)50,56970,07490+ days delinquent and still accruing9074,663NPAs & 90+ days delinquent$51,476$74,737Impaired loans (includes substandard, doubtful and loss)$97,527$116,223








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The composition of non-performing assets and 90-day delinquent loans is reflected in the following table.


December 31,December 31,(Dollars in Thousands)20152014Non-performing assets and 90+ days delinquent:Commercial and industrial loans$5,544$10,033Agricultural production financing and other loans to farmers8275,800Real estate loansConstruction9,3458,363Commercial and farmland18,24330,400Residential14,52817,079Home equity2,6652,802Individual's loans for household and other personal expenditures324260Other commercial loansNon-performing assets plus 90+ days delinquent$51,476$74,737








Although the Corporation believes its underwriting and loan review procedures are appropriate for the various kinds of loans it makes, its results of operations and financial condition could be adversely affected in the event the quality of its loan portfolio declines.  Deterioration in the economic environment including residential and commercial real estate values may result in increased levels of loan delinquencies and credit losses.





Commercial construction and land development loans were $366,704,000 at December 31, 2015, an increase of $159,483,000 from December 31, 2014.  At December 31, 2015, construction and land development loans represent 7.8 percent of loans compared to 5.3 percent at December 31, 2014.  Management continues to closely monitor this segment of the portfolio, as well as being selective with additional exposure to this industry.





In 2015, total net charge offs were $1,928,000, a decrease of $4,538,000 from 2014 and $6,216,000 from 2013.  The Corporation incurred two commercial loan charge offs over $500,000 in 2015 totaling $1,635,000.  Two recoveries over $500,000, totaling $1,640,000, were recognized during the year.  Residential real estate accounted for $1,298,000, or 67.3 percent of total net charge offs, compared to $633,000, or 9.8 percent, in 2014.





The table below represents loan loss experience for the years indicated.


(Dollars in Thousands)201520142013Allowance for loan losses:Balance at January 1$63,964$67,870$69,366Charge offs8,27217,38218,134Recoveries6,34410,9169,990Net charge offs1,9286,4668,144Provision for loan losses4172,5606,648Balance at December 31$62,453$63,964$67,870Ratio of net charge offs during the period to average loans outstanding during the period0.05%0.17%0.27%Ratio of allowance to non-accrual loans199.00%131.10%120.30%








The distribution of the net charge offs for the years indicated is provided in the following table.


(Dollars in Thousands)December 31, 2015December 31, 2014December 31, 2013Net charge offs:Commercial and industrial loans$(302)$865$1,932Agricultural production financing and other farm loans757970(317)Real estate loansConstruction101(509)6Commercial and farmland(1,209)3,8203,935Residential1,2986331,347Home equity1,0254531,247Individuals loans for household and other personal expenditures26828067Lease financing receivables, net of unearned income(22)11Other commercial loans(10)(24)(84)Total net charge offs$1,928$6,466$8,144








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Provision and Allowance for Loan Losses





The allowance for loan losses is maintained through the provision for loan losses, which is a charge against earnings.  The provision for loan losses in 2015, 2014 and 2013 were $417,000, $2,560,000 and $6,648,000, respectively, showing significant year-over-year declines.





Based on management’s judgment as to the appropriate level of the allowance for loan losses, the amount provided in any period may be greater or less than net loan losses for the same period.  The determination of the provision amount and the adequacy of the allowance in any period is based on management’s continuing review and evaluation of the loan portfolio, including an internally administered loan "watch" list and an independent review.  The evaluation takes into consideration identified credit problems, management's judgment as to the impact of current economic conditions on the portfolio and the possibility of losses inherent in the loan portfolio that are not specifically identified.  Additional details are discussed in Note 1.  NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, in the Notes to Consolidated Financial Statements included as item 8 of this Annual Report on Form 10-K.





Management believes that the allowance for loan losses is adequate to cover probable incurred losses inherent in the loan portfolio at December 31, 2015.  The process for determining the adequacy of the allowance for loan losses is critical to the Corporation’s financial results.  It requires management to make difficult, subjective and complex judgments to estimate the effect of uncertain matters.  The allowance for loan losses considers current factors, including economic conditions and ongoing internal and external examination processes and will increase or decrease as deemed necessary to ensure the allowance remains adequate.  In addition, the allowance as a percentage of charge offs and nonperforming loans will change at different points in time based on credit performance, portfolio mix and collateral values.  Management continually evaluates the commercial loan portfolio by including consideration of specific borrower cash flow analysis and estimated collateral values, types and amounts on non-performing loans, past and anticipated loan loss experience, changes in the composition of the loan portfolio, and the current condition and amount of loans outstanding.





In conformance with ASC 805 and ASC 820, loans purchased after December 31, 2008 are recorded at the acquisition date fair value.  Such loans are included in the allowance to the extent a specific impairment is identified that exceeds the fair value adjustment on an impaired loan.  An allowance may also be necessary if the historical loss and environmental factor analysis indicates losses inherent in a purchased portfolio exceed the fair value adjustment on the portion of the purchased portfolio not deemed impaired.





At December 31, 2015, the allowance for loan losses was $62,453,000, a decrease of $1,511,000 from December 31, 2014. As a percent of loans, the allowance decreased to 1.3 percent at December 31, 2015 from 1.6 percent at December 31, 2014.  The decrease in the ratio of allowance to loans was due in part to a $430,289,000 net increase in loans, net of fair value adjustments, resulting from the acquisition of Ameriana and C Financial.  During 2015, the specific reserves against impaired loans decreased by $927,000, and the allowance for loans not deemed impaired decreased by $584,000.  Not included in the allowance for loan losses is the remaining fair value discount on acquired loans of $47,057,000 and $43,250,000 as of December 31, 2015 and 2014, respectively.





Loans are generally secured by specific items of collateral, including real property and business assets.  Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral dependent loans.  If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized.  This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. The fair value of real estate is determined based on appraisals by qualified licensed appraisers. The appraisers determine the value of the real estate by utilizing an income or market valuation approach. Updated “as is” or “liquidation value” appraisals are obtained as individual circumstances and/or market conditions warrant. Partially charged off loans measured for impairment based on their collateral value are generally not returned to performing status subsequent to receiving updated appraisals or restructure of the loan. If an appraisal is not available, the fair value may be determined by using a discounted cash flow analysis. Fair value on other collateral such as business assets is typically ascertained by assessing, either singularly or some combination of, asset appraisals, accounts receivable aging reports, inventory listings and / or customer financial statements.  Both appraised values and values based on borrower’s financial information are discounted as considered appropriate based on age and quality of the information and current market conditions.





Loans deemed impaired according to guidance set forth in ASC 310 are evaluated during problem loan meetings held within each reporting period by a special assets management team.  Loan collateral and customer financial information are reviewed and the level of impairment is assessed to determine appropriate reserve and/or charge off amounts. Loans or portions of loans are charged off when they are considered uncollectible.  It is the Corporation’s policy to recognize losses promptly to prevent overstatement of assets, earnings and capital.





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The following table summarizes loan loss reserves by loan segment for the periods ended December 31, 2015 and 2014.


December 31, 2015(Dollars in Thousands)CommercialCommercialReal EstateConsumerResidentialFinanceLeasesTotalAllowance balances:Individually evaluated for impairment$1,277$243$169$1,689Collectively evaluated for impairment25,20121,753$2,68910,966$260,611Loans acquired with deteriorated credit quality1494153Total allowance for loan losses$26,478$22,145$2,689$11,139$2$62,453


December 31, 2014CommercialCommercialReal EstateConsumerResidentialFinanceLeasesTotalAllowance balances:Individually evaluated for impairment$1,455$470$194$2,119Collectively evaluated for impairment27,36918,207$2,65812,958$361,195Loans acquired with deteriorated credit quality650650Total allowance for loan losses$28,824$19,327$2,658$13,152$3$63,964








The historical loss allocation for loans not deemed impaired according to ASC 450 is the product of the volume of loans within the non-impaired criticized and non-criticized risk grade classifications, each segmented by call code, and the historical loss factor for each respective classification and call code segment.  The historical loss factors are based upon actual loss experience within each risk and call code classification.  The historical look back period for non-criticized loans is the most recent rolling-four-quarter average and aligns with the look back period for non-impaired criticized loans.  This look back period includes all charge offs from the most recent seven quarters and is reflective of current conditions.  The loss factor computation for this allocation includes a segmented historical loss migration analysis of non-impaired loans, by risk grade, to charge off.  The decrease in the allowance as a percent of originated loans reflected the impact of the stabilizing economic environment on the Corporation’s loan portfolio, resulting in improved credit quality and fewer charge offs.





In addition to the specific reserves and historical loss components of the allowance, consideration is given to various environmental factors to help ensure that losses inherent in the portfolio are reflected in the allowance for loan losses.  The environmental component adjusts the historical loss allocations for commercial and consumer loans to reflect relevant current conditions that have an impact on loss recognition.  Environmental factors that management reviews in the analysis include: National and local economic trends and conditions; trends in growth in the loan portfolio and growth in higher risk areas; levels of, and trends in, delinquencies and non-accruals; experience and depth of lending management and staff; adequacy of, and adherence to, lending policies and procedures including those for underwriting; industry concentrations of credit; and adequacy of risk identification systems and controls through the internal loan review and internal audit processes.  Each environmental factor receives an individual qualitative allocation that reflects losses inherent in the portfolio that are not reflected in the historical loss components of the allowance.  As the economic environment has seen improvement during recent periods, management believes losses inherent in the portfolio may not be immediately apparent for specific identification.





The Corporation’s primary market areas for lending are central Indiana, northwestern Indiana, northeastern Illinois, and central Ohio. When evaluating the adequacy of the allowance, consideration is given to this regional geographic concentration and the closely associated effect changing economic conditions have on the Corporation’s customers. The allowance for loan losses at December 31, 2015 is reflective of both the banking environment within the Corporation’s footprint and the Corporation’s recent loan and loss trends.





GOODWILL





Goodwill is reviewed annually for impairment.  The Corporation completed its most recent annual goodwill impairment test as of October 1, 2015 and concluded, based on current events and circumstances, goodwill is not impaired.  The Ameriana acquisition on December 31, 2015 and the C Financial acquisition on April 17, 2015 resulted in goodwill of $37,753,000 and $11,126,000, respectively.  On June 12, 2015, the sale of FMIG resulted in a goodwill reduction of $8,474,000.  Additionally, on November 7, 2014, the Community acquisition resulted in goodwill of  $13,776,000.  Details regarding the acquisitions and sale are discussed in Note 2.  ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





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LIQUIDITY





Liquidity management is the process by which the Corporation ensures that adequate liquid funds are available for the holding company and its subsidiaries. These funds are necessary in order to meet financial commitments on a timely basis. These commitments include withdrawals by depositors, funding credit obligations to borrowers, paying dividends to stockholders, paying operating expenses, funding capital expenditures, and maintaining deposit reserve requirements. Liquidity is monitored and closely managed by the asset/liability committee.





The Corporation’s liquidity is dependent upon the receipt of dividends from the Bank, which are subject to certain regulatory limitations and access to other funding sources. Liquidity of the Bank is derived primarily from core deposit growth, principal payments received on loans, the sale and maturity of investment securities, net cash provided by operating activities, and access to other funding sources.





The principal source of asset-funded liquidity is investment securities classified as available for sale, the market values of which totaled $658,400,000 at December 31, 2015 , an increase of $108,857,000, or 19.8 percent, from December 31, 2014 . Securities classified as held to maturity that are maturing within a short period of time can also be a source of liquidity. Securities classified as held to maturity and that are maturing in one year or less totaled $4,144,000 at December 31, 2015 . In addition, other types of assets such as cash and interest-bearing deposits with other banks, federal funds sold and loans maturing within one year are sources of liquidity.





The most stable source of liability-funded liquidity for both the long-term and short-term is deposit growth and retention in the core deposit base.  Federal funds purchased and securities sold under agreements to repurchase are also considered a source of liquidity.   In addition, Federal Home Loan Bank ("FHLB") advances are utilized as a funding source. At December 31, 2015 , total borrowings from the FHLB were $235,652,000 . The Bank has pledged certain mortgage loans and investments to the FHLB. The total available remaining borrowing capacity from the FHLB at December 31, 2015 was $388,176,000.





On November 1, 2013, the Corporation completed the private issuance and sale to four institutional investors of an aggregate of $70 million of debt comprised of (a) 5.00 percent Fixed-to-Floating Rate Senior Notes due 2028 in the aggregate principal amount of $5 million (the “Senior Debt”) and (b) 6.75 percent Fixed-to-Floating Rate Subordinated Notes due 2028 in the aggregate principal amount of $65 million (the “Subordinated Debt”).  The Senior Debt agreement contains certain customary representations and warranties and financial and negative covenants.  As of December 31, 2015 , the Corporation was in compliance with these covenants.





Additionally, on April 11, 2014, the Corporation entered into a line of credit agreement with U.S. Bank, N.A. with a maximum borrowing capacity of $20 million.  As of December 31, 2015 , there was no outstanding balance on the line of credit.  Interest is payable quarterly based on one-month LIBOR plus 2.00 percent.  The line of credit has a quarterly facility fee of 0.25 percent on the unused balance.  The line of credit agreement contains certain customary representations and warranties and financial and negative covenants.  As of December 31, 2015 , the Corporation was in compliance with these covenants.  The line of credit was scheduled to mature on April 10, 2015; however, on April 9, 2015 the agreement was renewed with a maturity date of April 8, 2016.





On August 10, 2015, the Corporation completed the cancellation of $5 million of subordinated debentures at a gain of $1.3 million.  As of December 31, 2015 , $51.7 million of subordinated debentures remain outstanding with a maturity date of September 15, 2037.





Additionally, on December 31, 2015 the Corporation acquired Ameriana Capital Trust I in conjunction with its acquisition of Ameriana Bancorp, Inc.  The subordinated debentures of Ameriana Capital Trust I were entered into in March 2007 for $10,310,000 and have a maturity of March 2036.  The interest rate is equal to the three-month LIBOR plus 1.50 percent, reset quarterly.  Interest is payable in March, June, September and December of each year.  The interest rate at December 31, 2015 was 2.0 percent. The Corporation holds all of the outstanding common securities of Ameriana Capital Trust I.


For further details related to the Corporation's borrowings, see Note 12. BORROWINGS, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





In the normal course of business, the Bank is a party to a number of other off-balance sheet activities that contain credit, market and operational risk that are not reflected in whole or in part in the consolidated financial statements. Such activities include: traditional off-balance sheet credit-related financial instruments, commitments under operating leases and long-term debt.





The Bank provides customers with off-balance sheet credit support through loan commitments and standby letters of credit. Summarized credit-related financial instruments at December 31, 2015 are as follows:


December 31,(Dollars in Thousands)2015Amounts of Commitments:Loan commitments to extend credit$1,547,048Standby letters of credit46,734$1,593,782








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Since many of the commitments are expected to expire unused or be only partially used, the total amount of unused commitments in the preceding table does not necessarily represent future cash requirements.





In addition to owned banking facilities, the Corporation has entered into a number of long-term leasing arrangements to support ongoing activities. The required payments under such commitments and borrowings at December 31, 2015 are as follows:


(Dollars in Thousands)201620172018201920202021 andafterASC 805 fair value adjustments at acquisitionTotalOperating leases$3,076$2,353$1,419$1,222$1,060$6,629$15,759Federal funds purchased49,72149,721Securities sold under repurchase agreements155,325155,325Federal Home Loan Bank advances91,44137,22226,85113,82831,31035,000235,652Subordinated debentures and term loans183132,012$(4,349)127,846Total$299,746$39,575$28,270$15,050$32,370$173,641$(4,349)$584,303








INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK





Asset and 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 review how changes in interest rates may 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 and liability management 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 constructed, presented and monitored quarterly.  Management believes that the Corporation's liquidity and interest sensitivity position at December 31, 2015 , remained adequate to meet the Corporation’s primary goal of achieving optimum interest margins while avoiding undue interest rate risk.





The following table presents the Corporation’s interest rate sensitivity analysis as of December 31, 2015 . December 31, 2015(Dollars in Thousands)1-180 Days181-365 Days1-5 YearsBeyond 5 YearsTotalRate-Sensitive Assets:Interest-bearing deposits$32,315$32,315Investment securities66,345$97,411$335,830$777,4131,276,999Loans2,543,191370,2831,015,545702,3504,631,369Federal Reserve and Federal Home Loan Bank stock37,63337,633Total rate-sensitive assets$2,641,851$467,694$1,389,008$1,479,763$5,978,316Rate-Sensitive Liabilities:Interest-bearing deposits$3,187,389$180,345$413,992$241,894$4,023,620Federal funds purchased49,72149,721Securities sold under repurchase agreements155,325155,325Federal Home Loan Bank advances74,24574,42365,50621,478235,652Subordinated debentures and term loans51,70276,144127,846Total rate-sensitive liabilities$3,518,382$254,768$479,498$339,516$4,592,164Interest rate sensitivity gap by period$(876,531)$212,926$909,510$1,140,247Cumulative rate sensitivity gap$(876,531)$(663,605)$245,905$1,386,152Cumulative rate sensitivity gap ratioat December 31, 201575.1%82.4%105.8%130.2%at December 31, 201475.8%84.9%111.2%130.5%








The Corporation had a cumulative positive gap of $663,605,000 in the one-year horizon at December 31, 2015 or 9.82 percent of total assets.





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Net interest income simulation modeling, or earnings-at-risk, measures the sensitivity of net interest income to various interest rate movements. The Corporation's asset liability process monitors simulated net interest income under three separate interest rate scenarios; base, rising and falling. Estimated net interest income for each scenario is calculated over a twelve-month horizon. The immediate and parallel changes to the base case scenario used in the model are presented below. The interest rate scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may introduce into the earnings of the Corporation.





The base scenario is highly dependent on numerous assumptions embedded in the model, including assumptions related to future interest rates. While the base sensitivity analysis incorporates management's best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact will likely differ from that projected. For certain assets, the base simulation model captures the expected prepayment behavior under changing interest rate environments. Assumptions and methodologies regarding the interest rate or balance behavior of indeterminate maturity products, such as savings, money market, NOW and demand deposits, reflect management's best estimate of expected future behavior.





The comparative rising 200 basis points and falling 100 basis points scenarios below, as of December 31, 2015 , assume further interest rate changes in addition to the base simulation discussed above. These changes are immediate and parallel changes to the base case scenario. In the current rate environment, many driver rates are at or near historical lows, thus total rate movements (beginning point minus ending point) to each of the various driver rates utilized by management have the following results:


At December 31, 2015RISINGFALLINGDriver Rates(200 Basis Points)(100 Basis Points)Prime200(25)Federal Funds200(25)One-Year CMT200(56)Three-Year CMT200(100)Five-Year CMT200(100)CD's200(21)FHLB200(83)








Results for the base, rising 200 basis points, and falling 100 basis points interest rate scenarios are listed below based upon the Corporation’s rate sensitive assets and liabilities at December 31, 2015 . The net interest income shown represents cumulative net interest income over a twelve-month time horizon. Balance sheet assumptions used for the base scenario are the same for the rising and falling simulations.


At December 31, 2015RISINGFALLING(Dollars in Thousands)Base(200 Basis Points)(100 Basis Points)Net Interest Income$198,711$213,758$188,921Variance from Base$15,047$(9,790)Percent of Change from Base7.57%(4.93)%








The comparative rising 200 basis points and falling 100 basis points scenarios below, as of December 31, 2014 , assume further interest rate changes in addition to the base simulation discussed above. These changes are immediate and parallel changes to the base case scenario. In addition, total rate movements (beginning point minus ending point) to each of the various driver rates utilized by management in the base simulation are as follows:


At December 31, 2014RISINGFALLINGDriver Rates(200 Basis Points)(100 Basis Points)Prime2000Federal Funds2000One-Year CMT200(15)Three-Year CMT200(83)Five-Year CMT200(100)CD's200(23)FHLB200(43)











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Results for the base, rising 200 basis points, and falling 100 basis points interest rate scenarios are listed below. The net interest income shown represents cumulative net interest income over a twelve-month time horizon. Balance sheet assumptions used for the base scenario are the same for the rising and falling simulations.


At December 31, 2014RISINGFALLING(Dollars in Thousands)Base(200 Basis Points)(100 Basis Points)Net Interest Income$180,175$192,164$175,118Variance from Base$11,989$(5,057)Percent of Change from Base6.65%(2.81)%








EARNING ASSETS





The following table presents the earning asset mix as of December 31, 2015 , and 2014 . Earnings assets at December 31, 2015 increased by $849,059,000 compared to December 31, 2014.  Loans and loans held for sale and investment securities increased by $771,616,000 and $96,368,000, respectively.  The five largest loan segments that experienced increases were commercial and industrial, construction, residential, commercial and farmland and other loans.  A slight decrease was noted in agricultural production financing and other loans to farmers.  The two most significant earning assets acquired in the Ameriana transaction were loans of $319,664,000 and investment securities available for sale of $63,058,000, while the most significant earning asset acquired in the C Financial transaction was loans of $110,625,000.


December 31,December 31,(Dollars in Thousands)20152014Interest-bearing time deposits$32,315$47,520Investment securities available for sale658,400549,543Investment securities held to maturity618,599631,088Mortgage loans held for sale9,8947,235Loans4,693,8223,924,865Federal Reserve and Federal Home Loan Bank stock37,63341,353$6,050,663$5,201,604








DEPOSITS AND BORROWINGS





The table below reflects the level of deposits and borrowed funds (federal funds purchased, repurchase agreements; FHLB advances; subordinated debentures and term loans) based on year-end levels at December 31, 2015 and 2014.


December 31,December 31,(Dollars in Thousands)20152014Deposits$5,289,647$4,640,694Federal funds purchased49,72115,381Securities sold under repurchase agreements155,325124,539Federal Home Loan Bank advances235,652145,264Subordinated debentures and term loans127,846126,810$5,858,191$5,052,688





The Ameriana acquisition on December 31, 2015 and the C Financial acquisition on April 17, 2015 resulted in deposits of $382,547,000 and $105,326,000, respectively.  As part of the Ameriana acquisition, the Corporation assumed approximately $24,938,000 of Federal Home Loan Bank Adances.  The C Financial acquisition resulted in an additional $18,958,000 of Federal Home Loan Bank advances at acquisition, of which, approximately $7,361,000 matured during 2015 and $11,597,000 remained at December 31, 2015.





On August 10, 2015, the Corporation completed the cancellation of $5,000,000 of subordinated debentures at a gain of $1,250,000.  This decrease was offset by an increase in subordinated debentures of $5,961,000 as a result of the Ameriana acquisition. Details regarding the acquisitions are discussed in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





The Corporation has leveraged its capital position with FHLB advances, as well as repurchase agreements, which are pledged against acquired investment securities as collateral for the borrowings. Further discussion regarding FHLB advances is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “LIQUIDITY”.  Additionally, the interest rate risk is included as part of the Corporation’s interest simulation discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K under the heading “INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK”.





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INCOME TAXES





Income tax expense totaled $25,665,000 for 2015 compared to $22,123,000 for 2014 .  The Corporation’s federal statutory income tax rate is 35 percent and its state tax rate varies from 0 to 9.5 percent depending on the state in which the subsidiary company is domiciled. The Corporation’s effective tax rate is lower than the blended effective statutory federal and state rates primarily due to the Corporation’s income on tax-exempt securities and loans, income generated by the subsidiaries domiciled in a state with no state or local income tax, income tax credits generated from investments in affordable housing projects, tax-exempt earnings from bank-owned life insurance contracts and reduced state taxes, resulting from the effect of state income apportionment.  The reconciliation of federal statutory to actual tax expense is shown in Note 22. INCOME TAX, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





The Corporation’s tax asset, deferred and receivable increased from $41,960,000 at December 31, 2014 to $46,977,000 at December 31, 2015 .  In addition, the Corporation’s net deferred tax asset has increased from $39,392,000 at December 31, 2014 to $43,555,000 at December 31, 2015 .  The $4,163,000 increase in the Corporation’s net deferred tax asset was primarily driven by a $9,262,000 increase resulting from the Ameriana acquisition.  The largest offsetting deferred tax asset decreases not related to the Ameriana acquisition were associated with accounting for loans, federal net operating loss carryforwards, deferred compensation, and allowance for loan losses of $1,873,000, $1,662,000, $857,000 and $789,000, respectively.  The deferred tax asset decreases were partially offset by a decline in the deferred tax liability associated with the accounting for unrealized gains on available for sale securities of $955,000.





The Corporation has recorded a valuation allowance of $15,736,000 related to deferred state taxes as it does not anticipate having future state taxable income sufficient to fully utilize the deferred state tax asset.  This is primarily due to the Corporation’s current tax structure as noted above.





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 and loan volume. 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 financial holding company’s operations is such that there will generally be an excess of monetary assets over monetary liabilities, and, thus, a financial holding company will tend to suffer from an increase in the rate of inflation and benefit from a decrease.





OTHER





The Securities and Exchange Commission maintains a website that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission, including the Corporation, and that address is www.sec.gov.


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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.





The quantitative and qualitative disclosures about market risk information are presented in the “INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





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 PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.








Report of Independent Registered Public Accounting Firm








Audit Committee, Board of Directors and Stockholders


First Merchants Corporation


Muncie, Indiana








We have audited the accompanying consolidated balance sheets of First Merchants Corporation (Corporation) as of December 31, 2015, and 2014, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2015. The Corporation's management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.





We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material


misstatement. Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and 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 referred to above present fairly, in all material respects, the financial position of First Merchants Corporation as of December 31, 2015, and 2014, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.





We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), First Merchants Corporation's internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated


Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 29, 2016, expressed an unqualified opinion on the effectiveness of the Corporation's internal control over financial reporting.











BKD, LLP











Indianapolis, Indiana


February 29, 2016





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 CONSOLIDATED FINANCIAL STATEMENTS





CONSOLIDATED BALANCE SHEETS


December 31,December 31,(Dollars in Thousands, Except Share Data)20152014ASSETSCash and cash equivalents$102,170$118,616Interest-bearing time deposits32,31547,520Investment securities available for sale658,400549,543Investment securities held to maturity (fair value of$632,380and$647,723)618,599631,088Loans held for sale9,8947,235Loans4,693,8223,924,865Less: Allowance for loan losses(62,453)(63,964)Net loans4,631,3693,860,901Premises and equipment97,64877,691Federal Reserve and Federal Home Loan Bank stock37,63341,353Interest receivable24,41519,984Core deposit intangibles16,63516,031Goodwill243,129202,724Cash surrender value of life insurance200,539169,424Other real estate owned17,25719,293Tax asset, deferred and receivable46,97741,960Other assets24,02320,764TOTAL ASSETS$6,761,003$5,824,127LIABILITIESDeposits:Noninterest-bearing$1,266,027$1,070,859Interest-bearing4,023,6203,569,835Total Deposits5,289,6474,640,694Borrowings:Federal funds purchased49,72115,381Securities sold under repurchase agreements155,325124,539Federal Home Loan Bank advances235,652145,264Subordinated debentures and term loans127,846126,810Total Borrowings568,544411,994Interest payable3,0923,201Other liabilities49,21141,411Total Liabilities5,910,4945,097,300COMMITMENTS AND CONTINGENT LIABILITIESSTOCKHOLDERS' EQUITYCumulative Preferred Stock, $1,000 par value, $1,000 liquidation value:Authorized - 600 sharesIssued and outstanding - 125 shares125125Common Stock, $.125 stated value:Authorized - 50,000,000 sharesIssued and outstanding -40,664,259and37,669,948shares5,0834,709Additional paid-in capital504,530431,220Retained earnings342,133292,403Accumulated other comprehensive loss(1,362)(1,630)Total Stockholders' Equity850,509726,827TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY$6,761,003$5,824,127











See notes to consolidated financial statements.


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 CONSOLIDATED FINANCIAL STATEMENTS





CONSOLIDATED STATEMENTS OF INCOME





December 31,December 31,December 31,(Dollars in Thousands, Except Share Data)201520142013INTEREST INCOMELoans receivable:Taxable$180,805$172,039$142,752Tax-exempt3,459327393Investment securities:Taxable17,88519,88215,214Tax-exempt16,92214,38310,829Deposits with financial institutions160124158Federal Reserve and Federal Home Loan Bank stock1,9672,1241,488Total Interest Income221,198208,879170,834INTEREST EXPENSEDeposits14,85511,67810,053Federal funds purchased74177102Securities sold under repurchase agreements368529787Federal Home Loan Bank advances2,8362,8422,096Subordinated debentures, revolving credit lines and term loans6,6616,6163,531Total Interest Expense24,79421,84216,569NET INTEREST INCOME196,404187,037154,265Provision for loan losses4172,5606,648NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES195,987184,477147,617OTHER INCOMEService charges on deposit accounts16,20115,74712,400Fiduciary activities9,1968,9668,594Other customer fees16,95915,69911,866Commission income4,1477,4117,141Earnings on cash surrender value of life insurance2,9193,6592,613Net gains and fees on sales of loans6,4834,8997,511Net realized gains on sales of available for sale securities2,6703,581487Gain on sale of insurance subsidiary8,265Gain on cancellation of subordinated debentures1,250Other income4,4416,4385,404Total Other Income72,53166,40056,016OTHER EXPENSESSalaries and employee benefits101,90896,49985,413Net occupancy14,66813,83110,291Equipment10,7879,3377,737Marketing3,4933,4642,236Outside data processing fees7,1097,3155,591Printing and office supplies1,3531,5651,340Core deposit amortization2,8352,4451,649FDIC assessments3,6553,7382,862Other real estate owned and foreclosure expenses6,1378,0436,661Professional and other outside services9,8558,1168,297Other expenses15,66914,23911,142Total Other Expenses177,469168,592143,219INCOME BEFORE INCOME TAX91,04982,28560,414Income tax expense25,66522,12315,884NET INCOME65,38460,16244,530Preferred stock dividends(2,380)NET INCOME AVAILABLE TO COMMON STOCKHOLDERS$65,384$60,162$42,150NET INCOME AVAILABLE TO COMMON STOCKHOLDERS PER SHARE:Basic$1.73$1.66$1.42Diluted$1.72$1.65$1.41











See notes to consolidated financial statements.


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 CONSOLIDATED FINANCIAL STATEMENTS





CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME





(Dollars in Thousands)December 31, 2015December 31, 2014December 31, 2013Net income$65,384$60,162$44,530Other comprehensive income (loss) net of tax:Unrealized holding gain (loss) on securities available for sale arising during the period, net of tax of $20, $8,001, and $6,841(37)14,860(12,705)Unrealized loss on securities transferred to held-to-maturity, net of tax of $0, $0, and $1,786(3,316)Unrealized gain on securities available for sale for which a portion of an other than temporary impairment has been recognized in income, net of tax of  $0, $995, and $7671,8471,425Unrealized gain (loss) on cash flow hedges arising during the period, net of tax of $588, $1,397, and $831(1,093)(2,599)1,543Reclassification adjustment for net losses (gains) included in net income net of tax of $435, $760, and $157(808)(1,410)291Defined benefit pension plans, net of tax of  $1,187, $4,264, and $6,382Net gain (loss) arising during period2,404(7,580)10,704Amortization of prior service cost(198)(338)1,1472684,780(911)Comprehensive income$65,652$64,942$43,619











See notes to consolidated financial statements.





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 CONSOLIDATED FINANCIAL STATEMENTS





CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY


PreferredCommon Stock(Dollars in Thousands, Except Share Data)SharesAmountSharesAmountAdditional Paid in CapitalRetained EarningsAccumulated Other Comprehensive Income (Loss)TotalBalances, December 31, 201290,908$90,90828,692,616$3,587$256,843$206,397$(5,499)$552,236Comprehensive incomeNet income44,53044,530Other comprehensive income (loss), net of tax(911)(911)Cash dividends on common stock ($.18 per share)(5,612)(5,612)Cash dividends on preferred stock under small business lending fund(2,380)(2,380)Preferred stock redemption under small business lending fund(90,783)(90,783)(90,783)Issuance of common stock related to acquisition7,079,457885134,757135,642Share-based compensation116,978151,7581,773Stock issued under employee benefit plans33,4514475479Stock issued under dividend reinvestment and stock purchase plan18,4492323325Stock options exercised13,7502113115Stock redeemed(32,940)(5)(486)(491)Balances, December 31, 2013125$12535,921,761$4,490$393,783$242,935$(6,410)$634,923Comprehensive incomeNet income60,16260,162Other comprehensive income, net of tax4,7804,780Cash dividends on common stock ($.29 per share)(10,694)(10,694)Issuance of common stock related to acquisition1,574,29819734,78434,981Share-based compensation132,446172,1602,177Stock issued under employee benefit plans26,5473475478Stock issued under dividend reinvestment and stock purchase plan24,5563520523Stock options exercised41,2495559564Stock redeemed(50,909)(6)(1,061)(1,067)Balances, December 31, 2014125$12537,669,948$4,709$431,220$292,403$(1,630)$726,827Comprehensive incomeNet income65,38465,384Other comprehensive income, net of tax268268Cash dividends on common stock ($.41 per share)(15,654)(15,654)Issuance of common stock related to acquisition2,769,56834670,05670,402Share-based compensation149,577192,2512,270Stock issued under employee benefit plans22,0743457460Stock issued under dividend reinvestment and stock purchase plan26,3753658661Stock options exercised96,066121,5191,531Stock redeemed(69,349)(9)(1,631)(1,640)Balances, December 31, 2015125$12540,664,259$5,083$504,530$342,133$(1,362)$850,509











See notes to consolidated financial statements.


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CONSOLIDATED STATEMENTS OF CASH FLOWS





December 31,December 31,December 31,(Dollars in Thousands)201520142013Cash Flow From Operating Activities:Net income$65,384$60,162$44,530Adjustments to reconcile net income to net cash provided by operating activities:Provision for loan losses4172,5606,648Depreciation and amortization6,2626,0074,670Change in deferred taxes4,44415,0482,147Share-based compensation2,2702,1771,773Tax benefit from stock options exercised(70)(60)Loans originated for sale(364,411)(222,892)(280,693)Proceeds from sales of Loans361,752220,988297,851Gain on sale of insurance subsidiary(8,265)Gain on cancellation of subordinated debentures(1,250)Gains on sales of securities available for sale(2,670)(3,581)(487)Change in interest receivable(2,833)(545)(535)Change in interest payable(162)1,332(364)Change in other receivable110,032Other adjustments(4,208)(5,356)(2,441)Net cash provided by operating activities$56,660$75,840$183,131Cash Flows from Investing Activities:Net change in interest-bearing deposits$24,917$24,075$196,753Purchases of:Securities available for sale(200,154)(110,936)(398,491)Securities held to maturity(87,282)(142,988)(11,145)Proceeds from sales of securities available for sale83,647126,57525,222Proceeds from maturities of:Securities available for sale63,12468,33993,273Securities held to maturity98,58169,42078,534Change in Federal Reserve and Federal Home Loan Bank stock7,268(413)(17)Net change in loans(350,287)(170,109)(142,861)Net cash and cash equivalents received (paid) in acquisition(7,936)(10,084)10,992Net cash received from sale of insurance subsidiary15,155Proceeds from the sale of other real estate owned12,56714,24112,346Other investing activities95,889(2,768)Net cash used in investing activities$(340,391)$(125,991)$(138,162)Cash Flows from Financing Activities:Net change in :Demand and savings deposits$240,736$53,062$141,052Certificates of deposit and other time deposits(79,656)127,740(211,399)Borrowings491,660678,290295,537Repayment of borrowings(370,813)(789,563)(163,838)Cash dividends on common stock(15,654)(10,694)(5,612)Cash dividends on preferred stock(2,380)Stock issued under employee benefit plans460478479Stock issued under dividend reinvestment and stock purchase plans661523325Stock options exercised1,461504115Tax benefit from stock options exercised7060Cumulative preferred stock redeemed (SBLF)(90,783)Stock redeemed(1,640)(1,067)(491)Net cash provided by (used in) financing activities$267,285$59,333$(36,995)Net Change in Cash and Cash Equivalents(16,446)9,1827,974Cash and Cash Equivalents, January 1118,616109,434101,460Cash and Cash Equivalents, December 31$102,170$118,616$109,434Additional cash flow information:Interest paid$24,903$20,412$16,639Income tax paid21,2006,2097,578Loans transferred to other real estate owned3,6444,4317,170Fixed assets transferred to other real estate owned1,600297461Non-cash investing activities using trade date accounting1,5593,1704,984














CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED








In conjunction with the acquisitions, liabilities were assumed as follows:


December 31, 2015December 31, 2014December 31, 2013Fair value of assets acquired$635,047$280,725$1,132,231Cash received (paid) in acquisition(14,500)(14,208)Less:  Common stock issued70,40234,981135,642Liabilities assumed$550,145$231,536$996,589








See notes to consolidated financial statements.





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NOTE 1





NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





The accounting and reporting policies of First Merchants Corporation (the “Corporation”), and its principal wholly owned subsidiary, First Merchants Bank, N.A. (the “Bank”), conform to accounting principles generally accepted in the United States of America and reporting practices followed by the banking industry. The Bank also operates Lafayette Bank and Trust, Ameriana Bank, Ameriana Financial Services and First Merchants Trust Company as divisions of First Merchants Bank, N.A.





The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 financial holding company whose principal activity is the ownership and management of the Bank and operates in a single significant business segment. The Bank operates under a national bank charter and provides full banking services. As a national bank, the Bank is subject to the regulation of the Office of Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”).  The OCC and the FDIC regulate or monitor virtually all areas of the Bank’s operations. The Bank must undergo regular on-site examinations by the OCC and FDIC and must submit periodic reports to both.





The Bank generates commercial, mortgage, and consumer loans and receives deposits from customers located primarily in central and northwest Indiana, northeast Illinois and central Ohio counties.  The Bank’s loans are generally secured by specific items of collateral, including real property, consumer assets and business assets.





A brief description of current accounting practices and current valuation methodologies are presented below.





CONSOLIDATION of the Corporation's financial statements include the accounts of the Corporation and all its subsidiaries, after elimination of all material intercompany transactions.





BUSINESS COMBINATIONS are accounted for under the acquisition method of accounting.  Under the acquisition method, assets and liabilities of the business acquired are recorded at their estimated fair values as of the date of acquisition with any excess of the cost of the acquisition over the fair value of the net tangible and intangible assets acquired recorded as goodwill.  Results of operations of the acquired business are included in the income statement from the date of acquisition.





AVAILABLE FOR SALE SECURITIES are recorded at fair value on a recurring basis with the unrealized gains and losses, net of applicable income taxes, recorded in other comprehensive income.  Realized gains and losses are recorded in earnings and the prior fair value adjustments are reclassified within stockholders' equity. Gains and losses on sales of securities are determined on the specific-identification method.  Amortization of premiums and accretion of discounts are recorded as interest income from securities.





Available for sale and held to maturity securities are evaluated for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities are generally evaluated for OTTI under ASC 320. However, certain purchased beneficial interest, including certain non-agency government-sponsored mortgage-backed securities, asset-backed securities and collateralized debt obligations are evaluated using the model outlined in ASC 325-10.





In determining OTTI under ASC 320, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Corporation has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether a decline exists that is other-than-temporary, involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.





When the Corporation does not intend to sell a debt security, and it is more likely than not, the Corporation will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income.  The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable income taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.





If the intent is to sell or it is more likely than not that the Corporation will be required to sell the security before recovery of its amortized cost basis, less any recognized credit loss, the OTTI is recognized in earnings equal to the entire difference between the investment’s amortized cost basis, less any recognized credit loss, and its fair value at the balance sheet date.


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HELD TO MATURITY 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.  For held to maturity debt securities, the amount of an OTTI recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.





LOANS HELD FOR SALE are carried at the principal amount outstanding.  The carrying amount approximates fair value due to the short duration between origination and the date of sale.





LOANS held in the Corporation’s portfolio are carried at the principal amount outstanding, net of unearned income. Certain non-accrual 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 Bank 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 ASC 310, 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 against earnings when considered uncollectable. Interest income accrued in the prior year, if any, is charged to the allowance for loan losses.  Interest income is subsequently recognized only to the extent cash payments are received and the loan is returned to accruing status. Certain loan fees and direct costs are being deferred and amortized as an adjustment of yield on the loans.





Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate, or the fair value of collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of the loan is confirmed. The valuation would be considered Level 3, consisting of appraisals of underlying collateral and discounted cash flow analysis.





Loan commitments and letters-of-credit generally have short-term, variable-rate features and contain clauses which limit the Bank’s 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.





LOANS ACQUIRED IN BUSINESS COMBINATIONS with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired.  Evidence of credit quality deterioration as of purchase dates may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages.  Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC 310-30).  These loans are initially measured at fair value based upon expected cash flows without anticipation of prepayments and includes estimated future credit losses expected to be incurred over the life of the loans.  As a result, related discounts are recognized subsequently through accretion based on the expected cash flows of the acquired loans.  For purposes of applying  ASC 310-30, loans acquired in business combinations are aggregated into pools of loans with common risk characteristics for the initial fair value measurement.  Accordingly, allowances for credit losses related to these loans are not carried over and recorded at the acquisition date.





The expected cash flows of the acquired loans in excess of the fair values recorded is referred to as the accretable yield and is recognized in interest income over the remaining estimated lives of the loans.  The Corporation will continually evaluate the fair value of the loans including cash flows expected to be collected.





ALLOWANCE FOR LOAN LOSSES is maintained to absorb losses inherent in the loan portfolio and is based on ongoing, quarterly assessments of the probable losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses, which is charged against current operating results. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The Corporation’s strategy for credit risk management includes conservative credit policies and underwriting criteria for all loans, as well as an overall credit limit for each customer significantly below legal lending limits. The strategy also emphasizes diversification on a regional geographic, industry and customer level, regular credit quality reviews and management reviews of large credit exposures and loans experiencing deterioration of credit quality.





The Corporation’s methodology for assessing the appropriateness of the allowance consists of three key elements – the determination of the appropriate reserves for specifically identified loans, probable losses estimated from historical loss rates, and probable losses resulting from economic, environmental, qualitative or other deterioration above and beyond what is reflected in the first two components of the allowance.





Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Corporation. Included in the review of individual loans are those that are impaired as provided in ASC 310. Any allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral. The Corporation evaluates the collectability of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.





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The historical allocation for commercial loans graded pass are established by loan segments using loss rates based on the Corporation’s migration analysis. This migration analysis shows the loss rates for each segment of loans based on the loan grades at the beginning of the twelve month period. This loss rate is then applied to the current portfolio of loans in each respective loan segment.





Homogenous loans, such as consumer installment and residential mortgage loans, are not individually risk graded. Reserves are established for each segment of loans using loss rates based on charge offs for the same period as the migration analysis used for commercial loans.





Historical loss allocations for commercial and consumer loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in loan growth and charge-off rates, changes in mix, concentration of loans in specific industries, asset quality trends (delinquencies, charge offs and non-accrual loans), risk management and loan administration, changes in the internal lending policies and credit standards, examination results from bank regulatory agencies and the Corporation’s internal loan review.





PENSION benefits are provided to the Corporation’s employees. Its accounting policies related to pensions and other post retirement benefits reflect the guidance in ASC 715, Compensation – Retirement Benefits. The Corporation does not consolidate the assets and liabilities associated with the pension plan. Instead, the Corporation recognizes the funded status of the plan in the consolidated balance sheets. The measurement of the funded status and the annual pension expense involves actuarial and economic assumptions. Various statistical and other factors, which attempt to anticipate future events, are used in calculating the expense and liabilities related to the plans. Key factors include assumptions on the expected rates of return on plan assets, discount rates, expected rates of salary increases and health care costs and trends. The Corporation considers market conditions, including changes in investment returns and interest rates in making these assumptions. The primary assumptions used in determining the Corporation’s pension and post retirement benefit obligations and related expenses are presented in Note 21. PENSION AND OTHER POST RETIREMENT BENEFIT PLANS, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





PREMISES AND EQUIPMENT is 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 ranging from three to forty years. Maintenance and repairs are expensed as incurred, while major additions and improvements,  which extend the useful life, 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 systems. The required investment in the common stock is based on a predetermined formula based on the level of borrowings and other factors.  These investments are carried at cost, classified as a restricted security and periodically evaluated for impairment based on ultimate recovery of par value.  Both cash and stock dividends are reported as income.





INTANGIBLE ASSETS that are subject to amortization, including core deposit intangibles, are being amortized on both the straight-line and accelerated basis over three to twenty years. Intangible assets are periodically evaluated as to the recoverability of their carrying value.





GOODWILL is maintained by applying the provisions of ASC 350. For purchase acquisitions, the Corporation is required to record the assets acquired, including identified intangible assets, and the liabilities assumed at their fair value, which in many instances involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analysis or other valuation techniques that may include estimates of attrition, inflation, asset growth rates or other relevant factors. In addition, the determination of the useful lives for which an intangible asset will be amortized is subjective.





Under ASC 350, Intangibles – Goodwill and Other , the Corporation is required to evaluate goodwill for impairment on an annual basis, as well as on an interim basis, if events or changes indicate that the asset may be impaired, indicating that the carrying value may not be recoverable. The Corporation has historically elected to test for goodwill impairment as of October 1 of each year and has determined that no impairment exists.





BANK OWNED LIFE INSURANCE has been purchased on certain employees and directors of the Corporation.  The Corporation records the life insurance at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or amounts due that are probable at settlement.





OTHER REAL ESTATE OWNED consists of assets acquired through, or in lieu of, loan foreclosure and are held for sale. They are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis.  Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.  Revenue and expenses from operations and changes in the valuation are included in net income or expense from foreclosed assets.  Other real estate owned also includes bank premises formerly, but no longer used for banking.  Bank premises are transferred at the lower of carrying value or fair value less cost to sell.





DERIVATIVE INSTRUMENTS are carried at the fair value of the derivatives and reflects the estimated amounts that would have been received to terminate these contracts at the reporting date based upon pricing or valuation models applied to current market information.





As part of the asset/liability management program, the Corporation will utilize, from time to time, interest rate floors, caps or swaps to reduce its sensitivity to interest rate fluctuations. These are derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets at fair value. Changes in the fair values of derivatives are reported in the consolidated statements of operations or other comprehensive income (“OCI”) depending on the use of the derivative and whether the instrument qualifies for hedge accounting. The key criterion for the hedge accounting is that the hedged relationship must be highly effective in achieving offsetting changes in those cash flows that are attributable to the hedged risk, both at inception of the hedge and on an ongoing basis.





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Derivatives that qualify for the hedge accounting treatment are designated as either: a hedge of the fair value of the recognized asset or liability or of an unrecognized firm commitment (a fair value hedge) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (a cash flow hedge). To date, the Corporation has only entered into a cash flow hedge. For cash flow hedges, changes in the fair values of the derivative instruments are reported in OCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in OCI are reflected in the consolidated statements of income in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item. Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At inception of the hedge, the Corporation establishes the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized currently in the consolidated statements of operations. The Corporation excludes the time value expiration of the hedge when measuring ineffectiveness.





The Corporation offers interest rate derivative products (e.g. interest rate swaps) to certain of its high-quality commercial borrowers. This product allows customers to enter into an agreement with the Corporation to swap their variable rate loan to a fixed rate. These derivative products are designed to reduce, eliminate or modify the risk of changes in the borrower’s interest rate or market price risk. The extension of credit incurred through the execution of these derivative products is subject to the same approvals and rigorous underwriting standards as the related traditional credit product. The Corporation limits its risk exposure to these products by entering into a mirror-image, offsetting swap agreement with a separate, well-capitalized and rated counterparty previously approved by the Credit and Asset Liability Committee. By using these interest rate swap arrangements, the Corporation is also better insulated from the interest rate risk associated with underwriting fixed-rate loans. These derivative contracts are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging , and, therefore, do not qualify for hedge accounting. The derivatives are recorded on the balance sheet at fair value and changes in fair value of both the customer and the offsetting swap agreements are recorded (and essentially offset) in non-interest income. The fair value of the derivative instruments incorporates a consideration of credit risk (in accordance with ASC 820), resulting in some volatility in earnings each period.





INCOME TAX in the consolidated statements 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.





The Corporation adopted the provisions of the ASC 740, Income Taxes , which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the implementation of ASC 740, the Corporation did not identify any uncertain tax positions that it believes should be recognized in the financial statements. The tax years still subject to examination by taxing authorities are years subsequent to 2011 .





STOCK OPTION AND RESTRICTED STOCK AWARD PLANS are maintained by the Corporation. The compensation costs are recognized for stock options and restricted stock awards issued to employees and directors based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options.  The market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation expense is recognized over the appropriate service period, which is generally two or three years.





TRANSFERS OF FINANCIAL ASSETS are accounted for as sales, when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation and put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.





NET INCOME PER SHARE is computed by dividing net income available to common shareholders by the weighted-average number of shares of common stock outstanding.  Diluted net income per share is computed by dividing net income available to common shareholders by the weighted-average number of shares of common stock outstanding, plus the dilutive effect of outstanding stock options and nonvested restricted stock.





RECLASSIFICATIONS have been made to prior financial statements to conform to the current financial statement presentation. These reclassifications had no effect on net income.








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NOTE 2





ACQUISITIONS AND DIVESTITURES





Ameriana Bancorp, Inc.





On December 31, 2015, the Corporation acquired 100 percent of Ameriana Bancorp, Inc., ("Ameriana").  Ameriana merged with and into the Corporation (the "Ameriana Merger") whereupon the separate corporate existence of Ameriana ceased and the Corporation survived.  Immediately following the Ameriana Merger, Ameriana Bank, and Indiana Bank and wholly-owned subsidiary of Ameriana, merged with and into First Merchants Bank, National Association, a national Bank and wholly-owned subsidiary of the Corporation (the "Bank"), with the Bank continuing as the surviving bank.  Ameriana was headquartered in New Castle, Indiana and had 13 banking centers serving central and east central Indiana.  Pursuant to the merger agreement, each Ameriana shareholder received 0.9037 shares of First Merchants common stock for each outstanding share of Ameriana common stock held.  The Corporation issued approximately 2.8 million shares of common stock, which was valued at approximately $70.4 million .





The Corporation engaged in this transaction with the expectation that it would be accretive and expand the existing footprint in central and east central Indiana.  Goodwill resulted from this transaction due to the expected synergies and economies of scale that are expected.





Under the acquisition method of accounting, the total purchase price is allocated to net tangible and intangible assets based on their current estimated fair values on the date of the acquisition.   Based on preliminary valuations of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the purchase price for the Ameriana acquisition is detailed in the following table.  Prior to the end of the one year measurement period for finalizing the purchase price allocation, if information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation retrospectively.


Fair ValueCash and cash equivalents$4,068Interest-bearing time deposits8,790Investment securities60,365Loans319,664Premises and equipment14,491Federal Home Loan Bank stock2,693Other real estate owned5,719Interest receivable1,306Cash surrender value of life insurance28,188Other assets7,086Deposits(382,547)Interest payable(24)Federal Home Loan Bank Advances(24,938)Subordinated Debentures(5,961)Other liabilities(9,451)Net tangible assets acquired29,449Core deposit intangible3,200Goodwill37,753Purchase price$70,402








Of the total purchase price, $3,200,000 has been allocated to a core deposit intangible that will be amortized over its estimated life of 10 years.  The residual purchase price has been allocated to goodwill, which is not deductible for tax purposes.





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C Financial Corporation





On April 17, 2015, the Corporation acquired 100 percent of C Financial Corporation, ("C Financial").  C Financial merged with and into the Corporation (the “C Financial Merger”) whereupon the separate corporate existence of C Financial ceased and the Corporation survived.  Immediately following the C Financial Merger, Cooper State Bank, an Ohio state bank and wholly-owned subsidiary of C Financial, merged with and into the Bank, with the Bank continuing as the surviving bank.  C Financial was headquartered in Columbus, Ohio and had 6 full service banking centers serving the Columbus, Ohio market.  As part of the $14.5 million C Financial Merger, shareholders of C Financial received $6.738 in cash for each share of C Financial common stock held.  The Corporation expects the transaction to be accretive to income and expand the existing footprint in Columbus, Ohio. Goodwill resulted from this transaction due to the synergies and economies of scale that are expected.





Under the acquisition method of accounting, the total purchase price is allocated to net tangible and intangible assets based on their current estimated fair values on the date of the acquisition.   Based on preliminary valuations of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on assumptions that are subject to change, the purchase price for the C Financial acquisition is detailed in the following table.  Prior to the end of the one year measurement period for finalizing the purchase price allocation, if information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation retrospectively.


Fair ValueCash and cash equivalents$2,496Federal Funds sold7,018Interest-bearing time deposits922Loans110,625Premises and equipment7,290Federal Home Loan Bank stock855Interest receivable292Other assets119Deposits(105,326)Interest payable(29)Federal Home Loan Bank Advances(18,958)Other liabilities(2,911)Net tangible assets acquired2,393Core deposit intangible981Goodwill11,126Purchase price$14,500








Of the total purchase price, $981,000 has been allocated to a core deposit intangible that will be amortized over its estimated life of 10 years.  The residual purchase price has been allocated to goodwill, which is deductible for tax purposes because the transaction was considered a taxable exchange.





Community Bancshares, Inc.





On November 7, 2014, the Corporation acquired 100 percent of Community Bancshares, Inc. ("Community").  Community merged with and into the Corporation (the "Community Merger") whereupon the separate corporate existence of Community ceased and the Corporation survived.  Immediately following the Community Merger, Community Bank, an Indiana bank and wholly-owned subsidiary of Community, merged with and into the Bank, with the Bank continuing as the surviving bank.  Community was headquartered in Noblesville, Indiana and had 10 full-service banking centers serving central Indiana.  Pursuant to the merger agreement, each outstanding share of common stock of Community was converted into the right to receive either (a) 4.0926 shares of the Corporation's common stock, plus cash in lieu of fractional shares; or (b) $85.94 in cash, based upon shareholder elections.  The Corporation paid $14.2 million in cash and issued approximately 1.6 million shares of common stock, valued at approximately $35.0 million , for a total purchase price of approximately $49.2 million .





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The Corporation engaged in this transaction with the expectation that it would be accretive and expand the existing footprint in central Indiana.  Goodwill resulted from this transaction due to the expected synergies from combining operations.  The purchase price of the Community acquisition was allocated as follows:


Fair ValueCash and cash equivalents$4,124Interest -bearing time deposits16,526Investment Securities, available for sale76,807Loans145,064Premises and equipment3,610Federal Home Loan Bank stock1,950Interest Receivable767Cash surrender value of life insurance3,266Other real estate owned6,662Taxes, deferred and receivable3,348Other assets167Deposits(228,424)Interest payable(98)Other liabilities(3,014)Net tangible assets acquired$30,755Core deposit intangible4,658Goodwill13,776Purchase price$49,189








Of the total purchase price, $4,658,000 has been allocated to a core deposit intangible that will be amortized over its estimated life of 10 years.  The residual purchase price has been allocated to goodwill, which is not deductible for tax purposes.





CFS Bancorp, Inc.





On November 12, 2013, the Corporation acquired 100 percent of CFS Bancorp, Inc. ("CFS") in an all stock transaction.  CFS merged with and into the Corporation (the "CFS Merger") whereupon the separate corporate existence of CFS ceased and the Corporation survived.  Immediately following the CFS Merger, Citizens Financial Bank, a federal savings bank and wholly-owned subsidiary of CFS, merged with and into the Bank, with the Bank continuing as the surviving bank.  CFS was headquartered in Munster, Indiana and had 20 full-service banking centers serving the northwestern Indiana and northeastern Illinois areas.  Pursuant to the merger agreement, the shareholders of CFS received 0.65 percent of a share of the Corporation's common stock for each share of CFS common stock held.  The Corporation issued approximately 7.1 million shares of common stock, which was valued at approximately $135.6 million .





The Corporation engaged in this transaction with the expectation that it would be accretive and add a new market area with a demographic profile consistent with many of the current Indiana markets served by the Bank.  Goodwill resulted from this transaction due to the expected synergies from combining operations. The purchase price for the CFS acquisition was allocated as follows:


Fair ValueCash and cash equivalents$10,992Interest-bearing time deposits213,379Investment securities available for sale15,913Investment securities held to maturity14,372Mortgage loans held for sale189Loans603,114Premises and equipment19,643Federal Home Loan Bank stock6,188Interest receivable1,770Cash surrender value of life insurance36,555Other real estate owned12,857Tax asset, deferred and receivable30,717Other assets111,656Deposits(955,432)Securities sold under repurchase agreements(9,830)Federal Home Loan Bank advances(15,000)Interest payable(294)Other liabilities(16,033)Net tangible assets acquired$80,756Core deposit intangible7,313Goodwill47,573Purchase price$135,642





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Of the total purchase price, $7,313,000 has been allocated to a core deposit intangible that will be amortized over its estimated life of 10 years.  The residual purchase price has been allocated to goodwill, which is not deductible for tax purposes.





First Merchants Insurance Services, Inc.





On June 12, 2015, the Corporation sold all of its stock in First Merchants Insurance Services, Inc., an Indiana Corporation ("FMIG"), to USI Insurance Services LLC, a Delaware limited liability company ("USI").  The sale price was $18.0 million , of which $16.0 million was paid at closing with the remaining $2.0 million paid through a two -year promissory note.  The sale of FMIG generated a gain on sale of $8.3 million .





Pro Forma Financial Information





The results of operations of C Financial, Community and CFS have been included in the Corporation's consolidated financial statements since the acquisition dates.  The following schedule includes pro forma results for the periods ended December 31, 2015, 2014 and 2013 as if the Ameriana, Community and CFS acquisitions had occurred as of the beginning of the comparable prior annual reporting period.  Pro forma financial information of the C Financial acquisition is not included in the table below as it is deemed immaterial.


201520142013Total revenue (net interest income plus other income)$291,614$284,890$253,668Net income$60,497$64,174$39,979Net income available to common shareholders$60,497$64,174$37,559Earnings per share:Basic$1.49$1.58$0.98Diluted$1.48$1.57$0.97








The pro forma information includes adjustments for interest income on loans, amortization of intangibles arising from the transaction, interest expense on deposits and borrowings acquired, premises expense for the banking centers acquired and the related income tax effects.  The pro forma information for the year ended 2015 includes operating results from Ameriana as if the acquisition occurred at the beginning of the year.  The 2015 pro forma includes $12.0 million , net of tax, of non-recurring expenses directly attributable to the Ameriana, C Financial and Community acquisitions and the FMIG divestiture.  The pro forma information for the year ended 2014 includes $1.6 million of operating revenue from Community since the acquisition and approximately $1.8 million , net of tax, of non-recurring expenses directly attributable to the Community acquisition.  The pro forma information for the year ended 2013 includes $4.9 million of operating revenue from CFS since the acquisition and approximately $9.5 million , net of tax, of non-recurring expenses directly attributable to the CFS acquisition.





The pro forma financial information is presented for information purposes only and is not indicative of the results of operations that actually would have been achieved had the acquisition consummated as of that time, nor is it intended to be a projection of future results.








NOTE 3





RESTRICTION ON CASH AND DUE FROM BANKS





The Corporation considers all liquid investments with original maturities of three months or less to be cash equivalents.  As of December 31, 2015 , cash and cash equivalents is defined to include cash on hand, deposits in other institutions and federal funds sold.





Effective October 3, 2008, the FDIC’s insurance limits temporarily increased to $250,000 . On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law, which, in part, permanently raised the standard maximum deposit insurance amount to $250,000 .  On November 9, 2010, the FDIC implemented section 343 of the Dodd-Frank Act providing unlimited insurance coverage on noninterest-bearing transaction accounts.  Beginning December 31, 2010, through December 31, 2012, all noninterest-bearing transaction accounts were fully insured, regardless of the balance of the account, at all FDIC-insured institutions.   As of January 1, 2013, noninterest-bearing transaction deposit accounts are no longer insured separately from other accounts at the same FDIC-insured institution.  Instead, noninterest-bearing transaction accounts are added to any of the Corporation's other accounts, and the aggregate balance insured up to at least the Standard Maximum Deposit Insurance Amount of $250,000 , at each institution.





At December 31, 2015 , the Corporation’s interest-bearing cash accounts and noninterest-bearing transaction deposits held at other institutions exceeded federally insured limits by approximately $63,132,000 . Each correspondent bank’s financial performance and market rating are reviewed on a quarterly basis to ensure the Corporation has deposits only at institutions providing minimal risk for those exceeding the federally insured limits.





Additionally, the Corporation had approximately $14,546,000 at the Federal Home Loan Bank and Federal Reserve Bank, which are government-sponsored entities not insured by the FDIC.





The Corporation is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank.  The reserve required at December 31, 2015 , was $19,288,000 .








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NOTE 4





INVESTMENT SECURITIES





The amortized cost, gross unrealized gains, gross unrealized losses and approximate market value of the Corporation's investment securities at the dates indicated were:


Amortized CostGross Unrealized GainsGross Unrealized LossesFair ValueAvailable for sale at December 31, 2015U.S. Government-sponsored agency securities$100$4$104State and municipal291,73014,241$60305,911U.S. Government-sponsored mortgage-backed securities342,5504,234518346,266Corporate obligations3131Equity securities3,9123,912Certificates of deposit2,1762,176Total available for sale640,49918,479578658,400Held to maturity at December 31, 2015State and municipal219,7676,98215226,734U.S. Government-sponsored mortgage-backed securities398,8327,601787405,646Total held to maturity618,59914,583802632,380Total Investment Securities$1,259,098$33,062$1,380$1,290,780Available for sale at December 31, 2014U.S. Government-sponsored agency securities$100$9$109State and municipal216,91511,801$123228,593U.S. Government-sponsored mortgage-backed securities310,4608,771127319,104Corporate obligations3131Equity securities1,7061,706Total available for sale529,21220,581250549,543Held to maturity at December 31, 2014State and municipal204,4435,71696210,063U.S. Government-sponsored mortgage-backed securities426,64511,527512437,660Total held to maturity631,08817,243608647,723Total Investment Securities$1,160,300$37,824$858$1,197,266








On December 31, 2015, the Corporation acquired 100 percent of Ameriana as discussed in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.  This purchase resulted in investment securities acquired of approximately $60.4 million .





Certain investments in debt securities are reported in the financial statements at amounts less than their historical cost.  The historical cost of these investments totaled $178,964,000 and $73,249,000 at December 31, 2015 and 2014 , respectively.  Total fair value of these investments was $177,584,000 and $72,390,000 , which was approximately 13.9 and 6.1 percent of the Corporation's available for sale and held to maturity investment portfolio at December 31, 2015 and 2014 , respectively.





Except as discussed below, management believes the decline in fair value for these securities was temporary. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income during the period the other-than-temporary impairment (“OTTI”) is identified.





The Corporation’s management has evaluated all securities with unrealized losses for OTTI as of December 31, 2015 .  The evaluations are based on the nature of the securities, the extent and duration of the loss and the intent and ability of the Corporation to hold these securities either to maturity or through the expected recovery period.





In determining the fair value of the investment securities portfolio, the Corporation utilizes a third party for portfolio accounting services, including market value input, for those securities classified as Level I and Level II in the fair value hierarchy.  The Corporation has obtained an understanding of what inputs are being used by the vendor in pricing the portfolio and how the vendor classified these securities based upon these inputs.  From these discussions, the Corporation’s management is comfortable that the classifications are proper.  The Corporation has gained trust in the data for two reasons:  (a) independent spot testing of the data is conducted by the Corporation through obtaining market quotes from various brokers on a periodic basis; and (b) actual gains or loss resulting from the sale of certain securities has proven the data to be accurate over time.   Fair value of securities classified as Level 3 in the valuation hierarchy was determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.





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U.S. Government-Sponsored Mortgage-Backed Securities





The unrealized losses on the Corporation's investment in mortgage-backed securities were a result of interest rate changes. The Corporation expects to recover the amortized cost basis over the term of the securities.  Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Corporation does not consider those investments to be other-than-temporarily impaired at December 31, 2015 .  As noted in the table above, the mortgage-backed securities portfolio contains unrealized losses of $518,000 on twenty-six securities and $787,000 on twenty-two securities in the available for sale and held to maturity portfolios, respectively.  All these securities are issued by a government-sponsored entity.





State and Municipal Securities





The unrealized losses on the Corporation's investments in securities of state and political subdivisions were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Corporation does not consider those investments to be other-than-temporarily impaired at December 31, 2015 .  As noted in the table above, the state and political subdivision securities portfolio contains unrealized losses of $60,000 on twenty-two securities and $15,000 on seven securities in the available for sale and held to maturity portfolios, respectively.





Certain Losses Recognized on Investments





Certain debt securities have experienced fair value deterioration due to credit losses and other market factors.  The following table provides information about debt securities for which only a credit loss was recognized in income and other losses were recorded in other comprehensive income.


Accumulated Credit Losses inAccumulated Credit Losses in20152014Credit losses on debt securities held:Balance, January 1$500$11,355Reductions for previous other-than-temporary losses realized on securities sold during the year(500)$(10,855)Balance, December 31$—$500








The following table shows the Corporation’s gross unrealized losses and fair value, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position at December 31, 2015 and 2014 :


Less than12 Months12 Months or LongerTotalFairValueGrossUnrealizedLossesFairValueGrossUnrealizedLossesFairValueGrossUnrealizedLossesTemporarily Impaired Available for Sale Securities at December 31, 2015State and municipal$7,558$60$7,558$60U.S. Government-sponsored mortgage-backed securities83,396445$2,101$7385,497518Total Temporarily Impaired Available for Sale Securities90,9545052,1017393,055578Temporarily Impaired Held to Maturity Securities at December 31, 2015State and municipal1,982151,98215U.S. Government-sponsored mortgage-backed securities69,64151912,90626882,547787Total Temporarily Impaired Held to Maturity Securities69,64151914,88828384,529802Total Temporarily Impaired Investment Securities$160,595$1,024$16,989$356$177,584$1,380Less than12 Months12 Months or LongerTotalFairValueGrossUnrealizedLossesFairValueGrossUnrealizedLossesFairValueGrossUnrealizedLossesTemporarily Impaired Available for Sale Securities at December 31, 2014State and municipal$1,256$7$9,850$116$11,106$123U.S. Government-sponsored mortgage-backed securities2,186135,4471147,633127Total Temporarily Impaired Available for Sale Securities3,4422015,29723018,739250Temporarily Impaired Held to Maturity Securities at December 31, 2014State and municipal5,119962505,36996U.S. Government-sponsored mortgage-backed securities9,7918238,49143048,282512Total Temporarily Impaired Held to Maturity Securities14,91017838,74143053,651608Total Temporarily Impaired Investment Securities$18,352$198$54,038$660$72,390$858


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The amortized cost and fair value of securities available for sale and held to maturity at December 31, 2015 by contractual maturity are shown below.  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.


Available for SaleHeld to MaturityAmortized CostFair ValueAmortized CostFair ValueMaturity Distribution at December 31, 2015Due in one year or less$4,658$4,704$4,144$4,148Due after one through five years13,72514,29528,05429,175Due after five through ten years52,87855,37581,48383,646Due after ten years220,600231,672106,086109,765291,861306,046219,767226,734U.S. Government-sponsored mortgage-backed securities342,550346,266398,832405,646Equity securities3,9123,912Certificates of deposit2,1762,176Total Investment Securities$640,499$658,400$618,599$632,380








Securities with a carrying value of approximately $637,358,000 , $449,408,000 and $373,533,000 were pledged at December 31, 2015 , 2014 and 2013 , respectively, to secure certain deposits and securities sold under repurchase agreements, and for other purposes as permitted or required by law.





Gross gains of $2,770,000 , $3,581,000 and $487,000 were realized on sales of investment securities in 2015 , 2014 and 2013 , respectively.  Gross losses of $100,000 were realized on sales of investment securities in 2015.  There were no losses from the sales of investment securities in 2014 or 2013 , respectively.








NOTE 5





LOANS AND ALLOWANCE





The Corporation's primary lending focus is small business and middle market commercial, commercial real estate, residential real estate and  consumer, which results in portfolio diversification.  The following tables show the composition of the loan portfolio, the allowance for loan losses and certain credit quality aspects, all excluding loans held for sale.  Loans held for sale at December 31, 2015 and 2014 , were $9,894,000 and $7,235,000 , respectively.





The following table illustrates the composition of the Corporation’s loan portfolio by loan class for the years indicated:


December 31, 2015December 31, 2014Commercial and industrial loans$1,057,075$896,688Agricultural production financing and other loans to farmers97,711104,927Real estate loans:Construction366,704207,221Commercial and farmland1,802,9211,672,661Residential786,105647,315Home equity348,613286,529Individuals' loans for household and other personal expenditures74,71773,400Lease financing receivables, net of unearned income5881,106Other commercial loans159,38835,018Loans4,693,8223,924,865Allowance for loan losses(62,453)(63,964)Net Loans$4,631,369$3,860,901








During the twelve months ended December 31, 2015, loans acquired through business combinations totaled $430,289,000 . See the information regarding the business combinations in the Note 2.  ACQUISITIONS AND DIVESTITURES section of the Financial Statements and Supplementary Data included as Item 8 of this Annual Report on Form 10-K.





At December  31, 2015, Other commercial loans totaled $159,388,000 , an increase of $124,370,000 from December 31, 2014. This increase was primarily a result of organic growth in the obligations of the state and political subdivisions sector of the portfolio.





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Allowance, Credit Quality and Loan Portfolio





The Corporation maintains an allowance for loan losses to cover probable credit losses identified during its loan review process.  Management believes that the allowance for loan losses is adequate to cover probable losses inherent in the loan portfolio at December 31, 2015 .  The process for determining the adequacy of the allowance for loan losses is critical to the Corporation’s financial results.  It requires management to make difficult, subjective and complex judgments to estimate the effect of uncertain matters.  The allowance for loan losses considers current factors, including economic conditions and ongoing internal and external examinations, and will increase or decrease as deemed necessary to ensure it remains adequate.  In addition, the allowance as a percentage of charge offs and nonperforming loans will change at different points in time based on credit performance, portfolio mix and collateral values.





The allowance for loan losses is maintained through the provision for loan losses, which is a charge against earnings. The allowance is increased by provision expense and decreased by charge offs less recoveries.  All charge offs are approved by the Bank’s senior loan officers or loan committees, depending on the amount of the charge off.  The Bank charges off a loan when a determination is made that all or a portion of the loan is uncollectible.   The amount provided for loan losses in a given period may be greater than or less than net loan losses experienced during the period, and is based on management’s judgment as to the appropriate level of the allowance for loan losses. The determination of the provision amount is based on management’s ongoing review and evaluation of the loan portfolio, including an internally administered loan "watch" list and independent loan reviews.  The evaluation takes into consideration identified credit problems, the possibility of losses inherent in the loan portfolio that are not specifically identified and management’s judgment as to the impact of the current environment and economic conditions on the portfolio.





The allowance consists of specific impairment reserves as required by ASC 310-10-35, a component for historical losses in accordance with ASC 450 and the consideration of current environmental factors in accordance with ASC 450.  A loan is deemed impaired when, based on current information or events, it is probable that all amounts due of principal and interest according to the contractual terms of the loan agreement will not be collected.





The historical loss allocation for loans not deemed impaired according to ASC 310 is the product of the volume of loans within the non-impaired criticized and non-criticized risk grade classifications, each segmented by call code, and the historical loss factor for each respective classification and call code segment.  The historical loss factors are based upon actual loss experience within each risk and call code classification.  The historical look back period for non-criticized loans looks to the most recent rolling-four-quarter average and aligns with the look back period for non-impaired criticized loans.  Each of the rolling four quarter periods used to obtain the average, include all charge offs for the previous twelve-month period, therefore the historical look back period includes seven quarters. The resulting allocation is reflective of current conditions.  Criticized loans are grouped based on the risk grade assigned to the loan.  Loans with a special mention grade are assigned a loss factor, and loans with a classified grade but not impaired are assigned a separate loss factor.  The loss factor computation for this allocation includes a segmented historical loss migration analysis of risk grades to charge off.





In addition to the specific reserves and historical loss components of the allowance, consideration is given to various environmental factors to  ensure that losses inherent in the portfolio are reflected in the allowance for loan losses.  The environmental component adjusts the historical loss allocations for non-impaired loans to reflect relevant current conditions that, in management's opinion, have an impact on loss recognition.  Environmental factors that management reviews in the analysis include: national and local economic trends and conditions; trends in growth in the loan portfolio and growth in higher risk areas; levels of, and trends in, delinquencies and non-accruals; experience and depth of lending management and staff; adequacy of, and adherence to, lending policies and procedures including those for underwriting; industry concentrations of credit; and adequacy of risk identification systems and controls through the internal loan review and internal audit processes.





In conformance with ASC 805 and ASC 820, loans purchased after December 31, 2008 are recorded at the acquisition date fair value.  Such loans are included in the allowance to the extent a specific impairment is identified that exceeds the fair value adjustment on an impaired loan or the historical loss and environmental factor analysis indicates losses inherent in a purchased portfolio exceeds the fair value adjustment on the portion of the purchased portfolio not deemed impaired.





At December 31, 2015, the allowance for loan losses was $62,453,000 , a decrease of $1,511,000 from the December 31, 2014 balance of $63,964,000 . Specific reserves on impaired loans decreased $927,000 to $1,842,000 , from $2,769,000 at December 31, 2014. Net charge offs for the twelve months ended December 31, 2015, were $1,928,000 , a decrease of $4,538,000 from the same period in 2014. The provision for loan losses for the twelve months ended December 31, 2015 was $417,000 , a decrease of $2,143,000 from the same period in 2014. The determination of the provision for loan losses in any period is based on management’s continuing review and evaluation of the loan portfolio, and its judgment as to the impact of current economic conditions on the portfolio.





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The following table summarizes changes in the allowance for loan losses by loan segment for the twelve months ended December 31, 2015, 2014 and 2013:


Twelve Months Ended December 31, 2015CommercialCommercial Real EstateConsumerResidentialFinanceLeasesTotalAllowance for loan losses:Balances, January 1$28,824$19,327$2,658$13,152$3$63,964Provision for losses(1,901)1,710299310(1)417Recoveries on loans1,9112,5453521,5366,344Loans charged off(2,356)(1,437)(620)(3,859)(8,272)Balances, December 31, 2015$26,478$22,145$2,689$11,139$2$62,453





Twelve Months Ended December 31, 2014CommercialCommercial Real EstateConsumerResidentialFinanceLeasesTotalAllowance for loan losses:Balances, January 1$27,176$23,102$2,515$15,077$67,870Provision for losses3,459(464)423(839)$(19)2,560Recoveries on loans5,4353,2973771,7832410,916Loans charged off(7,246)(6,608)(657)(2,869)(2)(17,382)Balances, December 31, 2014$28,824$19,327$2,658$13,152$3$63,964





Twelve Months Ended December 31, 2013CommercialCommercial Real EstateConsumerResidentialFinanceLeasesTotalAllowance for loan losses:Balances, January 1$25,913$26,703$2,593$14,157$69,366Provision for losses2,794340(11)3,514$116,648Recoveries on loans4,5863,5525561,29249,990Loans charged off(6,117)(7,493)(623)(3,886)(15)(18,134)Balances, December 31, 2013$27,176$23,102$2,515$15,077$67,870








The following tables show the Corporation’s allowance for loan losses and loan portfolio by loan segment for the years indicated:


December 31, 2015CommercialCommercialReal EstateConsumerResidentialFinanceLeasesTotalAllowance balances:Individually evaluated for impairment$1,277$243$169$1,689Collectively evaluated for impairment25,20121,753$2,68910,966$260,611Loans acquired with deteriorated credit quality1494153Total Allowance for Loan Losses$26,478$22,145$2,689$11,139$2$62,453Loan balances:Individually evaluated for impairment$7,877$16,670$4,020$28,567Collectively evaluated for impairment1,298,9882,096,089$74,7171,125,316$5884,595,698Loans acquired with deteriorated credit quality7,30956,8665,38269,557Loans$1,314,174$2,169,625$74,717$1,134,718$588$4,693,822





December 31, 2014CommercialCommercialReal EstateConsumerResidentialFinanceLeasesTotalAllowance balances:Individually evaluated for impairment$1,455$470$194$2,119Collectively evaluated for impairment27,36918,207$2,65812,958$361,195Loans acquired with deteriorated credit quality650650Total Allowance for Loan Losses$28,824$19,327$2,658$13,152$3$63,964Loan balances:Individually evaluated for impairment$16,108$23,963$4,022$44,093Collectively evaluated for impairment1,011,1221,796,797$73,400925,282$1,1063,807,707Loans acquired with deteriorated credit quality9,40359,1224,54073,065Loans$1,036,633$1,879,882$73,400$933,844$1,106$3,924,865


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The risk characteristics of the Corporation’s material portfolio segments are as follows:





Commercial





Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower.  The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.





Commercial real estate





These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.  Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.  Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.  Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria.  In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.





Residential and Consumer





With respect to residential loans that are secured by 1-4 family residences and are typically owner occupied, the Corporation generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles.  Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income and credit rating of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels.  Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.





Loans are reclassified to a non-accruing status when, in management’s judgment, the collateral value and financial condition of the borrower do not justify accruing interest. Uncollected interest previously recorded, but not deemed collectible, is reversed and charged against current income. Payments subsequently received on non-accrual loans are applied to principal.  A loan is returned to accrual status when principal and interest are no longer past due and collectability is probable, typically after a minimum of six consecutive months of performance.  Payments received on impaired accruing or delinquent loans are applied to interest income as accrued.





The following table summarizes the Corporation’s non-accrual loans by loan class for the years indicated:


December 31, 2015December 31, 2014Commercial and industrial loans$4,634$7,048Agriculture production financing and other loans to farmers8275,800Real estate loans:Construction7361,439Commercial and farmland11,27719,350Residential11,81812,933Home equity1,9521,988Individuals' loans for household and other personal expenditures145231Total$31,389$48,789








Commercial impaired loans include non-accrual loans, loans accounted for under ASC 310-30, and loans risk graded as substandard, doubtful and loss that were still accruing but deemed impaired according to the guidance set forth in ASC 310.  Also included in impaired loans are accruing loans that are contractually past due 90 days or more and troubled debt restructurings.





Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral dependent loans.  If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized.  This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.  The fair value of real estate is generally based on appraisals by qualified licensed appraisers.  The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach.  If an appraisal is not available, the fair value may be determined by using a cash flow analysis.  Fair value on other collateral such as business assets is typically ascertained by assessing, either singularly or some combination of, asset appraisals, accounts receivable aging reports, inventory listings and  or customer financial statements.   Both appraised values and values based on borrower’s financial information are discounted as considered appropriate based on age and quality of the information and current market conditions.





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The following tables show the composition of the Corporation’s commercial impaired loans by loan class for the years indicated:


December 31, 2015Unpaid PrincipalBalanceRecordedInvestmentRelatedAllowanceAverage Recorded InvestmentInterest Income RecognizedImpaired loans with no related allowance:Commercial and industrial loans$22,151$11,669$12,578$488Agriculture production financing and other loans to farmers370361439Real estate loans:Construction4,5512,3363,662157Commercial and farmland95,93069,02471,5693,328Residential11,2627,3387,926244Home equity297247249Other commercial loans20Total$134,581$90,975$96,423$4,217Impaired loans with related allowance:Commercial and industrial loans$3,043$2,690$1,247$2,752$38Agriculture production financing and other loans to farmers46646630538Real estate loans:Commercial and farmland2,1441,9333921,868Residential2,3001,4631731,787Total$7,953$6,552$1,842$6,945$38Total Impaired Loans$142,534$97,527$1,842$103,368$4,255








December 31, 2014Unpaid PrincipalBalanceRecordedInvestmentRelatedAllowanceAverage Recorded InvestmentInterest Income RecognizedImpaired loans with no related allowance:Commercial and industrial loans$35,514$18,029$18,711$362Agriculture production financing and other loans to farmers262226Real estate loans:Construction12,9569,3189,837427Commercial and farmland95,85668,18770,8443,389Residential10,5916,8396,987119Home equity3,590398402Other commercial loans30Total$158,563$102,793$106,807$4,297Impaired loans with related allowance:Commercial and industrial loans$1,766$1,684$1,055$1,721$40Agriculture production financing and other loans to farmers6,7775,7774008,0441Real estate loans:Commercial and farmland7,1594,9711,1204,99924Residential1,0019981941,000Total$16,703$13,430$2,769$15,764$65Total Impaired Loans$175,266$116,223$2,769$122,571$4,362








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December 31, 2013Unpaid PrincipalBalanceRecordedInvestmentRelatedAllowanceAverage Recorded InvestmentInterest Income RecognizedImpaired loans with no related allowance:Commercial and industrial loans$35,066$16,371$19,209$192Agriculture production financing and other loans to farmers323032Real estate loans:Construction16,10910,62511,621117Commercial and farmland128,07383,03384,0571,663Residential6,7463,9104,23675Home equity3,299112225Other commercial loans4541721811Total$189,779$114,253$119,561$2,048Impaired loans with related allowance:Commercial and industrial loans$1,390$1,216$683$1,240$9Real estate loans:Commercial and farmland4,6574,2158944,2919Residential7471676Total$6,121$5,502$1,583$5,607$18Total Impaired Loans$195,900$119,755$1,583$125,168$2,066








At December 31, 2015, the commercial impaired loan total of $97,527,000 included $11,365,000 and $1,841,000 in loans acquired from Ameriana and C Financial, respectively.  At December 31, 2014, the commercial impaired loan total of $116,223,000 included $17,027,000 in loans acquired from Community.  At December 31, 2013, the commercial impaired loan total of $119,755,000 included $69,448,000 in loans acquired from CFS.





As part of the ongoing monitoring of the credit quality of the Corporation's loan portfolio, management tracks certain credit quality indicators including trends related to: (i) the level of criticized commercial loans, (ii) net charge offs, (iii) non-performing loans and (iv) the general national and local economic conditions.





The Corporation utilizes a risk grading of pass, special mention, substandard, doubtful and loss to assess the overall credit quality of large commercial loans.  All large commercial credit grades are reviewed at a minimum of once a year for pass grade loans.  Loans with grades below pass are reviewed more frequently depending on the grade.  A description of the general characteristics of these grades is as follows:





|  |                                                                     
|- | --------------------------------------------------------------------
|• | Pass - Loans that are considered to be of acceptable credit quality.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Special Mention - Loans which possess some credit deficiency or potential weakness, which deserves close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Corporation's credit position at some future date.  Special mention assets are not adversely classified and do not expose the Corporation to sufficient risk to warrant adverse classification.  The key distinctions of this category's classification are that it is indicative of an unwarranted level of risk; and weaknesses are considered “potential”, not “defined”, impairments to the primary source of repayment. Examples include businesses that may be suffering from inadequate management, loss of key personnel or significant customer or litigation.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                         
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Substandard - A substandard loan is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  Assets so classified have a well-defined weakness that jeopardizes the liquidation of the debt.  They are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.  Other characteristics may include:

othe likelihood that a loan will be paid from the primary source of repayment is uncertain or financial deterioration is underway and very close attention is warranted to ensure that the loan is collected without loss,


othe primary source of repayment is gone, and the Corporation is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees,


oloans have a distinct possibility that the Corporation will sustain some loss if deficiencies are not corrected,


ounusual courses of action are needed to maintain a high probability of repayment,


othe borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments,


othe Corporation is forced into a subordinated or unsecured position due to flaws in documentation,


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oloans have been restructured so that payment schedules, terms and collateral represent concessions to the borrower when compared to the normal loan terms,


othe Corporation is seriously contemplating foreclosure or legal action due to the apparent deterioration of the loan, and


othere is significant deterioration in market conditions to which the borrower is highly vulnerable.





|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Doubtful - Loans that have all of the weaknesses of those classified as Substandard.  However, based on currently existing facts, conditions and values, these weaknesses make full collection of principal highly questionable and improbable. Other credit characteristics may include the primary source of repayment is gone or there is considerable doubt as to the quality of the secondary sources of repayment. The possibility of loss is high, but because of certain important pending factors that may strengthen the loan, loss classification is deferred until the exact status of repayment is known.




|  |                                                                                                                                                                                                                                                                                                                                                                            
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Loss – Loans that are considered uncollectible and of such little value that continuing to carry them as an asset is not warranted. Loans will be classified as Loss when it is neither practical not desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.







The following tables summarize the credit quality of the Corporation’s loan portfolio, by loan class for the years indicated.  Consumer non-performing loans include accruing consumer loans 90 plus days delinquent and consumer non-accrual loans.  The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified date.  Loans that evidenced deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected are included in the applicable categories below.


December 31, 2015Commercial PassCommercial Special MentionCommercial SubstandardCommercial DoubtfulCommercial LossConsumer PerformingConsumerNon PerformingTotalCommercial and industrial loans$962,340$48,432$45,984$319$1,057,075Agriculture production financing and other loans to farmers77,8846,66513,16297,711Real estate loans:Construction345,4491,2711,790$18,114$80366,704Commercial and farmland1,679,14146,44277,3381,802,921Residential171,5763,10710,428593,5337,461786,105Home equity8,21848600337,7182,029348,613Individuals' loans for household and other personal expenditures74,49122674,717Lease financing receivables, net of unearned income49593588Other commercial loans159,388159,388Loans$3,404,491$105,965$149,395$319$1,023,856$9,796$4,693,822








December 31, 2014Commercial PassCommercial Special MentionCommercial SubstandardCommercial DoubtfulCommercial LossConsumer PerformingConsumerNon PerformingTotalCommercial and industrial loans$823,732$24,455$48,226$275$896,688Agriculture production financing and other loans to farmers96,1551,1957,577104,927Real estate loans:Construction185,3943,1642,928$15,588$147207,221Commercial and farmland1,552,78129,48490,1612351,672,661Residential149,4306,32110,918470,9729,674647,315Home equity6,36812690277,5711,888286,529Individuals' loans for household and other personal expenditures73,16523573,400Lease financing receivables, net of unearned income9981081,106Other commercial loans35,01835,018Loans$2,849,876$64,631$160,608$275$837,296$12,179$3,924,865





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The following tables illustrate the past due aging of the Corporation’s loan portfolio, by loan class, for the years indicated:


December 31, 2015Current30-59 DaysPast Due60-89 DaysPast DueLoans > 90 DaysAnd AccruingNon-AccrualTotal Past Due& Non-AccrualTotalCommercial and industrial loans$1,052,275$166$4,634$4,800$1,057,075Agriculture production financing and other loans to farmers96,88482782797,711Real estate loans:Construction362,0843,8847364,620366,704Commercial and farmland1,786,0925,55211,27716,8291,802,921Residential765,6346,090$2,061$50211,81820,471786,105Home equity344,3441,4335603241,9524,269348,613Individuals' loans for household and other personal expenditures73,990445568114572774,717Lease financing receivables, net of unearned income588588Other commercial loans159,3246464159,388Loans$4,641,215$17,570$2,741$907$31,389$52,607$4,693,822








December 31, 2014Current30-59 DaysPast Due60-89 DaysPast DueLoans > 90 DaysAnd AccruingNon-AccrualTotal Past Due& Non-AccrualTotalCommercial and industrial loans$882,596$4,006$53$2,985$7,048$14,092$896,688Agriculture production financing and other loans to farmers98,2368915,8006,691104,927Real estate loans:Construction204,6831,017821,4392,538207,221Commercial and farmland1,642,0169,846778$67119,35030,6451,672,661Residential626,8214,8761,83185412,93320,494647,315Home equity282,8281,2133521481,9883,701286,529Individuals' loans for household and other personal expenditures72,85325853523154773,400Lease financing receivables, net of unearned income1,1061,106Other commercial loans35,01835,018Loans$3,846,157$22,107$3,149$4,663$48,789$78,708$3,924,865








See the information regarding the analysis of loan loss experience in the “Loan Quality" and "Provision And Allowance For Loan Losses" section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.





On occasion, borrowers experience declines in income and cash flow.  As a result, these borrowers seek to reduce contractual cash outlays including debt payments.  Concurrently, in an effort to preserve and protect its earning assets, specifically troubled loans, the Corporation is working to maintain its relationship with certain customers who are experiencing financial difficulty by contractually modifying the borrower's debt agreement with the Corporation.  In certain loan restructuring situations, the Corporation may grant a concession to a debtor experiencing financial difficulty, resulting in a trouble debt restructuring.  A concession is deemed to be granted when, as a result of the restructuring, the Corporation does not expect to collect all original amounts due, including interest accrued at the original contract rate.  If the payment of principal at original maturity is primarily dependent on the value of collateral, the current value of the collateral is considered in determining whether the principal will be paid.





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The following tables summarize troubled debt restructurings that occurred during the periods ended December 31, 2015 and 2014 :  December 31, 2015Pre-ModificationRecorded BalancePost-ModificationRecorded BalanceNumberof LoansCommercial and industrial loans$4,111$2,1157Real estate loans:Construction79801Commercial and farmland1,2813,0243Residential2001,11310Home equity2632421Individuals' loans for household and other personal expenditures26271Total$5,960$6,60123








December 31, 2014Pre-ModificationRecorded BalancePost-ModificationRecorded BalanceNumberof LoansReal estate loans:Commercial and farmland$259$2591Residential6326229Home equity32035011Individuals' loans for household and other personal expenditures26262Total$1,237$1,25723








The following tables show the recorded investment of troubled debt restructurings, by modification type, that occurred during the years indicated:


December 31, 2015TermModificationRateModificationCombinationTotalModificationCommercial and industrial loans$761$1,053$1,814Real estate loans:Commercial and farmland1,2311,0262,257Residential823$170451,038Home equity242242Individuals' loans for household and other personal expenditures2727Total$2,815$439$2,124$5,378








December 31, 2014TermModificationRateModificationCombinationTotalModificationReal estate loans:Commercial and farmland$288$288Residential31$218$360609Home equity100243343Individuals' loans for household and other personal expenditures2323Total$319$318$626$1,263


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Loans secured by commercial and farmland real estate made up 46 percent of the post-modification balances of the troubled debt restructured loans during the twelve months ending December 31, 2015 .  The second largest class of troubled debt restructurings during 2015 was commercial and industrial loans, which accounted for 32 percent of the total post modification balances.





The following tables summarize troubled debt restructures that occurred during the twelve months ended December 31, 2015 and 2014 , that subsequently defaulted during the period indicated and remained in default at period end.  For purposes of this schedule, a loan is considered in default if it is 30 or more days past due.


Twelve Months Ended December 31, 2015Number of LoansRecorded BalanceReal estate loans:Residential1$21Total1$21








Twelve Months Ended December 31, 2014Number of LoansRecorded BalanceReal estate loans:Residential1$70Total1$70








For potential consumer loan restructures, impairment evaluation occurs prior to modification.  Any subsequent impairment is typically addressed through the charge off process, or may be addressed through a specific reserve.  Consumer troubled debt restructurings are generally included in the general historical allowance for loan loss at the post modification balance.  Consumer non-accrual and delinquent troubled debt restructurings are also considered in the calculation of the non-accrual and delinquency trend environmental allowance allocation.  Commercial troubled debt restructured loans risk graded special mention, substandard, doubtful and loss are individually evaluated for impairment under ASC 310.  Any resulting specific reserves are included in the allowance for loan losses. Commercial 30 - 89 day delinquent troubled debt restructurings are included in the calculation of the delinquency trend environmental allowance allocation. All commercial non-impaired loans, including non-accrual and 90+ day delinquents, are included in the ASC 450 loss migration analysis.








NOTE 6





ACCOUNTING FOR CERTAIN LOANS ACQUIRED IN A PURCHASE





The Bank acquired loans in a purchase during the years ended December 31, 2015 , 2014, 2013 and 2012.  The acquired loans detailed in the tables below are included in Note 5. LOANS AND ALLOWANCE, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.  As described in Note 5, loans purchased after December 31, 2008 are recorded at the acquisition date fair value, which could result in a fair value discount or premium.  Purchased loans with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments are accounted for under ASC 310-30, Loans Acquired with Deteriorated Credit Quality .  The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the nonaccretable portion of the fair value discount or premium.  The accretable portion of the fair value discount or premium is the difference between the expected cash flows and the net present value of expected cash flows, with such difference accreted into earnings over the term of the loans.  All other loans not accounted for under ASC 310-30 are accounted for under ASC 310-20 which allows the remaining fair value adjustment to be accreted into income over the remaining life of the loans.















































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The following table includes the outstanding balance and carrying amount of all the performing and non-performing acquired loans, which are included in the Corporation's balance sheet at December 31, 2015 and 2014.


December 31, 2015AmerianaC FinancialCommunityCFSSCBTotalOutstanding Balance:Commercial and industrial loans$21,888$104$6,769$52,060$4,620$85,441Agricultural production financing and other loans to farmers1,7611,2883,049Real estate loans:Construction23,3656,21410,43697640,991Commercial and farmland144,51427,83849,997189,37213,293425,014Residential123,23155,85621,886118,1056,063325,141Home Equity14,2619,1448,23131,98613,43177,053Individuals' loans for household and other personal expenditures1,73110461443482,693Other commercial loans1,928722,000Total$330,918$99,166$99,541$393,014$38,743$961,382Carrying Amount$319,664$96,829$93,355$373,649$34,092$917,589Allowance4149153Carrying Amount Net of Allowance$319,664$96,829$93,351$373,500$34,092$917,436








December 31, 2014CommunityCFSSCBTotalOutstanding Balance:Commercial and industrial loans$8,168$64,897$6,059$79,124Agricultural production financing and other loans to farmers1,1008931,993Real estate loans:Construction19,0639,11328,176Commercial and farmland74,600251,00215,593341,195Residential28,863144,3967,384180,643Home Equity9,88139,24415,75864,883Individuals' loans for household and other personal expenditures1,3149221212,357Other commerical loans8686Total$142,989$509,660$45,808$698,457Carrying Amount$134,198$484,949$39,324$658,471Allowance650650Carrying Amount Net of Allowance$134,198$484,299$39,324$657,821








Certain purchased credit impaired loans with subsequent deterioration since acquisition required an allowance for loan losses and corresponding provision expense of $153,000 and $650,000 at December 31, 2015 and 2014, respectively.





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As customer cash flow expectations improve, nonaccretable yield can be reclassified to accretable yield.  The accretable yield, or income expected to be collected, and reclassifications from nonaccretable yield, are identified in the table below.


Twelve Months Ended December 31, 2015AmerianaC FinancialCommunityCFSSCBTotalBeginning balance$2,122$2,400$868$5,390Additions$2,848$1452,993Accretion(31)(723)(4,050)(1,046)(5,850)Reclassification from nonaccretable2492,8548223,925Disposals(140)(16)(2)(158)Ending balance$2,848$114$1,508$1,188$642$6,300








Twelve Months Ended December 31, 2014CommunityCFSSCBTotalBeginning balance$4,164$1,388$5,552Additions$2,2342,234Accretion(231)(4,146)(1,062)(5,439)Reclassification from nonaccretable1192,5535773,249Disposals(171)(35)(206)Ending balance$2,122$2,400$868$5,390








Twelve Months Ended December 31, 2013CFSSCBTotalBeginning balance$1,715$1,715Additions$3,5023,502Accretion(10)(463)(473)Reclassification from nonaccretable672177849Disposals(41)(41)Ending balance$4,164$1,388$5,552








The following table presents loans acquired during the periods ending December 31, 2015 and 2014, for which it was probable at acquisition that all contractually required payments would not be collected:


20152014AmerianaC FinancialTotalCommunityContractually required payments receivable at acquisition date$29,093$2,632$31,725$26,032Nonaccretable difference13,72863714,3653,498Expected cash flows at acquisition date15,3651,99517,36022,534Accretable difference2,8481452,9932,234Basis in loans at acquisition date$12,517$1,850$14,367$20,300



































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NOTE 7





PREMISES AND EQUIPMENT





The following table summarizes the Corporation's premises and equipment as of December 31, 2015 and 2014 :


20152014Cost at December 31:Land$26,510$19,373Buildings and Leasehold Improvements115,46199,451Equipment64,89256,606Total Cost206,863175,430Accumulated Depreciation and Amortization(109,215)(97,739)Net$97,648$77,691








The Ameriana acquisition on December 31, 2015 and the C Financial acquisition on April 17, 2015 resulted in additions to premises and equipment of $14,491,000 and $7,290,000 , respectively.  Additionally, on November 7, 2014, the Community acquisition resulted in an addition to premises and equipment of $3,610,000 .  Details regarding the acquisitions are discussed in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





The Corporation is committed under various non-cancelable lease contracts for certain subsidiary office facilities and equipment. Total lease expense for 2015 , 2014 and 2013 was $3,456,000 , $3,258,000 and $2,608,000 , respectively. The future minimum rental commitments required under the operating leases in effect at December 31, 2015 , expiring at various dates through the year 2035 are as follows for the years ending December 31:


Future Minimum Rental Commitments2016$3,07620172,35320181,41920191,22220201,060After 20206,629Total Future Minimum Obligations$15,759








NOTE 8





GOODWILL





The Ameriana acquisition on December 31, 2015 and the C Financial acquisition on April 17, 2015 resulted in goodwill of $37,753,000 and $11,126,000 , respectively.  On June 12, 2015, the sale of FMIG resulted in a goodwill reduction of $8,474,000 .  Additionally, on November 7, 2014, the Community acquisition resulted in goodwill of $13,776,000 .  Details regarding the acquisitions and sale are discussed in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





No impairment loss was recorded in 2015 or 2014.  The Corporation tested goodwill for impairment during 2015 and 2014.  In both valuations, the fair value exceeded the Corporation’s carrying value; therefore, it was concluded goodwill is not impaired. For additional details related to impairment testing, see the “GOODWILL” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 7 of this Annual Report on Form 10-K.


20152014Balance, January 1$202,724$188,948Goodwill acquired48,87913,776Goodwill reduction$(8,474)Balance, December 31$243,129$202,724








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NOTE 9





CORE DEPOSIT AND OTHER INTANGIBLES





The Ameriana acquisition on December 31, 2015 and the C Financial acquisition on April 17, 2015 resulted in a core deposit intangible of $3,200,000 and $981,000 , respectively.  On June 12, 2015, the sale of FMIG resulted in an other intangible reduction of $742,000 .  Additionally, on November 7, 2014, the Community acquisition resulted in a core deposit intangible of $4,658,000 .  Details regarding the acquisitions and sale are discussed in Note 2. ACQUISITIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.





The carrying basis and accumulated amortization of recognized core deposit and other intangibles are noted below.


20152014Gross carrying amount$58,360$53,702Core deposit intangible and other intangibles acquired4,1814,658Accumulated amortization(45,164)(42,329)Core deposit intangible and other intangibles reduction(742)Core Deposit and Other Intangibles$16,635$16,031








Amortization expense for the years ended December 31, 2015 , 2014 and 2013 , was $2,835,000 , $2,445,000 and $1,649,000 , respectively.





Estimated future amortization expense is summarized as follows:


Amortization Expense2016$3,05520173,01720181,90420191,67620201,618After 20205,365Total Future Minimum Obligations$16,635








NOTE 10





DEPOSITS





The composition of the deposit portfolio is included in the table below for the years indicated:


December 31, 2015December 31, 2014Demand deposits$2,576,283$2,146,492Savings deposits1,518,7221,376,707Certificates and other time deposits of $100,000 or more323,698260,685Other certificates and time deposits556,476523,010Brokered deposits314,468333,800Total deposits$5,289,647$4,640,694








At December 31, 2015, the contractual maturities of time deposits are summarized as follows:


Certificates and Other Time Deposits2016$600,5512017272,6522018126,929201974,750202055,187After 202064,573$1,194,642





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NOTE 11





TRANSFERS ACCOUNTED FOR AS SECURED BORROWINGS





The collateral pledged for all repurchase agreements that are accounted for as secured borrowings as of December 31, 2015 were:


Remaining Contractual Maturity of the AgreementsOvernight and ContinuousUp to 30 Days30-90 DaysGreater Than 90 DaysTotalU.S. Government-sponsored mortgage-backed securities$131,537$5,680$8,892$9,216$155,325








NOTE 12





BORROWINGS





The following table summarizes the Corporation's borrowings as of December 31, 2015 and 2014:


December 31, 2015December 31, 2014Federal funds purchased$49,721$15,381Securities sold under repurchase agreements155,325124,539Federal Home Loan Bank advances235,652145,264Subordinated debentures and term loans127,846126,810Total Borrowings$568,544$411,994








Securities sold under repurchase agreements consist of obligations of the Bank to other parties. The obligations are secured by U.S. Treasury and U.S. Government-Sponsored Enterprise obligations, certain municipal securities and mortgage loans. The maximum amount of outstanding agreements at any month-end during 2015 and 2014 totaled $163,128,000 and $155,941,000 , respectively, and the average of such agreements totaled $143,491,000 and $130,910,000 during 2015 and 2014 , respectively.





Maturities of borrowings as of December 31, 2015 , are as follows:


Maturities in Years Ending December 31:Federal Funds PurchasedSecurities SoldUnder Repurchase AgreementsFederal HomeLoan BankAdvancesSubordinatedDebentures andTerm Loans2016$49,721$155,325$91,441$183201737,222201826,851201913,828202031,310After 202035,000132,012ASC 805 fair value adjustments at acquisition(4,349)$49,721$155,325$235,652$127,846








The terms of a security agreement with the FHLB require the Corporation to pledge, as collateral for advances, qualifying first mortgage loans, investment securities and multi-family loans in an amount equal to at least 146 percent of these advances depending on the type of collateral pledged. Advances, with interest rates from 0 to 6.81 percent, are subject to restrictions or penalties in the event of prepayment. The total available remaining borrowing capacity from the FHLB at December 31, 2015 , was $388,176,000 .  As of December 31, 2015, the Corporation had $25,000,000 putable advances with the FHLB.  Additionally as part of the Ameriana acquisition on December 31, 2015, the Corporation assumed approximately $24,938,000 of Federal Home Loan Bank Advances.  The C Financial acquisition on April 17, 2015 resulted in an additional $18,958,000 of Federal Home Loan Bank advances at acquisition, of which approximately $7,361,000 matured during 2015 and $11,597,000 remained at December 31, 2015.





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Subordinated Debentures and Term Loans .  As of December 31, 2015 , subordinated debentures and term loans totaled $127,846,000 .


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | First Merchants Capital Trust II.  The subordinated debenture was entered into on July 2, 2007 for$56,702,000.  On August 10, 2015, the Corporation completed the cancellation of$5 millionof subordinated debentures at a gain of$1,250,000.  As of December 31, 2015,$51,702,000of subordinated debentures remain outstanding with a maturity date of September 15, 2037.  The Corporation could not redeem the debenture prior to September 15, 2012, and redemption is subject to the prior approval of the Board of Governors of the Federal Reserve System, as required by law or regulation. Interest was fixed at6.495 percentfor the period from the date of issuance through September 15, 2012; interest is now an annual floating rate equal to the three-month LIBOR plus1.56 percent, reset quarterly.  Interest is payable in March, June, September and December of each year. The interest rate atDecember 31, 2015was2.1 percent.  The Corporation holds all of the outstanding common securities of First Merchants Capital Trust II.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Ameriana Capital Trust I.On December 31, 2015 the Corporation acquired Ameriana Capital Trust I in conjunction with its acquisition of Ameriana Bancorp, Inc.  The subordinated debentures of Ameriana Capital Trust I were entered into in March 2007 for$10,310,000and have a maturity of March 2036.  The interest rate is equal to the three-month LIBOR plus1.50 percent, reset quarterly.  Interest is payable in March, June, September and December of each year.  The interest rate at December 31, 2015 was2.0 percent. The Corporation holds all of the outstanding common securities of Ameriana Capital Trust I.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | On November 1, 2013, the Corporation completed the private issuance and sale tofourinstitutional investors of an aggregate of$70 millionof debt comprised of (a)5.00 percentFixed-to-Floating Rate Senior Notes due 2028 in the aggregate principal amount of$5 million(the "Senior Debt") and (b)6.75 percentFixed-to-Floating Rate Subordinated Notes due 2028 in the aggregate principal amount of$65 million(the "Subordinated Debt").  The interest rate on the Senior Debt and Subordinated Debt remains fixed for the first ten (10) years and will become floating thereafter.  The Senior Debt agreement contains certain customary representations and warranties and financial and negative covenants.  As ofDecember 31, 2015, the Corporation was in compliance with these covenants.




Line of Credit .  As of December 31, 2015 , there was no outstanding balance on the line of credit.





|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | U.S. Bank, N.A.On April 11, 2014, the Corporation entered into a line of credit agreement with U.S. Bank, N.A. with a maximum borrowing capacity of$20 million.  As of December 31, 2015, there wasnooutstanding balance on the line of credit.  Interest is payable quarterly based on one-month LIBOR plus2.00 percent.  The line of credit has a quarterly facility fee of0.25 percenton the unused balance.  The line of credit agreement contains certain customary representations and warranties and financial and negative covenants.  As of December 31, 2015, the Corporation was in compliance with these covenants.  The line of credit was renewed on April 9, 2015 and will mature on April 8, 2016.




Subordinated Debentures and Term Loans .  As of December 31, 2014 , subordinated debentures and term loans totaled $126,810,000 .





|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | First Merchants Capital Trust II.  The subordinated debenture, entered into on July 2, 2007, for$56,702,000will mature on September 15, 2037. The Corporation could not redeem the debenture prior to September 15, 2012, and redemption is subject to the prior approval of the Board of Governors of the Federal Reserve System, as required by law or regulation. Interest was fixed at6.495 percentfor the period from the date of issuance through September 15, 2012; interest is now an annual floating rate equal to the three-month LIBOR plus1.56 percent, reset quarterly. Interest is payable in March, June, September and December of each year. The interest rate at December 31, 2014 was1.8 percent.  The Corporation holds all of the outstanding common securities of First Merchants Capital Trust II.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | On November 1, 2013, the Corporation completed the private issuance and sale tofourinstitutional investors of an aggregate of$70 millionof debt comprised of (a)5.00 percentFixed-to-Floating Rate Senior Notes due 2028 in the aggregate principal amount of$5 million(the "Senior Debt") and (b)6.75 percentFixed-to-Floating Rate Subordinated Notes due 2028 in the aggregate principal amount of$65 million(the "Subordinated Debt").  The interest rate on the Senior Debt and Subordinated Debt remains fixed for the first ten (10) years and will become floating thereafter.  The Senior Debt agreement contains certain customary representations and warranties and financial and negative covenants.  As of December 31, 2014, the Corporation was in compliance with these covenants.  The net proceeds of the placement were used to pay off the Corporation's$55 millioncredit facility with Bank of America, N.A. which was scheduled to mature on February 15, 2015.

Line of Credit .  As of December 31, 2014 , there was no outstanding balance on the line of credit.


|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | U. S. Bank, N.A.On April 11, 2014, the Corporation entered into a line of credit agreement with the U. S. Bank, N.A. with a maximum borrowing capacity of$20 million.  As of December 31, 2014, there wasnooutstanding balance on the line of credit.  Interest is payable quarterly based on one-month LIBOR plus2.00 percent.  The line of credit has a quarterly facility fee of0.25 percenton the unused balance.  The maturity date for the line of credit is April 10, 2015.  The line of credit agreement contains certain customary representations and warranties and financial and negative covenants.  As of December 31, 2014, the Corporation was in compliance with these covenants.




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NOTE 13





DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES





Risk Management Objective of Using Derivatives





The Corporation is exposed to certain risks arising from both its business operations and economic conditions.  The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and through the use of derivative financial instruments.  Specifically, the Corporation enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  The Corporation’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Corporation’s known or expected cash payments principally related to certain variable-rate liabilities.  The Corporation also has derivatives that are a result of a service the Corporation provides to certain qualifying customers, and, therefore, are not used to manage interest rate risk in the Corporation’s assets or liabilities.  The Corporation manages a matched book with respect to its derivative instruments offered as a part of this service to its customers in order to minimize its net risk exposure resulting from such transactions.





Fair Values of Derivative Instruments on the Balance Sheet





The table below presents the fair value of the Corporation’s derivative financial instruments as well as their classification on the Balance Sheet as of December 31, 2015 and December 31, 2014 .


Asset DerivativesLiability DerivativesDecember 31, 2015December 31, 2014December 31, 2015December 31, 2014Balance Sheet LocationFairValueBalance Sheet LocationFairValueBalance Sheet LocationFairValueBalance Sheet LocationFairValueDerivatives designated as hedging instruments:Interest rate contractsOther Assets$36Other Assets$137Other Liabilities$2,921Other Liabilities$2,650Derivatives not designated as hedging instruments:Interest rate contractsOther Assets$4,938Other Assets$3,730Other Liabilities$5,149Other Liabilities$3,887








Cash Flow Hedges of Interest Rate Risk





The Corporation’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Corporation primarily uses interest rate swaps and interest rate caps as part of its interest rate risk management strategy.  Interest rate swaps designated as cash flow hedges involve the payment of fixed amounts to a counterparty in exchange for the Corporation receiving variable payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.  As of December 31, 2015 and 2014 , the Corporation had five interest rate swaps with a notional amount of $56.0 million and one interest rate cap with a notional amount of $13.0 million .





The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During 2015 , $26.0 million of the interest rate swaps and the $13.0 million interest rate cap were used to hedge the variable cash outflows (LIBOR-based) associated with existing trust preferred securities when the outflows converted from a fixed rate to variable rate in September 2012 .  In addition, the remaining $30.0 million of interest rate swaps were used to hedge the variable cash outflows (LIBOR-based) associated with three Federal Home Loan Bank advances.  The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the years ended December 31, 2015 and 2014 , the Corporation did not recognize any ineffectiveness.





Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Corporation’s variable-rate liabilities.  During the next twelve months, the Corporation expects to reclassify $1,157,000 from accumulated other comprehensive income to interest expense.





Non-designated Hedges





The Corporation does not use derivatives for trading or speculative purposes.  Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain customers. The Corporation executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies.  Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Corporation executes with a third party, such that the Corporation minimizes its net risk exposure resulting from such transactions.  As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.  As of December 31, 2015 , the notional amount of customer-facing swaps was approximately $192,759,000 .  This amount is offset with third party counterparties, as described above.





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Effect of Derivative Instruments on the Income Statement





The tables below present the effect of the Corporation’s derivative financial instruments on the Income Statement for the years ended December 31, 2015 , 2014 and 2013 .





Derivatives NotDesignated as HedgingInstruments underFASB ASC 815-10Location of Gain(Loss) Recognized inIncome on DerivativeAmount of Gain (Loss)Recognized in Income onDerivative for the Year Ended December 31, 2015Amount of Gain (Loss)Recognized in Income onDerivative for the Year Ended December 31, 2014Amount of Gain (Loss)Recognized in Income onDerivative for the Year Ended December 31, 2013Interest rate contractsOther income$(53)$(73)$247








Derivatives in Cash Flow Hedging RelationshipsAmount of Gain (Loss) Recognized in Other Comprehensive Income on Derivative (Effective Portion) For the Year EndedLocation of Loss Reclassified from Accumulated Other Comprehensive Income (Effective Portion)Amount of Loss Reclassified from Other Comprehensive Income into Income (Effective Portion)For the Year Ended20152014201520142013Interest rate products$(1,681)$(3,996)Interest expense$(1,427)$(1,411)$(935)








The Corporation’s exposure to credit risk occurs because of nonperformance by its counterparties.  The counterparties approved by the Corporation are usually financial institutions, which are well capitalized and have credit ratings through Moody’s and/or Standard & Poor’s, at or above investment grade.  The Corporation’s control of such risk is through quarterly financial reviews, comparing mark-to-market values with policy limitations, credit ratings and collateral pledging.





Credit-Risk-Related Contingent Features





The Corporation has agreements with certain of its derivative counterparties that contain a provision where if the Corporation fails to maintain its status as a well/adequately capitalized institution, then the Corporation could be required to terminate or fully collateralize all outstanding derivative contracts.  Additionally, the Corporation has agreements with certain of its derivative counterparties that contain a provision where if the Corporation defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Corporation could also be declared in default on its derivative obligations.  As of December 31, 2015 , the termination value of derivatives in a net liability position related to these agreements was $8,367,000 . As of December 31, 2015 , the Corporation has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $11,690,000 . If the Corporation had breached any of these provisions at December 31, 2015 , it could have been required to settle its obligations under the agreements at their termination value.








NOTE 14





FAIR VALUES OF FINANCIAL INSTRUMENTS





The Corporation used fair value measurements to record fair value adjustments, to certain assets, and liabilities and to determine fair value disclosures. The accounting guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  ASC 820 applies only when other guidance requires or permits assets or liabilities to be measured at fair value; it does not expand the use of fair value in any new circumstances.





As defined in ASC 820, fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants. It represents an exit price at the measurement date. Market participants are buyers and sellers, who are independent, knowledgeable, and willing and able to transact in the principal (or most advantageous) market for the asset or liability being measured. Current market conditions, including imbalances between supply and demand, are considered in determining fair value. The Corporation values its assets and liabilities in the principal market where it sells the particular asset or transfers the liability with the greatest volume and level of activity. In the absence of a principal market, the valuation is based on the most advantageous market for the asset or liability (i.e., the market where the asset could be sold or the liability transferred at a price that maximizes the amount to be received for the asset or minimizes the amount to be paid to transfer the liability).





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Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability. Inputs can be observable or unobservable. Observable inputs are those assumptions which market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from a source independent of the Corporation. Unobservable inputs are assumptions based on the Corporation’s own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date. All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy which gives the highest ranking to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest ranking to unobservable inputs for which there is little or no market activity (Level 3). Fair values for assets or liabilities classified as Level 2 are based on one or a combination of the following factors: (i) quoted prices for similar assets; (ii) observable inputs for the asset or liability, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation considers an input to be significant if it drives 10 percent or more of the total fair value of a particular asset or liability.





RECURRING MEASUREMENTS





Assets and liabilities are considered to be measured at fair value on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly or quarterly). Recurring valuation occurs at a minimum on the measurement date. Assets and liabilities are considered to be measured at fair value on a nonrecurring basis if the fair value measurement of the instrument does not necessarily result in a change in the amount recorded on the balance sheet. Generally, nonrecurring valuation is the result of the application of other accounting pronouncements which require assets or liabilities to be assessed for impairment or recorded at the lower of cost or fair value. The fair value of assets or liabilities transferred in or out of Level 3 is measured on the transfer date, with any additional changes in fair value subsequent to the transfer considered to be realized or unrealized gains or losses.





Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.





Investment Securities





Where quoted, market prices are available in an active market and securities are classified within Level 1 of the valuation hierarchy. There are no securities classified within Level 1 of the hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include agencies, government-sponsored mortgage backs, state and municipal and equity securities and certificates of deposit. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include state and municipal, corporate obligations and equity securities. Level 3 fair value on state and municipal, corporate obligations and equity securities was determined using a discounted cash flow model that incorporated market estimates of interest rates and volatility in markets that have not been active.





Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.





Interest Rate Derivative Agreements





See information regarding the Corporation’s interest rate derivative products in Note 13. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.  The following table presents the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the ASC 820-10 fair value hierarchy in which the fair value measurements fall at December 31, 2015 and 2014 .


Fair Value Measurements Using:Quoted Prices in ActiveMarkets for Identical AssetsSignificant Other Observable InputsSignificantUnobservable InputsDecember 31, 2015Fair Value(Level 1)(Level 2)(Level 3)Available for sale securities:U.S. Government-sponsored agency securities$104$104State and municipal305,911300,014$5,897U.S. Government-sponsored mortgage-backed securities346,266346,266Certificates of deposit2,1762,176Corporate obligations3131Equity securities3,9123,9084Interest rate swap asset4,9384,938Interest rate cap3636Interest rate swap liability8,0708,070





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Fair Value Measurements Using:Quoted Prices in ActiveMarkets for Identical AssetsSignificant Other Observable InputsSignificantUnobservable InputsDecember 31, 2014Fair Value(Level 1)(Level 2)(Level 3)Available for sale securities:U.S. Government-sponsored agency securities$109$109State and municipal228,593221,982$6,611U.S. Government-sponsored mortgage-backed securities319,104319,104Corporate obligations3131Equity securities1,7061,7024Interest rate swap asset3,7303,730Interest rate cap137137Interest rate swap liability6,5376,537








LEVEL 3 RECONCILIATION





The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheets using significant unobservable Level 3 inputs for year ended December 31, 2015 and 2014 .


Available for Sale SecuritiesFor The Year EndedDecember 31, 2015December 31, 2014Beginning Balance$6,646$9,977Included in other comprehensive income1993,656Principal payments(913)(6,987)Ending balance$5,932$6,646








There were no gains or losses for the period included in earnings that were attributable to the changes in unrealized gains or losses related to assets or liabilities held at December 31, 2015 or 2014 .





TRANSFERS BETWEEN LEVELS





There were no transfers in or out of Level 3 during 2015 or 2014.





NONRECURRING MEASUREMENTS





Following is a description of valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy for year ended December 31, 2015 and 2014 .


Fair Value Measurements UsingQuoted Prices in ActiveMarkets for Identical AssetsSignificant Other Observable InputsSignificantUnobservable InputsDecember 31, 2015Fair Value(Level 1)(Level 2)(Level 3)Impaired Loans (collateral dependent)$7,066$7,066Other real estate owned$5,529$5,529








Fair Value Measurements UsingQuoted Prices in ActiveMarkets for Identical AssetsSignificant Other Observable InputsSignificantUnobservable InputsDecember 31, 2014Fair Value(Level 1)(Level 2)(Level 3)Impaired Loans (collateral dependent)$17,134$17,134Other real estate owned$5,155$5,155


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Impaired Loans (collateral dependent)





Loans for which it is probable that the Corporation will not collect all principal and interest due according to contractual terms are measured for impairment.  Allowable methods for determining the amount of impairment include estimating fair value of the collateral for collateral dependent loans.  If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized.  This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.  A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of the loan is confirmed. During 2015 , certain impaired loans were partially charged off or re-evaluated. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.





Other Real Estate Owned





The fair value for impaired loans and other real estate owned is measured based on the value of the collateral securing those loans or real estate and is determined using several methods. The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis. Fair value on other collateral such as business assets is typically ascertained by assessing, either singularly or some combination of,  asset appraisals, accounts receivable aging reports, inventory listings and  or customer financial statements.   Both appraised values and values based on borrower’s financial information are discounted as considered appropriate based on age and quality of the information and current market conditions.





UNOBSERVABLE (LEVEL 3) INPUTS





The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements, other than goodwill, at December 31, 2015 and 2014 .


December 31, 2015Fair ValueValuation TechniqueUnobservable InputsRange            (Weighted-Average)State and municipal securities$5,897Discounted cash flowMaturity Call DateUS Muni BQ curveDiscount rate1 month to 15 yearsA- to BBB-.80% - 5%Corporate obligations and Equity securities$35Discounted cash flowRisk free rateplus Premium for illiquidity3 month LIBORplus 200 bpsImpaired loans (collateral dependent)$7,066Collateral based measurementsDiscount to reflect current market conditions and ultimate collectability0% - 50%                 (2%)Other real estate owned$5,529AppraisalsDiscount to reflect current market conditions0% - 20%                 (2%)








December 31, 2014Fair ValueValuation TechniqueUnobservable InputsRange            (Weighted-Average)State and municipal securities$6,611Discounted cash flowMaturity Call DateUS Muni BQ curveDiscount rate1 month to 15 yearsA- to BBB-.90% - 5%Corporate obligations and Equity securities$35Discounted cash flowRisk free rateplus Premium for illiquidity3 month LIBORplus 200 bpsImpaired loans (collateral dependent)$17,134Collateral based measurementsDiscount to reflect current market conditions and ultimate collectability0% - 50%                 (3%)Other real estate owned$5,155AppraisalsDiscount to reflect current market conditions0% - 20%                 (7%)








The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.





State and Municipal Securities, Corporate Obligations and Equity Securities





The significant unobservable inputs used in the fair value measurement of the Corporation's state and municipal securities, corporate obligations and equity securities are premiums for unrated securities and marketability discounts.  Significant increases or decreases in either of those inputs in isolation would result in a significantly lower or higher fair value measurement.  Generally, changes in either of those inputs will not affect the other input.





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FAIR VALUE OF FINANCIAL INSTRUMENTS





The following table presents estimated fair values of the Corporation's financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2015 and 2014 .


2015CarryingAmountQuoted Prices in Active Markets for Identical Assets (Level 1)Significant Other Observable Inputs(Level 2)Significant Unobservable Inputs(Level 3)Assets at December 31:Cash and cash equivalents$102,170$102,170Interest-bearing time deposits32,31532,315Investment securities available for sale658,400$652,468$5,932Investment securities held to maturity618,599598,08234,298Loans held for sale9,8949,894Loans4,631,3694,539,940Federal Reserve and Federal Home Loan Bank stock37,63337,633Interest rate swap asset4,9744,974Interest receivable24,41524,415Liabilities at December 31:Deposits$5,289,647$4,095,004$1,177,142Borrowings:Federal funds purchased49,72149,721Securities sold under repurchase agreements155,325155,325Federal Home Loan Bank advances235,652236,375Subordinated debentures and term loans127,846103,643Interest rate swap liability8,0708,070Interest payable3,0923,092








2014CarryingAmountQuoted Prices in Active Markets for Identical Assets (Level 1)Significant Other Observable Inputs(Level 2)Significant Unobservable Inputs(Level 3)Assets at December 31:Cash and cash equivalents$118,616$118,616Interest-bearing time deposits47,52047,520Investment securities available for sale549,543$542,897$6,646Investment securities held to maturity631,088614,45733,266Loans held for sale7,2357,235Loans3,860,9013,810,912Federal Reserve and Federal Home Loan Bank stock41,35341,353Interest rate swap asset3,8673,867Interest receivable19,98419,984Liabilities at December 31:Deposits$4,640,694$3,532,199$1,099,610Borrowings:Federal funds purchased15,38115,381Securities sold under repurchase agreements124,539124,539Federal Home Loan Bank advances145,264146,669Subordinated debentures and term loans126,81092,802Interest rate swap liability6,5376,537Interest payable3,2013,201








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The following methods were used to estimate the fair value of all other financial instruments recognized in the Consolidated Condensed Balance Sheets at amounts other than fair value.





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 value is based on quoted market prices, if available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.  The fair value of certain Level III securities is estimated using discounted cash flow analysis, using interest rates currently being offered on investments with similar maturities and investment quality.





Loans held for sale :  The carrying amount approximates fair value due to the short duration between origination and date of sale.





Loans: The fair value for loans is estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  See Impaired Loans above.





Federal Reserve and Federal Home Loan Bank stock :  The fair value of Federal Reserve Bank and Federal Home Loan Bank stock is based on the price which it may be resold to the Federal Reserve and Federal Home Loan Bank.





Derivative instruments :  The fair value of interest rate swaps reflect the estimated amounts that would have been received to terminate these contracts at the reporting date based upon pricing or valuation models applied to current market information.  Interest rate caps are valued using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rose above the strike rate of the caps.  The projected cash receipts on the caps are based on an expectation of future interest rates derived from observed market interest rate curves and volatilities.





Interest receivable and Interest payable :  The fair value of interest receivable/payable approximates carrying value.





Deposits: The fair values of noninterest-bearing and 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 to a schedule of aggregated expected monthly maturities on such time deposits.





Borrowings: The fair value of Federal Funds purchased approximates the carrying amount.  The fair value of all other borrowings is estimated using a discounted cash flow calculation, based on current rates for similar debt.








NOTE 15





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 Corporation's 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 Bank uses the same credit policies in making such commitments as they do for instruments that are included in the consolidated balance sheets.





Financial instruments, whose contract amount represents credit risk as of December 31, were as follows:


20152014Amounts of commitments:Loan commitments to extend credit$1,547,048$1,617,552Standby letters of credit$46,734$52,655








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 Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank 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 Bank 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.





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NOTE 16





STOCKHOLDERS' EQUITY





National banking laws restrict the maximum amount of dividends that a bank may pay in any calendar year.  National 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, 2015 , available for 2016 dividends from the Corporation’s subsidiaries (both banking and non-banking) was $29,812,000 .





Total stockholders' equity for all subsidiaries at December 31, 2015 , was $930,360,000 of which $900,548,000 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 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.





Preferred Stock





On September 22, 2011 , the Corporation entered into a Securities Purchase Agreement with the Treasury, pursuant to which the Corporation issued 90,782.94 shares of the Corporation’s Senior Non-Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”), having a liquidation amount per share equal to $1,000 , for a total purchase price of $90,782,940 . The Purchase Agreement was entered into, and the Series B Preferred Stock was issued, pursuant to the SBLF program, a $30 billion fund established under the Small Business Jobs Act of 2010, that encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion.





On January 3, 2013, the Corporation redeemed 22,695.94 shares of the Series B Preferred Stock held by the Treasury at an aggregate redemption price of $22,695,940 plus accrued but unpaid dividends.  Following the redemption, the Treasury held 68,087 shares of the Series B Preferred Stock representing a remaining liquidation amount of approximately $68 million .





On July 2, 2013, the Corporation redeemed an additional 34,044 shares of the Series B Preferred Stock held by the Treasury at an aggregate redemption price of $34,044,000 plus accrued but unpaid dividends.  Following the redemption, the Treasury held 34,043 shares of the Series B Preferred Stock representing a remaining liquidation amount of approximately $34 million .





On November 22, 2013, the Corporation redeemed the final 34,043 shares of the Series B Preferred Stock held by the Treasury at an aggregate redemption price of $34,043,000 plus accrued but unpaid dividends.  There are no shares of the Corporation's Series B Preferred Stock currently outstanding.





CFS Acquisition





On November 12, 2013, the Corporation acquired 100 percent of CFS Bancorp, Inc. ("CFS") in an all stock transaction.  Pursuant to the merger agreement, the shareholders of CFS received 0.65 percent of a share of the Corporation's common stock for each share of CFS Bancorp common stock held.  The Corporation issued approximately 7.1 million shares of common stock, which was valued at approximately $135.6 million .





Community Acquisition





On November 7, 2014, the Corporation acquired 100 percent of Community Bancshares, Inc. ("Community").  Pursuant to the merger agreement, each outstanding share of common stock of Community was converted into the right to receive either (a) 4.0926 shares of First Merchants' common stock, plus cash in lieu of fractional shares; or (b) $85.94 in cash, based upon shareholder elections.  The Corporation paid $14.2 million in cash and issued approximately 1.6 million shares of common stock, valued at approximately $35.0 million , for a total purchase price of approximately $49.2 million .





Ameriana Acquisition





On December 31, 2015, the Corporation acquired 100 percent of Ameriana Bancorp, Inc., ("Ameriana").  Pursuant to the merger agreement, each Ameriana shareholder received 0.9037 of a share of First Merchants common stock for each outstanding share of Ameriana Bancorp common stock held.  The Corporation issued approximately 2.8 million shares of common stock, which was valued at approximately $70.4 million .








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NOTE 17





ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)





The following table summarizes the changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, as of December 31, 2015 and 2014 :


Accumulated Other Comprehensive Income (Loss)Unrealized Gains (Losses) on Securities Available for SaleUnrealized Gains (Losses) on Securities Available for Sale for which a Portion of Other-Than-Temporary Impairment has been Recognized in IncomeUnrealized Gains (Losses) on Cash Flow HedgesUnrealized Gains (Losses) on Defined Benefit PlansTotalBalance at December 31, 2014$14,098$—$(2,182)$(13,546)$(1,630)Other comprehensive income before reclassifications(37)(1,093)2,4041,274Amounts reclassified from accumulated other comprehensive income(1,736)928(198)(1,006)Period change(1,773)—(165)2,206268Balance at December 31, 2015$12,325$—$(2,347)$(11,340)$(1,362)Balance at December 31, 2013$1,566$(1,847)$(501)$(5,628)$(6,410)Other comprehensive income before reclassifications14,8601,847(2,599)(7,580)6,528Amounts reclassified from accumulated other comprehensive income(2,328)918(338)(1,748)Period change12,5321,847(1,681)(7,918)4,780Balance at December 31, 2014$14,098$—$(2,182)$(13,546)$(1,630)








The following table presents the reclassification adjustments out of accumulated other comprehensive income (loss) that were included in net income in the Consolidated Condensed Statements of Income for the twelve months ended December 31, 2015 , 2014 and 2013 :


Amount Reclassified from Accumulated Other Comprehensive Income (Loss) For the Year Ended December 31,Details about Accumulated Other Comprehensive Income (Loss) Components201520142013Affected Line Item in the Statements of IncomeUnrealized gains (losses) on available for sale securities (1)Realized securities gains reclassified into income$2,670$3,581$487Other income - net realized gains on sales of available for sale securitiesRelated income tax expense(934)(1,253)(170)Income tax expense$1,736$2,328$317Unrealized gains (losses) on cash flow hedges (2)Interest rate contracts$(1,427)$(1,411)$(935)Interest expense - subordinated debentures and term loansRelated income tax benefit499493327Income tax expense$(928)$(918)$(608)Unrealized gains (losses) on defined benefit plansAmortization of net loss and prior service costs$305$520$(1,765)Other expenses - salaries and employee benefitsRelated income tax benefit (expense)(107)(182)618Income tax expense$198$338$(1,147)Total reclassifications for the period, net of tax$1,006$1,748(1,438)








(1) For additional detail related to unrealized gains (losses) on available for sale securities and related amounts reclassified from accumulated        other comprehensive income see Note 4. INVESTMENT SECURITIES.





(2) For additional detail related to unrealized gains (losses) on cash flow hedges and related amounts reclassified from accumulated other comprehensive income see Note 13. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES.








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NOTE 18





REGULATORY CAPITAL





Capital adequacy is an important indicator of financial stability and performance.  The Corporation and the Bank 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 four ratios that are calculated according to the regulations: total risk-based capital, tier 1 risk-based capital, common equity 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.  Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, or leverage ratio, all of which are calculated as defined in the regulations.  Banks with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual levels.  The appropriate federal regulatory agency may also downgrade a bank to the next lower capital category upon a determination that the bank is in an unsafe or unsound practice.  Banks are required to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category.





Basel III was effective for the Corporation on January 1, 2015.  Basel III requires the Corporation and the Bank to maintain minimum amounts and ratio of common equity tier 1 capital to risk weighted assets, as defined in the regulation.  Under the new Basel III rules, in order to avoid limitations on capital distributions, including dividends, the Corporation must hold a capital conservation buffer above the adequately capitalized common equity tier 1 capital to risk-weighted assets ratio.  The capital conservation buffer is being phased in from zero percent to 2.50 percent by 2019.  Under Basel III, the Corporation and Bank elected to opt-out of including accumulated other comprehensive income in regulatory capital.  Regulatory capital ratios at December 31, 2015 , were calculated under Basel III while regulatory capital ratios at December 31, 2014, were calculated under Basel I.





As of December 31, 2015 , the Bank met all capital adequacy requirements to be considered well capitalized.  There is no threshold for well capitalized status for bank holding companies.  The Corporation's and Bank's actual and required capital ratios as of December 31, 2015 and December 31, 2014 were as follows:


Prompt Corrective Action ThresholdsActualAdequately CapitalizedWell CapitalizedDecember 31, 2015AmountRatioAmountRatioAmountRatioTotal risk-based capital to risk-weighted assetsFirst Merchants Corporation$783,77614.94%$419,8098.00%N/AN/AFirst Merchants Bank739,79313.98423,2428.00$529,05210.00%Tier 1 capital to risk-weighted assetsFirst Merchants Corporation$656,32312.51%$314,8576.00%N/AN/AFirst Merchants Bank677,34012.80317,4316.00$423,2428.00%Common equity tier 1 capital to risk-weighted assetsFirst Merchants Corporation$603,06311.49%$236,1434.50%N/AN/AFirst Merchants Bank677,34012.80238,0744.50$343,8846.50%Tier 1 capital to average assetsFirst Merchants Corporation$656,32310.85%$242,0014.00%N/AN/AFirst Merchants Bank677,34011.22241,4234.00$301,7795.00%Prompt Corrective Action ThresholdsActualAdequately CapitalizedWell CapitalizedDecember 31, 2014AmountRatioAmountRatioAmountRatioTotal risk-based capital to risk-weighted assetsFirst Merchants Corporation$685,50715.34%$357,5818.00%N/AN/AFirst Merchants Bank653,16914.64356,8848.00$446,10510.00%Tier 1 capital to risk weighted assetsFirst Merchants Corporation$564,53512.63%$178,7914.00%N/AN/AFirst Merchants Bank597,30513.39178,4424.00$267,6636.00%Tier 1 capital to average assetsFirst Merchants Corporation$564,53510.15%$222,5334.00%N/AN/AFirst Merchants Bank597,30510.56226,3394.00$282,9535.00%








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NOTE 19





LOAN SERVICING





Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets.  The loans are serviced primarily for the Federal Home Loan Mortgage Corporation, Fannie Mae, and Federal Home Loan Bank of Indianapolis, and the unpaid balances totaled $312,204,000 , $254,223,000 and $271,871,000 at December 31, 2015 , 2014 and 2013 , respectively.  The amount of capitalized servicing assets is considered immaterial.








NOTE 20





SHARE-BASED COMPENSATION





Stock options and restricted stock awards ("RSAs") have been issued to directors, officers and other management employees under the Corporation's 1999 Long-term Equity Incentive Plan and the 2009 Long-term Equity Incentive Plan.  The stock options, which have a ten -year life, become 100 percent vested ranging from six months to two years and are fully exercisable when vested. Option exercise prices equal the Corporation's common stock closing price on NASDAQ on the date of grant.  RSAs issued to employees and non-employee directors provide for the issuance of shares of the Corporation's common stock at no cost to the holder and generally vest after three years.  The RSAs vest only if the employee is actively employed by the Corporation on the vesting date and, therefore, any unvested shares are forfeited.  For non-employee directors, the RSA's vest only if the non-employee director remains as an active board member on the vesting date and, therefore, any unvested shares are forfeited. RSAs for employees and non-employee directors retired from the Corporation are either immediately vested at retirement or continue to vest after retirement, depending on the plan under which the shares were granted. Deferred stock units ("DSUs") can be credited to non-employee directors who elect to defer payment of compensation under the Corporation's 2008 Equity Compensation Plan for Non-employee Directors.  DSUs credited are equal to the restricted shares that the non-employee director would have received under the plan.  As of December 31, 2015 , the Corporation did not have any outstanding DSUs.





The Corporation’s 2009 Employee Stock Purchase Plan (“ESPP”) provides eligible employees of the Corporation and its subsidiaries an opportunity to purchase shares of common stock of the Corporation through quarterly offerings financed by payroll deductions. The price of the stock to be paid by the employees shall be equal to 85 percent of the average of the closing price of the Corporation’s common stock on each trading day during the offering period. However, in no event shall such purchase price be less than the lesser of an amount equal to 85 percent of the market price of the Corporation’s stock on the offering date or an amount equal to 85 percent of the market value on the date of purchase. Common stock purchases are made quarterly and are paid through advance payroll deductions up to a calendar year maximum of $25,000 .





Compensation expense related to unvested share-based awards is recorded by recognizing the unamortized grant date fair value of these awards over the remaining service periods of those awards, with no change in historical reported fair values and earnings. Awards are valued at fair value in accordance with provisions of share-based compensation guidance and are recognized on a straight-line basis over the service periods of each award. To complete the exercise of vested stock options, RSA’s and ESPP options, the Corporation generally issues new shares from its authorized but unissued share pool. Share-based compensation for the years ended December 31, 2015 , 2014 , and 2013 was $2,270,000 , $2,177,000 , and $1,773,000 , respectively, and has been recognized as a component of salaries and benefits expense in the accompanying CONSOLIDATED STATEMENTS OF INCOME.





There were no stock options granted in 2015.  The estimated fair value of the stock options granted during 2014 and 2013 was calculated using a Black-Scholes option pricing model.  The following summarizes the assumptions used in the Black-Scholes model for those options granted in 2014 and 2013:


20142013Risk-free interest rate2.41%1.25%Expected price volatility45.05%45.68%Dividend yield2.73%2.96%Forfeiture rate5.46%4.73%Weighted-average expected life, until exercise7.74years7.27years








The Black-Scholes model incorporates assumptions used to value share-based awards. The risk-free rate of interest, for periods equal to the expected life of the option, is based on a U.S. government instrument over a similar contractual term of the equity instrument. Expected price volatility is based on historical volatility of the Corporation’s common stock.  In addition, the Corporation generally uses historical information to determine the dividend yield and weighted-average expected life of the options until exercise. Separate groups of employees that have similar historical exercise behavior with regard to option exercise timing and forfeiture rates are considered separately for valuation and attribution purposes.





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Share-based compensation expense recognized in the CONSOLIDATED STATEMENTS OF INCOME is based on awards ultimately expected to vest and is reduced for estimated forfeitures. Share-based compensation guidance requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods, if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be approximately 5.5 percent for the year ended December 31, 2015 , based on historical experience.





The following table summarizes the components of the Corporation's share-based compensation awards recorded as expense:


Year EndedDecember 31,Year EndedDecember 31,Year EndedDecember 31,201520142013Stock and ESPP OptionsPre-tax compensation expense$101$237$253Income tax expense (benefit)4(47)(16)Stock and ESPP option expense, net of income taxes$105$190$237Restricted Stock AwardsPre-tax compensation expense$2,169$1,940$1,520Income tax benefit(749)(679)(531)Restricted stock awards expense, net of income taxes$1,420$1,261$989Total Share-Based Compensation:Pre-tax compensation expense$2,270$2,177$1,773Income tax benefit(745)(726)(547)Total share-based compensation expense, net of income taxes$1,525$1,451$1,226








As of December 31, 2015 , unrecognized compensation expense related to RSAs was $3,269,000 and is expected to be recognized over weighted-average period of 1.28 years . The Corporation did no t have any unrecognized compensation expense related to stock options as of December 31, 2015 .





Stock option activity under the Corporation's stock option plans, as of December 31, 2015 , and changes during the year ended December 31, 2015 , were as follows:


Number ofSharesWeighted-AverageExercise PriceWeighted AverageRemaining ContractualTerm (in Years)AggregateIntrinsic ValueOutstanding at January 1, 2015737,931$20.99Exercised(96,066)$15.21Canceled(199,853)$25.99Outstanding December 31, 2015442,012$19.993.11$2,599,319Vested and Expected to Vest at December 31, 2015442,012$19.993.11$2,599,319Exercisable at December 31, 2015442,012$19.993.11$2,599,319








There were no options granted during the year ended December 31, 2015 . The weighted-average grant date fair value was $8.13 and $5.73 for stock options granted during the years ended December 31, 2014 and 2013 , respectively.





The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Corporation's closing stock price on the last trading day of 2015 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their stock options on December 31, 2015 .  The amount of aggregate intrinsic value will change based on the fair market value of the Corporation's common stock.





The aggregate intrinsic value of stock options exercised during the years ended December 31, 2015 and 2014 was $921,000 and $392,000 , respectively.  Cash receipts of stock options exercised during 2015 and 2014 were $1,461,000 and $504,000 , respectively.





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The following table summarizes information on unvested RSAs outstanding as of December 31, 2015 :


Number ofSharesWeighted-AverageGrant Date Fair ValueUnvested RSAs at January 1, 2015385,450$15.65Granted125,050$23.48Forfeited(6,419)$17.99Vested(149,577)$11.88Unvested RSAs at December 31, 2015354,504$19.65








The grant date fair value of ESPP options was estimated at the beginning of the October 1, 2015, quarterly offering period of approximately $23,000 . The ESPP options vested during the three months ending December 31, 2015 , leaving no unrecognized compensation expense related to unvested ESPP options at December 31, 2015 .








NOTE 21





PENSION AND OTHER POST RETIREMENT BENEFIT PLANS





The Corporation’s defined-benefit pension plans cover approximately 20 percent of the Corporation’s employees. In 2005 , the Board of Directors of the Corporation approved the curtailment of the accumulation of defined benefits for future services provided by certain participants in the First Merchants Corporation Retirement Plan.  No additional pension benefits have been earned by any employees who had not attained both the age of 55 and accrued at least 10 years of vesting service as of March 1, 2005 .  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 Corporation also maintains post retirement benefit plans that provide health insurance benefits to retirees. The plans allow retirees to be carried under the Corporation’s health insurance plan, generally from ages 55 to 65 . The retirees pay 100 percent of the premiums due for their coverage.  The table below sets forth the plans’ funded status and amounts recognized in the consolidated balance sheets at December 31 , using measurement dates of December 31, 2015 and 2014 .


20152014Change in Benefit Obligation:Benefit obligation at beginning of year$80,650$62,270Service cost5573Interest cost3,0873,235Actuarial loss (gain)(5,617)12,968Benefits paid(6,428)(5,541)Net transfers in from CFS acquisition7,645Benefit obligation at end of year$71,747$80,650Change in Plan Assets:Fair value of plan assets at beginning of year$77,139$69,871Actual return on plan assets1535,232Employer contributions532504Benefits paid(6,428)(5,541)CFS acquisition7,073End of year71,39677,139Funded status at end of year$(351)$(3,511)Assets and Liabilities Recognized in the Balance Sheets:Deferred tax asset$7,461$8,541Assets$4,006$1,329Liabilities$4,357$4,840Amounts Recognized in Accumulated Other Comprehensive Income Not Yet Recognized as Components of Net Periodic (Benefit) Cost Consist of:Accumulated loss$(13,857)$(15,863)Prior service credit(305)(346)$(14,162)$(16,209)








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The actuarial gain recognized in 2015 was primarily due to an increase in the discount rate assumption from 4.00% at December 31, 2014 to 4.50% at December 31, 2015.  The actuarial loss recognized in 2014 was primarily due to two factors.  The first factor was a decrease in the discount rate assumption from 4.80% at December 31, 2013 to 4.00% at December 31, 2014.  The second factor contributing to the loss was the Corporation's adoption of the Society of Actuaries new mortality tables.





Ameriana participated in the Pentegra Defined Benefit Plan for Financial Institutions (the "Pentegra Plan”), an industry-wide, tax-qualified defined-benefit pension plan. The Pentegra Plan operated as a multi-employer plan for accounting purposes and as a multiple employer plan under ERISA and the Internal Revenue Code. On November 20, 2015, Ameriana provided Pentegra a 60 -day written notice of withdrawal as a Participating Employer in the Pentegra Plan. Upon completion of the withdrawal from the Pentegra Plan, the assets and liabilities will be merged into the First Merchants Corporation Retirement Plan.  A liability of $5,435,000 has been recorded as the estimated final contribution to the Pentegra Plan to complete the withdrawal.  The merging of the plan assets and liabilities is expected to occur in early 2016.





The accumulated benefit obligation for all defined benefit plans was $71,747,000 and $80,650,000 at December 31, 2015 and 2014 , respectively.





Information for pension plans with an accumulated benefit obligation in excess of plan assets is included in the table below.


December 31, 2015December 31, 2014Projected benefit obligation$4,357$4,840Accumulated benefit obligation$4,357$4,840Fair value of plan assets








The following table shows the components of net periodic pension costs:


December 31, 2015December 31, 2014December 31, 2013Service cost$55$73$131Interest cost3,0873,2352,670Expected return on plan assets(4,471)(4,467)(4,265)Amortization of prior service costs648125Amortization of net loss1,7224782,131Net periodic pension (benefit) cost$457$(600)$692








Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss):


December 31, 2015December 31, 2014December 31, 2013Net periodic pension (benefit) cost$457$(600)$692Net gain (loss)1,299(12,203)11,942Amortization of loss1,7224782,131Amortization of prior service cost648125Total recognized in other comprehensive income (loss)3,085(11,644)14,098Total recognized in net periodic pension cost and other comprehensive income (loss)$2,628$(11,044)$13,406








The estimated net loss and transition obligation for the defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic pension cost over the next fiscal year are:


December 31, 2015December 31, 2014December 31, 2013Amortization of net loss$(1,505)$(1,770)$(533)Amortization of prior service cost(61)(64)(25)Total$(1,566)$(1,834)$(558)








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Significant assumptions include:


December 31, 2015December 31, 2014December 31, 2013Weighted-average Assumptions Used to Determine Benefit Obligation:Discount rate4.50%4.00%4.80%Rate of compensation increase for accruing active participants3.00%3.00%3.00%Weighted-average Assumptions Used to Determine Cost:Discount rate4.00%4.80%4.00%Expected return on plan assets6.00%6.00%7.00%Rate of compensation increase for accruing active participants3.00%3.00%3.00%





At December 31, 2015 and 2014 , the Corporation based its estimate of the expected long-term rate of return on analysis of the historical returns of the plans and current market information available. The plans’ investment strategies are to provide for preservation of capital with an emphasis on long-term growth without undue exposure to risk. The assets of the plans’ are invested in accordance with the plans’ Investment Policy Statement, subject to strict compliance with Employee Retirement Income Security Act of 1974 ("ERISA") and any other applicable statutes.





The plans’ risk management practices include quarterly evaluations of investment managers, including reviews of compliance with investment manager guidelines and restrictions; ability to exceed performance objectives; adherence to the investment philosophy and style; and ability to exceed the performance of other investment managers. The evaluations are reviewed by management with appropriate follow-up and actions taken, as deemed necessary. The Investment Policy Statement generally allows investments in cash and cash equivalents, real estate, fixed income debt securities and equity securities, and specifically prohibits investments in derivatives, options, futures, private placements, short selling, non-marketable securities and purchases of non-investment grade bonds.





At December 31, 2015 , the maturities of the plans’ debt securities ranged from 15 days to 9.04 years , with a weighted average maturity of 4.47 years . At December 31, 2014 , the maturities of the plans’ debt securities ranged from 15 days to 9.59 years , with a weighted average maturity of 5.02 years .





The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as of December 31, 2015 . The minimum contribution required in 2016 will likely be zero but the Corporation may decide to make a discretionary contribution during the year.


2016$4,81420174,72920184,65720194,83820204,772After 202024,440$48,250








Plan assets are re-balanced quarterly. At December 31, 2015 and 2014 , plan assets by category are as follows:


December 31, 2015December 31, 2014ActualTargetActualTargetCash and cash equivalents2.2%2.0%2.6%2.0%Equity securities58.160.058.760.0Debt securities37.436.036.536.0Alternative investments2.32.02.22.0100.0%100.0%100.0%100.0%








The First Merchants Corporation Retirement and Income Savings Plan (the “Savings Plan”), a Section 401(k) qualified defined contribution plan, was amended on March 1, 2005 to provide enhanced retirement benefits, including employer and matching contributions, for eligible employees of the Corporation and its subsidiaries. The Corporation matches employees’ contributions primarily at the rate of 50 percent for the first 6 percent of base salary contributed by participants.





Beginning in 2005 , employees who have completed 1000 hours of service and are an active employee on the last day of the year receive an additional retirement contribution after year-end. Employees hired after January 1, 2010 do not participate in the additional retirement contribution.  Effective January 1, 2013, the additional retirement contribution was fixed at 2 percent. Full vesting occurs after five years of service. The Corporation’s expense for the Savings Plan, including the additional retirement contribution, was $3,526,000 , $3,396,000 and $3,138,000 for 2015 , 2014 and 2013 , respectively.





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The Corporation maintains post retirement benefit plans that provide health insurance benefits to retirees. The plans allow retirees to be carried under the Corporation’s health insurance plan, generally from ages 55 to 65 . The retirees pay 100 percent of the premiums due for their coverage. The obligations payable under the plans totaled $1,403,000 and $1,811,000 at December 31, 2015 and 2014 , respectively. Post retirement plan expense totaled $(127,000) , $97,000 and $519,000 for the years ending December 31, 2015 , 2014 and 2013 , respectively.





Pension Plan Assets





Following is a description of the valuation methodologies used for pension plan assets measured at fair value on a recurring basis, as well as the general classification of pension plan assets pursuant to the valuation hierarchy.





Where quoted market prices are available in an active market, plan assets are classified within Level 1 of the valuation hierarchy.  Level 1 plan assets total $52,433,000 and include cash and cash equivalents, common stocks, mutual funds and corporate bonds and notes.  If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of plan assets with similar characteristics or discounted cash flows.  Level 2 plan assets total $18,963,000 and include governmental agencies, taxable municipals, common collective trust investments (which are classified below as Party-in-Interest investments -- common bond fund and common equity fund) and certificates of deposit.  In certain cases where Level 1 or Level 2 inputs are not available, plan assets are classified within Level 3 of the hierarchy.  There are no assets classified within Level 3 of the hierarchy at December 31, 2015 and 2014 .


Fair Value Measurements UsingQuoted Prices inActive Markets forIdentical AssetsSignificant Other Observable InputsSignificantUnobservableInputsDecember 31, 2015Fair Value(Level 1)(Level 2)(Level 3)Cash & Cash Equivalents$1,608$1,608Corporate Bonds and Notes9,1139,113Government Agency and Municipal Bonds and Notes6,993$6,993Certificates of Deposit1,5111,511Party-in-Interest InvestmentsCommon Stock1,5381,538Common Bond Fund4,6474,647Common Equity Fund5,8125,812Mutual FundsTaxable Bond4,5364,536Large Cap Equity18,52818,528Mid Cap Equity8,5378,537Small Cap Equity3,5783,578International Equity3,3533,353Specialty Alternative Equity1,6421,642$71,396$52,433$18,963








Fair Value Measurements UsingQuoted Prices inActive Markets forIdentical AssetsSignificant Other Observable InputsSignificantUnobservableInputsDecember 31, 2014Fair Value(Level 1)(Level 2)(Level 3)Cash & Cash Equivalents$2,032$2,032Corporate Bonds and Notes9,3849,384Government Agency and Municipal Bonds and Notes8,252$8,252Certificates of Deposit1,0011,001Party-in-Interest InvestmentsCommon Stock1,3761,376Common Bond Fund4,6154,615Common Equity Fund5,8585,858Mutual FundsTaxable Bond4,9874,987Large Cap Equity21,18521,185Mid Cap Equity9,4349,434Small Cap Equity3,8723,872International Equity3,4743,474Specialty Alternative Equity1,6691,669$77,139$57,413$19,726

















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NOTE 22





INCOME TAX





The reconciliation between the statutory and actual income tax expense (benefit) is summarized in the following table for the years indicated:


201520142013Income Tax Expense for the Year Ended December 31:Currently Payable:Federal$21,221$7,075$13,737StateDeferred:Federal3,95214,5382,147State492510Total Income Tax Expense$25,665$22,123$15,884Reconciliation of Federal Statutory to Actual Tax Expense:Federal Statutory Income Tax at 35%$31,867$28,800$21,145Tax-exempt Interest Income(7,083)(5,148)(3,923)Basis Difference on Sale of Insurance Subsidiary2,252Stock Compensation343650Earnings on Life Insurance(1,012)(1,271)(905)Tax Credits(583)(911)(857)Other190617374Actual Tax Expense$25,665$22,123$15,884








Tax expense applicable to security gains and losses, including unrealized losses relating to other-than-temporary impairment charges, for the years ended December 31, 2015 , 2014 and 2013 , was $435,000 , $760,000 and $157,000 , respectively.





The Corporation or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  With a few exceptions, the Corporation is no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities for years before 2012 .





The tax effects of temporary differences related to deferred taxes shown on the balance sheets were:


20152014Deferred Tax Asset at December 31:Assets:Differences in Accounting for Loan Losses$25,867$26,665Differences in Accounting for Loan Fees762747Differences in Accounting for Loans and Securities9,3599,910Deferred Compensation5,1005,234Difference in Accounting for Pensions and Other Employee Benefits2,2471,084Federal & State Income Tax Loss Carryforward and Credits23,73723,977Other9,3108,535Total Assets76,38276,152Liabilities:Differences in Depreciation Methods7,7428,220State Income Tax591591Net Unrealized Gain on Securities Available for Sale6,6367,591Gain on FDIC Modified Whole Bank Transaction1,4051,694Other7171,096Total Liabilities17,09119,192Net Deferred Tax Asset Before Valuation Allowance59,29156,960Valuation allowance:Beginning Balance(17,568)(17,171)Decrease/(Increase) During the Year1,832(397)Ending Balance(15,736)(17,568)Net Deferred Tax Asset$43,555$39,392














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The $4,163,000 increase in the Corporation’s net deferred tax asset was primarily driven by a $9,262,000 increase resulting from the Ameriana acquisition.  The largest offsetting deferred tax asset decreases not related to the Ameriana acquisition were associated with accounting for loans, federal net operating loss carryforwards, deferred compensation, and allowance for loan losses of $1,873,000 , $1,662,000 , $857,000 and $789,000 , respectively.  The deferred tax asset decreases were partially offset by a decline in the deferred tax liability associated with the accounting for unrealized gains on available for sale securities of $955,000 .





The Corporation has recorded a valuation allowance of $15,736,000 related to deferred state taxes as it does not anticipate having future state taxable income sufficient to fully utilize the deferred state tax asset.  This is primarily due to the Corporation’s current tax structure as discussed in the “INCOME TAXES” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as item 7 of this Annual Report on Form 10-K.





As of December 31, 2015 , the Corporation had approximately $121,626,000 of state tax loss carryforward available to offset future state taxes.  This state loss carryforward has a valuation allowance of approximately $120,369,000 .





The Corporation has additional paid-in capital that is considered restricted resulting from the acquisitions of CFS and Ameriana of approximately $13,393,000 and $11,883,000 , respectively.  CFS and Ameriana qualified as a banks under provisions of the Internal Revenue Code which permitted them to deduct from taxable income an allowance for bad debts which differed from the provision for losses charged to income.  No provision for income taxes had been provided.  If in the future this portion of additional paid-in capital is distributed, or the Corporation no longer qualifies as a bank for income tax purposes, income taxes may be imposed at the then applicable tax rates.   The unrecorded deferred tax liability at December 31, 2015 , would have been approximately $8,847,000 .








NOTE 23





NET INCOME PER SHARE





Basic net income per share is computed by dividing net income by the weighted-average shares outstanding during the reporting period. Diluted net income per share is computed by dividing net income by the combination of all dilutive common share equivalents, comprised of shares issuable under the Corporation’s share-based compensation plans, and the weighted-average shares outstanding during the reporting period.





Dilutive common share equivalents include the dilutive effect of in-the-money share-based awards, which are calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, the exercise price of share-based awards, the amount of compensation expense, if any, for future service that the Corporation has not yet recognized, and the amount of estimated tax benefits that would be recorded in additional paid-in capital when share-based awards are exercised, are assumed to be used to repurchase common stock in the current period.





The following table reconciles basic and diluted net income per share for the years indicated:


201520142013Weighted-Average SharesWeighted-Average SharesWeighted-Average SharesBasic net income per share:$65,384$60,162$44,530Preferred stock dividends(2,380)Net income available to common stockholders65,38437,816,399$1.7360,16236,266,356$1.6642,15029,731,420$1.42Effect of dilutive stock options and warrants271,834288,253276,960Diluted net income per share:Net income available to common stockholders$65,38438,088,233$1.72$60,16236,554,609$1.65$42,15030,008,380$1.41








Options to purchase 286,119 , 543,514 , and 800,674 shares of common stock with weighted average exercise prices of $19.99 , $20.99 , and $21.32 at December 31, 2015 , 2014 and 2013 respectively, were excluded from the computation of diluted net income per share because the options exercise price was greater than the average market price of the common stock.






































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NOTE 24





QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)





The following table sets forth certain quarterly results for the years ended December 31, 2015 and 2014 :


20152014FirstSecondThirdFourthFirstSecondThirdFourthInterest income$52,944$55,202$56,538$56,514$51,009$51,527$53,290$53,053Interest expense5,9686,1716,2156,4405,1175,4085,4245,893Net interest income46,97649,03150,32350,07445,89246,11947,86647,160Provision for loan losses4171,600960Net interest income after provision for loan losses46,97648,61450,32350,07445,89246,11946,26646,200Non-interest income16,23224,63316,89914,76715,43416,17918,41216,375Non-interest expense41,20246,42343,59846,24643,08941,25042,57641,677Income before income tax expense22,00626,82423,62418,59518,23721,04822,10220,898Income tax expense5,8348,8566,5574,4184,6175,8885,9805,638Net income available to common stockholders$16,172$17,968$17,067$14,177$13,620$15,160$16,122$15,260Basic EPS$0.43$0.47$0.46$0.37$0.38$0.42$0.45$0.41Diluted EPS$0.43$0.47$0.45$0.37$0.38$0.41$0.45$0.41Average Shares Outstanding:Basic37,709,88337,793,44837,850,82737,908,87335,956,43636,026,76336,054,86737,018,014Diluted38,000,07438,043,35938,118,19938,190,69436,260,62436,294,14936,328,98137,323,276








NOTE 25





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 Sheets


December 31, 2015December 31, 2014AssetsCash$43,622$36,044Investment in subsidiaries932,372820,123Goodwill448448Other assets9,6686,281Total assets$986,110$862,896LiabilitiesBorrowings$127,663$126,702Other liabilities7,9389,367Total liabilities135,601136,069Stockholders' equity850,509726,827Total liabilities and stockholders' equity$986,110$862,896





























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Condensed Statements of Income and Comprehensive Income


December 31, 2015December 31, 2014December 31, 2013IncomeDividends from subsidiaries$39,032$53,231$63,732Gain on the sale of  insurance subsidiary8,265Gain on cancellation of subordinated debentures1,250Other income19753845Total income48,74453,76963,777ExpensesInterest expense6,6616,6163,531Salaries and employee benefits3,0233,1283,284Net occupancy and equipment expenses464442258Other outside services1,4554581,141Professional services636409648Other expenses1,2341,132870Total expenses13,47312,1859,732Income before income tax benefit (expense) and equity in undistributed income of subsidiaries35,27141,58454,045Income tax benefit (expense)(974)3,9993,153Income before equity in undistributed income of subsidiaries34,29745,58357,198Equity in undistributed (distributions in excess of) income of subsidiaries31,08714,579(12,668)Net income65,38460,16244,530Preferred stock dividends and discount accretion(2,380)Net income available to common stockholders$65,384$60,162$42,150Net income$65,384$60,162$44,530Other comprehensive income (loss)2684,780(911)Comprehensive income$65,652$64,942$43,619








Condensed Statement of Cash Flows


Year Ended December 31,201520142013Cash Flow From Operating Activities:Net income$65,384$60,162$44,530Adjustments to Reconcile Net Income to Net Cash:Share-based compensation843887778Distributions in excess of (equity in undistributed) income of subsidiaries(31,087)(14,579)12,668Gain on sale of insurance subsidiary(8,265)Gain on cancellation of subordinated debentures(1,250)Net Change in:Other assets(441)2,425(1,354)Other liabilities(1,486)1,466(8,438)Investment in subsidiaries - operating activities197(4,517)12,991Net cash provided by operating activities23,89545,84461,175Cash Flow From Investing Activities:Net cash paid in acquisition(14,500)(12,832)Proceeds from business divestitures16,000Other575240Net cash provided (used) in investing activities2,075(12,832)240Cash Flow From Financing Activities:Cash dividends(15,654)(10,694)(7,992)Repayment of borrowings(3,750)(55,000)Proceeds from issuance of long-term debt70,000Preferred stock redemption under small business lending fund(90,783)Stock issued under employee benefit plans460478479Stock issued under dividend reinvestment and stock purchase plan661523325Stock options exercised1,531564115Stock redeemed(1,640)(1,067)(491)Net cash used by financing activities(18,392)(10,196)(83,347)Cash, beginning of the year36,04413,22835,160Cash, end of year$43,622$36,044$13,228








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NOTE 26





ACCOUNTING MATTERS





FASB Accounting Standards Updates No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): recognition and Measurement of Financial Assets and Financial Liabilities


The FASB has issued Accounting Standards Update (ASU) No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended to improve the recognition and measurement of financial instruments. The ASU affects public and private companies, not-for-profit organizations, and employee benefit plans that hold financial assets or owe financial liabilities.





The new guidance makes targeted improvements to existing U.S. GAAP by:


Requiring equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income;


|  |                                                                                                                                                
|- | -----------------------------------------------------------------------------------------------------------------------------------------------
|• | Requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes;

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|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements;

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|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Eliminating the requirement to disclose the fair value of financial instruments measured at amortized cost for organizations that are not public business entities;

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|• | Eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; and

|  |                                                                                                                                                                                                                                                                                                                                                                                                       
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | Requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments.




The new guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The new guidance permits early adoption of the own credit provision. In addition, the new guidance permits early adoption of the provision that exempts private companies and not-for-profit organizations from having to disclose fair value information about financial instruments measured at amortized cost.  Adoption of the ASU is not expected to have a significant effect on the Corporation’s consolidated financial statements.





FASB ACCOUNTING STANDARDS Update No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments.





The FASB has issued Accounting Standards Update (ASU) No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. To simplify the accounting for adjustments made to provisional amounts recognized in a business combination, the amendments eliminate the requirement to retrospectively account for those adjustments.





U.S. GAAP currently requires that during the measurement period, the acquirer retrospectively adjust the provisional amounts recognized at the acquisition date with a corresponding adjustment to goodwill. Those adjustments are required when new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts initially recognized or would have resulted in the recognition of additional assets or liabilities. The acquirer also must revise comparative information for prior periods presented in financial statements as needed, including revising depreciation, amortization, or other income effects as a result of changes made to provisional amounts.





The amendments require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date.





The amendments require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date.





For public business entities, the amendments are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years.  Adoption of the ASU is not expected to have a significant effect on the Corporation’s consolidated financial statements.





The only disclosures required at transition should be the nature of and reason for the change in accounting principle. An entity should disclose that information in the first annual period of adoption and in the interim periods within the first annual period if there is a measurement-period adjustment during the first annual period in which the changes are effective.








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FASB Accounting Standards Update No. 2015-15, Interest-Imputation of Interest (Subtopic 835-30), Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.





The FASB has issued Accounting Standards Update (ASU) No. 2015-15, Interest - Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements - Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting. This ASU adds SEC paragraphs pursuant to the SEC Staff Announcement at the June 18, 2015, Emerging Issues Task Force meeting about the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements.





In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires the presentation of debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability. ASU 2015-03 does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements.





Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement.  This ASU was effective upon issuance (August 18, 2015) and adoption did not have a significant effect on the Corporation’s consolidated financial statements.





FASB Accounting Standards Update No. 2015-03 , Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs





The FASB has issued Accounting Standards Update (ASU) No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU.





The amendments should be applied on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon transition, an entity is required to comply with the applicable disclosures for a change in an accounting principle. These disclosures include the nature of and reason for the change in accounting principle, the transition method, a description of the prior-period information that has been retrospectively adjusted, and the effect of the change on the financial statement line items (i.e., debt issuance cost asset and the debt liability).





For public business entities, the amendments are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.   Early adoption of the amendments is permitted for financial statements that have not been previously issued.  Adoption of the ASU is not expected to have a significant effect on the Corporation’s consolidated financial statements.





FASB Accounting Standards Update No. 2015-01, Eliminating the Concept of Extraordinary Items





The FASB has issued Accounting Standards Update (ASU) No. 2015-01 , Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. The FASB issued this ASU as part of its initiative to reduce complexity in accounting standards. The objective of the simplification initiative is to identify, evaluate, and improve areas of U.S. GAAP for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to the users of financial statements.





This ASU eliminates from U.S. GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement - Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item.





If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item.





The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption.  Adoption of the ASU is not expected to have a significant effect on the Corporation’s consolidated financial statements.





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NOTE 27





GENERAL LITIGATION





The Corporation is subject to claims and lawsuits that 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, results of operations and cash flow of the Corporation.








NOTE 28





SUBSEQUENT EVENTS





On February 9, 2016, the Board of Directors of the Corporation approved a stock repurchase program of up to $15 million of the outstanding shares of the Corporation’s common stock.  At the February 9, 2016 trading price of the shares, this amount would represent approximately 1.7% of the number of shares outstanding.  The shares may be purchased from time to time in open market transactions at prevailing market prices in accordance with federal securities laws.  The Corporation is not obligated to purchase any shares under the program, and the program may be discontinued at any time.  The actual timing, number and share price of shares purchased under the repurchase program will be determined by the Corporation at its discretion and will depend upon such factors as the market price of the stock, general market and economic conditions and applicable legal requirements.





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ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.





In connection with its audits for the two most recent fiscal years ended December 31, 2015 , there have been no disagreements with the Corporation’s independent registered public accounting firm on any matter of accounting principles or practices, financial statement disclosure or audit scope or procedure, nor have there been any changes in accountants.





ITEM 9A.  CONTROLS AND PROCEDURES





At the end of the period covered by this report (the “Evaluation Date”), the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”). Based upon that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Corporation reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.





MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING





Management of First Merchants Corporation (the “Corporation”) is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Corporation’s internal control over financial reporting is designed to provide reasonable assurance to the Corporation’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. As part of its function of assisting the Corporation’s Board of Directors in discharging its responsibility of ensuring financial reporting and regulatory risks to the organization are properly being managed, mitigated and monitored by Management, the Audit Committee of the Board of Directors oversees management’s internal controls over financial reporting.





Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Accordingly, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.





Management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria set forth in “Internal Control - Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission.  Based on this assessment, management has determined that the Corporation’s internal control over financial reporting as of December 31, 2015 is effective based on the specified criteria.  As permitted, the Corporation excluded the operations of Ameriana Bancorp, Inc., acquired on December 31, 2015, from the scope of management's report on internal control over financial reporting.





There have been no changes in the Corporation’s internal controls over financial reporting identified in connection with the evaluation referenced above that occurred during the Corporation’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.





BKD, LLP, the independent registered public accounting firm that audited the financial statements included in Item 8 of this Annual Report on Form 10-K, has issued an attestation report on the Corporation’s internal control over financial reporting as of December 31, 2015 , which appears as follows.





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 PART II: ITEM 9., ITEM 9A. AND ITEM 9B.





Report of Independent Registered Public Accounting Firm








Audit Committee, Board of Directors and Stockholders


First Merchants Corporation


Muncie, Indiana








We have audited First Merchants Corporation's internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Corporation's internal control over financial reporting based on our audit.





We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was


maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.


Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.





A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of reliable financial statements in accordance with accounting principles generally accepted in the United States of


America. Because management's assessment and our audit were also conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), our examination of Corporation's internal control over financial reporting included controls over the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C). A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.





Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.





As permitted, the Corporation excluded the operations of Ameriana Bancorp acquired on December 31, 2015, from the scope of management’s report on internal control over financial reporting. As such, this entity has also been executed from the scope of our audit of internal control over financial reporting.





In our opinion, First Merchants Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).





We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of First Merchants Corporation and our report dated February 29, 2016, expressed an unqualified opinion thereon.











BKD, LLP














Indianapolis, Indiana


February 29, 2016





ITEM 9B. OTHER INFORMATION





None





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PART III





ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE





The information in the Corporation’s Proxy Statement dated March 23, 2016 to be furnished to its stockholders in connection with an annual meeting to be held May 2, 2016 (the “2016 Proxy Statement”), under the captions "BOARD OF DIRECTORS”; “CORPORATE GOVERNANCE”; "BOARD COMMITTEES - AUDIT COMMITTEE"; and "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE", is expressly incorporated herein by reference. The information required under this item relating to executive officers is set forth in Part I, “Supplemental Information - Executive Officers of the Registrant” of this Annual Report on Form 10-K.





The Corporation has adopted a Code of Ethics that applies to its Chief Executive Officer, Chief Financial Officer, Chief Banking Officer, Senior Vice President of Finance, Corporate Controller and Corporate Treasurer. It is part of the Corporation’s Code of Business Conduct, which applies to all employees and directors of the Corporation and its affiliates. A copy of the Code of Business Conduct may be obtained, free of charge, by writing to First Merchants Corporation at 200 East Jackson Street, Muncie, IN 47305. In addition, the Code of Ethics is maintained on the Corporation’s website, which can be accessed at https://www.firstmerchants.com.





ITEM 11. EXECUTIVE COMPENSATION





The information in the Corporation’s 2016 Proxy Statement, under the captions, "BOARD COMMITTEES - COMPENSATION AND HUMAN RESOURCES COMMITTEE - Compensation and Human Resources Committee Interlocks and Insider Participation and Compensation and Human Resources Committee Report"; "BOARD COMMITTEES - RISK AND CREDIT POLICY COMMITTEE"; "COMPENSATION OF EXECUTIVE OFFICERS"; and "COMPENSATION OF DIRECTORS" is expressly incorporated herein by reference.





ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS





The information in the Corporation’s 2016 Proxy Statement, under the captions, "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT", is expressly incorporated herein by reference. The information required under this item relating to equity compensation plans is set forth in Part II, Item 5 under the table entitled “Equity Compensation Plan Information” on this Annual Report on Form 10-K.





ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE





The information in the Corporation’s 2016 Proxy Statement, under the captions, "CORPORATE GOVERNANCE - BOARD INDEPENDENCE"; and "TRANSACTIONS WITH RELATED PERSONS", is expressly incorporated herein by reference.





ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES





The information in the Corporation’s 2016 Proxy Statement, under the caption "INDEPENDENT AUDITOR", is expressly incorporated herein by reference.








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PART IV





ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES





FINANCIAL INFORMATION








(a) 1.           The following financial statements are filed as part of this document under Item 8 hereof:


Independent accountants' report


Consolidated balance sheets at December 31, 2015 and 2014


Consolidated statements of income, years ended December 31, 2015 , 2014 and 2013


Consolidated statements of comprehensive income, years ended December 31, 2015 , 2014 and 2013


Consolidated statements of stockholders' equity, years ended December 31, 2015 , 2014 and 2013


Consolidated statements of cash flows, years ended December 31, 2015 , 2014 and 2013


Notes to consolidated financial statements








(a) 2.           Financial statement schedules:


All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or related notes.





(a) 3.           Exhibits:


Exhibit No:Description of Exhibits:


2.1Agreement and Plan of Reorganization and Merger Between First Merchants Corporation and Ameriana Bancorp dated as of June 26, 2015 (Incorporated by reference to registrant's Form 8-K filed on June 29, 2015)3.1First Merchants Corporation Articles of Incorporation, as amended (Incorporated by reference to registrant’s Form 10-Q filed on November 9, 2011) (SEC No. 000-17071)3.2Bylaws of First Merchants Corporation dated October 28, 2009 (Incorporated by reference to registrant’s Form 10-Q filed on November 9, 2009) (SEC No. 000-17071)3.3First Merchants Corporation Articles of Amendment of the Articles of Incorporation for the Series B Preferred Stock (Incorporated by reference to registrant’s Form 8-K filed on September 23, 2011) (SEC No. 000-17071)4.1First Merchants Corporation Amended and Restated Declaration of Trust of First Merchants Capital Trust II dated as of July 2, 2007 (Incorporated by reference to registrant's Form 8-K filed on July 3, 2007) (SEC No. 000-17071)4.2Indenture dated as of July 2, 2007 (Incorporated by reference to registrant's Form 8-K filed on July 3, 2007) (SEC No. 000-17071)4.3Guarantee Agreement dated as of July 2, 2007 (Incorporated by reference to registrant's Form 8-K filed on July 3, 2007) (SEC No. 000-17071)4.4Form of Capital Securities Certification of First Merchants Capital Trust II (Incorporated by reference to registrant's Form 8-K filed on July 3, 2007) (SEC No. 000-17071)4.5First Merchants Corporation Dividend Reinvestment and Stock Purchase Plan (Incorporated by reference to registrant’s Post-Effective Amendment No. 1 to Form S-3 filed on August 21, 2009) (SEC 033-45393)4.6Upon request, the registrant agrees to furnish supplementally to the Commission a copy of the instruments defining the rights of holders of its (a) 5.00% Fixed-to-Floating Rate Senior Notes due 2028 in the aggregate principal amount of $5 million and (b) 6.75% Fixed-to-Floating Rate Subordinated Notes due 2028 in aggregate principal amount of $65 million.10.1First Merchants Corporation Senior Management Incentive Compensation Program, dated February 26, 2015 (Incorporated by reference to registrant's Form 10-K filed on February 27, 2015) (1)10.2First Merchants Corporation Equity Compensation Plan for Non-Employee Directors, effective as amended January 1, 2015 (Incorporated by reference to the registrant's Form 10-K filed on February 27, 2015) (1)10.3First Merchants Corporation 2009 Long-Term Equity Incentive Plan, effective as amended January 1, 2015 (Incorporated by reference to registrant's Form 10-K filed on February 27, 2015) (1)10.4First Merchants Corporation Change of Control Agreement, as amended, with Michael C. Rechin dated June 1, 2011 (Incorporated by reference to registrant’s Form 10-Q filed on August 9, 2011) (SEC No. 000-17071) (1)10.5First Merchants Corporation Change of Control Agreement, as amended, with Mark K. Hardwick dated June 1, 2011  (Incorporated by reference to registrant’s Form 10-Q filed on August 9, 2011) (SEC No. 000-17071) (1)10.6First Merchants Corporation Change of Control Agreement, as amended, with Michael J. Stewart dated June 1, 2011 (Incorporated by reference to registrant’s Form 10-Q filed on August 9, 2011) (SEC No. 000-17071) (1)10.7First Merchants Corporation Change of Control Agreement, as amended, with John J. Martin dated June 1, 2011 (Incorporated by reference to registrant’s Form 10-Q filed on August 9, 2011) (SEC No. 000-17071) (1)10.8First Merchants Corporation Change of Control Agreement, as amended, with Kimberly J. Ellington dated June 1, 2011 (Incorporated by reference to registrant’s Form 10-Q filed on August 9, 2011) (SEC No. 000-17071) (1)10.90First Merchants Corporation Change of Control Agreement, as amended, with Jeffery B. Lorentson dated June 1, 2011 (Incorporated by reference to registrant’s Form 10-Q filed on August 9, 2011) (SEC No. 000-17071) (1)10.10First Merchants Corporation Change of Control Agreement, effective February 11, 2014, with Stephan H. Fluhler (Incorporated by reference to registrant's Form 8-K filed on May 12, 2014) (SEC No. 000-17071) (1)10.11Resolution of the Board of Directors of First Merchants Corporation on director compensation dated December 4, 2007 (Incorporated by reference to the registrant's Form 10-K for year ended December 31, 2007) (SEC No. 000-17071) (1)


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10.12First Merchants Corporation Supplemental Executive Retirement Plan and amendments thereto (Incorporated by reference to registrant's Form 10-K for year ended December 31, 1997) (SEC No. 000-17071) (1)10.13First Merchants Corporation Defined Contribution Supplemental Retirement Plan dated January 1, 2006 (Incorporated by reference to registrant's Form 8-K filed on February 6, 2007) (SEC No. 000-17071) (1)10.14First Merchants Corporation Participation Agreement of Michael C. Rechin dated January 26, 2007 (Incorporated by reference to registrant's Form 8-K filed on February 6, 2007) (SEC No. 000-17071) (1)10.15First Merchants Corporation 2009 Employee Stock Purchase Plan effective July 1, 2009 (Incorporated by reference to registrant's Form 8-K filed on May 11, 2009) (SEC No. 000-17071) (1)10.162011 Executive Deferred Compensation Plan, effective January 1,  2011 (Incorporated by reference to registrant’s Form 8-K filed on November 3, 2011) (SEC No. 000-17071) (1)10.17Voting Agreement dated June 26, 2015, by and among First Merchants Corporation and certain shareholders of Ameriana Bancorp (Incorporated by reference to registrant's Form 8-K filed on June 29, 2015) (SEC No. 000-17071)21Subsidiaries of registrant (2)23Consent of Independent Registered Public Accounting Firm (2)24Limited Power of Attorney (2)31.1Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 (2)31.2Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 (2)32Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2)99.1Financial statements and independent registered public accounting firm’s report for First Merchants Corporation 2009 Employee Stock Purchase Plan (2004) (2)101.INSXBRL Instance Document (3)101.SCHXBRL Taxonomy Extension Schema Document (3)101.CALXBRL Taxonomy Extension Calculation Linkbase Document (3)101.DEFXBRL Taxonomy Extension Definition Linkbase Document (3)101.LABXBRL Taxonomy Extension Label Linkbase Document (3)101.PREXBRL Taxonomy Extension Presentation Linkbase Document (3)(1) Management contract or compensatory plan(2) Filed herewith.(3) Furnished herewith.














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PART IV: ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS





SIGNATURES





Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 29th day of February, 2016.





FIRST MERCHANTS CORPORATIONBy:/s/ Michael C. RechinMichael C. Rechin,President and Chief Executive Officer





Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed by the following persons on behalf of the registrant and in the capacities indicated, on this 29th day of February, 2016.








/s/ Michael C. Rechin/s/ Mark K. HardwickMichael C. Rechin, President andMark K. Hardwick, Executive ViceChief Executive OfficerPresident and Chief Financial Officer(Principal Executive Officer)(Principal Financial and Accounting Officer)/s/ Michael R. Becher*/s/ Michael C. RechinMichael R. Becher, DirectorMichael C. Rechin, Director/s/ Roderick English*/s/ Charles E. Schalliol*Roderick English, DirectorCharles E. Schalliol, Director/s/ F. Howard Halderman*/s/ Patrick A. Sherman*F. Howard Halderman, DirectorPatrick A. Sherman, Director/s/ William L. Hoy*/s/ Terry L. Walker*William L. Hoy, DirectorTerry L. Walker, Director/s/ Gary J. Lehman*/s/ Jean L. Wojtowicz*Gary J. Lehman, DirectorJean L. Wojtowicz, Director


*By Mark K. Hardwick as Attorney-in Fact pursuant to a Limited Power of Attorney executed by the directors listed above, which Power of Attorney is being filed with the Securities and Exchange Commission as an exhibit hereto.


By:/s/ Mark K. HardwickMark K. HardwickAs Attorney-in-FactFebruary 29, 2016


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